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The Ultimate Guide to Saving for a New Home

Here’s Everything You Need to Know

A home is the largest investment most people will ever make, and saving up enough to buy a home can feel impossible.

But with a solid saving plan, anyone can put away enough for a down payment and closing costs on the home of their dreams.

Here are several simple strategies you can use to make saving for a home easier.

Decide How Much Home You Can Afford

Before you can make any other plans, you’ll need to decide how much home you can afford and how much you ideally want your mortgage payment to be each month.

Approved doesn't always mean affordable

"Use a mortgage calculator to determine the monthly payment you want to have and see how much home you can afford from there."

First, let's get this out of the way. Just because a bank has approved you for a certain loan amount does not mean you can actually afford it. The bidding wars and high prices make it unusually tempting to take out the largest allowable loan so you can afford to actually make a competitive bid.

Unfortunately, this is how people end up not being able to make their monthly payments, struggling with which bills to pay, and/or getting underwater on their loans.

Instead, do your own budgeting and work out what monthly payments you’re willing to make, considering other expenses, debt, financial goals, etc. A good mortgage calculator will let you work from that to a loan amount you can afford.

For some people, this might be their current mortgage payment or their current rent. If you’ve been paying rent on time with no issues for a year or two, you can probably comfortably set that as your monthly payment limit.

And, of course, know how much you can afford as a down payment. A down payment of more than 20% allows you to avoid paying PMI (private mortgage insurance) with your payments and save you money in the long term.

Consider these when determining how much to spend

If you have an idea of what you’d like to spend, the next step is to get an idea of the kind of home that amount can get you.

You can be strategic about this, though. If you’re looking for a home around $300,000 with 4 bedrooms, at least 2 bathrooms, and a home office, it may be difficult to find exactly what you’re looking for in your favorite neighborhood.

If you expand your search parameters, however, or decide that a home office isn’t necessarily a need you may either be able to find exactly what you’re looking for or find close to what you’re looking for in a near location.

Here are a few aspects to consider when thinking about what goes into a home’s value:

Location

  • School districts
  • The value of the other homes in the neighborhood
  • The way the value of the homes in your neighborhood is trending
  • Local amenities

Needs vs wants

  • Home office
  • Guest bedroom
  • 2-3 car garage

Fixer-uppers vs new build or fully renovated

  • Character
  • New and shiny finishes
  • Warranties

Get pre-approved

It's even more important in a seller's market to get pre-approved so you know how much you can offer. Consider, however, the caveat above; you might consider the full pre-approval amount to be your budget, or you might want to drop it to keep the payments reasonable.

Be realistic with your bank about how much you’re willing to pay in monthly payments. Some realtors even refuse to show homes without a pre-approval because of the pandemic, although that trend will likely fade, eventually. Pre-approval will also tell you what you can bid on a home.

Now, Determine Exactly How Much You Need to Save

To pinpoint your down payment saving goal, you’ll first need to decide the type of loan you plan to take out. This will give you a clear idea of the amount of down payment that’s required as well as any other aspects to consider like private mortgage insurance, the length of the loan, and, of course, interest rates.

Here's how much to save for different types of mortgages

The type of mortgage you'll take is the most significant determinant of your down payment.

Generally, all loans fall into two categories: conventional mortgages and non-conventional mortgages.

Building on that, conventional mortgages are those loans that aren't backed by the government, whereas non-conventional mortgages are those backed by the government.

1. Conventional Mortgage

These are mortgages that aren't backed by the federal government in most instances.

If you’re going to take a conventional mortgage, you’ll most likely pay a high down payment (20% and above) or, put less money down and pay private mortgage insurance (PMI). While paying PMI isn’t ideal, many homebuyers see it as a fair trade-off if it means getting into their dream home sooner.

So, depending on your financial situation, paying mortgage insurance may be preferable to living with your parents or a weird landlord until you can afford a 20% down payment. The choice is yours...

Common types of conventional mortgages include:

30-year fixed — We'll bet you five bucks that most of your current or future neighbors are on 30-year fixed mortgages. These are mortgages with a fixed interest rate that you finance within a thirty-year limit.

Like most other conventional mortgages, it's recommended to put about 20% down to avoid paying PMI (or private mortgage insurance). However, most people may prefer to put down less than 20% of their home value and pay the PMI instead.

15-year fixed — A 15-year fixed is a less popular option. Here, you will finance the value of your home within fifteen years at a fixed interest rate.

Without a 20% down payment for a 15-year fixed, you may have to pay yearly PMI.

However, one advantage of thirty and 15-year fixed loans is that once your mortgage is backed by Fannie Mae or Freddie Mac, you get to pay lower premiums, as low as 3%.

Jumbo loan — A Jumbo Loan is a non-conforming conventional mortgage. This means that unlike the previous two, its value is above the federal mortgage limit.

If you're buying a home above $548,250 in a low-cost area or $822,375 in a high-cost area, you're probably going to take a Jumbo loan. Your down payment should probably be 20%. It could be lower, but you'd have to cope with PMI.

2. Fixed-Rate Mortgage

A fixed-rate mortgage is a loan with a consistent interest rate payment throughout the life of your repayment.

Common types of fixed-rate mortgages are the 10, 15, and 20-year fixed-rate mortgages. By taking a fixed-rate mortgage, you get to pay fixed monthly payments regardless of the interest rate.

If you're planning to take a fixed-rate mortgage that isn't federally backed, you need to pay at least 20% down in order not to pay PMI.

3. Adjustable-Rate Mortgage

Unlike fixed-rate mortgages, the interest rates in adjustable-rate mortgages vary with the Federal rate. However, there's a catch.

The interest rates in Adjustable mortgage rates are lower than conventional mortgages for a period after which they steadily increase.

For an adjustable-rate mortgage, you're better off putting 20% down (if you can afford it) to avoid paying PMI. However, since most people take AMR's because they can pay them off earlier, you're not losing that much by paying a down payment lower than 20%.

4. Non-Conventional Mortgages

These are mortgages that are offered or backed by government agencies. Most non-conventional mortgages have lower down payment options than those offered by private lenders.

FHA Loans — FHA loans are government-backed loans offered by FHA-backed lenders. These loans have down payments as low as 3.5% for a credit score of 580 and above. However, for credit scores within the 500 -579 range, the down payments are about 10%.

If you put more than 10% down, you get to pay PMI only for the first eleven years. However, if your down payment is less than 10%, you will end up paying PMI until you refinance or clear your mortgage.

USDA Loans — USDA loans are good news for anyone in rural America. These are mortgages that are offered directly or guaranteed at low-interest rates to farmers in rural America by the USDA.

But that's not the best part yet. If you live in rural America and are eligible for a USDA loan, you get home financing with zero down payment. However, income limits and property cap values apply to this type of mortgage.

VA Home Loans — If you're a veteran, you'll be glad to hear about VA Home loans. VA Loans are mortgages offered by Veteran Affairs for service members, veterans like John, and their spouses.

Like the USDA loans, VA loans come at zero down payment, limited closing costs, and low-interest rates.

Determine a realistic budget

Now that you have a better idea of the type of mortgage you want to take out, you can plan a budget to determine how much you can actually afford to spend each month on mortgage payments.

Be sure to closely examine all your monthly expenses. Try to come up with a realistic budget of how much you can afford to spend on your mortgage each month. Keep in mind that this number should include all of the following:

  • Your mortgage principal and interest
  • Taxes
  • Insurance
  • PMI (or private mortgage insurance, if applicable)
  • Any homeowners' association fees

Once you know how much you can afford to spend each month, this will help you determine a realistic price range when looking at homes.

A good rule of thumb to follow is the 50/30/20 rule, where you allocate a portion of your take home pay into three categories:

  • 50 percent towards essentials (think: food, housing, transportation)
  • 30 percent towards lifestyle (dinners out, entertainment, and memberships)
  • 20 percent towards financial priorities (like debt, student loans, retirement, and savings)

Since you have your sights set on a new home, try moving 5 to 10 percent of your lifestyle budget into the savings category. It might be challenging, but you’ll reap the benefits as your savings continue to build.

If you’re unsure what size mortgage you can afford given your monthly budget, consider using an online mortgage calculator, or talk to a lender who can help you to determine how much you can realistically afford to spend on a house.    

Remember to save for closing costs

When you do find the house of your dreams at a price within your budget, congratulations! The next step is to factor in fees for your mortgage and related services – known as closing costs - that place those house keys in the palm of your hand.

Many first-time homebuyers are surprised to learn that closing costs can amount to 2-3% of a home's sale price (!!!), and unless the seller agrees to cover closing costs, you may have to front this money.

When saving for a new home, plan to set aside 3% of your intended home value for closing costs in addition to your down payment.

Some mortgage lenders also offer "no-closing cost" loans – mortgages you can roll your closing costs into rather than paying them upfront. The “pro” to this is that it gets you into your home with less up-front costs. The “con” is that you’ll pay for your closing costs over time (in your mortgage payment) with interest tacked on, ultimately costing you more.

What's included in closing costs?

Attorney and title fees

Buying a home may be the largest financial commitment that you make. It's key to building your family's financial stability. You'll need someone whose job it is to have your back as you move through the sale, and that's your real estate attorney. Your attorney or title company (depending on your state) will know which steps to take to protect your investment - such as a title search - to ensure you have hassle-free, legal ownership of the property.

Closing fee

An attorney or title company finalizing the paperwork for the sale to go through. The seller may agree to cover this one.

Lender fees

Mortgage loans come with interest costs. These days, the high demand for new homes makes it tough to lock in a mortgage rate: be wary of hefty fees that may accompany lock-in rates. Additionally, since the lender has a financial stake in your home, your closing costs will include an application processing fee, and an appraisal.

Escrow

Lenders will collect a two-month escrow deposit, required for both the home insurance company and the county tax collector for property taxes.  

Title Insurance

Collected by your lender, this fee protects the title company and optionally, you as well.

Negotiables

There is the option to pay "points" upfront to decrease your interest rate. One point equals 1% of the loan. Paying 1–2% in points is a way to decrease your monthly mortgage payment, but it does add to your upfront costs. The origination fee usually is lower than 1% and cannot be rolled into the loan. There's a break-even point to consider: does it make sense to for you to pay the money upfront in order to save down the road? Or are assets tight right now, and you can afford the monthly payment?

Real estate commission

*At 5%–6% of the property's price, this fee may be negotiable, and most times is paid by the seller.

Are there any ways I can reduce closing costs?

Keeping a sharp eye on the bottom line makes great sense. Your lender legally must disclose your loan estimate, a document that lists the closing and loan fees, within three days of your application. Then, three days before your closing date, your lender will provide the final closing and loan costs. Details matter: compare the estimate with the final disclosures and question any significant changes.

There are other strategies that will hold down costs. Savvy homebuyers come armed with these tips to lower fees:  

  • Push that closing date out to the end of the month to avoid daily interest fees if the seller is willing during negotiations.
  • For your mortgage, shop around for a lender with competitive rates and/or flexible fees. Compare their estimated closing costs.
  • Be sure your mortgage has an option to pay ahead without a penalty: in the long term, paying more towards the principal of your mortgage will save you interest over the life of the loan.
  • Make a down payment of at least 20% if you are able, to avoid mortgage insurance.
  • If the house has been on the market for some time, consider negotiating for the seller to cover more closing costs or even lower the purchase price.

If you’re still not sure exactly how much to save before purchasing a home, you may find it helpful to meet with a mortgage loan officer. They can help you to determine what types of loans you could qualify for, what price range you can realistically afford, and how much money you would need to save for a down-payment and closing costs.

Effective Home Saving Strategies

Once you know how much money you need to save before you can buy a house, you can start setting goals.

By setting aside a little money each month and finding new places to cut excess spending, you may be surprised how quickly your savings can grow.

To reach your goal, take a look at some of these best practices to help you take better control of your finances and allocate more money towards you down payment.

Pay yourself first

As you begin saving for a new home, make a habit of adding funds to your savings at the beginning of each month. One of the biggest mistakes people make is setting aside funds at the end of the month, leaving how much they save more or less up to chance. It’s too tempting to unintentionally spend more than you planned to each month.

Instead, first calculate how much you can budget into your savings and make a plan to set this money aside at the beginning of the month. While having less of a cushion throughout the month may take some getting used to, putting money into savings right after payday will help ensure you follow through with your savings plan.

Set up an automated savings transfer

Of course, when you first start saving, it may be hard to remember to transfer money to your savings account each month. If so, set up an automatic withdrawal from your checking to your savings account that comes out the day after you receive your paycheck.

That’ll make it easy for you to save without having to remember to transfer funds and also removes the temptation of unnecessary spending. The Lower App also makes this easy to do while allowing you to auto-transfer money to your mortgage savings and matching up to $500 of those savings.

Pay your future mortgage

One way to get in the habit of saving for your new home is to act as though you’re already paying it. This means that if your monthly mortgage payment (and HOA fees) will be higher than your current rent, put the difference into your savings account and treat it like any other monthly bill.

Not only can doing so help you quickly set aside a significant amount of money, but it’ll also help prepare you for paying your mortgage and prevent your monthly house payment from being a shock to your budget later on.

Boost your income

If saving enough for a home is taking longer than you'd like, it may be time to find other creative ways to boost your income.

Here are a few ideas to try:

  • Take on a part-time job
  • Start a side hustle/freelance work
  • Work as a rideshare or delivery driver
  • Open an Etsy shop
  • Hire yourself out for off jobs like lawn mowing
  • Refurbish and resell furniture on eBay

Feel free to get creative! Every dollar you make over your regular income can go directly into your home savings account.  

Save all unexpected or irregular income

Surprised with unexpected cash, like a work bonus, tax refund, or a gift from a relative? Fight the urge to treat yo’ self. Stay strong and put any unexpected cash and income you receive into your down payment savings account.

Depositing any lump sums of money you receive into a savings account can significantly speed up the savings process, potentially helping you to buy a home a year or two quicker than you anticipated.  

Find ways to cut back and reduce spending

In the end, there's only so much you can do about existing debt. You certainly can't choose to simply pay less on those bills. There are, however, many areas of your life where you can choose to spend less.

If some of the cutbacks suggested below seem undesirable, try to think of how much more you'll enjoy these things once you've saved up your down payment and can resume them in a new house.

  1. Cable — For a long time, consumers have realized how much they are paying for a lot of channels they never watch. Cable is one of the least cost-effective ways to consume video content these days. Consider finding a few streaming services that can replace your cable bill entirely.
  2. Streaming services — The recommendation to switch from cable to streaming services isn't unconditional. If you end up subscribing to every streaming service available, you're still spending as much as you did on cable, or more. If you're already subscribed to a lot of streaming services, look at which ones you make the most use of and consider cutting the rest.
  3. Cell phone — Most cell phones come with the requirement to have a data plan these days, but they don't require that you have the most expensive data plan. Many people pay for the premium plans, but don't end up using anywhere near the amount of data to justify those costs. You can save big money by finding your average monthly data usage and picking the cheapest plan that will cover that amount.
  4. Dining out — For many people, a trip to the drive-thru on the way to work or on the way home is a regular occurrence. These are the types of small purchases that quickly add up without you realizing it. A $3 energy drink on the way to work every day is around $60 a month. A $5 sandwich on the way home from work is $100 a month. Eating at home can save a significant amount of money.

Temporarily pause your retirement savings

Another great way to temporarily cut back and add more to your down payment savings is to look into your retirement savings plan. Saving for retirement is extremely important, but if you have a near-term goal of getting into a home of your own, it might be worth cutting down on the amount you’re contributing each month in order to put more towards your savings.  For those who are a long way from retirement, a temporary pause in 401k contributions could allow you to put aside a significant amount of money without having too large of an impact on your long-term retirement goals.  

Downsize

If you’re currently renting and your lease is almost up, consider downsizing and moving into a smaller apartment.

"Reducing your rent by $400 per month could help you to save close to $5,000 in a year, which would put you significantly closer to your goal of saving for a house."

While living a more simple lifestyle for the next year may be a struggle, particularly if you are used to having extra space, it may be worth it if you’re able to purchase a house much quicker than you anticipated.    

Rent out a spare room

Of course, depending on rent prices in your area, you may actually make more money renting out a spare room than you would by downsizing.

If you’re comfortable doing so, finding a roommate to rent out your spare room to could give you a steady stream of new income that you could deposit directly into your down payment savings account.

If you’re not looking for a permanent roommate, you could also consider occasionally renting out a room on a hospitality website like Airbnb. Airbnb can be a great option as it allows you to control who uses your space and when. This gives you the flexibility to only rent out your room when it is convenient, and, depending where you live, you may be surprised by how much you could make by listing a room on Airbnb.

Implementing even a few of these strategies can help you to set aside thousands of dollars in a relatively short timeframe, helping to make your dream of buying a home a reality.

Manage Your Debt

It’s time to face the facts. Existing debt can be a huge strain on your existing finances. But getting your debt under control doesn’t have to be an uphill battle. Here’s why managing your debt before buying a home is important and how to get started.

Determine your debt-to-income ratio

What is your DTI? Your debt-to-income ratio compares your gross monthly income (the amount you make before taxes and deductions are withheld) with how much you pay each month towards any debts you owe.

DTI looks at student loans, credit cards, auto loans, personal loans, and your potential mortgage payment giving expenses such as food, clothing, health or car insurance, and utilities are not included.

Basically, lenders are trying to determine whether your monthly income and your other debts will allow you to afford your mortgage payment each month. The lower your DTI, the less risk you pose to defaulting on your mortgage.

How do you calculate debt-to-income ratio?

To calculate your DTI, add up your total monthly payments for bills like:

  • Mortgage payments (or your potential payment)
  • Credit card payments
  • Student loans
  • Auto loans
  • Personal loans
  • Medical bills
  • Timeshare payments
  • Child support/alimony

Once you’ve totaled your monthly debt payments, divide by your monthly gross income. That will give you a decimal number. Multiply that by 100 to reach your percentage.

For example, if your monthly household income is $6,000, you pay $1,000 on credit cards and student loan debt, and you're looking at homes with a monthly mortgage payment of $2,300, your DTI would be 55 percent.

Get debts under control

Here are two important steps to get that debt under control and set yourself on the path to homeownership.

  1. Shift high-interest payments — Take a thorough accounting of all the credit card debt and other debt you have. The goal here is to shift your balances from high-interest credit cards to cards with lower interest. This will serve the dual purpose of making the monthly payments easier to handle while allowing you to pay off your principal balances faster. If you have a lot of debt, a consolidation loan may be an attractive option.

  2. Pay off as much as possible — Paying extra on bills may seem counterintuitive when you're trying to save up for a new home. However, a big part of your ability to get a loan will be your debt-to-income ratio. By paying off as much of your existing debt as possible, you'll be improving that ratio and increasing your chances of getting that new mortgage.

Save Even Faster with Free Tools

A solid savings plan will help you to set aside money for your down payment, but it also helps to be smart about where you put your money if you want to get the most out of your savings.

"Very personable, professional, and caring. The app is very helpful and easy to use, and provides future homebuyers with tools useful for tracking savings and credit scores."

Christopher K.
5 Stars!
Verified App User

Conventional banks typically offer 0.02% interest on their savings accounts, but there are other options out there that will provide you a much higher rate.

At Lower, we know how difficult it can be to save for a home, which is why we strive to help our customers get the most out of their money. Not only does our app make it easy to transfer money, keep track of your finances, and meet your goals, but we also offer a competitive interest rate of 0.75% APY.

If you need help to get started saving for your home contact us to speak with an advisor to learn more about how the Lower app can help you to meet your financial goals.

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