Saving Up for a Down Payment? Here's Where To Put Your Money
Updated: May 8, 2020
The coronavirus crisis has heightened financial anxiety and uncertainty. But if buying a home has been part of your life plan, there's no need to panic. Many Americans will receive stimulus payments in the coming weeks, which could ease some of the burden, and if you're able, now is still a good time to start saving for the down payment on your mortgage.
So where should you put that money while you amass the right amount? There are a number of places to stash your cash—each with its own pros and cons.
“Some have low risk, but also low returns, like a savings account or CD,” says Sherry Graziano, head of mortgage omni experience at Truist. “Other options may have higher returns, but they typically have a higher risk associated with them.”
Savings, checking, or money market accounts
Best for: People buying a home in three months or less
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If you plan to buy a home fairly soon, a savings account is one of the safest places to put your money. They are FDIC-insured, meaning your money is protected in case of banking institution failures, and your money is always accessible.
“The least risky type of account is a savings account,” says Shelby McDaniels, channel director of corporate home lending at JPMorgan Chase. “They are highly insured. It is simple to link a checking or direct deposit to the account, and most do not have any restrictions on timing.”
Most first-time home buyers, she says, use a savings account to begin the process of buying a home.
The downside? Savings account interest rates tend to be low, with less than a 2% annual percentage yield, according to an America’s Best Rates survey. High-yield savings accounts averaged 2% to 2.4%, but some require a minimum deposit or that you maintain a minimum balance.
Money market accounts are another option. They are similar to savings accounts, but offer some checking features and sometimes a little more interest.
If you’re opting for a savings account, make sure you’re aware of any fees or requirements, like maintaining a minimum balance, Graziano says.
Certificate of deposit
Best for: People buying a home in three to 12 months
A certificate of deposit, or CD, is another low-risk option. Offered by banks and credit unions, CDs give savers interest on a lump sum of money if they leave it in the account for a designated time frame, such as three, six, or 12 months, or even longer.
If you’re saving for a down payment, CDs have a couple of downsides.
“CDs typically don’t allow for additional deposits, so that may not be the best option if a client is planning on making continuous deposits,” Graziano says.
CDs also have a low interest rate—just a hair higher than savings accounts—and the money isn't accessible until the CD has matured.
McDaniels suggests choosing a CD that will work well within your time horizon so you can use it when you need it.
Best for: People buying a home in three years or less
A 401(k) is a retirement account that you contribute to tax-free, but it has annual contribution caps and limits when you can withdraw money before you reach age 59 and a half. For 2020, the contribution limit is $19,500, according to the IRS.
Buying a home is one instance where you can use money from your 401(k) before reaching retirement age, but it can be risky.
Early withdrawals come with a 10% penalty on the amount taken out, and you’ll have to pay income tax on the distribution.
You can also take a loan against the 401(k). However, Graziano says, “the client would want to determine the amount of the repayment, and be sure that they will be comfortable with the new house payment and 401(k) repayment responsibility.”
Another thing to consider: You’ll miss out on any interest you would have earned on the money taken out of the 401(k), McDaniels notes.
“This can be a good short-term option for someone who knows they will be able to pay back their 401(k) loan quickly, with no penalty,” she says.
Best for: First-time home buyers purchasing within three years
A Roth IRA, or individual retirement account, is usually opened at a bank or investment firm. Roth IRAs are a good way to save, because you fund the account with after-tax money, meaning contributions aren’t deducible but funds withdrawn when you retire are also not taxed as income.
First-time home buyers can often take money out of their Roth IRA to buy a home without paying a penalty. You can withdraw the amount you’ve contributed tax- and penalty-free, and then, once the contribution amount is maxed, you can take out as much as $10,000 of the account’s earnings.
Historically, IRAs have earned high interest of 7% to 10%, and money can be accessed within a few days. But keep in mind that Roth IRA contributions are capped at $6,000 for 2020, so you can save only so much per year. And you can’t repay the money you take out like you can with a 401(k). So once you take it out, even to buy a home, it’s gone and you miss out on the years of accumulating interest.
Best for: People buying a home in five years or more
The stock market fluctuates, so investing and hoping your money grows before you buy a house with it can be a risky move. Still, if your time horizon for home buying is more than a few years off, this could be a decent option where your money could expand by as much as 10% during boom market years.
“Higher risk typically means greater return,” Graziano says. “But keep in mind there is no guarantee when investing in the stock market. The account may lose value, too.”
Investing in the stock market can be complex, and you may owe fees and commissions.
McDaniels suggests carefully examining your financial situation and home-buying plans to evaluate the benefits and risks. And when you sell your stock, it can take up to three days to see your money, according to rules set by the Securities and Exchange Commission.
Make sure the cash is accessible
Wherever you choose to put your money, make sure it’s accessible when you find your home.
“The timeline and flexibility with the amount of down payment are the two biggest factors that a buyer should take into consideration,” McDaniels says. “Someone who has a flexible timeline or already has a portion of their down payment might want to consider an investment account. While someone who is just starting to save or plans to buy in a shorter timeframe (of a few months) might be best suited for a savings account.”
Exactly how much you need to save for a down payment varies by your lender and the type of loan you get. Before you buy a home, McDaniels recommends saving 20% of your take-home pay, as well as three to six months of your mortgage payment.
Lenders usually require 60 days of asset account statements verifying the funds needed for the home purchase, and the source of any large deposits.
“Money kept at home in a safe commonly known as ‘mattress money’ is not eligible to be used for the down payment or closing costs,” Graziano says.