How do you save for a home?
Beth tells Michael and Samantha-and anyone else who has trouble saving-what to do.
They worry about money. They obsess about it. Sometimes they even fight about it. What Samantha and Michael aren't doing is saving enough of it.
- Set specific (and realistic) goals.
Samantha knows all about her ideal home: It will be a three-bedroom spread in Westport, Connecticut, with about two acres of land. Sounds heavenly. Unfortunately, heaven doesn't come cheap. Samantha's dream house could easily cost $1 million-which is far more than our newlyweds can afford.
In fact, in the wake of the housing crisis, it can be harder to get a home at all. Lenders are much more reluctant to take a chance on risky borrowers these days. That means Sam and Mike should work to make sure their credit is in the best possible shape by the time they're ready to apply for a mortgage.
They can get their credit reports from all three major reporting agencies for free at AnnualCreditReport.com. If they find any errors, it's important to start the process of correcting them now. Their credit scores aren't free, but they can get them for about $16 apiece from FairIsaac.com.
The most important thing Sam and Mike can do to protect their credit is pay all of their bills on time; not being late is the single biggest component of their (or anyone's) credit scores. Mike's tendency to flake out and leave the mail unopened on the coffee table has hurt them here in the past. Beth recommends they sign up online to pay all of their major accounts (utilities, credit cards) automatically every month, or at least get reminders sent to their email or cell phones that a payment is due.
Sam and Mike should also start saving now for a down payment. The days of zero down loans are over, and today most lenders want to see borrowers come up with at least 20% of the cost of their new home. (There are special programs that can reduce this requirement to as little as 3%, but the more you can put down, the better.) And they should also budget for moving expenses and the "closing costs" associated with buying a home-these added costs will probably come to at least $10,000 that Sam and Mike should save over and above their down payment. - Save 15% of your gross income.
This is considered a reasonable goal by most financial planners. It will take effort, as our couple is currently saving only about 5%. With their $130,000 gross income, they should be saving about $19,500 a year instead of the $7,000 they're saving now. That leaves a hole of $12,500 that they will have to plug with a new budget.
To help Mike and Sam get a handle on where their money goes each month, Beth asked them to keep a spending diary. For one week they kept track of every penny they spent. (See their budget here.) The diaries show that Sam and Mike have a few expensive habits-cigarettes and coffee for Michael, taxis to work ($10 each way) for Samantha. They may decide that these habits make them happy and are worth keeping. But if they truly want to buy a home in five years, they will have to make some hard choices.
Some obvious spending areas to cut: vacations ($6,000 a year seems more than necessary); clothes ($6,000 is a lot of money); gifts for friends ($3,600 sounds high, and Sam and Mike admit they probably overspend); and dining out ($8,400). By reducing these costs, they could save more than $8,000 a year. - Find a cheaper bank and limit ATM trips.
Bank fees may not look like much-$2 here, $1.50 there-but they sure can add up. In fact, Samantha and Michael pay an astonishing $1,700 a year in bank fees alone, most of which can be avoided.
For starters, they have three checking accounts: his, hers, and joint. Okay so far, but because these are interest-bearing accounts, the bank requires them to keep $6,000 on deposit in each account to maintain free checking. Since they hardly ever meet that requirement in any of their accounts, they end up paying three maintenance fees every month. The minimal interest their money earns (0.10%) doesn't even begin to cover the $432 a year the bank is charging them.
As it happens, there are a lot of banks out there that provide free checking. All Sam and Mike need to do is shop around on sites like Bankrate.com and BankingMyWay.com. In addition to switching banks, Michael must curb his ATM habit. Instead of going twice a day, he needs to figure out what his expenses will be and withdraw the cash he needs once every two weeks. Samantha should do the same. This will also help them stick to a budget more easily. Ideally, they'll use their new bank's machines to avoid the fees that other banks would charge.
(Some Internet-based banks have free checking accounts and pay interest, but they'll have to watch ATM charges if they go in this direction. Again, Bankrate.com has a list.)
WHAT MIKE AND SAM COULD SAVE
TOTAL SAVINGS: $12,500 per year - Get out of individual stocks.
Michael and Samantha received $28,000 in wedding gifts from generous friends. Based on advice from a relative, the couple invested this cash in six individual stocks. Tragically, they made these investments right before the market headed down. Current value of those stocks: $13,000!
Mike and Sam should sell their money-losing individual stocks and put the money to better use elsewhere. Our happy couple also has nearly $6,000 in credit card debt, all of which is being charged at least 19% interest. They also owe nearly $4,000 in other loans. This debt is dragging them down financially (and hurting their credit rating as well). The best investment they can make is to pay it all off right away. (For a more detailed explanation, see Get Out of Debt).
Sam and Mike should take $10,000 of the money they will make from selling their individual stocks, and use it to wipe out their credit card debt and other loans. To avoid getting in debt in the future, they should pay off their credit card balances every month. - Max out your 401(k)s and IRAs.
In May 2000, Michael signed up for his company 401(k). He currently puts away about $500 a month ($6,000 a year) into his plan. But at his income level, his company would match an additional $3,000 a year in contributions. He should do so, especially because his company allows him to borrow against his 401(k) to buy a first home.
Michael and Samantha should also put up to $5,000 a year into Roth IRAs, up from the $1,000 that Sam already contributes. Roth IRAs permit penalty-free withdrawals of up to $10,000 for first-time homebuyers. - Get into mutual funds.
Sam and Mike should take the $3,000 left over from the sale of their individual stocks-as well as the new money derived from their budgeting-and invest in mutual funds.
By focusing on where they want to be in five years, Michael and Samantha have learned that they will need to save at least $9,000 more a year than they currently do. That's not easy. But with a combined income of more than $100,000, it can be done. And by paying off their credit card and other debts now, they are not only saving themselves a lot of money but also improving their credit scores-which will help them get better terms on their mortgage when they shop around for one a few years from now.
Because they will be saving more each year, Sam and Mike will be better prepared in five years to have a child. If they do, of course, they will probably find themselves tightening their belts even further. But some saving will no doubt occur naturally: Samantha and Michael won't be able to eat out as much if they have a child, for example, or take as many vacations. For now, they're on the right track.