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Money Makeover

Savings level, not tax incentive, should drive decision to buy home

Emily Judd, shown making dinner at home, was hoping to take advantage of an incentive program for first-time home buyers. Emily Judd, shown making dinner at home, was hoping to take advantage of an incentive program for first-time home buyers. (Barry Chin/Globe Staff)
By Lynn Asinof
Globe Correspondent / September 27, 2009

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This spring, Emily Judd, 31, made an offer on a fixer-upper in Quincy, hoping to take advantage of the soon-to-expire $8,000 federal tax break for first-time home buyers.

The seller accepted her offer, but the deal later fell apart. Rather than plunge back into the market, Judd, who does marketing for a Brookline assisted-living facility, decided she could use some professional advice. So she applied for a Boston Globe Money Makeover.

“I feel a home is the way to plan for my financial and familial future,’’ she said. And with the federal tax credit set to expire Nov. 30 and home prices yet to recover from the recent market rout, she figured she couldn’t afford to dawdle.

But when she sat down for her makeover with Susan Brown of Back Bay Financial Group, Boston, the fee-only financial adviser told Judd to take a deep breath and slow down. The tax credit may be enticing, she said, but Judd simply didn’t have enough money in the bank to take on the financial burden of a house.

“The reason I don’t want you to rush into buying a home is because it would use up all of your cash,’’ said Brown.

The mortgage on a $250,000 house would nearly triple Judd’s current $450 monthly housing costs even before taxes, utilities, insurance, and maintenance were added on. And with just $10,000 in the bank, Judd would have to continue paying off both her student loans and her car, come up with the tuition for her current master’s degree program in gerontology, and make sure there’s enough left in the emergency fund to replace the roof on a new home if necessary.

Having applied the brakes to Judd’s near-term home buying, Brown and Emily O’Hara, her associate, drew up a new financial plan designed to make the Quincy resident a homeowner before 2013. The plan calls for Judd to do some aggressive saving to come up with a larger down payment, a more robust emergency fund, and a good start on her retirement savings.

Where does all that savings come from? When she filled out Brown’s cash flow analysis questionnaire, Judd couldn’t immediately quantify some $3,000 of monthly expenses. “If you don’t know where it is going, maybe you don’t need to spend it,’’ said Brown. “We call that financial flexibility.’’

Brown started by allocating some of that spending money to Judd’s company retirement plan. By tucking 5 percent of her salary, or $346 a month, into her 403(b), Judd could take full advantage of her employer’s 50 percent match. “That’s a couple of thousand dollars of free money every year,’’ Brown said.

Since the contributions would also reduce Judd’s taxable earnings, she’d save another $165 a month in taxes. Moreover, the contributions would keep her income below $80,000 a year, which would entitle her to a tax deduction of up to $2,000 for qualified education expenses from her master’s program. The bottom line: It would cost Judd just $181 a month, or $2,172, to tuck $6,228 into her retirement plan over the next year.

Brown then outlined plans for building up both Judd’s emergency fund and her down-payment savings. She recommended that Judd save at least $700 a month, having it taken directly out of her check and deposited in a high-interest online savings account. Add that to the retirement plan contributions, she said, and Judd will be saving just over $1,000 a month.

Fast forward three years, and the result of all that savings is impressive. Even assuming absolutely no return on that money, this aggressive plan would grow Judd’s nonretirement savings to $36,700 by the end of 2012. And that, Brown said, is enough for a $25,000 house down payment with close to $12,000 left over - an amount that Brown said is the minimum needed in Judd’s emergency fund if she is to buy a house.

“I think that’s awesome,’’ Judd said when she saw the calculations. “It’s just so easy. It’s in black and white. It is so simple.’’

Turning to retirement savings, Brown noted that Judd had already selected a diversified lifecycle fund designed for someone retiring in 2040. The fund, which currently has about 84 percent of its assets invested in equities, is “quite aggressive,’’ Brown said. “But if you can stand the volatility, it is a good choice,’’ at least until Judd’s savings grow above $50,000. No problem, said Judd, who made it clear she’s not the type to check her portfolio every day. She said she’s more than willing to take on that type of risk in exchange for good long-term growth.

By deciding to wait to purchase her home, Judd will have to forgo Uncle Sam’s $8,000 tax break. She may even miss the bottom of the Boston-area housing market.

“When I turned 30, I bought my first new car,’’ she said. “I thought when I turned 31, I could buy a new home.’’ Now, she’s going to have to wait until she’s 33. But with her plan in hand, Judd said, 33 just doesn’t seem that far away.

Emily Judd

Goal: Taking advantage of current tax incentives to buy her first home

With Boston-area home prices yet to recover, Judd figured it was the right time to buy. And if she acted soon, she could lock in an $8,000 federal tax credit for first-time home buyers. But she hadn’t been able to find a house she could afford and was concerned about the impact on her finances.

Recommendations from fee-only adviser Susan Brown: ■Don’t rush into a purchase simply to qualify for the tax credit.

■Save aggressively to build up a larger down payment, a bigger emergency fund, and a solid base for retirement.

■Don’t buy with less than a 10 percent down payment.

■Make sure your emergency fund is large enough to cover unexpected costs after you buy your house.