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How can we save enough for our first house?

How can we save enough for our first house? answers your questions on business, personal finance.
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Maybe it's because the year is still young and resolutions still fresh, but a lot of readers are focused this week on their savings. Melinda, a newlywed in Florida, is trying to figure out how to save up enough money for a down payment in one of the priciest real estate markets in the country.

We were married at the end of December. We would like to buy our first home this year. But we live in Palm Beach County in Florida. The average used house price is over $400,000. What are first-home buyers supposed to do?
— Melinda G., Boynton Beach, Fla.

Like many retirees who find they can’t make ends meet in areas of the country with high housing costs, you may have to consider moving to a part of the country where housing is cheaper. But if you’re determined to stay in a high-cost real estate market, perhaps to be near family and friends, there are basically two ways to go.

One way is to rent for a few years while you save for the biggest down payment you can muster. Then look for a beat-up old house or condo in need of repairs that you can handle on your own. Buy it and live there for many years while making the improvements. If you find you need more house, wait for a lull in the market (this could take several more years) and then trade up.

Here’s another way: Ask your parents, relatives and anyone else you can think of to give or loan you money for that down payment. Max your credit cards to the limit. Then go get the biggest mortgage you can possibly qualify for. Expect to give up dining out, movies, travel and any other expenses besides taxes, insurance, mortgage payments and food (better sell your car), and move in today.

Lots of people go for option No. 2, buying the house before they can truly afford it. And there are plenty of real estate agents and mortgage brokers licking their chops, ready to help you jump into debt beyond your wildest dreams. But you will be a slave to your monthly mortgage payments until the day you win the lottery.

I just calculated that if my savings gradually accumulate to $1 million in 25 years, it will be worth roughly $385,000 in today's dollars adjusted for inflation. Does this make sense? How can anybody afford to retire if this is true?
— Robert P., Massachusetts

Despite the confident-sounding “projections” you’ll get from financial advisers and the nifty calculators that claim to predict with precision what your nest egg will be worth in 25 years, there's really no way to know how much you will need to retire. To calculate this, you first would have to calculate the inflation rate in each of the 300 months between now and then. (Which is, of course, impossible.)

So, while these may be “educated guesses,” they’re just guesses. The expectation is that your investment returns will outpace inflation, but there is no guarantee of that. It’s that difference between the two that really matters. If cost of living grows faster than your nest egg, your purchasing power won’t keep up with your present level of spending. Only by beating inflation with investments can you hope to get ahead.

If you do strive for “financial independence,” you’re also going to have to decide how much you need to live on in the future. That’s also more or less impossible to predict. While you’re at it, don’t forget to predict how long you’re going to live. Unless you have a substantial retirement account, you’ll probably have to spend principal to pay the bills. But in order to know how fast you can take money out, you need to know how long you’ll live. If you spend too fast (and “outlive” your savings), you’ll go broke.

There is a bigger point to consider. Many retirement plans peddled by financial advisors assume that you’re going to work until you’re 65, go to a fancy retirement dinner where they give you a big watch, and then play golf all day long while you live off your nest egg. But that is not what people are doing. They’re staying healthy longer and working longer — albeit often part-time and/or at a reduced salary. So you might want to consider alternatives to the “stash a big pile of cash and then play golf” form of retirement.

In the meantime, the best you can do is save as much as you can and invest wisely. One simple way to get ahead: Every time you get a raise, set aside at least half that new income for savings. That way, you’ll save faster and your cost of living will rise more slowly.

Considering we don't have 6 months worth of living expenses in savings, after I max my 401k at 15k in 2006 should I pay down my student loans (23k) which I just refinanced at 4% or take advantage of a money market account that's paying 4%? My student loans are the only expenses we have outside of fixed monthly expenses.
Tia, Lansing, Mich.

Most financial advisors insist you need six months of savings at all times. But the “rules” of personal finance are made to be broken. The important thing is understanding why they're there.

The reason to have six months worth of savings is to give you the financial flexibility you need to get out of a jam -- any of a million events that throw a short-term financial hurdle in front of you, from losing a job to an unexpected major expense. The ideal situation is to have that savings account as a buffer to help blunt these unpleasant eventualities. But if you're still closer to getting started than retiring, that may not be possible.

So look for ways to maintain that financial flexibility without tying up every available cent you have in a money market account. Maybe you can use credit as your cushion. Credit cards are the worst choice because the interest rates are immorally high. (In another time, in another country, American credit card companies would be hauled off to jail for usury.) If you own a house or a condo, a home equity line of credit -- tapped only in the direst emergencies -- can be an alternative to cash savings. Even a family member, who agrees up front to step in if you need help, can help you prepare for the prospect of a financial emergency. But you should have a plan to pay the bills for six months if the worst happens.

As for which loans to pay off, the rule is pretty simple: start with the ones that offers the biggest payback. If the choice is between saving with a return of x percent or paying off a loan with an interest rate y percent, pick the one with the highest number. (The exception is for mortgage interest, which is tax deductible.) There's not much point earning 4 percent on a money market if you're paying 6 percent on a student loan. If it's a tie (4 percent savings return v. 4 percent, non-deductible loan), a lot depends on other factors like your personal tolerance for debt. Some people just like to be debt free -- and there's nothing wrong with that.

The one wrinkle with 401(k) savings accounts is the matching funds you get from your employer: it trumps every other choice. It's free money. Once you reach the max for matching, the only real bias in favor of 401(k) contributions is that you can save tax-free. But if you're worried about freeing up your income to pay the bills, pay off the loans as quickly as possible. It's like giving yourself a raise.