Saving for a house is one of the hardest financial goals you can have. Depending on where you live, you’ll have to come up with between $50,000 – $300,000 based on a 20% downpayment.
The reason why so many adult children still live at home with their parents in places like San Francisco, New York, and Vancouver is because the median home price in these cities is around $1.5 million and up. There’s just no way the average person in their 20s can buy a median priced home.
Here are some of the best ways to save for a house downpayment. To get neutral property as soon as you know where you want to live for the next 5-10 years is a good idea. Real estate is one of the best ways to build wealth.
Best Ways To Save For A Down Payment
A) Have A Target Goal In Mind
You can’t start saving unless you really know how much home you can afford and when you’ll want to buy it.
Stick to the 30/30/3 rule for home buying. Here’s the rule in more detail.
1) Cash flow. Traditionally the industry says to spend no more than 30% of your gross income on your monthly mortgage payment, but I think you can stretch it to 50% if you think you’ll be making more money in the future. Don’t bank on it though, as this downturn has shown many people, including myself.
50% of your gross income on $50,000/month is much different from 50% on $2,000/month mind you. You must be able to take care of your basic needs with the money remaining. Hence, I suggest spending LESS as a percentage of your gross income the more income challenged you are. I wouldn’t spend more than 30% of gross, if income is $10,000/month or less.
2) Down Payment. You should have at least 30% of the value of the home saved in cash. 20% is for the downpayment to avoid PMI insurance, and the other 8-10% is for a healthy cash buffer. There are some high-risk people out there who want their home so bad that they put down only 10%, and take another 10% in the form of a maxed out HELOC loan just to get in the home. If you don’t have at least 30% of the value of the home saved up, then it’s best to start eating only ramen to bolster savings!
3) Value of the home. Cash flow affordability is a function of the price you pay. If you are able to meet the first two hurdles of cash flow and down payment, then you can tie it all together with a proper multiple of your yearly gross income to see what you can afford. The MAX multiple I recommend is 5X if you meet the first two conditions, but 3X is better. In this case, the more you make, riskier it is to go to an upper limit multiple because of leverage. 5X $500,000 is much more daunting than 5X of a $50,000 salary for example. You can always refinance your home, but you can never change your initial purchase price!
Good Example: $100,000/yr income, $120,000 in cash saved, $400,000 home no problem! $320,000 mortgage after putting 20% down, and you still have a $40,000 buffer. Your monthly payment is $1,918/month PMI at 6%, and is a suitable 23% of your monthly gross income of $8,333. In case of layoff, you have 21 months of mortgage coverage with your $50,000 buffer.
B) Track Down Every Penny
Find out where all your money is. The best way to keep track of your finances is to use a free online financial app like Personal Capital. The free tools give you a holistic view of your money and tracks your cash flow. No longer do you need to track your finances by paper or with Excel.
I’ve used Personal Capital since 2012 and have been able to significantly optimize and grow my wealth since.
You should also hunt down all the people who owe you money and ask for your money back. Don’t let anybody welch on their debt to you!
C) Pay Down High Interest Debt
High-interest debt, like credit card debt, can be a huge drain on your finances. Not even the great Warren Buffet can beat the average credit card APR rate of 15%. In other words, credit cards are milking money off you if you don’t pay in full each month!
It may sound counterintuitive to pay down debt when you’re trying to save up for a downpayment but it isn’t. Let’s say you have a high-interest debt that’s charging you 15% and you are saving money into a high yield savings account getting you somewhere around 1% – that’s a brutal 14% spread.
Pay down high interest rate debt as quickly as possible. You can take advantage of 0% balance transfer offers so you get a little extra breathing room, but don’t do this if you plan on buying a house in the next year or so. When you open a credit card you trigger a hard inquiry on your credit report, which can ding your score a few points.
Check out my FS-DAIR methodology for paying down debt and investing. It is a fantastic framework to do both depending on the interest rate.
D) Invest Your Down Payment Wisely
The closer you are to buying a home, the more conservative you should become with how you invest your down payment. Check out How To Invest Your Down Payment If You’re Planning On Buying A House.
If you are planning on buying a house within 12 months, I would seriously invest most of your down payment in 3-month treasury bonds or a high interest rate online account. The last thing you want is your down payment to go poof.
E) Sell Your Unwanted Clutter
Perhaps you have an overabundance of clothes and shoes. Sell them on eBay or Craigslist. Perhaps you have an awesome baseball card collection from the 1950s? Raise some cash by selling some cards.
Over the years, you will have accumulated a lot of stuff you don’t need or want. Not only does it feel great to get rid of your clutter, it also feels great to raise some money!
F) Start a Side Hustle
Not only should you be working hard at your job to make more money, you should also be investing your non-house downpayment fund. But to earn even more money, you should start a side hustle.
Being a rideshare driver or a Tasker are great side hustles. I started Financial Samurai as a side hustle when the world was falling apart in 2009. Now Financial Samurai makes more than a typical Managing Director at a major investment bank! But such revenue took 10 years to achieve.
You never know when a small side job can turn into a much larger one. Here’s my step-by-step guide on how to start your own website today.
Other Ways To Save For A Down Payment
1. Move money into a house down payment account each month
This is the most popular—and convenient—way to save. Set up an automatic direct deposit into a savings account. Commit to never use these savings for any purpose other than your down payment.
2. Don’t go on vacation
If you save the money you would have spent vacationing, you can make significant contributions toward a down payment.
3. Lower your expenses
Review your expenses and look for what you can reduce or eliminate. Put the money you would have spent on these items into your down payment savings account.
4. Pay down high interest debt
High interest rates on credit cards can seriously limit your ability to save. Pay off your high interest rate credit cards. Start with your highest interest rate card; when you’ve paid the entire balance, close the card, and proceed to pay off the next. At a minimum, transfer your credit card balances to the card with the lowest interest rate.
5. Borrow money from your parents
Many parents or relatives help out when it’s time to buy a first home. Gifts can come from your family, spouse or a domestic partner. Just be sure to include the amount of the gift on your loan application. See: How To Get Your Parents To Pay For Everything As An Adult
6. Borrow from your retirement plan
Look for penalty-free withdrawals for home buyers in your plan. Many company-sponsored 401(k) or profit-sharing plans allow employees to borrow against their savings to purchase a home. Your Human Resources or Payroll department can help. This is generally not a good idea.
7. Sell some of your investments
Think of this simply as a way to move some of your current investments into another investment vehicle – your home! As you make payments on your mortgage, you accrue equity in your home. As the value of the home increases, so does the return on your investment.
I sold about $1,000,000 of stock in 2019 to buy a home. I’m glad I did as real estate is significantly outperforming stocks in 2020.
8. Build more income streams
Even temporarily, earnings from a second job can help you make substantial contributions to your down payment savings. Everybody should be developing new passive income streams for financial independence.
9. Make a deal with the seller
A motivated seller might take out a second mortgage to cover some of the purchase price. If you’re considering this, make sure a qualified attorney reviews everything from top to bottom. Always negotiate with a real estate lover letter so you can make a connection!
10. Get help from the government
Some organizations might help you with your down payment. See if you qualify with the Federal Housing Administration, the US Department of Agriculture Rural Housing Service and the Veterans Administration. Also check out local housing authorities to see if they have programs to help.
Invest In Real Estate for The Long Term
Real estate is absolutely my favorite asset class to building wealth over time. It’s understandable, provides utility, and generates rental income.
If you don’t have enough to buy a place yet, I suggest looking into real estate crowdfunding with Fundrise to get long real estate. Instead of having to come up with tens or hundreds of thousands for a downpayment, you can invest as little as $500 into a Fundrise eREIT or commercial real estate deal.
It’s free to sign up and explore. I’ve personally invested $810,000 in real estate crowdfunding to simplify life and generate passive income after I sold my SF rental house for 30X annual gross rent.
Good luck on your real estate purchase!