The housing market is a little insane right now. Home inventories are low in real estate markets across the country. This causes prices to drive higher and many buyers are getting into brutal bidding wars where the winner pays $20,000 to $30,000 over the asking price. A smart move to make when buying a home is to save up a 20% downpayment.
Though I’m not sure how long this will last, it’s important to realize the one major lesson in all of this: cash is still king. When it comes to buying a home, cash is a very important asset to have in your corner.
While you often don’t have to make a 20% downpayment for a home, it’s a nice thing to have since it can not only help you win a bid on a home but it can also keep your monthly mortgage payment more manageable. Still, this amount is not small so I wanted to share some key tips to help you maximize your savings and stack your cash.
Break Down Your Goal and Make it Realistic
How much are homes in your area and what is a realistic budget for you? The average home price in the U.S. reached $389,400 in 2020. That makes a 20% down payment of $77,880. In other words, A LOT of money.
Here’s the thing though. In many areas of the country, you can still buy a nice home for around $250,000. This is an average 3-bedroom, 2-bath home where a 20% down payment would be around $50,000.
Another thing to consider is that where home prices are much higher, the cost of living and wages are often higher too. This means you might earn more money living in Seattle than you would by living in Indianapolis with a similar job.
If you’re serious about buying a home, you need to make sure you can realistically afford to buy a home in your area. There are several calculators online that can help you determine your monthly mortgage payment. Even if you think you can afford it, you still need to factor in other costs like maintenance, repairs, insurance, and tax increases. This is why it’s often a good idea to make a larger down payment and have more cash reserves lined up.
Realize also that it’s okay to take my tips in this article and use it to save a 10% down payment. Once you’ve assessed housing prices in your area, break down your goal by monthly or yearly savings accounts so it will be more attainable.
Lower Your Standards of Living ASAP
Let’s go with the example of saving up a $50,000 down payment. Maybe you want to do this in 3 years or less by contributing at least $16,666 annually or $1,388 per month.
One of the best things you can do when you’re trying to save for an aggressive goal is to lower your cost of living. You can live nice when you buy your home but in the meantime, you may have to make some necessary lifestyle adjustments and sacrifices so you can reap the benefits in the future.
The best thing is, what you give up is your choice. If you don’t want to stop having brunch with friends each Sunday, you don’t have to. Just understand how your choices will offset your cash flow and goals.
One of the most efficient ways to lower your standards of living is to consider cutting your 3 biggest expenses
- Housing – see if you can find an affordable place to rent that’s low maintenance where you won’t be charged a ton of extra fees. Your rental house or apartment may not be glamorous and you may even have a roommate, but you’ll be able to stack your savings quicker that way.
- Food – Set a firm grocery budget and do most of your cooking at home. You’ll automatically save $1,000+ each year just by bringing your lunch to work so that’s a great start.
- Transportation – Drive an older car with no car note. This will save you $300 to $450 per month on average and also help keep insurance costs lower.
Practice Delayed Gratification
Most people don’t like the idea of saving up for something because it means they’ll have to wait. We live in a society that praises and promotes instant gratification.
We want our food now, our internet to work at lightning speed and we like credit cards because they give us the ability to purchase whatever we want when we want it.
The idea of spending up to 3 years saving for a 20% downpayment for a home may not sound too fun, but if we learn how to practice delayed gratification and wait for good things in our lives, it will be worth it.
You can practice delayed gratification with small things at first like telling yourself no when you think about running through the drive-through at Starbucks in the morning. Instead, make a coffee and breakfast at home. When you’re in a store and see something you like, see if you can wait for 48 and truly think about whether that purchase would truly be a good idea.
Practicing delayed gratification doesn’t mean you have to deprive yourself of everything you want or need at the moment. It just means there are benefits in waiting sometimes and allowing yourself the time to work up to a specific goal for your money and your life.
Cut and Earn
I’m tired of hearing the debates about whether saving money or earning more is most important. Both of them are important and play a major role in your financial success.
So, I made up a process called ‘cut and earn’. It allows you to cut expenses from your budget combined with efforts to increase your income.
For our 20% downpayment example, we’d need to be saving about $1,388 per month on average. Of the amount you need, I like to recommend reaching it by cutting your expenses 20% to 30% and making up the remaining 70% to 80% with an income increase.
You can only cut your expenses by so much, so yes, you will need to also focus on earning more whether it’s by getting a raise or switching employers, or obtaining a side hustle. So how this would break up is cutting your monthly spending by at least $277 to $416.40 and earning anywhere from $971.60 to $1110.40 per month.
Temporarily Reduce Other Savings Goals
To help you cut and earn, you can also consider temporarily reducing your other savings goals as well while you save up a 20% downpayment for a home.
This might mean, making only minimum payments on your debt for the time being or pausing your travel savings fund while you direct more toward your down payment savings.
Remember, these sacrifices are only temporary and whether you do them is completely up to you and your timeline.
Carefully Consider Borrowing From Retirement
One common option I see people choose is to take out a 401(k) loan or withdraw from another retirement account in order to put more money toward a downpayment on its own.
It’s important to realize that while a 401(k) loan will not count in your debt-to-income ratio when you apply for a mortgage, you could pay taxes on the amount you borrowed as well as an early withdrawal fee.
With an IRA, you can withdraw funds without taxes or penalties to help with your down payment so long as you are a first-time homebuyer.
However, keep in mind that taking money out of retirement has its own opportunity costs. When you touch your retirement money too soon, you could reduce its growth over time and this will impact you in the future so be sure to weigh the pros and cons.
Other Realistic Ways to Reach 20%
- Live on one income – if you have a partner who also works, see if you can live solely on one person’s income and save the other income
- Pay off a debt – Doing this lowers your debt-to-income ratio and can also free up more money for you to save each month
- Consider getting a $500/month side hustle – If earning an extra $1,000+ per month seems out of the cards for you, start by getting a side hustle or part-time job that will pay you at least $500/month then funnel all that money to savings
- Skip a vacation – Sure, it’s not fun to skip an annual vacation, but doing so could save you $1,000 to $3,000
- Automate your savings – pay yourself first automatically by setting up automatic transfers so you can stay on track.
A 20% Downpayment Isn’t Required, But It Does Help
No, you don’t need to save up a 20% downpayment for a home, but it definitely can come in handy. You’ll have a lower mortgage payment and cut out PMI (private mortgage insurance) payments. Plus, you can also have more cash on hand to help you during the negotiating process when buying your home.