Saving a down payment

In short

A friend of mine once kept his house money in a jar on the kitchen shelf, and it grew slower than a pot of cold water. You can do better than that with a plan that fits on one index card. Pick a price range for the home you want, and then work out the cash you will need on closing day, which is the day the keys change hands. Divide that total by the number of months you have, and you have your monthly target. Many people set up a transfer that moves the money out of each paycheck before it can be spent. The savings can sit in an insured account that pays interest, and the FDIC and the NCUA explain their coverage on their own websites. Check your progress every three months, and adjust without scolding yourself.

The whole of it

What it is

I once watched a young couple stand in an open house, holding hands and doing math on the back of a flyer. They had good jobs and good hearts. What they did not have was a clear picture of what cash they needed. If you are dreaming of a front porch of your own, you may be in that same spot.

A down payment is the part of the price you pay from your own pocket. The lender covers the rest with a mortgage, which is a loan secured by the house. If a home costs 250,000 dollars and you put down 10 percent, you pay 25,000 dollars yourself. The lender covers the other 225,000 dollars.

Cash needed on closing day is more than the down payment, though. There are also closing costs, which are fees for things like the appraisal, the title search, and the loan itself. Buyers often also prepay some insurance and taxes, and some set aside money for moving and repairs. So your savings goal has several pieces, and it pays to name them all.

How it works

A neighbor of mine used to say that a habit beats a burst of effort every time. He was right about house money. Saving a down payment works well when it is automatic and boring.

Start by choosing a target price. Then pick a down payment percent. Some loans ask for very little down, and others ask for more. Lower down payments often come with extra monthly costs, such as mortgage insurance, which protects the lender if you stop paying. That is not a bad thing. It is simply a cost you should see before you sign.

Next, decide where the money will sit. If you may need it in a few years, you want a place where the balance does not swing up and down. A high yield savings account at an insured bank or credit union fits that need. Deposits there are covered by federal insurance up to a set limit, and the FDIC and the NCUA each explain their limits on their own websites. Stock prices can move a lot in a short time, so money you need soon carries more risk there.

Then there is the matter of automation. Your employer may let you split your direct deposit so a fixed amount lands in the savings account each payday. Many people find they miss the money less than they feared. It is easy to forget about, and that is the point.

The numbers, and where to find yours

You have probably wondered which numbers really matter. A few of them are set by law or by the loan program, and they change, so I will point you to the source rather than guess.

Some loan programs set a minimum down payment. For a loan backed by the Federal Housing Administration, the minimum is the current figure, which the official source publishes each year for a borrower who meets the credit score rule. The FHA explains this on its page at HUD.gov, and your lender can confirm it for your case. Conventional loans have their own minimums, which lenders set within the rules of the loan buyers.

Loan size limits also change from year to year. The Federal Housing Finance Agency publishes the conforming loan limit each year, and today that figure is the current figure, which the official source publishes each year. If you borrow more than that limit, you are in jumbo territory, and the rules get stricter.

If you want to save inside a special account, the numbers matter even more. If you plan to borrow from a retirement account for a first home, check the current withdrawal rules on IRS.gov, including the first time homebuyer exception, which today is the current figure, which the official source publishes each year. Those rules carry taxes and penalties if you get them wrong, so read the IRS page before you touch that money.

For your own numbers, look at your last two pay stubs, your bank statements, and your credit report. The site AnnualCreditReport.com offers free reports from the three credit bureaus. Your credit score affects the rate a lender offers, and that rate changes what you can afford each month.

A worked example

Let me tell you about Marcus, a teacher I will invent for the sake of the numbers. Marcus earns a salary of 52,000 dollars a year. He wants a home priced at 200,000 dollars and hopes to buy in three years.

First, Marcus picks a down payment of 5 percent. That is 200,000 times 0.05, which equals 10,000 dollars. He then estimates closing costs at 3 percent of the price. That is 200,000 times 0.03, which equals 6,000 dollars. He wants 2,000 dollars extra for moving and first repairs.

Now he adds it up. 10,000 plus 6,000 plus 2,000 gives a goal of 18,000 dollars.

Marcus has three years, which is 36 months. He already has 3,600 dollars in savings. So he still needs 18,000 minus 3,600, which equals 14,400 dollars. He divides 14,400 by 36 months, and that gives 400 dollars a month.

Marcus checks whether that fits. His pay before tax is 52,000 divided by 12, which is about 4,333 dollars a month. Four hundred dollars is about 9 percent of that. He decides it works, but tight months worry him, so he sets up two transfers of 200 dollars, one on each of two paydays.

He also thinks about interest. If his account pays a small rate, he will earn a bit more than his plan needs. He does not count on it, though. He treats any interest as a nice surprise, and his plan stands without it.

Where it goes wrong

I have made my share of money mistakes, so I will not preach. But I have seen a few traps often enough to name them.

The first is forgetting closing costs. People save for the down payment and then get surprised by thousands of dollars in fees. A lender can give you a Loan Estimate, a standard form that lists expected costs, so you can see them early. The Consumer Financial Protection Bureau explains this form on its website.

The second is draining your emergency fund. If you put every dollar into the house and then the car breaks down, you may end up in debt. A home brings surprise bills of its own, which is why some buyers keep a separate cushion.

The third is chasing high returns with money you need soon. It feels smart when prices rise. It feels awful when they fall the month before closing. Short deadlines leave little room for swings.

The fourth is taking on new debt while you save. A new car loan can change your borrowing power overnight. Lenders compare your monthly debt against your pay. A big purchase before closing can change the answer a lender gives you.

The last trap is quitting after a slow month. You will have one. Everyone does. It passes.

Questions to answer before you leave this page

What price range feels comfortable to you, and what monthly payment would still let you sleep at night? How much cash will you need on closing day once you add the down payment, the closing costs, and a cushion? How many months do you have before you want to buy, and what monthly amount does that give you when you divide the goal by the months? Where will the money sit so it stays safe and insured, and have you confirmed the coverage limit with the FDIC or the NCUA? Have you set up an automatic transfer so the saving happens without a fight? Do you have an emergency fund that is separate from the house money? And who is the one person you will tell about this goal, so that somebody can cheer you on when the going gets slow?