A Guide to Saving for a House Down Payment

Saving for a house down payment while renting can seem like a daunting task, especially in this economic environment. Housing prices continue to soar, and savings accounts offer very little interest. Given these circumstances, setting aside money in a bank savings account can make the uphill climb seem even more challenging.

How Much Money to Save for a House

How do you save enough money as a first-time homebuyer? There are a variety of things to consider when saving for a home. Here are the main costs you need to consider:

  • Down payment. The amount you put towards the total purchase price of the house. Putting down 20% will help you get approved and avoid private mortgage insurance. It is possible to put down as little as 3% in some situations.
  • Closing costs. The fees associated with closing the mortgage loan. Expenses can range from 2% to 5% of the mortgage loan.
  • Everything else. Moving expenses, furnishings, remodeling, and the endless trips to home stores over the weekend.

House Prices Keep Rising

Home prices have been soaring over the past couple of years. In September, annual growth in home prices set a new record at 18.4%. When interest rates eventually climb, demand for mortgages will fall, and the housing market should cool.

Without question, the pandemic changed the housing market. People have more of a demand for space, and monetary policy made people more willing to take on a larger mortgage. When we look outside the pandemic, housing prices have increased on an annual average of 3.5% since 2000.

Where to Save Money for a House Down Payment While Renting

Investing Money to save for a house. Banks savings accounts yield 0.05% per year, home prices have historically risen 3.5% per year, investing your money can get you ahead of on your down payment savings

Bank Savings Account

A bank savings account seems like the most logical choice for many saving for a home down payment. They are convenient to set up with your local bank, and you can have funds automatically transferred into the account.

The average interest rate for a bank savings account is about 0.05%, so effectively nothing. With a $10,000 balance, you can expect to earn about $50 a year, which is not nearly enough to get ahead in your down payment fund.

Certificate of Deposit

Bank certificates of deposit will lock your money up for six months or more and might yield around 1.00-1.5% per year the longer you lock your money up. The problem is the same as with a regular savings account, and you are well behind in matching the rate you need to meet your goal.

Independent Retirement Account

Surprising to many, you can also withdraw $10,000 from your traditional IRA or Roth IRA should you meet the first-time homebuyer rules under the IRS. So, while you should generally leave money in your retirement accounts, you can use them with your overall savings strategy.

Open an Investment Account to Buy a Home

Saving for a house while renting is extremely difficult if home prices rise 3% faster than your bank savings account. The difference can add up if you need a few years or more to reach your goal, and you will have to save more aggressively or longer to buy a house.

To meet the constant rise of home prices, prospective home buyers need to be more aggressive. An investment account would allow savers to earn more towards their goal. There is a potential that you could lose money in an investment account. However, taking on this additional risk could make a significant difference in buying a house.

Investing Your Savings to Buy a House

You need to grow your savings for a home purchase. Let’s keep things straightforward and use a simple portfolio of stock and bond mutual funds to help meet your goal.

Stocks. Stocks allow investors to hold a little piece of a corporation. Investors experience ups and downs similar to what an owner would. A stock (equity) mutual fund is a collection of many different stocks.

Buying into a mutual fund allows an investor to own many different companies for a smaller cash investment. The mutual fund will enable investors to take on stock market returns while diversifying against any individual company’s misfortune.

U.S. Treasury Bonds. Unites States Treasury Bonds are the safest investments anyone can hold. Because they are so safe, investors use them to balance out the riskier parts of their portfolios.

Now we put it all together. To earn more than a bank savings account, you need to risk some investment (stocks). The safest way to take on stock investment risk is with a diversified stock mutual fund.

However, equity risk alone would be too much to take, given your investment objective and time horizon of buying a house. To offset some stock risk, you need to hold Treasury Bonds. By holding Treasury Bonds, you give up some potential returns to avoid potentially significant and unnecessary losses.

Congrats! You now have a degree in finance.

How to Save for a House Down Payment

While a bank savings account is technically safer, its rate of return is significantly less than the expected price increase of homes. Bank savings accounts effectively guarantee that your savings will not keep pace with price increases. This is why you don’t want to keep your money in a bank account while you are renting and saving for a house down payment.

With the above information in mind, we can make a first-time homebuyer’s savings account with a higher expected return (and more risk) than bank savings accounts.

For example, the House Savings Portfolio consists of 60% Treasury bonds and 40% of an S&P 500 indexed mutual fund (or ETF).

Annualized ReturnWorst Rolling 3-YearWorst Year
House Savings Portfolio7.59%0.68% (2002)-10.21% (2008)
S&P 500 Index10.69%-12.22% (2002)-36.01% (2008)
Bloomberg U.S. Treasury Index Intermediate4.82%1.84% (2005)-1.73% (1994)
Performance data shown represents past performance, and past performance is no guarantee of future results. Current performance may be higher or lower than the performance shown for illustrative purposes only.

From 1991 to now, this portfolio has only been negative three times. If we look at trailing, rolling three-year periods, the portfolio has not been negative. Said differently, the portfolio has not been negative when held for three years within the periods observed.

Over the observed period, the House Savings Portfolio returned 7.59% per year, significantly outperforming savings accounts. I must state that past performance is not indicative of future performance, but taking on some investment risk to save for a home can significantly benefit savers.

A Better Way to Save: First Time Homebuyer Savings Plan

Saving up to buy your first home can be challenging. Cutting back on expenses is one thing, but making sure you get a solid return on your savings is another. With interest rates so low while home prices climb, it makes sense to take on investment risk.

Setting up an investment account and making investment decisions can be complicated for anybody. Talking with a qualified fiduciary financial planner can help you make the best decision for your circumstances.

By Ryan Graves

Ryan Graves is a St. Louis, MO fee-only financial advisor serving clients locally and across the country. Bemiston Asset Management provides comprehensive financial planning to help millennial professionals and their families organize, grow and protect their assets through life’s transitions. As a fee-only, fiduciary, and independent financial advisor, Ryan Graves is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.