Saving for a down payment: How much and where to stash it

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Saving for a down payment: How much and where to stash it
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Are you saving for a down payment on a home? How much will you need and where should you put the money while it’s building up?

What you need to know about down payment

The conventional wisdom about down payment is that you need 20% of the purchase price to get mortgage financing. But there are a couple of workarounds to that old rule of thumb, and they offer great opportunities to the aspiring homebuyer.

The FHA loan program has long offered you the ability to bring a much smaller amount of money than 20% to the closing table. In fact, most FHA loans only require a 3.5% down payment of the purchase price.

One caveat though: If you put down less than 20% through the FHA loan program, you’re typically locked into a mortgage insurance premium (MIP) for the life of the loan. MIP is a monthly add-on currently set at 1.75% of the base loan amount.

MIP is different than the traditional PMI (private mortgage insurance) that you would pay if you put down less than 20% on a mortgage through a bank or a credit union. That’s because you have the ability to dump PMI when your loan-to-value ratio reaches 80%. But with MIP, you’re stuck with it for the life of your FHA loan.

Either way you slice it, MIP or PMI is an insurance you have to pay that protects lenders against losses resulting from defaults on home mortgages. If you can get around either one, you’d be wise to do so.

Which brings us to another opportunity: A better deal all around might be what Bank of America (of all places!) is offering. Bank of America has a new loan program that allows borrowers to make a down payment of as low as 3% and bypass PMI too. That’s a win-win! Since PMI can cost borrowers thousands of dollars a year, this news is huge for potential homebuyers who want to save more on their monthly payments.

Read more: Bank of America’s new mortgage program requires down payment of only 3%

Down payment: Where to stash it?

Now that we’ve outlined a few opportunities for you to get in a home with less than 20% down, the next logical question is where should you save your down payment to maximize its growth and protect it from losses?

Clark’s advice is to start by looking at your home-buying timeline. If you’re going to be purchasing in 10 years or more, you have a bit more breathing room than if you’re going to need your money for a down payment in 24 months.

So if you’re already saving for a home purchase that’s 10 years down the road or more, you might consider putting the money into the stock market through a low-cost vehicle known as an exchange-traded funds (ETF).

Fidelity, Charles Schwab, Vanguard, TD Ameritrade and Scottrade all offer a range of ETFs that are commission-free. As an added bonus, the management fees on some of these offerings are so low that they are almost zero. Click here for more info on what ETFs are and how to get invested in them.

Of course, saving 10 years ahead of time would make you quite the advanced planner. The reality is that very few people think that far ahead.

If your time horizon is anything less than 10 years, then you can’t treat your money like an investment; rather, you’ve got to be a saver. In that case, you’re just looking for a parking space for your money because you can’t risk any possible short-term declines. So you have to stash your cash in lower-paying options like savings accounts, CDs, high-yield checking accounts and the like. 

BankRate.com offers a comprehensive survey of the best interest rates for savers on their homepage.

Don’t forget about your credit in this equation

Here are a couple more key pointers to keep in mind as you undertake the process of qualifying for a loan and shopping for your first home.

Make sure your credit is in good working order

If you’re in the market for a mortgage, begin by visiting myFICO.com and getting your true credit score. If you and a partner or spouse want to buy a home, you may want to try to qualify for mortgage underwriting on just the income of the person who has a better score; most lenders will base your rate on the lower score if you’re a couple.

In addition to your credit score, you’ll also want to pull a free copy of your credit reports at AnnualCreditReport.com. Make sure there are no surprise delinquencies eating up your credit. If there are, many times they’ll be small piddling bills of a medical nature. Get those things paid off pronto before you apply for a mortgage.

Read more: How to raise your credit score

Pre-qualify for a mortgage

It’s very important to pre-qualify for a mortgage before you start the formal shopping process. By doing this, you can get an idea of what kind of home you can afford and what the monthly payment will look like.

Most people only get one mortgage quote. That’s the wrong way to go about it. You’ll want to get quotes from multiple lenders. Check with a local bank or credit union and maybe even get an online quote or two. Credit unions in particular offer creative mortgages that can save you money.

But know this: Each time a lender pulls your credit to give you a quote for a mortgage interest rate, it will ding your file. You can minimize the damage by getting all quotes within a 30-day period, so it doesn’t look you’re applying for multiple loans from multiple lenders.

BONUS TIP: When you apply for a mortgage, you’ll face a variety of junk fees. Many of them can negotiated down or away altogether. Know the junk fees so you can take action!

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