You’re ready to buy a home, but you want to first save up enough money for a down payment. But how much should you set aside each month to do that? And how long will it take you to save enough?
Not surprisingly, that’s a complicated question.
Shane Lee, a data analyst at New York City-based home investment site RealtyHop, said that how much you should save will depend largely on how much you earn, how pricey of a home you want and how soon you want to move.
"There is no perfect rule in terms of the percentage, but I recommend that buyers calculate their percentage based on other expenses," Lee said.
Say all your monthly expenses consume 47 percent of your monthly income. You then have about 53 percent of your monthly income available for saving for a down payment. You don't want to commit all that extra income to your down payment fund. But how much of it you save will either lessen or increase the number of months or years it will take you to save up for your down payment, Lee said.
Does a smaller down payment make sense?
Sarah Larbi, a real estate investor and speaker based in Oakville, Ontario, said that you should consider another factor: How eager you are to enjoy the benefits of owning a home.
Consider the value of equity. When you make your mortgage payments, you build equity in your home. You'll build equity, too, if your home rises in value after you buy it. Say you owe $150,000 on your mortgage and your home is worth $220,000. You now have $70,000 in equity. You can borrow against this equity with home equity loans or lines of credit, and then use that money for everything from home improvements to your children's college education. You can also use it to pay off high-interest-rate credit card debt.
You get certain tax benefits when owning a home. You can deduct the interest you pay on your mortgage loan each year on your taxes. You can also deduct the property taxes that you pay.
Finally, there are mortgage rates to consider. No one knows for sure, but it seems as if interest rates will continue to rise. If you want to buy a home before these rates go too far higher, you might have to buy sooner rather than later.
Larbi says that it might make financial sense, then, to decide to save up a smaller down payment to get into a home faster. After all, it will take longer to save up enough money for a down payment of 20 percent. Instead, you might be able to qualify for a mortgage with as little as 3 percent down.
The good news? Certain loan types, such as an FHA loan or a Fannie Mae HomeReady loan, allow far these smaller down payments.
The down payment formula
Say the home you want to buy costs $200,000. A down payment of 20 percent would be $40,000, a lot of money to save. But a down payment of 3 percent on the same home would be a less intimidating $6,000. It will take less time to save that amount
"If you are in a more expensive area, it may make more sense to save less than 20 percent to get into the market and gain some immediate benefits rather than spending years saving," Larbi said. "That can help you get ahead faster than if you wait for the 20 percent.”
There is a downside to saving less than 20 percent. If you don't come up with a down payment of at least 20 percent, you'll have to pay private mortgage insurance, better known as PMI, each month. This extra payment protects your lender in case you default on your loan. Your lender is required to cancel PMI once you have paid down the balance of your mortgage loan to 78 percent of your home's original value.
How much to save
Larbi recommends that future buyers save a minimum of 10 percent of their income each month to help build a down payment fund. If you are earning $59,055 a year, you would then have $5,905 saved for a down payment after one year. At this rate, if you want to buy a home costing $200,000, it would take you almost seven years to save up enough for a down payment of 20 percent.
But, if you decide to save up enough for a down payment of 10 percent, it would take you half the time. And if you only wanted to save 5 percent? It would take you less than two years to have enough for your down payment at this rate of savings.
You can speed the process, then, by saving a larger percentage of your income and aiming for a smaller down payment. But before making any of these decisions, you'll have to look at your own income, the average prices of homes where you want to live and how soon you want to buy. Don't save so much for a down payment that you are struggling to pay your other monthly bills.
How long it will take
While there's no easy answer for how much you should be saving each month for a down payment, it is easier to determine how long it will take you to gather these funds.
Shawn Breyer, owner of Breyer Home Buyers in Suwanee, Georgia, said you just need to determine what type of home you want and how much that home will cost.
Say you plan to spend about $250,000 on your home. If you decide you will put down 3.5 percent of that price, you'll need a down payment of $8,750. If you want to own a home in two years, you simply divide that $8,750 by 24 months, Breyer said.
This means you'll need to save $365 a month to save up enough for your down payment in two years. Just change the numbers to match your own situation and you’ll know exactly how long it will take you to save for your desired down payment.