First of all, good for you for making the bold, life-changing decision to become a homeowner and take what may be your first step onto the property ladder! As a proud owner of bricks and mortar, I know the sacrifices it can take to purchase a place of your own. While there can be downsides to purchasing a house—property taxes, maintenance costs, the possibility it may decrease in value—the advantages to home ownership are plain as day; real estate is often a worthwhile investment in your future.
First things first: How much of a house can you afford to buy?
Getting pre-qualified for a mortgage is your first step, because it will determine how much you need to save for a down payment and the type of property available within your price range.
Having a specific sum in mind will really help to focus your saving strategy. Calculate how much a mortgage will cost you in monthly payments: Is it a reasonable percentage of your income? To help ensure you donʼt bite off more than you can chew, check out Shelly Ewekaʼs recent article,
“How much of your income should you spend on housing?”
In terms of the down payment, most mortgage lenders require that you pay at least 3% of the sale value of the property upfront. But it varies. Someone with poor credit, for example, may be required to put as much as 20% down, possibly more. Once youʼve shopped around and found the best mortgage for you in terms of interest rate, monthly payments and other variables, consider paying as big a down payment as possible (it will lower your monthly payments or mortgage rate). 5% of a $300,000 property is $15,000, but it may be realistic for you to set a much higher target, especially if you have a comfortable timeframe and/or a nice amount of money already saved. On the other hand, pouring all your liquid savings into home equity carries risks: Iʼll talk more about the importance of having an easy-access rainy-day fund below.
Ways to invest
Once you run the numbers and look at your lifestyle and cash flow, you can calculate how long it will take you to reach that down-payment target. A house is often the biggest single expense that many people ever save up for, and it requires self-discipline and sacrifice. Many young people decide to move back in with their parents for a while, to save on food and rent. However, if that isnʼt an option for you, it may make sense for you to downsize to a more modest apartment or share with roommates while pursuing your goal—thereby minimizing your monthly rent payments and maximizing your savings.
If you already have a lump sum saved but still have a way to go, you may be tempted to get your stockbroker on the line. But playing with the stock market is generally not the right option when saving to buy a house, and you donʼt want to expose what you've already amassed to the volatility of the market.
Conversely, you might look to put your money somewhere extra safe, and while savings accounts offered by banks are indeed a relatively safe place to stash your cash, they wonʼt put your dollars to work for you. In fact, the interest rates are typically lower than inflation, so even though youʼre not risking any of your principal, your savings will depreciate in real terms.
A Certificate of Deposit (CD) might seem to be another obvious solution, but they involve locking your money into a fixed interest rate—not great if interest rates subsequently go up, and youʼre unable to take advantage of them. So, what offers better returns than a savings account without downside risk?
Keep it liquid in a money market account
Any money you need to keep liquid is typically better kept in a money market account (MMA) because they generally offer better interest rates than traditional savings accounts. And like your checking and regular savings accounts, MMAs are FDIC-insured subject to applicable limits. These days itʼs just as easy to manage your money market account online. In fact, not only is virtual banking more convenient, it often gets you the best rate. Online transactions are cheaper to operate since the overheads are lower, and those savings are then passed on to you, the consumer. In addition, you can withdraw money whenever you want and thereʼs no withdrawal penalty. All youʼre giving up is immediate access to your money because you canʼt withdraw it from an ATM, as you might with a savings account. Which, when saving to a buy a house, is probably a good thing.
Whereas a checking account allows for unlimited withdrawals, an MMA limits the number of transfers and withdrawals you can make per month. The Federal Reserve requires that you make no more than six transactions per month. Cash withdrawals and transfers using an ATM do not count toward this limit. If you exceed the limit, your bank has to convert your MMA to a checking account. Consider, then, setting up a direct deposit of say 30% of your paycheck into an MMA, and the other 70% into your regular bank account, for everyday expenses.
Keep it apart from your emergency money
An emergency fund (covering six months of expenses in the event of job loss) serves an important role within your grand home-buying scheme. It will help you stick to your goal of diligently putting away your monthly allotment; without an emergency fund to act as a buffer, some of that down-payment money youʼve been painstakingly saving might end up getting diverted to pay for unexpected expenses or to tide you over during a couple of months of unemployment. Therefore, when you decide you want to buy a house, itʼs a big mistake to plunder your rainy-day fund or simply re-label it your home fund.
Being realistic, not everyone has an adequate emergency fund to begin with. Here you can read
Alicia Waltenbergerʼs article about just how big your emergency fund should be.
If youʼre one of those people with a generic lump of savings, earmarked not only for specific goals like buying a house but also for emergencies, you may want to consider connecting your money market account to your traditional savings account. This way, you can transfer money between the two, online, in case an emergency does strike.
One last thing: Be 100% committed!
Saving diligently for years requires a lot of determination and single-mindedness. Itʼs a big commitment. But so is being a homeowner. Think carefully about the time and money youʼll need to commit after youʼve purchased the property: Things like repairs, maintenance, taxes and insurance.
Once youʼve decided you definitely want to own a home for at least five years, you can start putting your plan into action by researching homes, mortgage rates and money market accounts.
Remember: What youʼre getting with a money market account is a mix of security and a little extra growth—just what you need when saving for that down payment on a fabulous new home!
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