Have you been asking yourself: “How do I save up for a house?”
If you’ve had your mind on no longer renting, and getting your own house, either for your personal living or as a rental (or investment) property, then one of the biggest hurdles you’d need to overcome is this: saving up enough to own your own house.
The Top Two Barriers to Home Ownership In America
According to a 2018 Urban Institute survey, 68% of renters cite inability to come up with a down payment as a barrier to their home ownership in America, while 53% say they do not qualify for a mortgage.
So the top two reasons are:
- “I can’t afford a down payment”
- “I can’t qualify for a mortgage”
Let’s talk about how to solve both issues in this Question & Answer series.
To save up for a house, it’s generally a good idea to not pay cash for the house outright.
If you put the same amount in a high-yield savings account over the next 15 or 30 years (that you’re supposed to pay for your house), you’ll very likely get a higher return on your investment than outrightly paying off the mortgage on the house now.
This idea is also known as the “opportunity cost” of doing A vs B.
That is, if you decide to do A, in what ways are you missing out on B?
As a result, to save up for a house, you’d want to get a mortgage/house loan from a bank at a very attractive interest rate.
For a bank (or lender) to give you the loan, there are certain requirements that they will expect you to meet, so they can determine that you will hopefully be a good borrower.
Now, keep in mind, that depending on the area where you’re planning to buy a house… how competitive the local real estate market is… the type of lenders you approach; your specific situation will likely vary.
But typically, these requirements hold true in most situations.
With that said, here are the requirements that banks (or lenders) will expect you to meet before giving you a loan for a house:
1. A good credit score
Perhaps the most common way to see how well someone has managed their finances is by looking at their credit score.
As a result, banks typically want you to have a good credit score. A credit score of 740 or higher is pretty good.
If you have a credit score of up to 760 or more, your credit profile start getting very attractive to banks. That’s when banks start courting you to give you special deals, just because they feel you’ll be more trustworthy as a borrower.
2. Two years of tax returns
Banks also want to see how well your income and expenses have fared for at least the past two years.
How much income do you make? How much do you spend each month? Do you have a consistent and reliable source (or sources) of income? Banks typically look at your net income (after you’ve made all the tax deductions).
So generally, the lesser the tax deductions you have, the more attractive your credit record becomes to banks.
That said though, the goal here is to get a relatively larger loan based on your income. So, if you’ve been staying on top of your finances, at least for the past 2 years, then you’re sitting pretty as regards getting approved for a relatively high loan amount.
3. Bank statements
Beyond what goes in and out of your account based on taxes, banks also want to see how financially disciplined you are.
They generally ask for 3 to 6 months back of your past bank statements.
Basically, they want to make sure you have no suspecting money habits, addictions, sudden large cash deposits; or just weird money moves that might put you at risk of failing to come up with your monthly mortgage payments later on.
They want to see that your income and withdrawals are recurring, stable, and reliable.
4. Cash reserves
Outside of your month-to-month income and expenses, how much do you have in savings, reserves or long-term operated accounts (such as your retirement accounts)?
If you end up getting the house, you’ll need to pay your monthly mortgage and other fees.
And so banks want to see that you have up to about 3 to 6 months in cash reserves for fees; and in the event of any home-related emergencies.
If you’ve been building up your investment accounts (Roth IRA, 401(k), etc.), banks also consider these as part of your cash reserves.
Once you’ve satisfied these requirements and others in place (depending on your specific lender), then you’d need to have a down payment.
Your Down Payment
The down payment is the initial part of the total amount of the house that you’ll pay upfront.
This down payment represents “your skin in the game.” Think of the down payment as your way of sharing the risk of the home investment with the bank.
Here’s the good news.
However much your down payment is, it will go into part of your payments for the house. So, think of your down payment as your initial investment in your house.
How much should you pay for your down payment?
Generally, prepare for about 15-20% of the amount of the property.
In some other cases, your down payment may be lesser (7% to 10%) or slightly more (25%-35%).
When you’re saving up for a house, you’re really saving up for the down payment of the house.
And then building good financial habits to make sure you can keep coming up with your monthly payments on the house.
From the bank’s standpoint, the down payment also gives the bank some cushion; in case they need to foreclose the house (that is, the bank taking over the house because the owner is unable to come up with monthly mortgage payments).
If a bank end up foreclosing a house, then the owner also loses the down payment. That way, the owner also bears the brunt of the transaction going sour.
In some other cases, the proposed owner may pay a Private Mortgage Insurance (PMI) fee. Unlike the down payment, the PMI fee is usually an extra fee tacked on to the amount of the loan. The PMI fee usually ranges between 0.5%-1% of the total amount of the loan. Again, its purpose is for the banks to cover some of their bases.
If you end up paying the PMI fee, you can refinance your loan after a few years, so that you can eventually get rid of the PMI.
Keep in mind that: although you might have weak financial records, you might still get a loan (even higher than you expected). It all simply boils down to your interest rate. In other words, what interest rate is the bank lending the money to you?
To recap, when you’ve saving up for a house, you’re really saving up for the downpayment of the house… with the assurance that you’ll be able to consistently come up with the remaining amount of the loan (plus interest) over the lifetime of the payments (typically 15 years, 30 years, etc.)
So, How Do You Save Up For A Down Payment?
Buying a house will probably be the biggest purchase you’ll ever make, so you need a written game plan in order to win. Fortunately, many of the proven methods about saving also apply here.
1. Be conscious and intentional about saving: Make it a priority to save for a “house fund.” Create a goal-based savings account in your main savings account, specifically devoted to saving up for a house. You can use a Capital One’s or Ally’s high-yield online savings account to set up these goal-based savings accounts.
2. Live on far less than you make: There’s no other way to sugarcoat this: you’ll need to spend far less than you make. That way, you can save the balance as part of funds for your house.
3. Get out of debt: For most people, it’s better to pay off debts than try to tack on more debts (in the form of mortgages) in buying a house. For example, if you can get a 5% rate of return on a real estate property, that’s a pretty good investment return. Which means if you have student loan debt with interest rate of 7% or 10%, then it actually pays to pay off your student loans first rather than trying to save up for a house.
4. Track your expenses: To be able to save more, you’ll need to justify every single expense you make. The way to do this is to track every single thing you spend money on. You need to know where your money is going. That way, you’re able to identify the ‘money holes’ draining your finances, and then plug those holes.
I’ve found Personal Capital to be a very good tool to track my expenses.
With Personal Capital, you get a holistic and simplistic overview of all your accounts, expenses, and streams of income, all in one place. It’s easy to use, and it does a much better job of tracking your finances, more than a typical credit card account would.
5. Have a separate savings account: You might find it challenging to try to save in the same checking account in which you get your paychecks. A much better way is to open an online high yield savings account with Capital One or Ally bank. That way, you don’t get to see this money every now and then. And you can just reduce the chance that you’ll spend the money on unnecessary expenses.
6. Cut back on things you don’t need: It’s possible to come up with the down payment, and still fall short in paying the monthly mortgage on a house (thus leading to a foreclosure). Which is why you need to develop sound financial habits that will last.
One very prudent financial habit to master is to eliminate expenses that are nice to have, but that you probably don’t need. For example, subscriptions you don’t use (gym, Netflix, Hulu, etc.), late fees, the latest gadgets, shoes, watches, or necklaces, extremely high car insurance payments, spending on habits that kill (for example, smoking), etc.
You want to be able to drastically cut back your expenses, so that you know what you sacrificed in order to eventually live in your own dream home.
7. Earn more: Cutting back and saving more will help you start on a sound financial footing, but you’ll likely need to earn more money… in order to save up for your own house.
There’s a limit to how much you can save. BUT there’s no limit to how much you can earn.
If your current income is not enough, you will NEED to earn more money. Focus on building one stream of income (most likely your day job). Then, start working on stacking multiple streams of income.
As you do these, you want to decrease your expenses as much as you can.
In other words, it’s not how much you make, but how much you keep.
In your current job, you might need to get a raise, take on more high-paying projects, work more hours (for better commissions)… or start your own business.
You’ll need to build new skills, start a side hustle, or take on remote jobs or work shifts.
Bottom line: If you want buy a house bad enough, you’ll find a way to (legally and morally) make it happen… and yes, without getting ridiculously high interest rates or racking TONS of debt.
If you can focus on these areas, you’ll have a financial lifestyle attractive to the banks. And therefore making them more comfortable in giving you loans at low-rate interest rates.