Saving For a Down Payment on Your First Home

December 17, 2018

One of the many questions that I get on a regular basis is, "how much money do I need to buy my first home?"  Most first time home buyers freeze up when they hear from their parents, friends, or co-workers that they must have 20% down to buy a house.  The truth is that you do not need 20% down to buy a house.  In fact, in most cases, saving for that big down payment will actually cost you more money in the time it takes you to save up for that 20% down payment.

Let's walk through the financial comparison of buying your first home now using the money you have in the bank vs. buying later so you can save up for a 20% down payment.

Benefits of a large down payment on your first home

The most obvious reason to put 20% down on your first home is so that you can get a loan that has no mortgage interest and also to have a much lower monthly payment.  These are both great reasons to make 20% down your goal in purchasing a home.

Depending on the type of loan you choose, FHA or conventional, your mortgage interest can be a huge burden for you, at least for a short amount of time.  Mortgage insurance payments are required for buyers that do not put down 20%.  

On an FHA loan, the mortgage insurance you pay is for the life of the loan, whereas on a conventional loan, you can drop the mortgage insurance when you get to an 80/20 loan to value ratio.  On a conventional loan, the mortgage insurance rate is determined by your credit score, so if you can go conventional, that would be the best option for you, especially if you have a high credit score.  If you have a low credit score, then FHA may be your best option.  If this is the case, when your loan to value ratio hits 80/20, then it is best to look into refinancing the loan into a conventional loan.

Down Payment options for your first home, or any home, are going to be anywhere from 1%-20% (or as high as you want to go).  

Note: If you are a veteran, then you can take advantage of a VA loan, in which case you can put 0% down on the home and finance the full purchase.

Should I continue to rent to save for a large down payment on a house?

Waiting to buy a house to save up a 20% down payment may end up saving you money on your monthly budget down the road, but it will cost you a small fortune while you wait to get to that point in your savings plan.

This rent or buy now calculator is a great visualization of what this looks like for your finances.  You can follow along with me and plug in these numbers as we move along to see what they actually look like in a well organized format.

Let’s plug in some numbers here to get a picture of what all of this looks like.  Let’s assume you are paying the average rent in the area of $1500 a month.  Let’s also assume that you are able to save $500 a month for a home purchase and that your credit score is good.  You are going to buy a starter home that is going to be around $200,000 to purchase.  You have $10,000 in the bank so far to use toward buying your first home.  Interest rates are currently hovering around 5%, so we will go with that number as your interest rate.

Calculating these numbers, it will take you about 6.3 years to save up the 20% you need for your future down payment.  In those 6.3 years, your $200,000 home will now cost about $241,000 to buy, which means that your 20% down payment has also gone up to about $48,500.  During these 6 years, you will have paid about $120,000 in rent, and that rent gives you no equity.  That money is going to your landlord and fattening their wallet!  

saving for a down payment to buy your first home

If you were to use your $10,000 to buy a home now, the numbers look very different.  First and foremost, you do not “throw away” $120,000 on rent.  Secondly, you are not having to put $48,500 down on a house and you can use that savings and invest it wisely to help secure your future.  

Here’s the craziest part of it all.  In both scenarios, your monthly payment is less than you are currently paying for rent.  If you buy now, your monthly payment is calculated at $1457.79.  In 6.3 years, your monthly payment is calculated at $1432.19.  That is a difference of about $25 a month.

How does home equity work?

If you take this a step further, in that 6.3 years, you are building up equity in your home.  Equity is the value of the home minus how much you owe on it, or your mortgage balance.  Each of your monthly payments ticks down your principal balance, and each year your home appreciates in value.  If you make the right upgrades to the home, this will help you build up even more equity.

Let’s take our above example and look at it from an equity standpoint.  You purchase a home for $200,000.  Your down payment is 3%, which is $6,000.  Remember, that home is projected to be worth $241,000 in 6.3 years.  With your normal monthly payments, in 6.3 years, you will have paid $111,253 in housing payments, and your home equity position will be $71,561.  If you were to sell your home at the 6.3 year mark and take into account about 7.25% in REALTOR fees and closing costs, that leaves you with about $54,000 that you can use for a down payment on your next home.  That is more than the $48,500 that you would have saved in 6.3 years of renting to use for your down payment.  In addition, you would have paid about $120,000 in rent over that time, so you are out an additional $9000.  That $9000 looks really nice in an emergency fund, college fund, mutual funds, or general savings.

first time home buyer first home equity table

The longer you stay in the home, the better these numbers end up working in your favor.  All of these numbers are assuming you make the minimum mortgage payment without paying extra each month toward the principal balance, and we are not taking into consideration the $500 a month that you were able to save while working toward your 20% down payment.  This would be an additional $37,800 in the bank!

Your first home as an investment

You can look at your first home as an investment in two simple ways.  You are already committed to paying $1500 a month in rent, so we are going to take that variable out for simplicity.  

The first way is to look at the amount of cash you have on hand.  You currently have $10,000 available that you are going to put into the house in the buy now scenario.  In 6.3 years, this amount of cash increases to $54,000 when you sell the house.  That means that you have made $44,000 in 6.3 years, or about $7,000 a year.  This is an 18.5% return over 6.3 years, or about 3% a year.

The other way to look at it is in the overall purchase price of your home.  The above numbers are assuming a 3% appreciation per year, which increases the overall value of the home from $200,000 to $241,000.  Either way you look at it, you are getting about a 3% yearly return, which is much better than increasing your landlord’s wallet by $120,000 in that same time frame.

These are fairly conservative numbers.  We have seen the Houston real estate market increase on average 4-6% for the past few years.  Depending on the location, these numbers could very easily be much higher.  As with any investment, they could also be much lower, so it’s best to consult with your REALTOR to help you visualize what the market has done in the past and where it is projected to go in the future.

As always, we are here to help.   Shoot us an email from our contact page or reach out if you have any questions.  

About the author 

Jack Allen

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