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How do I save up for a first home?

Joshua in Boston is trying to figure out the best way to save up for a first home.  This week's Inbox also brought questions about giving away a  million dollars, cut-rate mortgages and stock market predictions. Answer Desk, by John W. Schoen.
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I am a 23 year old living in Massachusetts. I am currently fully employed and living with my girlfriend who is also fully employed, although combined we make about $61,000 pre-tax. Both of us want to begin saving money so we can buy a home in the next 5 years, but we find it very difficult to do so while living in such a high-rent area. We both have a 401k and find that this is the most that we are able to put away. What are your tips on saving while living in an area with a high cost of living.
Joshua, Boston, MA

You’ve probably already heard the usual advice for savers: cut back on dinners out, rent movies instead of going to the local Cineplex, cancel those premium cable packages.  Changing your spending habits, obviously, is an important and necessary first step. Everyone's budget is different, but to become a saver, you're going to have to get creative. (The other way to save more is to go make more money, but we’ll assume you’ve exhausted that track for the time being.)

The problem with the general advice about cutting back spending — or even getting anther job — is that you still have to agonize over each spending decision and carefully monitor your savings account to know whether you’re making progress. Most people don’t have this kind of patience or discipline. To get around that problem, our favorite approach is the Pay Yourself First system. If you haven’t come across it, it goes something like this:

Figure out now much you want to save — which, in your case means looking at some houses, asking about a mortgage and coming up with a down payment number. Then figure out how fast you want to save it. (The plan works for any other savings goal.)

Let’s say you want to save $20,000 over 5 years. To get there, at 5 percent interest on savings, you’ll need to put aside $67.65 a week, or $293.94 a month. (Weekly gets you there a little faster because compounding works harder.)  To change the target amount, use one of the calculators out there. We like

The important thing is to treat that saving deposit like another involuntary paycheck deduction (like taxes). To set this up, go to a bank or mutual fund company, open an account and have them automatically deduct your savings from your paycheck (If they want to charge a fee for this, find another financial institution.)

The result is that you just gave yourself a pay cut; in your tax bracket, that’s probably about 8 percent of after-tax income. That means you’ll have to figure out how to make it through the month with 8 percent less money. No doubt this will entail some sacrifice; we have yet to come across a savings plan that’s “painless.”

The strength of this system is its simplicity. You never “see” the money you’re saving. But you know you’re going to reach your savings goal — as long as you don’t dip into that savings account or run up your credit card. Yes, this is going to hurt, especially at first. But there’s really no way around that. The confidence that you’re going to reach your goal should help keep you on track — and may help dull the pain.

If your savings goal is long-term (say, more than three years) you may want to consider moving some your accumulated cash into riskier investments like stocks to increase your return. A longer time horizon helps smooth out the market’s ups and downs, but you still risk losing some of your hard-earned savings. So a lot depends on how critical your goal is. The consequences of falling short in your quest for a big screen TV are a lot less than losing the down payment on a house for a growing family.

One other thing to consider: if you’re already saving in a 401k plan, you may be able to borrow against it for the down payment on a first home without paying any penalties. (To find out, check with your HR department or plan administrator.) But then tapping into your 401k savings before you retire sort of defeats the purpose of saving for retirement.

The problem you’re going to have (as we see it) is that in the “high-rent” housing market you’re living in, you’re going to have to stretch to find something affordable no matter how much you save. For someone in your shoes, this probably means finding a run-down “starter” home that you then fix up over time. (Shop carefully. There are “starter” homes and then there are “money pits” — so insist on a thorough inspection before you buy.) Or you may end up moving to a cheaper or more distant neighborhood to get started and then trading up as your income rises. That’s one reason average commute times are up — many housing markets have priced people out of housing near their jobs.

There are general guidelines for how much house you can afford, but they are only a starting point. In the end, the real issue is how much mortgage you can comfortably carry. There’s no easy way to do the math: a lot depends on your monthly costs, how much additional debt you have, etc. Bankrate has a pretty good calculator for that too.

If I would like to give New Yorkers a Christmas present and drop a million dollars from a helicopter over Manhattan, would this be a crime?
Nick S., New York

The only legal wrinkle we could see would be the gift tax. The IRS says you can only give away $12,000 a year to any individual without paying taxes. So if someone got lucky and scooped up more than that, in theory, you’d have to file a return and pay the gift tax.

It’s conceivable that if your generosity tied up traffic or sparked public pandemonium, the NYPD might decide to cite you for creating a public disturbance. But our hunch is that – unlike the Cartoon Network’s recent Boston bomb scare – public sentiment would be on your side.

So as long as you obtain the money legally, and your helicopter pilot follows all FAA regulations, we say: go for it.

And when you decide when and where to make the drop, please let us know in advance.

I'm always seeing ads and hearing commercials for mortgage loans that say you can get a super low rate or a $300,000 loan for $700 a month. Are these places legit? What is the difference in these places and your local bank? Should I consider calling one of these places?
Janet, Auburn, Ala.

The monthly payment on a $300,000, 30-year fixed mortgage at 5.75 percent comes to $1750.72. There’s really no alternate way to do the math. A so-called “interest only” loan - (you still owe the principal at the end of the life of the loan) would be several hundred dollars less, depending on the term.

To get the monthly payment down to $700, you would almost certainly have to get some form of what’s called a “negative amortization” loan. What that means is that the lender is essentially lending you more money every month to keep the payment low.

The problem is that the balance on the loan then goes up, not down. So you end up quickly owing more money than your house is worth. When you sell, you have to come up with a big chunk of money to cover the difference.

So we’d steer clear of these.

I would like to know what's holding up the stock market at these levels. I read almost daily about companies financial difficulties and layoffs. I can see a 500-1000 point drop coming, do you agree or am I just being a pessimist?
Larry N., Rochester, Minn.

Here’s our explanation: Stock prices have been rising because there are more buyers than sellers. If the changes — more sellers show up than buyers — prices will likely go down.

Other than that, we don’t make stock market predictions. And after listening to the “experts” for 30 years, we have little faith in the predictions of those who do.

My son graduated from college last June and foolishly traveled to Ireland incurring $6,000 in debt still to be paid off. He is paying on it but it does not seem to be getting smaller. Where is the best places in the Santa Cruz, Calif., area for him to get help? He is 23 years of age.
Ronald S., Seal Beach, Calif.

There's nothing foolish about going to Ireland, but that's a lot of Guinness.

The only credit counseling service we’ve come across that’s legit is the National Federation of Credit Counselors.

To locate an agency in your area, check out their web site.