Saving for a Down Payment: Where Should I Keep My Money?

Saving towards a down payment for a mortgage is the first major step towards buying a home. It requires the discipline to put aside the money, obviously, as well as a decision on where best to store those funds. 

When granting a mortgage, a bank requires a down payment to help reduce its risk in financing the remaining cost of the home.

Banks prefer borrowers who can pony up at least a fifth of a home's asking price. If you have excellent credit or qualify for certain programs, you may be able to secure a loan with less than 20% down, or even with no down payment at all. Keep in mind, though, that the programs that offer low or no down payment usually require the borrower to pay private mortgage insurance (PMI) at an additional monthly cost.

Conversely, if you're deemed to be a high-risk borrower, because of your credit history or other factors, the bank may seek a higher percentage of the home's value as a down payment before they'll grant the mortgage.
[Important: Whether to use a bank, an online bank, or the stock market to stash those tens of thousands of down-payment dollars depends on your timeline.]

You're free to opt for a down payment of more than 20% of the home's value if you have the money available. The bigger the down payment, after all, the smaller the mortgage and the less onerous its monthly payments. (To calculate the numbers involved, you can use a loan amortization schedule.) 

The money for a down payment needs to be accessible easily and quickly, which all but rules out such options as a long-term certificate of deposit (CD). It also should be in a form that you can easily add to—from your paycheck, for example. Ideally, the funds should earn a return, while also remaining stable enough in value that they'll be sufficient to meet the down payment when the time comes. Finding the balance of risk, reward, flexibility, and timing that works for you is the key consideration as you choose among the options below.

Savings Account 

Storing your funds in a savings account at the bank where you do your checking is probably the simplest and easiest choice. As an existing customer, you can open a savings account quickly, and then readily transfer money to it from your checking account, either manually or through a series of recurring transfers on every payday.

The funds are highly secure, since they're guaranteed by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Association (NCUA). The downside to this option is a meager return on your funds, since regular savings accounts come with very low interest rates.

High-Yield Savings Account

If you want to earn more interest without sacrificing the safety of FDIC or NCUA protection, opt for a high-yield savings account. As the term suggests, these pay far higher interest than a regular account, sometimes 10 to 20 times as much.

You can open such an account at your current bank, which will satisfy a condition that's sometimes imposed on high-yield accounts: that the customer already holds another account at the institution. However, the highest rates on these accounts are offered by online-only banks. If you can live with their absence of brick-and-mortar locations, one of these virtual institutions may be the best savings option of all.

That said, if you're not already an online banking customer you'll likely need to wait a little longer for transfers from your checking account than if you held the savings account at your own bank. And even the interest rates of online savings accounts are nothing to brag about compared with the potential earnings from other investment options.

Investment Account

If you have an appetite for higher risk, you can opt to have your down payment fund accumulate in an investment account at a major brokerage. The account will allow you to invest the money in stocks and mutual funds that will potentially earn far higher returns than even a high-yield savings account.

However, given the volatility of the stock market, you may not realize those healthy returns as quickly as you need. Investing a fund in stocks, then, is best reserved for those whose timeline to buy a home is flexible and can afford to wait out any fluctuations in the market. As a rule, the stock market generally recovers from downturns over time, and funds held in stocks achieve healthier earnings in the long run.

If you're are unsure of how to choose a broker or you can check out this list of the best online stock brokers.

If you want convenience above all else, you'll do perfectly well with a saving account at the brick-and-mortar bank you may already use. If you want a little more return, and don’t mind waiting on transfers between banks, you can look to an online bank and earn more interest. If you can take the risk, investment accounts offer the best returns, but also present the highest risk that the value of your down payment fund might drop in the short term at the point when you need the money.

Given that you'll likely save tens of thousands of dollars for a down payment, it's wise to carefully research where best to hold that money, and choose the option that aligns with your needs and priorities.