Owning a home is a financial goal for many Americans. For those who live in the most expensive real estate markets, like the New York City area, the D.C. area, the Boston area and pretty much the entire states of California and Hawaii, that goal may appear hopelessly out of reach. Median housing prices in these regions are astronomically high compared to the U.S. median home price ($252,800 as of May 2017). How do you save enough for a home down payment when you are already paying very high rent as a percentage of your income? It can be done, but it’s not likely to happen the traditional way.
Make sure it makes sense to buy.
Buying a home is likely to be the largest financial commitment you make in your life. Make sure that it really makes sense to buy instead of continuing to rent. As I mentioned in a recent post about saving for a down payment on a first home:
“Real estate is like marriage. The wrong choice can really mess up your life. Renting, on the other hand, is like dating. It’s something you should keep doing until you are sure you want to settle down and are ready for a committed relationship. Many people are happy dating – and renting – for a long time before they decide to commit.”
If you are ready to commit to a geographic location (and school district, if you have kids), the next step is to evaluate if it makes sense in your geographic market. Is it cheaper to rent or buy? Use this tool from the New York Times to run the numbers.
Calculate your home budget from your rent.
If you are renting, you may already be paying a mortgage, interest and property taxes – your landlord’s. Use your monthly rent as a starting point for how much you can realistically afford to pay every month in total housing costs. Last week, I spoke to an employee on our Financial Helpline who wanted to buy her first home in Southern California. She and her husband paid rent, not including utilities, of $2,800 per month. We ran some numbers (see the calculation here) and determined that if their housing costs were similar, they could support a mortgage of $460,000 to $510,000.
You can run your own assessment with this calculator. Make sure you include assumptions about down payment, mortgage term, mortgage interest rate, private mortgage insurance (mandatory with a low down payment mortgage), homeowner’s insurance and property taxes. Don’t forget:
- If your current rent includes utilities, make sure you back out the average cost since you’ll be paying those directly as a homeowner. Keep in mind that if you’re increasing your home size (e.g., from a 2-bedroom apartment to a 3-bedroom single family home) your energy costs will probably increase.
- If you’re looking to buy a condo or home, your current rent must support a mortgage, interest, insurance, taxes – and possibly HOA fees.
- Home maintenance will be extra. Be prepared to budget an additional 1 to 4 percent of your purchase price annually for the care and upkeep of your home.
Don’t fixate on one neighborhood.
You may love where you are living now, but there is more than one neighborhood for everyone. You may find that looking outside of your current area opens the possibility of lower home prices, better schools or a more spacious home. I suggest you house hunt in a minimum of three different neighborhoods before you settle on your top target location.
Look at your trade-offs.
For example, if you live closer to your workplace so you can walk to work and to the grocery store, you might be able to give up one car. Conversely, it may be worth paying more to keep your child in their school. Consider the commute time and the effect on family life. As the saying goes, you can have anything you want but not everything you want.
Explore first time homebuyer programs.
Lenders typically require that home buyers pay at least 20 percent of the home’s purchase price and will offer a mortgage of up to 80 percent of the appraised value of the home. In an insanely expensive real estate market like Southern CA or the NYC region, where median home prices are very high, a 20 percent down payment could amount to several years’ salary. Accumulating that large of a down payment may not be realistic while you are paying high rent each month, but that does not mean you can’t buy a home. You could be eligible for a low down payment mortgage backed by the FHA, VA, USDA, or Freddie Mac, with some as low as 3 percent of the purchase price. Explore all the first-time home buying programs summarized in this article.
City, county, and state governments may also offer down payment assistance programs, so check and see if you qualify. For example, I encouraged the helpline caller I mentioned to check out the CA Housing Finance Agencyfor down payment assistance as it appeared that she might qualify based on her household size and income. A similar family in NYC could check out their Home First Down Payment Assistance Program.
Downsize your lifestyle while saving for a down payment.
During the 1-3 years prior to your home purchase, consider downsizing your lifestyle to save as much as possible for your home down payment, closing costs, and moving expenses. If you can shave off just $10 per day by eating at home more and put that money away in a savings account or money market fund, you will have $10,800 after three years. (See calculation here.)
Let’s say you downsize from your 2 bedroom to a studio apartment and save $600 per month. After 3 years, you’d have $21,600. (See calculation here.)
Do both? That’s $32,400 after 3 years. (See calculation here.)
Perhaps you have kids and it’s not realistic to move into a smaller space? Consider downsizing other areas of your financial life, such as going from two cars to one. I gave up my car in my thirties when I lived in an urban area and our Forbes blog editor Erik Carter went carless last year. We both saved thousands in transportation costs. If you’ve got kids, it may be impractical to get around everywhere without a car, but do you really need two?
Even if you can’t downsize your housing or your transportation, you may be able to downsize other areas of your lifestyle, such as cooking more at home, managing the high costs of your children’s sports, and foregoing some small luxuries while you prioritize home savings. Need more ideas? Check out my post on 11 Easy Ways to Save Money Without Changing Your Lifestyle.
Maximize your credit score.
The higher your credit score up to a certain point (about 760), the better the mortgage interest rate you will receive. Those homebuyers with better credit will be more likely to be eligible for a lower down payment program than those with poor scores (although programs are available for both). A lower mortgage interest rate also means you’ll be able to buy more home for what you can afford every month. While it can take 5-7 years to dramatically improve your credit score if it’s very low right now, you may be able to improve your credit score incrementally and quickly by using these tips.
Consider multi-family housing.
Are you interested in also being a landlord? Both conventional (20% down) and flexible down paymentFHA or Freddie Mac backed loans are available for owner-occupant duplexes and small (up to 4 units) buildings so you and your family could live in one unit, and you could rent out the remaining units. If you have long term leases in place before purchase on the other units, you may be able to use the projected rental income to help qualify you for the loan. If you think you have landlord potential (take this quiz to find out), a multi-family home may help you get in your own home and build a portfolio of investment properties.