Saving for a Home: Preparing for the Upfront Costs

Piggy bank on a pile of money

What this article is all about:



The Challenge of Saving for a Home

For many aspiring homebuyers, saving enough money to cover the initial expenses is a major hurdle on the path to homeownership. Even low-barrier loan programs will require you to have some cash available to complete the purchase. Read on to learn about the upfront costs you should be prepared for and how to build a reasonable savings plan.

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How Much Money Do I Need to Buy a House?

The amount of cash you'll need to have available to complete your home purchase depends on multiple factors, primarily the price you paid for the house and the type of loan you've acquired.

Common expenses

You can expect to encounter the following fees in most standard real estate transactions. Occasionally a portion of these costs are covered by the seller, either as local custom or negotiated as part of the offer. Talk to your real estate agent to understand what's typical in your area.

Down payment, including earnest money deposit

An earnest money deposit, submitted with the offer, is normally 1-3 percent of the offer price. When the offer is accepted, this deposit becomes part of your down payment.

Down payment requirements are calculated as a percentage of the purchase price and vary by loan program and lender. Expect your mortgage lender to ask for anywhere from 3.5-20 percent down. Higher down payments often result in preferable loan terms and more options for the borrower, which is why so many people aim for the 20 percent mark.

Home inspection

According to HUD, home inspector fees typically range from $300-$500. Your cost will vary depending on location and the size of your property, and whether you order any special evaluations in addition to the standard inspection. Your agent can advise on the fee range for your area.

Closing costs

Many parties have an interest or involvement in your home purchase and closing day is the time most of these entities collect their fees. Closing costs include real estate attorney fees, tax payments, title expenses, and mortgage processing fees, among others. These can vary by locality and the price of your home. For the purposes of establishing a savings target, most experts recommend budgeting 2-5 percent of your total purchase price.

Cash reserves

While not exactly an upfront expense, many lenders will require you to have a certain amount of remaining cash available at the time of closing as a stipulation of the loan. It's often based on your monthly mortgage obligation and a common range is two to six months worth of payments.

Additional considerations

Are you planning to hire movers? Have significant renovation or redecoration plans? If any of these expenses will be incurred immediately after taking possession of the home, be sure you've budgeted accordingly.

Estimating your savings goal

Use this table to calculate the minimum you should save for your home purchase and estimate what the upfront costs could be on the high end.

Cost category Low estimate High estimate
Down payment (incl. earnest money) 3.5% of purchase price 20% of purchase price
Home inspection $300 $500
Closing costs 2% of purchase price 5% of purchase price
Cash reserves 2 months of payments 6 months of payments

For example, a $200,000 home with a 5% interest rate on a 30-year fixed-rate mortgage:

LOW ESTIMATE
Down payment (incl. earnest money): $7,000 = $200,000 * 3.5%
Home inspection: $300
Closing costs: $4,000 = $200,000 * 2%
Cash reserves**: $2,082 = $1,041 monthly payment * 2 months
Low estimate: $13,382

HIGH ESTIMATE
Down payment (incl. earnest money): $40,000 = $200,000 * 20%
Home inspection: $500
Closing costs: $10,000 = $200,000 * 5%
Cash reserves**: $5,154 = $859 monthly payment * 6 months
High estimate: $55,654

**Your down payment impacts your monthly mortgage obligation. For the purposes of this example, we assumed the coordinating high/low down payment was paid. In the case of the high estimate, the larger down payment lowers your monthly mortgage cost. Read "How Mortgage Payments Work" for details on calculating your home loan payments. Note that this calculation did not include the cost of Private Mortgage Insurance (PMI) or real estate tax escrow contributions. If these costs are part of your monthly mortgage payment, your lender may include them in their cash reserves requirement calculation.

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Three Steps to Saving for a Home

Now that you have an idea of how much money you'll need to save, let's talk about how to get there.

Track your spending

The first step to saving for a home is establishing a monthly budget. To do that, you'll need to understand where your money goes right now.

Whether you use a free online tool like Mint.com or keep track of your spending by hand, the important thing is to categorize your spending. What percentage of your monthly income goes to your current rent or mortgage payment? How much do you spend on vehicle payments and maintenance? Do you dine out frequently? Categorizing your spending will help you identify your largest cost centers and start to think about ways you could reduce your monthly expenses.

You'll also want to get a big-picture view of your monthly expenses and how they compare to your income. At the end of the month, how much is left over?

Set a monthly goal

There are two parts to establishing a monthly home savings goal. First, calculate your ideal monthly savings based on how much you already have saved, the total amount you've estimated you'll need to purchase a home, and your preferred timeline for purchasing.

For example, for a total savings goal of $20,000 with $5,000 in the bank and a plan to purchase in two years (24 months):

$625 per month = ($20,000 - $5,000) ÷ 24 months

Next, compare this amount to the total cash you have left each month after all expenses are paid. If this savings target is less than your monthly surplus, congratulations! Consider setting up a savings account and having the funds directly deposited to keep you on-track.

For many people, their monthly surplus will fall short of their ideal savings goal. If your home purchase plans are flexible, consider extending your timeline to reduce the amount you need to save each month. When delaying is not an option it's time to examine your spending and look for ways to cut costs.

Find ways to reduce expenses

Cutting monthly expenses is often the quickest way to expedite the growth of your home fund. The question is, how?

There are numerous resources out there providing recommendations on how to save money. Many tips involve cutting small costs that add up over time. While packing your lunch every day or canceling your Netflix subscription will allow you to save more, the impact of these cost-cutting measures is often not as substantial as you'd like – especially if you aim to purchase a home in the near term and have a large savings goal.

Reducing your largest expenses can free up significant funds to put toward your home purchase. Take a look at your household budget and identify the areas where you spend the most each month. Two of the largest spending categories for a typical household are housing expenses and transportation costs.

If you're currently renting, consider moving to a less expensive area or smaller unit when your lease is up and funneling those savings into your home fund. While your new residence might be less than ideal, remember that this is a temporary stop on your path to homeownership.

The cost of owning and maintaining a car also adds up quickly. Evaluate your current transportation expenses and look for ways to cut costs. Completely eliminating a vehicle when possible – for example, going from a two-car household to a one-car household – will often allow you to realize significant savings.

Don't forget to take a look at your current debt, including mortgages, student loans, and credit card payments. You might be able to reduce your monthly expenses in this area through refinancing or other methods. Talk to a licensed financial advisor to understand your options and the long-term impact of any changes you wish to make.

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