Down payment or emergency fund: how to split your savings

What lenders require you to keep

Lenders call savings left after closing "reserves," usually measured in months of the new housing payment. Fannie Mae's Selling Guide explains that the minimum varies with the transaction, occupancy, number of units and other financed properties. For loans run through its Desktop Underwriter system, it lists:

• Two months for a second home.
• Six months for a two- to four-unit principal residence, an investment property, or certain cash-out refinances.
• Reserves equal to the balance of any 30-day charge accounts.
• Any additional reserves DU asks for based on its overall risk assessment.

For many one-unit principal residence purchases, there is no fixed minimum at all. Manually underwritten loans follow Fannie Mae's eligibility matrix, and FHA, VA and USDA have their own rules. The takeaway is that a lender's minimum is often zero or close to it. That is a floor for getting approved, not advice on what is safe for you.

What a bigger down payment buys

More money down does three things:

1. Lowers the loan and the payment. Each extra $10,000 down on a 30-year loan at 6.5% trims about $63 a month from principal and interest.
2. Reduces or removes mortgage insurance. On a conventional loan, reaching 20% down generally avoids PMI. The CFPB explains that PMI can also be cancelled later once your balance reaches 80% of the original value, and must end automatically at 78% if you are current.
3. Builds equity from day one, which helps if values dip or you need to sell early.

What it does not do is help you in an emergency. Equity is hard to reach: getting it out means borrowing against the home or selling it.

What a cushion protects you from

The CFPB's guide to emergency funds describes them as a cash reserve set aside for unplanned expenses such as car repairs, home repairs, medical bills or a loss of income. Without one, it notes, people often turn to credit cards or loans, or pull from retirement savings, and those choices can leave lasting damage.

Homeownership adds risks a renter does not carry. The CFPB points out that when something breaks, such as a furnace, a roof leak or a sewer backup, the owner has to pay for often expensive repairs right away. Your first year in a home is when you discover what the inspection missed.

Sizing your cushion

There is no official number. The CFPB suggests looking at the unexpected expenses you have actually had and how much they cost, then setting a goal from there. For a new homeowner, a practical approach is to think in two parts:

• Living expenses. A few months of total expenses, including the new mortgage payment, to cover a job loss or illness.
• Repair fund. A separate amount for the house itself, sized to the age of the roof, heating and cooling system and water heater you are buying. Your inspection report is the best guide.

If the cushion you want plus the down payment you want exceeds what you have, you have three choices: put less down, buy a less expensive home, or wait and save more.

Where to keep the cushion

An emergency fund needs to be safe and reachable. The CFPB suggests keeping it in a place you can get to quickly but are not tempted to dip into. A savings account at a bank or credit union is the usual choice. The FDIC explains that deposits at insured banks are protected up to $250,000 per depositor, per bank, per ownership category, and credit union accounts have similar coverage through the NCUA.

Avoid tying the cushion up in investments that could fall in value just when you need them, and do not count retirement accounts as your emergency fund; early withdrawals can bring taxes and penalties.

When to tilt toward a bigger down payment

Putting more down can make sense when:

• Your income is stable and you have other savings outside this pile.
• The extra amount gets you to a threshold that removes mortgage insurance or improves pricing.
• The home is newer or has recently replaced major systems, lowering near-term repair risk.

Tilt toward a bigger cushion when your income varies, you are the only earner, the home is older, or you have dependents relying on you.

The bottom line

Lender reserve rules are a minimum, often zero, not a safety plan. Decide first how many months of expenses and how much repair money you want left after closing, then let the rest go toward the down payment. Use the calculator to see your months of cushion at each down payment level, and keep the cushion in an insured account you can reach fast.