Offering a big down payment on your first house can save you a lot of money in the long run. Here’s how to save for a down payment the smart way.
In seven steps, we’ll show you how to start saving for the biggest purchase you’ll probably ever make, and how to do it in the smartest way possible.
Step 1: Determine how much you’ll need to save
Before you start saving for a down payment on a house, you need to know how much you need to save. You will want to sit down with a mortgage broker who will give you an idea of how much of a mortgage you can afford.
Generally speaking, your housing expense should not exceed 30 percent of your stable monthly income. So if your income is $8,000/month (net), you can safely allocate $2,400 of that ($8,000 x 30%) to your future house payment.
Keep in mind that $2,400 includes your mortgage principal and interest, property taxes, home insurance, electricity, gas and condo fees (if any).
With mortgage interest rates at about 2.5 percent, this will translate into a mortgage loan amount of about $540,000 with a down payment of 20%. No, that’s not the minimum but we recommend you avoid anything less than 20 percent because you then have to pay CMHC mortgage insurance.
So here’s the summary of your transactions:
Total house value: $675,000
Down payment: $135,000 + $5,975 land transfer tax (includes first time home buyer rebate)
Amortization period: 25 years
Interest rate: 2.5%
Total mortgage payment: $2,419/month
Don’t worry about those calculations– a mortgage broker will be happy to run different scenarios for you.
PRO TIP #1: work with a mortgage broker and not your bank as they have access to various lenders.
PRO TIP #2: get pre-approved by your mortgage broker that way you know how much house you can afford.
Step 2: Know your timeframe
The next step is to establish your timeframe. If you plan on purchasing a home in 10 years, you’ll have to be prepared to save $14,097.50 per year ($140,975 divided by 10 years).
Of course, the shorter your timeframe is, the higher your annual savings goal will need to be.
Step 3: Figure out the best way to save for your down payment
Since you’re likely working with a relatively short time-line, you want to stay away from risky investments like stocks, REITS and mutual funds. Instead, you should look to safer investments like high interest savings accounts, GICs and equivalents.
Of course you could potentially make more money by taking on more risk, but since we’re working with such a short time frame, your investments wouldn’t have time to weather a severe storm in the markets. We need to make sure the money is there when you need it.
Step 4: Cut back on expenses
We’re talking about a big sum of money here , so you might have to cut back on some expenses. Look at your budget and try to differentiate the “needs” vs the “wants”. The “wants” look something like clothing you don’t really need, restaurant visits and subscriptions you no longer use and the “wants” are what you will need to cut back on.
Step 5: Automate your savings
Make it easier on yourself. You’ve established how much you need to save every month, now you should allocate a certain percentage or dollar amount of your regular pay to go directly into a savings account dedicated to accumulating the funds for your down payment.
It will take some time to get used to the money no longer being available for the odd splurge but you will get used to your new budget in no time and the end result is totally worth it!
Step 6: Put those windfalls in the bank
If you receive a large chunk of change, be sure to make it easier on yourself by setting those aside for your down payment. These can include tax refunds, gifts, inheritance, bonuses or large commission.
By setting aside money for your down payment, you are essentially chopping off a few years of savings. So if you started with a 10 years plan, you could drop instantly to a 7 year plan depending on the size of the windfall.
Step 7: Make sure your plan is flexible
Life happens – if you stretch yourself too thin you might have to change your plan and that’s OKAY. Nobody can predict major car repairs, replacement of a car, uncovered medical expenses, or even the temporary loss of a job. But be sure to roll with the punches and adjust your budget accordingly.
PRO TIP #3: Before you even get started saving for a down-payment, you should have an emergency fund set aside, which usually represents 4-6 months’ worth of living expenses or income that way when that bad luck happens – you’re not forced to change your overall game plan.
Let’s summarize, buying a home demands patience and sacrifice and nobody said it was going to be easy but think of it as preparation for homeownership. Once you own a house you will have added expenses and up-keep, so you should always have a slush fund ready to pay for the next major expense. That said, there’s know better feeling knowing that your mortgage payments are going towards building equity and your net worth instead of filling up your landlords pockets!
