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The Easy Way to Save for a Home Down Payment

Updated on January 20, 2014
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Keith Schroeder writes The Wealthy Accountant blog with 30 years experience in the tax field. He is the tax adviser of Mr. Money Mustache.

 

Buying a home takes time. The searching for the right home is nothing compared to the time involved saving for the down payment. Twenty percent down is a good goal to shoot for. The more you put down the lower your mortgage payment and the less interest you pay.

When saving for a home, slow and steady wins the race. The sooner you begin a savings ritual the better. It is best to start the habit of making a mortgage payment well in advance of having a real mortgage. Putting aside a set amount each week into savings builds a nice down payment in a reasonable amount of time. The amount you dedicate toward your down payment account should be at least the amount your estimated mortgage payment minus your current rent. This practice will build the habit of making a mortgage payment in full on time.

You should have a good idea of the kind of home you want. You need to set a goal and knowing the price range of your new home is required. Calculate your future mortgage payment. A mortgage is usually more than your current rent because you will probably have a larger home than apartment.

You must also consider additional costs like property tax, insurance, and maintenance. As you save for your home, add the estimated cost of tax and insurance to your savings goal. Your mortgage company will require escrow of tax and insurance plus the mortgage payment. Building a habit of paying a mortgage should include the property tax and insurance. Otherwise, you have a large bill due at the end of the year.

As you build your down payment savings, consider padding the account. When you buy your home, your savings account for the down payment converts to an emergency fund. Always keep extra in the account for unexpected expenses such as furnace repair or property taxes and insurance if your mortgage company does not escrow these amounts.

Once you have committed to saving for a home, you need to decide where to save the money. There are only three real options for saving for a home. Handled properly, you can realize tax advantage while you save toward your home purchase.

Banks and Credit Unions

If you plan on purchasing a house within a year, your only real choice is a bank or credit union. Your savings will grow slow, but are guaranteed by the federal government, so your money is safe. Safety is the key word whenever saving for a home and for future home expenses.

Become proactive in your savings. Use whichever bank account pays the most. Review several local banks and credit unions for the best savings account, money market accounts, and short-term certificates of deposit interest rates. As your account grows an extra quarter percent here and a quarter percent there, it starts adding up.

There are no tax advantages to using a bank account when saving for a home. All interest is taxed as earned.

IRA

The IRS allows a penalty free distribution from your IRA for a first-time home owner. A first-time home owner is defined as someone who has not owned a home in the prior two years. The distribution is limited to $10,000 in a lifetime. You can take the entire $10,000 on your next home purchase or, if you use less than the $10,000 and are considered a first-time home owner in the future (two years of no home ownership), you can take the remainder then.

Saving in a traditional IRA allows a deduction up front so you have more saved and growing tax deferred. More of your money stays at work earning interest. You still need to consider safety when saving. Your local credit union is a prime consideration.

As you save, consider the time frame before your home purchase. If you have a five-year plan, review longer-term CDs for a higher rate of return.

Savings Bonds

U.S. savings bonds are the most interesting way to save for a home and offers tax advantages. You can start a regular savings plan buying Series EE and Series I savings bonds at your bank. It is easier online buying directly from the government at www.treasurydirect.gov.

Savings bonds grow tax deferred; you pay tax on the interest when you cash them in. Savings bonds also are state and local tax-free. High tax state residents realize serious tax savings. Not only does your money build faster tax-deferred, but the taxes are lower when you do cash the bonds in.

Series EE bonds have a set rate of interest. Series I bonds are inflation protected. The Series I savings bonds adjust the interest rate every six months based on inflation. If inflations increases your interest rate increases.

Before you jump into savings bonds there are a few points you need to consider. Savings bonds must be held for at least one year. If your planned home purchase is less than a year, banks offer the best savings avenue. Also, if you cash in your savings bonds within five years there is a three month interest penalty (the most recent three months of interest). Even with the small penalty, savings bonds are usually the superior investment vehicle. They are safe and guaranteed by the government.

If you are starting your house savings program now and have a five year window, consider savings bonds. Buy them online or at the bank, whichever is more convenient for you.

Savings Facts

Investment
Tax Deferred
Tax-Free
Guaranteed
Special Features
Bank Deposits
 
 
x
 
IRA
x
 
x
$10,000 limit, penalty free only
Savings Bonds
x
State & local
x
Must hold 1 year, 3 month interest penalty 1st 5 years

Final Thoughts

Planning your home purchase is exciting and fun. Success is determined by the mundane and unexciting process of regular savings. Turn your home purchase savings program into a habit. The sooner you start the easier it is.

Banks will allow smaller down payments, but a larger down payment lowers your monthly mortgage payment (nice when money is tight) and reduces the interest you pay over the life of the mortgage. The goal is to own your home and have as much money as possible along the way.

Remember, you are building your net worth. Each mortgage payment is paying down principle. Eventually the mortgage is paid off and the mortgage payment is now available for other goals like retirement.

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