When Jim and Pam first started out, they bought a modest three-bedroom home that was perfect for the two of them. Seven years later, with the addition of a child and an adult parent living with them, that home was cramped. The space no longer fit their family’s changing needs.
Greg and Lauren have always dreamed of having a four-bedroom with a large bonus room and big backyard, with a big deck and lots of room for Greg’s DIY projects. They aren’t getting any younger, and they wonder how long they’ll have to wait to purchase their dream home.
Can you relate? The circumstances may be a little different, but the problem is the same—needing to move into a larger home without sacrificing their financial health or their retirement planning. Or maybe you’re in a starter home now but hope one day to live somewhere else that costs more. Whatever your reasons, I have great news. You can save for that upgraded home without pressing pause on your retirement savings.
Move into that dream home by following these steps:
- Pay off your starter home first.
- Find out your home’s current value.
- Put your mortgage payments into savings.
- Set your new home-buying budget.
- Be picky and patient.
Now, these steps don’t include the financial basics: get out of debt, get on a budget, and build up an emergency fund. If you haven’t completed these steps, they come first. After that, you’re ready to start thinking about your dream home.
Step 1: Pay Off Your Starter Home First
I know, that sounds difficult—but you can do it. As your career grows and your salary increases, keep putting away 15% of your monthly income for retirement (that never stops!). Then put extra money toward paying off the house. Let’s say you started a job in 2009 making $3,200 a month. You got a home with a mortgage payment of $800, the recommended 25% of your income. Now, you’re make $5,000 a month. If you keep paying 25% of your take-home pay toward your mortgage, you’d be sending the lender $1,250 a month—an extra $450! Think about how quickly you could pay off your mortgage if you got super focused.
If you’re wondering about buying that dream home while you still owe money on your starter home, you need to think through whether you can afford the upgrade right now. A bigger home means a larger mortgage (and higher utility bills). And you’ll have to add in closing costs and a real estate agent’s fees. The smarter move may be to get rid of that mortgage payment first. By maintaining a modest lifestyle and being patient, you’re setting yourself up for future success.
Step 2: Find Out Your Home’s Current Value
Knowledge is power. How much is your home worth right now, compared to when you first bought it? In most cases, its value increases over time. That’s your starting point for the new home. The amount you make on the sale of your starter home combined with money you’ve been saving becomes the basis for your forever home.
Follow me here: Let’s say your home’s current value is $125,000. When you sell that house, you’ll have between 2–5% in closing and another 6% in fees for the real estate agent who helped you sell it.
minus $6,250 (5% closing costs)
minus $7,500 (6% agent fees)
= $111,250 equity for your new home
When the timing is right, you can estimate clearing $111,000 from selling your house. That’s a great down payment on your forever home.
Step 3: Put Your Mortgage Payment into Savings
After you’ve paid off the starter home, keep paying the mortgage—but put the money into your savings account instead of the lender’s! Picture this: You’ve been paying $1,250 a month toward the mortgage (remember those pay increases we talked about?). Once that home is paid off, you’ll be putting $1,250 a month in savings. In a year, you’ve got $15,000! If you can stay in your current home for five years, you can make a serious down payment on your new home.
Look at it this way:
plus $75,000 (five years of saving mortgage payments of $1,250)
You’ve got $186,000 to put toward your dream home! That will put a huge dent in the price!
Step 4: Set Your New Home-Buying Budget
While you continue to pour your mortgage payments into savings, do the calculations to determine how much home you can afford based on your current salary. I recommend you keep the mortgage payment at no more than 25% of your take-home pay on a 15-year, fixed-rate mortgage. Don’t do a 30-year mortgage even if the bank offers it. You’re paying a fortune in interest that could be going toward wealth-building.
Let’s assume that in the five years that you’ve been putting money away for a new home, you’ve gotten a 2% cost of living adjustment every year. That $5,000 a month take-home pay five years ago is now $5,520 a month (roughly). And that doesn’t include promotions and other bonuses. If you calculated 25% of that take-home pay, you’re looking at around $1,650 per month for a mortgage payment. You can buy a great dream home on that amount, especially when you consider that you’ve already got $186,000 to go toward it!
When you set your budget for the new home, account for higher utility costs and other fees you might not have now. If you’re moving into a 2,500-square-foot home, it will cost more to heat and cool than that 1,500-square-foot starter home. You can the utility company for a usage history to get an idea. Also budget for a real estate agent’s commission, closing fees, moving expenses, and any upgrades or repairs you might need to make. Don’t let these hidden costs catch you off guard or deplete your emergency fund. Nothing ruins a new home purchase faster than moving in without a sufficient buffer between you and Murphy.
Step 5: Be Picky and Patient
I know you’re anxious to get into those new digs, but be patient for a good deal. Don’t just get “good enough.” Wait for the right house at the right time. Remember, this is your dream home! You can wait for The One! Work with a real estate agent who can be on the lookout for homes that match your budget and needs. And never, ever purchase on impulse or when you feel pressured. Give yourself time to think it over after your emotions have evened out.
Don’t Fall for Lifestyle Creep
Once you’re in your new home, don’t feel like you have to keep up with the new neighbors’ lifestyles. Living in an upgraded home doesn’t mean an upgraded lifestyle! And don’t try to redecorate the whole house at once. Stick to your budget and don’t pull back on your retirement savings just so you can put a new rug in the dining room. That piece of carpet won’t pay your bills when you aren’t working anymore!
You don’t have to sacrifice wealth-building so you can have a dream home. Follow these five steps, stay focused on the bigger financial picture, and give yourself time to find the right place. You’ll be hosting a housewarming party in no time!