Where to Keep Your Down Payment Savings: The Good and The Ugly

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A down payment on your first house is probably the largest single sum of cash you’ll ever put together outside of retirement savings. Assembling this bundle of dough in an ultra-low-interest rate environment is enough to turn you into the kind of person who complains about interest rates at parties—and if you go to the kind of parties I do, there will be plenty of people to complain right along with you.

Well, I have bad news and good news. The bad news: there is no magic way to earn high interest without taking considerable risks with your down payment money. “If you’re going to need the money in three to five years, that’s still too short a time frame to edge out into something riskier like stocks,” says Richard Barrington, personal finance expert for MoneyRates.com. “You can’t guarantee the money is going to be there when you need it.”

The good news—for you, at least, not your poor neighbors—is that home prices continue to fall. Will that trend continue over the next few years as you feed your down payment piggybank? Nobody knows. For now, however, even the money in a lousy savings account is growing faster than the price of housing, which should put low interest rates in perspective.

Let’s assume you want to save up for a substantial five-figure down payment and have three to five years to do it. Here are four good places to keep your down payment savings, and two ugly ones.

Good: Online savings accounts


A savings account, whether at an online bank or your local branch, is FDIC-insured up to $250,000 for an individual account or $500,000 for a joint account. (And if you have a $500,000 down payment, pick me up in the Bentley, because I’d like to swim in one of your many pools.)

But online banks almost always pay more interest. “It’s very rare to have a brick and mortar savings account that has any decent rates,” says Ken Tumin, founder of DepositAccounts.com.

Rates: 1% to 1.25% for unrestricted accounts. Online savings account rates at DepositAccounts.com.

Good: Certificates of deposit

CDs are also FDIC-insured, and if you agree to lock up your money for several years, they’ll reward you with a higher rate than a savings account. If you have your down payment in hand right now but aren’t planning to buy for a couple of years, a CD is the way to go. If you’re putting aside money every month, however, CDs are a pain. Most have minimum balances, and you’ll need your down payment all at once, not spread out over several months as a bunch of CDs mature.

“When you reach a certain critical mass, maybe you can move some of it over into a higher-yield CD,” says Barrington.

Tumin points out that Ally Bank’s 5-year CD pays 2.4% APY and has only a 60-day withdrawal penalty. That means you can break the CD early, pay a small penalty, and still earn a much better rate than a savings account.

Rates on 5-year CDs: Up to 3%. CD rates at Money-Rates.com.

Good: Reward checking

Did you know a checking account can pay higher interest than a savings account? It’s true! And all you have to do is be the bank or credit union’s trained monkey and jump through a few flaming hoops. This usually consists of making a dozen debit transactions per month, using online bill pay, having your paycheck direct-deposited, and taking e-statements rather than paper statements.

Obviously, using your down payment stash to shop a dozen times each month isn’t a good idea, but there are easy ways around it, like depositing back every vent that goes out through your debit card. Play by the rules, and you’ll earn up to 3% interest on balances of $25,000 and under. Fall short by one measly debit and you’ll get 0.1% for that month.

Rates: 2% to 3% on balances under $25,000. Reward checking at DepositAccounts.com.

Good: I Bonds

Remember when I said there was no magic investment that was both safe and paid high interest? I Bonds are a wee bit magical. They’re US savings bonds, issued by the Keebler elves at the US Treasury, and are as safe as a CD. They pay interest linked to the rate of inflation. Currently, they’re paying—this is not a typo—4.6%.

You have to hold onto I Bonds for at least one year, and then you can redeem them any time (though you’ll pay a small penalty if you redeem them in less than five years). Furthermore, you can set up an automatic purchase program to buy I Bonds every month via the Treasury Department’s web site, TreasuryDirect, just like setting up an automatic transfer to a savings account. “That would definitely be a good option,” says Tumin. “For the next year, you’ll have a return of at least 2.3%.”

The downside to I Bonds: an individual can only buy $10,000 worth per year ($20,000 for a couple), and buying the full amount is a pain, because half of them have to be paper bonds and half electronic bonds. Still, $20K is a lot of money, and are you going to pass up earning 4.6% for at least the next six months? Me neither. Flaming hoops, here I come.

Rates: Adjust every six months; currently 4.6%. More information from TreasuryDirect.

Ugly: Bond funds

When interest rates dive, corporate or government bond funds tempt savers with the promise of higher yields. Don’t be lured in, says Barrington. “That yield and even the principal aren’t necessarily guaranteed,” he says. “And so you may run into a volatile period where within a three to five year time frame, you don’t get the return you thought you’d be getting or you even experience a negative return.” Think about how your spouse or partner will feel when you break the news.

Ugly: Money market funds

Unlike a bond fund, you’ll almost definitely get your principal back from a money market mutual fund—but that’s about all you’ll get. Money market funds are offering close to zero interest; in fact, many offer literally zero. Sure, you shouldn’t take risks for a little extra yield, but don’t be a chump, either.

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