When you think about buying a house, saving for a down payment is probably one of the first tasks that comes to mind. Setting aside such a large amount of cash may also leave you wondering where to save your money for a house.
The answer is not a simple as you think — and depends on how soon you plan to buy a home and your personal finance habits.
If you’re not sure where to save money for a house, consider the following types of accounts and if they may make sense for your situation.
If you’re buying in the next 5 years
With a relatively-short time span, you’ll likely want an account that allows you to continually put funds into it while also being able to earn some return on your cash — all without putting your money at too much risk.
Here are some options to consider if you’re buying in the next five years.
High-yield savings account
Storing cash in a high-yield savings account is typically the easiest choice as you can open an account quickly — many online banks can help you open one within minutes — and you can transfer money whenever you want, whether it’s through automated or manual transfers. You can also withdraw the cash at any time, though savings accounts limit you to six withdrawals a month.
Because you’re not investing your money, your savings aren’t put at risk. Plus, high-yield savings accounts are often insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), typically up to $250,000. That means if the bank fails, your money won’t be lost.
High-yield savings accounts typically earn much higher interest than other types of savings accounts — though the returns may be lower than some other kinds of accounts. A savings account also may not be the best choice if you’re tempted to withdraw the cash to spend on other purposes.
A certificate of deposit (CD) is a type of account where you put your funds aside for a predetermined amount of time — usually anywhere from a few months to a few years. In turn, the bank will offer you a guaranteed rate of return. Typically, the longer the term, the more interest you’ll receive.
The advantage of a CD is that you could get a higher rate of return than a high-yield savings account, and you’re guaranteed a rate of return. If you’re the type that doesn’t want to be tempted, a CD can be great because you can’t access your funds until your contract matures. CDs are also typically FDIC- or NCUA-insured.
However, most CDs don’t allow you to deposit more funds once you open the account. That means they’re usually best for saving a larger lump sum, rather than setting aside a smaller amount each month.
And if you’re not sure when you’ll need the cash, keep in mind that your money is tied up for a specified amount of time. If you try to withdraw it early, the bank will likely charge a penalty — which could be a large chunk of the interest earned.
Money market accounts
A money market account is similar to a high-yield savings account; it can be a great way to earn some returns and gives you the option to deposit money whenever you want. You can typically open these accounts online or at your local bank, which may be a good choice if you want to bank at a brick-and-mortar location.
Your money is typically FDIC- or NCUA-insured, which protects your funds in case the bank fails. Some money market accounts also offer limited check-writing capabilities and even debit cards, which may be more convenient compared to savings accounts that typically only offer online transfers.
Although you could get a decent rate of return compared to other savings accounts, some money market accounts require a higher opening deposit or account minimums — which may not be the best choice if you don’t have a lot of money to start with.
Money market accounts might work for those who want more immediate access to their funds — perhaps you’re considering keeping your emergency fund with your home down payment and want to be able to access the money in a pinch.
But don’t confuse a money market account with a money market fund, which is invested in the market and can carry more risk than a money market account.
Also known as T-bills, Treasury bills are issued by the U.S. government to help fund different public projects. Think of a T-bill like an IOU from the government, where you’ll earn a guaranteed rate of return over a specified amount of time, similar to a CD.
You purchase the Treasury bill at a discount, and when it matures, you receive the face value. For example, say the face value is $2,000 and you purchased it for $1,950; you’ll receive $2,000 upon maturity, earning you $50.
Although Treasury bills aren’t insured, they can still be a safe bet since they’re backed by the government. You can purchase them directly or through a bank or broker; both methods require you to go through auction, though the bid selection can differ.
T-bills can be more flexible than a CD because you don’t have to wait until maturity to cash out — you can resell them in a secondary market. If you decide to resell before one matures, your T-bill runs the risk of being sold for lower than what you originally paid, meaning you’ll experience a loss in your investment.
Another disadvantage is that you won’t receive interest until your treasury bill matures, and the returns may not be as high as other options. In addition, the terms are short (anywhere from a few days to a year), which means it’s a more active type of investing; this may not be as attractive to investors looking for a more hands-off approach.
If you’re buying in 5 or more years
For those who don’t plan on purchasing a home for at least another five years, you might consider investing your money, since you could get a better return long-term compared to the options mentioned above. Considering markets can be volatile, the following options are best for those who can withstand some risk.
Consider investing it
Investing your money with a brokerage account can be a good idea if you can tolerate more risk. If your future home purchase is still several years away, you’ll have more time to withstand the ups and downs of the market, which can help you earn much higher returns than more conservative options like high-yield savings accounts.
Investing does offer some flexibility in that you can add more money whenever you want and sell it off whenever you intend to purchase a house. However, you will have to pay taxes on any long- or short-term gains when you sell, so take that into consideration.
A word of caution: While your money is insured if your brokerage firm goes belly up, your investments could still go down in value. You could lose money, including the principal amount.
There are also lots of ways to invest money, so make sure you do your research to understand what you’re getting into, including fees and the types of accounts to invest in.
Rethink your IRA
It’s generally frowned upon to tap into your Individual Retirement Account (IRA) for other purposes since that money is intended for your retirement — the IRS discourages you from withdrawing money before you’re 59.5 years old by enforcing a 10% penalty on top of income taxes on what you take out.
However, you can withdraw up to $10,000 penalty-free from your IRA to cover the costs of a house purchase if you qualify as a first-time homebuyer. If you’re married, your spouse can also withdraw up to $10,000 from their account, which could be enough for your down payment — but keep in mind this is a lifetime limit. In some states, you qualify as a first-time homebuyer if you haven’t owned a home in the previous three years.
In an IRA, your funds could yield greater returns than short-term options like a high-yield savings account. It’s also a great place to shelter your funds if you feel tempted to take money out — to withdraw money, you must go through considerably more hoops than a money market or savings account.
Unfortunately, you’re still subject to income taxes on the amount you withdraw, with the exception of tax-free accounts, such as qualified distributions from Roth IRAs. Also, you face reducing the earning potential of your IRA when you withdraw money and may find it difficult to catch up with your retirement savings.
Where to save money for a house
When you’re setting aside money for your house down payment, where you park your funds will differ depending on your timeline. If you’re saving for the short term, accounts that allow you more flexibility while balancing risk are usually best. For time frames of five years or longer, investing the money could be a good bet. Whatever you do, make sure you weigh the pros and cons of each choice.