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How to save a down payment for a home

Want a house like this? Better start saving. (Photo from Flickr user <a href="" rel="noopener" target="_blank">Universal Pops </a> under Creative Commons license)

When Thomas James Slater moved to San Francisco last year with his wife, they picked the cheapest apartment they could find.

Slater says that between their tech industry salaries (he is a software engineer and his wife works for a startup) the two could probably afford to rent a place that costs three times as much. Instead they’ve sacrificed the chance to live in a hip neighborhood and settled somewhere more suburban so that they could stash the money for a down payment on a home.

“I knew that it would be wiser to try to buy a place here than to continually rent,” Slater says. “I’m less concerned with being trendy.”

As the housing market slowly rebounds, those thinking about buying often stall at the first step: saving the down payment. That’s not altogether surprising. With wages largely flat, saving any money, nevermind money for something as substantial as a down payment, requires drastic changes, advisers say. “You’re not going to earn a down payment by stopping Starbucks,” says Michael Corbett, a real estate expert for Trulia and author of “Before You Buy,” a guidebook for home buyers.

Some people are tempted to pull the money for a down payment from a retirement account, such as a 401(k) or a traditional individual retirement account. But there are better ways, financial advisers say. A 401(k) loan has to be repaid, says Heather Evans, a Merrill Lynch senior vice president and wealth management adviser.

And while first-time home buyers can pull up to $10,000 from an IRA for a down payment without paying a 10 percent tax penalty, they would still need to pay taxes on the cash. Any money that could be used either for retirement or for a new house would be better off in a Roth IRA, Evans says, because those take after-tax dollars and can be cashed out for a house, tax-free, after the account has been open at least five years.

How much to save? For first-time buyers, a 20 percent down payment can increase the chances of qualifying for the loan by giving them a bigger stake in the property, says Scott Halliwell, financial planner with USAA. FHA loans, or those insured by the Federal Housing Administration, require much smaller down payments, as low as 3.5 percent of the purchase price. But those mortgages also require buyers to pay for private mortgage insurance, which can cost 0.3 percent to 1.5 percent of the loan amount per year, according to

Cut out the small stuff. It may seem obvious, but the first step to saving a down payment should be to cut down on luxuries that can add up. That could include things like cutting down on daily coffee runs (saving about $1,000 a year), bagging your own lunch (another $2,600) and cooking more meals at home, Evans says.

Sell your car. People might see their house fund grow more quickly if they can cut down on bigger expenses like a car, Evans says. A couple with two monthly car payments may think about selling one car. Even a person with one car might free up a few hundred dollars a month by swapping a newer car for a sturdy used car they can pay for in full, Evans says. Of course, the trade-off could be higher maintenance costs, she says.

Downsize your current housing. As the Slaters know, lowering housing costs can be an easy way to save a large amount of money quickly. For some younger workers, that may include living with mom and dad for a few years so they can save the money they would be paying in rent, Corbett says. People with an extra bedroom might take on a roommate for added income.

Live off of one spouse’s income. In the way that new parents often have to temporarily adjust to having only one paycheck, some couples can set aside one person’s paycheck for the house fund, Halliwell says. Of course, not all couples can afford their monthly expenses this way, but the practice could lead couples to discover savings strategies that may stick even after the home is bought, he says.

Turn your hobby into a paycheck. Some people have success saving by generating a new source of income that is solely for the purpose of buying a home, Corbett says. That might include teaching tennis, waiting tables on the weekends or finding freelance work.

Make it automatic. Once you calculate how much you can set aside each month, have the money diverted automatically from your paycheck into a savings account, Halliwell says. A traditional savings account or money market fund will work for people who are planning to buy a home soon, say in the next year or two, Evans says.

Invest it. Aspiring homeowners who don’t plan to buy for at least five years might help their savings grow if they invest a part of it, Halliwell says. But only a portion of savings should be put into market-based investments, like an S&P 500 index fund, he says. “You have to understand the risk associated with that,” he says. “There is no guarantee you’re going to make money, especially in shorter time frames.”

Don’t force it. Not all people who have the money for a down payment will be ready for homeownership. Prospective buyers should plan for other costs that may arise, such as insurance, renovations and maintenance, Evans says. And people who suspect they won’t be able to keep up with those total costs without giving up their side jobs may want to re-evaluate the timing of their decision. “If you find yourself in a situation where you’re trying to do some financial gymnastics to get into a house, you’re not ready,” Halliwell says.

Dig deeper: Housing + Personal finance

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Many people are tempted to pull from a retirement account, but there are better ways, according to financial advisers.