The thought of spending 10s or 100s of thousands of dollars on something can be daunting, to say the least. Where do you start? How much can you afford? How much do you need to save and how do you save it? Tackling the answers to these questions is pivotal to saving for a massive expense in your life. Since a home is typically the single most expensive purchase in most of our lives, it will be our main focus in this article, but whether it’s a car, a wedding, or a dream vacation, the tips discussed will still apply.
With anything like this, you need to start with the end in mind. You need to decide on a budget and what you can actually afford. The reason I emphasize “actually” is often times what the bank or a lender says you can afford or get approved for may be much more than you’re comfortable with. You need understand the total cost of buying a home including the mortgage, interest, property taxes, home insurance, closing costs and any ancillary fees relating to the transaction. Once you know what you can afford you can decide how much you need for a down payment, and I would suggest looking at it on a monthly payment basis, with a rule of thumb that your total housing expense should be no more than 28% of your gross income.
In a perfect world, 20% is typically the best down payment number, so you can avoid paying for private mortgage insurance, but for those of you looking in the $500,000-$600,000 range, 20% is going to be in the $100,000-$120,000 range. That’s a big chunk of change for most people! There are options out there for first time home buyers as well as other down payments options you can speak to a mortgage lender about, but at a bare minimum, I’d say you want to shoot for 5-10% down payment.
A strategy I’ve found extremely helpful to implement in the early stages of planning for this big expense is to start living like you’re already there. What I mean by this is (about a year or so out from the date you’d like to buy) start living and budgeting on a monthly basis like you’re already paying your future mortgage. So, let’s say you’re a first-time home buyer and are currently renting a place. If your current rent payment is $1,500 per month, and your total estimate mortgage you plan to have a year from now is going to be closer to $2,500 per month, then start treating your living expense like you have to pay $2,500 today and you’ll become more used to the larger expense while saving an extra $1,000 per month during that year. This allows you to become familiar with your new lifestyle while saving that extra $1,000 per month for your down payment. This brings me to my next point of actually saving the money you’ll need for your down payment…
We already discussed how to decide on that down payment number, and once you know the amount you’ll need, it’s all about sticking to a savings plan to save it. If you need $30,000 and you’re planning to buy in a year, you need to save $2,500/month. This part clearly isn’t rocket science, but it’s all about taking action! I’d encourage you to look at this savings goal as more of a current expense than current savings and here’s what I mean by that is; rather than saying “well I know I have to save about $2,500/month, so I hope I have roughly that at the end of the month after I pay for everything else.” If you’re truly serious about it, I would START the month by putting that money into savings. THEN whatever money you have left over is what you get to spend the rest of the month. It takes a fair amount of consistent discipline to save that kind of money, but as long as you’re committed and it’s a realistic number, you can get there.
The last piece of advice I would give is, while you’ll need to save for the big expense coming, look at ALL of your total debt outstanding and decide which of it you should try and reduce or eliminate before your mortgage begins (especially if the debt is high interest). It may cut into your savings goal or take away from the “fun money” you have remaining after you save, but eliminating the nastier debt will free up more cash flow when your home payments begin.
Saving for a big expense truly comes down to diligent planning and commitment to that plan once it’s in place. This is one of the areas of your person financial life where you do have total control and that in itself should give you confidence. Happy saving!Categories: Educational Articles, Zak Leedom