Saving to buy a home is both exciting and overwhelming. When my wife and I were saving to buy our first home, I thought we’d never have enough for the down payment. But somehow we came up with the money. One of the keys to our success was saving the cash in the right type of account.
To be on the safe side, those who are about ready to purchase a home should put their money in “cash equivalents” that are protected by the FDIC or the United States Government. In doing so, one might sacrifice return, but will have the peace of mind that the money will be available when needed. Make the wrong decision, and you could see your account balance decline. If you are saving to buy a home, here are five good saving options for your down payment.
1. Savings Account: FDIC insured up to $250,000 is an ideal place to keep your cash while you save for the big day. The best option is a savings account at an online bank for two reasons. First, the interest rates on online banks, while not enough to make you rich, are generally higher than with traditional banks. And second, because you won’t be driving by the bank’s branch every day (they don’t have any), you’ll be a little less likely to spend the money. These accounts are easy to open, and you can get access to your money immediately when you find that perfect bungalow.
2. Certificates of Deposit (CD’s): As with savings accounts, most CDs are FDIC insured. Unlike savings accounts, however, there are generally penalties if you withdrawal the money before the term of the CD elapses. The penalty can be a helpful deterrent if you fear you may be tempted to spend the money. Alternatively, you can invest in short-term CDs with durations of 3 to 12 months. Or you can put your money in a no-penalty CD, which as the name suggests, doesn’t charge a penalty if you decided to take the money out early. Keep in mind that the longer the CD term, the more interest you’ll typically earn.
Factoid: According to the National Association of Home Builders, the average age of a first time home buyer is 33 and the average first-time buyer household had an income of $64,074.
3. U.S. Treasury Bills: U.S. Treasury bills are obligations of the federal government that mature in one year or less. They are considered to be virtually risk-free as they are backed by the full faith and credit of the U.S. government. Treasury bills are purchased at a discount and upon maturity the investor receives the full face value. To make the investment worthwhile, financial experts suggest purchasing at least $10,000 or $20,000. If you go this route, I’d suggest I bonds purchased through Treasury Direct. But keep in mind that you cannot redeem these bonds for one year, and there is a small interest penalty if you cash in the bonds before five years.
4. Reward Checking Account: With the right checking account, you can save money in an FDIC insured account and earn some perks at the same time. Some checking accounts offer bonuses to new account holders. For example, ING Direct’s Electric Orange checking account offers a $50 bonus. Other checking accounts pay interest, which can help add to your down payment savings. One of my favorites is FNBO Direct, which pays one of the top interest rates I’ve seen. You can check out the details on our list of free checking accounts.
5. Money Market Account: A money market account is another great way to insulate your money while earning higher interest rates (based on the amount you have to deposit). Money market accounts can be purchased through your local bank and should not be confused with money market funds, which are similar to mutual funds, yet buy cash equivalents as investments. Money market accounts are almost always FDIC insured if your bank is a member financial institution. Make sure to always confirm that this is the case, however and know that there are withdrawal restrictions.
As always, one must consider their time frame and risk tolerance. A down payment on a home is not money that can be lost. Investors must realize that parking their money for the short-term in a safe place will give them peace of mind, but most likely a lower return. The key is liquidity, safety and accessibility.