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Buying a home today is expensive. The median home sale price in June was $426,900, according to the National Association of Realtors. If you’re looking at a comparably priced home and want to put down 20% to avoid private mortgage insurance, you’ll need about $85,000 — ouch.
But no matter what down payment you’re trying to save up, your goal may be to earn as high a return on that money as you can until you’re ready to make an offer on a home. And you may be tempted to invest your down payment in stocks if you don’t think you’ll be ready to buy for a good couple of years. But instead of investing your down payment, putting it into a CD could be a much safer bet.
Historically, the stock market has outperformed CDs. Over the past 50 years, its average annual return has been 10%, which clearly beats the 5% CD rates savers have been enjoying this year. But investing a home down payment is risky for one big reason — you probably don’t have ample time to ride out stock market turbulence.
The 10% average annual return mentioned above accounts for years of great performance and years when the market tanked. Now, if you have, say, a 10-year window to invest your money, it makes sense to load up on stocks, because you might have more than enough time to ride out a downturn during that time and come out ahead.
But let’s say you’re trying to buy a home in the next two years. That’s not a lot of time for the stock market to recover from a slump. If you put your home down payment into stocks, you risk losing some of it — or even all of it in an extreme situation.
With CDs, your principal deposit is protected as long as it’s not more than $250,000 and you’ve chosen a bank with FDIC insurance. And while a savings account will give you the most flexibility with your money, the benefit of choosing a CD is locking in your interest rate. At a time like this when interest rates are expected to start falling pretty soon, that’s important, especially if you have a specific savings goal you’re trying to meet.
A CD could be a great place to put the money you’re saving for a home. But you need to choose your CD term carefully.
Withdrawing money from a CD before its maturity date generally results in a penalty. You don’t want that sort of penalty to eat into your down payment savings. So you’re better off erring on the side of choosing a shorter CD term than your home-buying time frame.
Let’s say you expect to be in a position to buy a home in 18 to 24 months. Your safest bet in that scenario is to stick to a 12-month CD.
You might think an 18-month CD makes sense, since it’s more in line with your estimated timeline. But your situation might change. You might get a bonus at work at the end of the year that puts you in a position where you can make an offer on a home a bit sooner. So it’s better to build some wiggle room into your plans.
Of course, if you’re completely unsure of your home-buying time frame, then it’s generally best to steer clear of CDs altogether and keep your money in a savings account, where you can withdraw it at any time without a penalty. But if you have a pretty clear sense of when you’ll be able to buy, then a CD could work out well provided you’re careful about the term you choose.
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