When buying a home, saving for a decent down payment is essential. With a minimum of 5% required for a down payment on a home, this can amount to a large chunk of cash. Without a solid budget and savings plan, it can be difficult to get this cash together.
The 50-30-20 budget rule was first coined in 2005 by Elizabeth Warren and her daughter Amelia Warren Tyagi in their book, ‘All Your Worth: The Ultimate Lifetime Money Plan’. In this plan, savers use a system of percentages to plan their monthly budget, allowing consistent savings each month. The same plan can be used to help you save for a down payment. Here’s how it works.
The 50-30-20 Budget Rule
The first step of the plan is to add up your monthly after-tax income. Those in steady employment can do this relatively easily, by checking their payslips and adding back pension and medical insurance payments if necessary. For the self-employed, simply take your gross income minus business expenses and taxes.
With your monthly income figured out, divide it into 3 categories: 50% needs, 30% wants and 20% savings and debt payments. This will give you the amount of money you can spend each month in each category. For example, if you earn $4,000 a month, you’ll have $2,000 to spend on needs, $1,200 to spend on wants and $800 to put into your savings.
The difficult part is working out which expenses fall under which category. This is different depending on your circumstances; for example, some people need a car to get to work if there is no public transport, while others can do without one. Below are some general rules of thumb.
In the needs category you’ll find all the expenses and bills that must be paid in order for you to survive and not incur fines. Rent or mortgage payments typically make up the larger chunk here, along with other expenses including groceries (the essentials), utilities, healthcare, and possibly car payments and insurance. Additionally, any minimum debt repayments should also be included. Any payments that will get you into trouble should you miss them – such as child support – are included in this category as well. Trying to save for a down payment by cutting down on expenses from this category might prove tricky, but if you’re determined to find the home of your dreams, finding a cheaper rent, for example, might go a long way.
Your wants are, as described above, those things that you could do without at a push or could at least downgrade. The expenses in this category are generally the fun things that spice up your life, such as vacations, gym membership, going out, clothes and shoe shopping (unless desperately needed!) and TV packages.
If you find it difficult to pack all your wants into 30% of your budget, you might consider living a little less extravagantly. Living frugally isn’t much fun, but cutting down on your lifestyle expenses can really pay off in the long run. Giving up movie nights or brunch with friends sounds punishing, but try envisioning your future home and never lose sight of your long-term goal. The wants category is, after all, your best ally when it comes to saving for a down payment.
20% Savings & Debt Payments
The remaining chunk of your monthly income can all be put into savings accounts or go towards paying off your debt quicker. While minimum debt payments are a need, anything you pay back above the minimum should be counted in this category. Your savings accounts may include a retirement account, emergency funds or specific savings, such as for a down payment.
Using the 50-30-20 Rule to Save for a Down Payment
It’s well worth bearing in mind that this budget rule is not set in stone and you shouldn’t panic if the numbers don’t add up exactly. It’s more of a guideline and should be treated as such, allowing you to adapt it to best suit your needs.
When saving for a down payment, you may choose to cut down on your wants and lifestyle choices and dedicate only 20% to them. In this way, you can save 30% of your income each month, allowing you to add more to your down payment each month.
It’s easy to mistake luxuries for necessities, with many people putting high speed internet, anything more than basic cell phone plans and cable TV into the Needs category. But none of these are particularly essential for most of us and could be downgraded if needed. The same applies to payments for expensive cars when a cheaper, older car would suffice. You can save more by really thinking about these categories and becoming aware of your spending habits; this helps with the down payment, but it will also make a difference if you want to pay your mortgage faster or if you’re simply trying to save more for other purposes.
Using this budget plan can help you realize where your paycheck is going each month, enabling you to cut down on certain, unnecessary spending habits. It’s also a good indicator of whether you’re currently spending beyond your means and whether now is the right time to start thinking about buying a new home. Don’t feel tied to it and feel free to tweak it to help you realize your needs and goals.