Your Step-By-Step Guide to the Home Buying Process

Step 1: How to fund your down payment with savings

These 3 little words can cause you to feel everything from tingles of excitement to outright panic: Buying a home. You’re excited about building equity and owning property that’s truly your own. And you feel ready to put down some permanent roots. But you may be wondering, “How does buying a house work? Where do I even start?”

As with many big-ticket items, the first thing to consider is money: Before you start researching neighborhoods (East side or west side? Near the parks or near the shopping?), styles of homes (Ranch or Victorian?) and school districts, you’ll need to save money for a down payment.

Thinking about all of the steps to buying a house can be overwhelming, especially for a first-time buyer. This house buyer’s guide can help get you through it with tips on all aspects of the home buying process: Putting together your down payment, qualifying for a mortgage, finding the best time to buy, understanding how owning a home will impact your finances and preparing for the closing. In this first article of a 5-part series, find out about down payment rules.

Ways to fund your down payment

So, what do you need to buy a house? The typical buyer puts down 20%1 of the home’s purchase price in cash as a down payment.2 For many people, it may take 5 to 7 years to save that kind of money, depending on how much they’re willing and able to set aside.2

A good rule of thumb is to save between 10 and 20% of your income toward your down payment each year. For example, if you make an annual salary of $75,000, try to put between $7,500 and $15,000 into a savings account yearly. But don’t worry: Since many people don’t have 20% of the home’s purchase price in savings, there are ways to put down less or get the cash you need for a down payment.

Apply for an FHA loan to pay less up front

An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA). This is a great option if you don’t have much cash saved up for a down payment. You can pay a smaller amount of money upfront, saving you cash, while building up savings through equity in a home. There are many advantages to this type of loan.

  • There’s more flexibility: Because of the insurance, lenders have more wiggle room with a borrower’s qualifications. That means even if you have some red flags on your credit history or less than 20% to put down, you may qualify for an FHA loan.3

  • You can have a smaller down payment: FHA loans often only require a 3.5% cash down payment (instead of 20%) if your credit score is above 80. If your score is less than that, you’ll have to put down 10%.3

However, there are some downsides4:

  • You pay insurance: Because FHA loans are insured, you’ll have to pay a monthly and annual insurance premium. For a $200,000 home, you’d pay about $1,700 per year for insurance.5 Borrowers who get a typical loan and put down 20% can avoid mortgage insurance altogether.

  • You’ll need to follow the HUD rules: The U.S. Department of Housing and Urban Development (HUD) manages FHA loans. HUD has rules about what types of properties can be purchased with an FHA loan. A HUD-approved appraiser will need to visit the property to ensure it meets all program requirements.

Withdraw from an IRA or 401(k) without a penalty

You may consider your retirement savings untouchable until you’re 59½. However, there are certain cases where you can use part of your retirement without having to pay the traditional 10% early withdrawal tax.6

Buying a home for the first time is one of those cases. First-time home buyers can withdraw up to $10,000 from an IRA without penalty.6 If you’re married, your spouse can do the same. That means that each of you can take up to 10% from your IRA and combine them for the down payment—all penalty free. Keep in mind, that depending on the type of IRA and how long you’ve had it, you may have to pay income taxes on the amount you’ve withdrawn.

Using the money from your IRA may help you breathe a sigh of relief, knowing that all of the money in your savings account isn’t going toward the house. You can still save for other goals or dip into your savings in case of an emergency.

You’re also able to borrow up to $50,000 or half of the amount in your 401(k), whichever is less. Your employer has to allow you to take this type of loan, and they give you the loan and set the terms. What are the benefits of this route?

  • You pay yourself: During the loan, you’ll pay principal (the amount you borrowed and have to pay back) and interest to yourself, which comes out of your paycheck after tax.

  • You get a low interest rate: The interest rate is generally lower than you’d receive from another lender. Since you’re paying less in interest, you may be able put more money into savings or pay more toward the equity of your home.

But you’ll also need to keep this in mind:

  • There’s a penalty if you become unemployed: If you lose your job, you’ll have to pay back the total loan at once (instead of the standard 5 to 15 years).

  • Your retirement savings will be less: You’ll have less money in your retirement account that’s actively earning interest while you pay back the loan.

See if you’re eligible for government assistance

There are grants available to first-time home buyers through the government. In general, each state has their own requirements to buy a house if you use their grants.

Usually, the home buyer will need to earn less than the average median income for the state7 to qualify for a grant. The government grant is basically an interest-free loan to pay for the down payment. Even better, some down payment grants don’t need to be paid back at all.8 If you’re eligible for either option, you can save a ton (either in interest or the down payment entirely). A site like downpaymentresource.com can help you determine if you qualify.

Save for the closing

The closing is the final step in the home buying process, and it may seem far away now. But while you’re saving for your down payment, you may want to put aside some extra cash for closing costs as well.

Most homeowners need to pay between 2 and 5% of the purchase price of the home in closing costs.9 That means if you’re buying a $200,000 house, you can expect to pay between $4,000 and $10,000 in fees at the closing. You may want to start setting aside that money now, little by little, while you house hunt. Most likely, Future You will be very thankful you did that.

Whether you diligently save, tap into your retirement funds or apply for government assistance, funds for a down payment may be within your reach sooner than you think. Once you have the down payment in place, you’re ready for step 2 in the home buying process: Qualifying for a mortgage.

Part 2 of our First-Time Home Buyers Guide will show you how.


This site is for educational purposes. The material provided on this site is not intended to provide legal, investment, or financial advice or to indicate the availability or suitability of any Capital One product or service to your unique circumstances. For specific advice about your unique circumstances, you may wish to consult a qualified professional.

Citations

  1. Bundrick, C. H. (2017, October 10). How much down payment do you need to buy a home? Retrieved October 14, 2017, from https://www.nerdwallet.com/blog/mortgages/payment-buyhome/

  2. Meyer, Cynthia. (2017, June 11). How to save for a down payment on a first home -- without giving up avocado toast. Retrieved August 07, 2017, from https://www.forbes.com/sites/financialfinesse/2017/06/11/how-to-save-for-a-down-payment-on-a-first-home-without-giving-up-avocado-toast/#5325384b30b3

  3. Geffner, Marci. FHA loans (2017, January 25) 7 crucial facts about FHA loans. Retrieved August 28, 2017, from http://www.bankrate.com/finance/mortgages/7-crucial-facts-about-fha-loans-2.aspx

  4. Cornett, Brandon. (2017). Downside: The disadvantages of FHA loans for home buyers. Retrieved August 28, 2017, from http://www.fhahandbook.com/blog/downside-disadvantages-of-fha/

  5. 2017 FHA MIP Chart - How much & how to drop/avoid MIP. (2017, July 13). Retrieved September 28, 2017, from https://thelendersnetwork.com/fha-pmi-mip-chart/

  6. Lenore, Matt. (2014, May 23). When can you withdraw from your 401k or IRA penalty free? Retrieved August 28, 2017, from https://www.personalcapital.com/blog/retirement-planning/can-withdraw-401k-ira-penalty-free/

  7. Lake, Rebecca. (2017, June 12). What you should know about down payment assistance. Retrieved August 28, 2017, from https://smartasset.com/mortgage/what-you-should-know-about-down-payment-assistance

  8. Lerner, Michele. (n.d.). Down payment assistance programs: How to find help to buy a home. Retrieved October 2, 2017, from https://www.newhomesource.com/guide/articles/down-payment-assistance-programs-how-to-find-help-to-buy-a-home

  9. Closing costs - What are closing costs? | Zillow. (n.d.). Retrieved September 01, 2017, from https://www.zillow.com/mortgage-learning/closing-costs/

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