Buy a house and save for retirement

NEW YORK (Money) -- Question: My wife and I are currently renting, but we'd like to buy a house. Problem is, we happen to live in somewhat expensive area where single-family homes cost at least $300,000. Our combined income is low and we barely have enough savings for even a small down payment.

We're thrifty, though, and we can now save about $1,000 per month. My question is whether we're better off saving all that money for a down payment for a house in a couple of years or focus on putting money in our retirement accounts? We think we can carry a decent size monthly mortgage payment, but I'm afraid we won't qualify for a loan because our income is too low. What should we do? - H.S., North Bend, Washington

Answer: You're actually dealing with two separate but related issues here. The first is whether you should defer saving for retirement - or at least put it on the back burner for a while - so that you can accumulate a down payment for a house.

The second question is, even assuming you do raise a large enough down payment, can you handle the ongoing costs of owning that home without jeopardizing your current financial security as well as your future retirement prospects?

Let's start with the down payment. I don't necessarily see a problem if you plan on directing your saving effort over the next two years or so toward building a down payment even if it means compromising your retirement-savings effort.

I think you still ought to try to contribute at least enough to your 401(k) to get the employer match, since not doing so is giving up free money. You could then sock away every other cent you can manage for the home down payment.

You should try to come up with 20 percent of the purchase price so you don't have to pay private mortgage insurance (PMI), which is a monthly charge to protect the lender should you default on your loan. But if doing so will significantly lengthen the amount of time you need to scrape together the money, you can go with less than 20 percent and then look into canceling the PMI (or refinancing without it) when you've got enough equity.

Once you've accumulated your down payment - which should be invested in secure options like money-market funds or CDs if you need the money in a couple of years - you can then turn your attention to funding your retirement plans as much as you possibly can.

But that brings us to the second issue - namely, whether having bought the house, you can really afford to pay for it and still save for retirement. Will you have sufficient income to pay the mortgage, insurance, real estate taxes, utilities and maintenance costs and still sock away enough in 401(k)s and other retirement plans so you'll have an adequate nest egg when you retire?

That can be a tough call. For one thing, you've got to have a sense of how much of your annual income you should be saving for retirement. For guidelines on that, check out our "What You Need To Save" calculator.

You've also got to factor in future earnings prospects. After all, things could be tight now and for the next couple of years. But if your salary is likely to rise significantly in the not too distant future, then you'll probably have a lot more wiggle room after housing costs, allowing you to ramp up your retirement savings effort.

But if buying and maintaining the house strains your budget so much that it's unlikely you'll be able to set aside a decent amount of money for retirement for many years to come, well, then maybe buying a house isn't such a hot idea, or at least not one that costs so much.

You may be shifting too large a portion of your resources into one area, your home, at the expense of giving short shrift to others, especially your retirement. (By the way, I think many people already do this with cars. They drive expensive Statusmobiles when they could just as easily drive a more modest car and plow the dough they save into retirement accounts.)

That said, there might be a way to find a house in your area that gives you more maneuvering room in your budget. It's no secret that houses are taking longer to sell and prices are weak or falling in many areas. By finding a motivated seller - i.e., somebody who really needs to unload his or her house - you may be able to pick up something for a bargain price.

Being resourceful in other ways can also pay off. Check out the less desirable neighborhoods where prices are lower or even marginal areas that have the potential to improve. Or you might consider something other than a traditional single-family home - a duplex, say, where you live in one unit and rent out the other, or a condo instead of a house.

By getting your foot in the door, so to speak, you may be able to build enough equity to move up to something closer to your dream home in the near future. You might even consider relocating to another area where housing prices are more affordable. After all, given your income, house prices may just be too high for you to be a homeowner where you are now.

If owning a home is that important to you, you may even be better off moving to a town where prices are more in line with your income.

My advice: consider some of the options I've mentioned above and then compare how large a down payment you would have to come up with and what sort of annual outlays are required for each. Once you've done that, you'll have a much better sense of which of the alternatives is realistically within your financial reach, assuming you also want to prepare for retirement.