Saving for a Down Payment Over Several Years? Here's Where to Put Those Funds

Saving for a home can take time. Here's where to stash your cash.

Most of us can't afford to buy a home outright, so we take out a mortgage to finance it. But you'll still need to make a down payment. The amount will depend on your lender and the type of home loan you get. And if you're applying for a conventional loan, it's a good idea to make a 20% down payment to avoid private mortgage insurance (PMI).

But saving that 20% can take time. Imagine you're looking at a neighborhood where the median home value is $500,000. Putting down 20% could mean you have to save up $100,000, and that's not going to happen overnight. Nor is it likely to happen in the course of a year. As such, you'll want to find a good place to stash your down payment funds while you're accumulating them. Here are some options.

A high-yield savings account

The upside of putting your down payment funds in a traditional savings account is you get both protection and flexibility. You can withdraw your money when you want it, and your principal deposit will be guaranteed for up to $250,000 per depositor as long as your bank is FDIC insured. Of course, even a high-yield savings account may not pay a huge amount of interest, especially these days. But if you're looking for a safe place to store your cash, it's a good bet.

A certificate of deposit (CD)

With a CD, you agree to lock your money away for a preset period of time. CDs tend to offer higher interest rates than regular savings accounts. They're less flexible -- you'll be penalized to the tune of a few months of interest for cashing out a CD before it matures. But they're also safe in that you get that same guarantee of up to $250,000 per depositor.

When it comes to CDs, often, the longer you agree to lock your money away, the higher an interest rate you'll snag. When you first start to save for a home, you may want to open a one- or two-year CD. But as you get closer to your savings goal, you may be better off with a six-month CD. That way, your money won't be tied up for too long.

Where not to house your down payments funds

Savings accounts and CDs are good places to put the money you have earmarked for a home down payment. In contrast, a brokerage account is not a smart choice, even though there's the potential to earn a much higher return on your cash. The reason? Your principal investment isn't protected in a brokerage account. As such, you might lose money if you have to cash out your account when your investments are down.

Generally speaking, a brokerage account is suitable for money you're not planning to need for at least seven years. But money you expect to use within a few years should be kept someplace safer -- someplace your principal is protected.

Setting aside cash for a home can be a multi-year process. And it's important to find the right home for your money while you save. Your best bet, generally speaking, is to put that cash into a savings account, CD, or combination of both. Investing your down payment in the stock market is a dangerous move that could stop you reaching your goal. So stick to safer options, even if it means you generate lower returns on your money and delay your home purchase a bit.