Additional Information

Retirement Accounts

The IRS has gradually taken away a lot of our tax write-offs in the past few years. One thing that has remained, though changed in some ways, is our ability to put money into a retirement account and reap the tax benefits. This is a very desirable benefit and one that everyone should consider.

Money placed into a 401-k or 403-b is usually tax deductible, saving you from paying the taxes on these funds in the year for which the contribution was made. The money you earn from these investments compounds over time and you do not have to pay the taxes on this money.

The sooner you start to deposit money into an IRA account the better. The advantages that can be taken from the compounding of the earnings on this type of account can be staggering. Consider the following scenario: A man at age 22 invests $2,000 per year into an IRA for eight years. He invests a total of $16,000 and then, at age 30 stops adding any money. When he retires at age 65, he will have amassed $642,750, assuming he reinvests his capital gains and earns an average ten percent rate of return.

Let’s look at what would happen if the same man were to wait until he was age 30 to start saving. He put $2,000 per year into his IRA for every year until he retired at age 65. He invested a total of $70,000 and accumulated $542,050.

Why would he have $100,700 less, if he invested over 4 times more? It’s the power of compounding. The sooner you start saving, the longer the money has to grow.

Putting money into some type of a retirement account is a good idea, both for the savings and the tax benefits. One thing you do not want to do is put money you are saving for a home or some other short-term goal into this type of an account. Withdrawals from this account prior to age 59 1/2 will incur a penalty. Besides paying the taxes on this money, you will also pay a 10% penalty to the federal government and usually an additional penalty to the state.

Some people have borrowing privileges against their employer’s retirement-savings plans. With these arrangements you can fund for your retirement, reap the tax benefits, and also borrow your own money for the down payment of a house. Be sure that you understand that this money must be paid back, and what those payments will be.

Your Down Payment

It can be difficult in a rising home price market to accumulate enough money for a 20% down payment. In fact many loans are now available with a 3, 5 and 10 percent down payment. It is important to keep in mind though that these lower down payment mortgages have additional costs added into them.

A mortgage lender is most likely going to require you to obtain mortgage insurance if your down payment is less then 20%. PMI (private mortgage insurance) typically adds several hundred dollars to $1,000 or more annually to the cost of your loan. It protects the lender financially in case you default.

PMI is not a permanent cost. You should no longer need PMI once you can prove you have 20% equity in your property. Equity is the current value of your home minus the balance of your loan. The 20% can come from loan pay-down, appreciation, improvements, or any combination of these. To remove PMI most lenders require an appraisal of the property at your expense.

Saving For Your Down Payment

The first thing you must decide is how much money you will need and how much you need to put away each month to get there.

The type of investment you choose to accumulate your savings will depend on your timeframe for home ownership. If you plan to purchase a home within the next 5 years you will have to be more cautious with your investment because there won’t be enough time to make up for any downturns in the market. That puts any type of stock purchase or stock mutual fund out of the picture entirely.

There are other types of mutual funds however. A money market mutual fund is invested in only safe securities. You will not have to worry about losing you principal. Bank savings accounts will also pay interest but usually at the same amount or less then the best money market.

If you really want to save at a bank, shop around. Smaller savings and loans or Credit Unions sometimes offer higher rates.

If you expect to be saving for over 5 years you can look at a few other more risky investments. Specifically long-term bonds and stocks. A bank certificate of deposit may also be a good investment.

Are You Financially Prepared?

Certain things in life are done one step at a time. Putting on your socks before your shoes for example. There is usually a good reason for the steps involved. Before you jump headfirst into home ownership take a look at your whole financial picture. No one can do this but you. No one else will care how the purchase of a home will affect your particular situation the same way you will.

What Are Your Spending Habits?

Most people have a spending pattern. They earn an income each month and either spend all of it, some of it, or maybe even more then they are earning. The average American saves less then 5% of their take-home income. This is considerably less then the average industrialized country. If you intend to buy a home, it is best to be the type of person who consistently saves more than 5% of their income.

First, you need to save money for a down payment. You can try to obtain the money you need from relatives. Unless you are putting down at least 20%, most lenders will require that you have at least 5% of your own money into the purchase. With some relatives there can be strings attached to a gift, so make it clear up front if there is anything expected of you.

After you buy your home there will be additional expenses each month. If you have already developed a pattern of setting aside money to go into savings, it will be less difficult to come up with the extra money needed for these additional monthly expenses.

Click here for the Financial Worksheet (PDF).

Trimming Your Budget

You may need to trim your budget in order to save enough to buy a home. This reduction in monthly expenditures will also come in handy after the purchase to allow you to afford other costs involved with home ownership.

The first thing to look at when trimming your budget is current balances on credit cards and auto loans. It is a good idea to reduce or if you can, eliminate these expenses entirely. The interest on this debt is usually high, and not tax deductible. You will be doing yourself a great financial favor by ridding yourself of this debt.

If you currently have savings that you could use to pay off this debt you should consider doing so. The interest being earned on your savings accounts probably does not come close to what you are paying on this debt each month. Also consider that the interest you are earning on your savings is taxable. Be sure you can access emergency funds should you need to, either through family or friends.

If you cannot pay off your debt, consider looking into obtaining lower interest rate credit to refinance your debt into. Then try to reduce your spending and use that money to pay down your debt.

It would also be a good idea to close most of your credit card accounts. If you pay with a credit card because of its convenience you should consider using your bank debit card instead. This card can generally be used like a Visa or Mastercard but the money is automatically deducted from your checking account. That way you are only purchasing items from accessible cash. This also gives you an excellent record of your spending.

Next go through your budget and cut out items that are not necessities. Focus your spending with an eye on value. Small adjustments can add up to a lot of money over time.

Once you have analyzed your spending you should come to only one of 3 different conclusions:

You spend too much: When some people analyze their spending they become horrified at how much certain small extravagances are costing them. Even a small cost adds up over time. You must decide where to make the reductions, and stick with your decision.

You’re saving just enough: Maybe you’ve already made the decision to save and have been doing so for some time. Great! Just remember that buying a home can put some changes into your current savings plan. Make sure you review your current savings plan with the added costs of home ownership worked in.

You save a lot: If you are one of these rare people who can save a large portion of their earnings, congratulations! You may be able to stretch the amount you spend on a house and borrow more then you expected.

How Much do You Need to Save?

Most people don’t know the answer to this one. You need to have money saved for things other then the purchase of a house. Everyone should have at least three months worth of living expenses put away in an accessible savings account at all times. That is a minimum. Knowing your savings goals and planning on how to achieve them is something that should be addressed before you ever purchase your first home. Each person’s situation is different, and that makes their savings goals different also.

First Set Your Goals

You don’t need to know exactly what you want to do in the next 40 years, only some idea of what you want. Even if you are sure that you don’t want to retire, it is important to put some money aside anyway. Things can change, and it is best to be prepared.