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How to Save Money If You Want to Buy a House

Oct 24, 2017 5 min read George Mannes

Key Takeaways

  • Can you afford it? Figure out first if you should buy or rent.
  • Avoid paying mortgage insurance by putting down at least 20%.
  • Are the rules different for buying a second home? Nope.


Like many Americans, Kate and Will dream of moving into their own home. In fact, the couple — video producers who are engaged to be married — are so focused on buying that future home that, in order to save money, they’ve moved out of their respective apartments and are living, rent-free, in the converted attic of Kate’s parents’ home. “I admit that this cramps our style,” says Kate. “But the sacrifice is worth it.”


The affordability test

It’s no surprise that Kate and Will (not their real names) are pinching pennies like this. With the median home price in the U.S. now over $230,000, a home is probably the costliest thing that they, or you, will ever spend money on. The important thing to focus on, however, isn’t whether a home is expensive; it’s whether it’s affordable — to you.

How do you judge affordability for a purchase that will likely require a down payment in the thousands or tens of thousands of dollars, plus a mortgage that’s designed to be paid back over 30 years?

Start with your income, financial professionals say.

One quick way to estimate how much of a monthly payment you can afford is to divide your annual gross income by 12 — and multiply the result by 0.28, says Cary Carbonaro, managing director at United Capital and author of the book, The Money Queen’s Guide.

The dollar amount you end up with is the most you should consider spending on monthly housing costs: your mortgage payment (principal and interest combined), property taxes, and insurance. So, for example, if you had $72,000 in annual income, you’d take 1/12 of that, or $6,000, and multiply that by 0.28 to arrive at a maximum monthly fixed housing costs of about $1,680. That amount, equal to 28% of your average monthly gross income, is “a great rule of thumb,” Carbonaro says.

To ballpark your possible housing costs you can use one of the many mortgage calculators on the internet; a good one is Zillow’sOpens in a new window, which makes it easy to see the impact of property taxes and insurance on the affordability of a particular purchase.

While the 28% formula is a useful guideline — one that will probably help determine how much a bank is willing to lend you - keep in mind that a bank might be willing to lend you more than you can comfortably afford to pay, says Jude Boudreaux, founder of Upperline Financial Planning in New Orleans.

In part, that’s because those monthly payments are only part of the cost of owning a home. You’ll also have to pay for utilities, such as water and electric, and any repairs that pop up, like a broken air conditioner or a leaky roof. As Boudreaux puts it, “You always want to have some cash available to take care of the relatively predictable but unpredictable things that happen when you own a home.”

So you have to take a good, hard look at your cash flow, which Boudreaux divides into three different elements: money that you’ve already committed to paying, such as a car loan or student debt; money you need to cover your day-to-day expenses, such as food, transportation, clothing, phone service and entertainment; and money you’re saving for future needs, such as retirement.

Any mortgage payment will have to come out of your current spending or savings for the future, so set your sights on a home that you’ll enjoy but won’t cost so much that, as Boudreaux puts it, “you can’t enjoy anything else in your life.”


Putting money down

Before those monthly costs hit your bank account, though, you’ll have to come up with a down payment. How much will you need for that? With a Federal Home Administration (FHA) loan, you can buy a house putting down as little as 3.5% of a home’s cost upfront. But financial professionals suggest saving up for a 20% down payment.


The smaller your down payment, the higher your monthly mortgage bill — and the more interest you’ll pay over the life of your loan.


One reason, says Boudreaux, is that if you can save up that amount, it’s a good sign that you’ll be able to manage your household cash flow in the years ahead, when you’ll have the added financial pressures of owning a house.

Another reason is that if the down payment is smaller than 20%, you’ll have to pay what’s known as mortgage insurance, which protects the lender financially if you default on your home loan. That insurance can add up. If, for example, you put 3.5% down and got an FHA loan to buy a starter home priced at $116,000 (about half the current cost of a median-priced single-family home in the U.S.), on top of a regular mortgage payment of at least $500, you’d pay about $100 in insurance premiums every month.


Saving up to put money down

As for building up that down payment, how you save it is largely a function of how soon you want to buy. The closer you are to buying a house, and the less willing you are to put off your plans, the more likely you should consider putting that money in the bank, even if interest rates are low.

“If I’m planning to spend something in the next two years, I don’t want to have that subject to market risk,” says Boudreaux. “The chance that we’re up 10%, I don’t believe, is worth the chance that we’re down 10% when we find that right place. What we get, hopefully, is some stability and the ability to move when the right opportunity presents itself.”

If you don’t expect to buy a house for several years, or if you’re willing to be flexible, it may make more sense to invest in the market, where you have the chance for higher returns than you would in a bank account. David John Marotta, president of Marotta Wealth Management in Charlottesville, Virginia, suggests using a Roth IRA as a savings vehicle. Currently, depending on earnings, taxpayers can contribute up $5,500 per year apiece ($6,500 if age 50 or older). Earnings in a Roth IRA grow tax-deferred, and aren’t subject to federal tax upon withdrawal if you have had the Roth account for five tax years and are over age 59 ½, disabled or die. You can withdraw up to $10,000 in earnings for a first time home purchase without paying the 10% tax penalty for a first time home purchase (note this is a lifetime limit). You can withdraw contributions at any time without income tax or tax penalty.

If you’re trying to save up for a house, Moratta proposes allocating the money in a nicely diversified portfolio, “If, over a five-year period, you get a return over inflation, you have more for a down payment.” Boudreaux suggests investing in a balanced fund comprising roughly 60% stocks and 40% bonds.

“Hopefully, we can get some return, but we’re not taking on a big amount of risk,” he says.

Just remember diversification does not assure a profit or protect against loss in declining markets and it is possible to lose money when investing in securities.


Second home

Are the rules any different if you’re saving up for a second home?

Not really, say professionals. “I go through this all the time with clients; everybody wants to buy a second and third home,” says Carbonaro. But whether you have one home or two, you still should keep your total housing costs under 28% of income, says Carbonaro. “I’m super-conservative,” she acknowledges, “but it’s served me well.”

Marotta also advises taking a tough look at second homes. Pretend you’re thinking of buying a $400,000 beach house, he says. Let’s say you took that $400,000 and invested it elsewhere. Is the money that the $400,000 investment would generate each year more than it would cost to rent a home for the time you spend at the beach? If so, rather than buying the house, he says, “you would do better to rent the nicest house you could for two weeks.”


What you can do next

Build up your down payment. The larger it is, the wider a selection of homes you’ll have. To make saving easier, establish automatic monthly payments to an account dedicated to your housing fund — one which is hard for you to raid in a weak moment (and definitely doesn’t come with an ATM card). “Set it and forget it,” says Cary Carbonaro. “If given the choice to save, you won’t. It’s human nature.” For extra motivation, put a picture of your dream home on your refrigerator, she says. “Just so you know why you’re doing what you’re doing.”



George Mannes, a former senior editor at Money, has been writing about investing and personal finance since 1998.


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