Jun 30th, 2008
A down payment between 10 and 20% on your first home or condo is more important today than ever before. Following the sub-prime mortgage meltdown, lenders are more cautious with mortgage applications and borrowers have (hopefully) learned some lessons about risky home loans. Of course, socking away $20,000 or more isn’t easy, especially in your twenties. Here are five steps to take to save up your down payment in record time.
1. Determine how much you need, and when you need it. Tying an exact amount to your down payment savings goal will help keep you motivated and allow you to track your progress. Get a sense of how much your target home will cost, and try to save 20% for a down payment. Next, set a deadline. You may discover you need to save more each month than you thought, but that’s okay— these goals can push you to find extra ways to save you might otherwise overlook.
2. Create a separate savings account for your down payment. Whether you have $1 or $10,000 already saved for your down payment, stash it in a separate savings account to avoid tapping the money for other expenses. You can do this with a free online high yield savings account or simply by creating a new account designation at your current bank. Some local banks and credit unions even provide special accounts for first-time home buyers offering higher returns or rebates on mortgage closing costs.
3. Make your savings contributions automatic. Once you have determined how much you need to save each month, have that money automatically transferred to your down payment savings account every two weeks. Even better, most employers will deposit your paycheck into multiple accounts if you ask. If you never see the money you’re saving for a down payment, you can’t spend it.
4. Load up your traditional IRA. Traditional IRAs, which let you invest up to $5,000 in pre-tax dollars annually, provide an often-overlooked benefit for first-time homebuyers. You can withdraw up to $10,000 from your IRA for first-time homebuyer expenses (including your down payment) without paying the usual 10% early withdrawal penalty assessed for IRA withdrawals prior to age 59 1/2. Roth IRAs provide a similar benefit, but with some more complicated rules. With this benefit it mind, make contributing to an IRA a priority. You can save with pre-tax dollars, and stand to earn a better return on your cash than in a savings account.
5. Dump large monthly expenses. If you’re already managing to sock away a large sum each month to save for your down payment, you know that saving means sacrificing other things. As you get closer to your savings goal, make an effort to slash major monthly expenses like auto loans or credit card debt payments. Not only will this free up more cash to save, it will improve your debt-to-income ratio, an important factor in calculating your mortgage rates. Most importantly, a lean budget will put you in great shape on the day you finally become a homeowner.
I'm David, an ex- financial journalist and recovering debtaholic. I'll help you get out of debt, get saving, and get on with life. Sound good? Please subscribe (RSS or e-mail) or follow me on Twitter.
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What about using the money in a 401k?
Good question, Yackie.
Unfortunately you can only take penalty-free distributions from IRAs for first-time, up-front home purchase expenses, not a 401(k) or other employer-sponsored retirement account. (Don’t ask me why; I have no idea).
Of course, anytime you change jobs you can rollover your 401(k) into either your new employer’s 401(k) or to a traditional IRA. So your question illustrates one reason you might want to roll over your funds to an IRA.
Some people take money from their 401(k) to buy a home anyway, but end up paying the price: a minimum 20% federal income tax and 10% early withdrawal penalty. You could also take a 401(k) loan to fund your down payment, but that’s not the best idea, either.
A simple thing that you can do is pay yourself first. Select an amount you wish to save per month/year/week/etc.. and break that down into paychecks or other time goal. Then on that interval, move that dollar amount over.
For example, I selected a target amount to put into savings and divided that amount over 24 pay periods in the year. Then 1 day after each pay period I have a recurring deposit made into my savings account. This way I can ensure I’m getting a better interest rate (in my case my Savings > Checking interest) and I’m also automatically saving for the future.