Can $50,000 a year cut it?

By Deborah Adamson
Advertiser Staff Writer

Can a couple earning a moderate income in the tourism trade realize a dream of owning a home in today's overheated real-estate market?

Michael and Kristy Lum turned to a financial adviser who told them what adjustments to make. Gregory Yamamoto • The Honolulu Advertiser

Michael, 30, is a hotel reservations agent for Aloha 7 Travel. Kristy, 31, is employed as a guest service representative at Outrigger & Ohana hotels. Together, they make about $50,000 a year.

"First and foremost, we want to get a home and, second, we want to be financially stable," Michael said.

With the median price for a home in Honolulu topping $475,000 and condominiums at $219,000, affording a home isn't easy.

The good news: Their parents will kick in $10,000 for a down payment on the house. While they owe nearly $12,000, mainly in an auto loan, the Lums are savers.

But it didn't start out that way.

"We weren't saving before," Kristy said. "But Oprah had a financial planner on her show and he was saying everyone should pay themselves first."

It was David Bach, author of "The Automatic Millionaire." His three pieces of advice: Paying yourself first, or saving, is the key to making a million dollars; make saving automatic, such as setting up regular deposits from your paycheck into a retirement account; and, finally, buy a home and pay it off early.

Earlier this year, the Lums started automatically diverting about $1,000 of their monthly pay into a 401(k), a Roth IRA and a savings account. Even then, they are still left with $200 a month in surplus cash.

But to have money to save, they had to change their spending habits. For instance, they used to love buying CDs at Tower Records or buy movies on DVD. Now, they wait and rent the movies at Blockbuster or they patronize discount movie houses. Kristy clips coupons.

Still, are they doing enough to afford a home without ignoring their retirement goals and plans to raise a family?

For the answer, they turned to Chad Adams, a financial advisor with American Express Financial Advisors in Honolulu.

"Yes, you can buy a house now," he said. "But you'll have to make some adjustments."

On a $200,000 condominium, with $10,000 down and a mortgage rate of 5.5 percent for 30 years, principal and interest payments come to about $1,100 a month. At present, the Lums pay nearly $600 a month for rent.

They have to find another $500 to cover the mortgage, plus free up another $300 to set aside for homeowners insurance, taxes and maintenance fees.

The Lums could take their $200 monthly surplus and apply it toward the mortgage. They also could pay off their $1,000 credit-card debt, stop charging about $300 a month and stick to their monthly cash allowance.

They would still need about $300 more, which they could take from the $500 they put away in their savings account every month.

Once they buy a home, they should look into getting life insurance, Adams said. So if one passes away, the surviving spouse won't lose the house. They should also look into any disability insurance provided by their employers.

The remaining $200 in savings they could use to build up an emergency fund equal to three to six months of living expenses. That's about $9,000 to $18,000 for the Lums. but a good goal is $12,000, Adams said. The couple already have $6,000 in savings.

Once they're fully funded for emergencies, they should invest the $200 in their Roth IRA.

If they become homeowners, the Lums stand to gain significant tax benefits.

The mortgage interest rate is tax-deductible. Since the larger part of mortgage payments for the first year go toward interest, the Lums should get a good-sized tax refund. If they want the money sooner, they could claim more personal exemptions to lower the tax withheld on their paychecks.

The Lums also may qualify for mortgage certificate credits, or MCCs, which are issued by the Housing and Community Development Corp. of Hawaii. MCCs let you take a federal tax credit on 20 percent on the mortgage interest; 80 percent will be tax-deductible.

A tax credit is better than a tax deduction because it's a dollar-for-dollar reduction on your taxes. For instance, if you're in the 25 percent tax bracket and you deduct $1,000 from taxes, your actual saving is about $250. If you get a $1,000 tax credit, you will save the entire $1,000 in taxes.

For the Lums, assuming they have a $190,000 loan at 5.5 percent, they would pay more than $10,000 mortgage interest in the first year of the loan. With an MCC, they get to save $2,000 — or 20 percent — as a tax credit.

The remaining $8,000 will be treated as a tax deduction. Since they're in the 15 percent tax bracket, they save another $1,200 for a total of $3,200. In contrast, if they took a tax deduction for the entire amount, they would only save $1,500 in taxes. You can claim the MCC every year.

In Honolulu, a family of less than three would qualify for an MCC if they make less than $78,840 a year. For a family of three or more, it's $91,980. The price of the purchased home must not exceed $441,562. Not all lenders offer the MCC and they charge a fee for the program.

But the program has restrictions. You might be required to pay federal taxes on the amount you saved with an MCC if you sell your home within nine years and make a profit on the sale and if your income rises past certain limits. (For more information, call 587-0567.)

Even after buying a house, the Lums should be on track to meet their retirement goals, assuming they plan to retire at 62, Adams said.

At present, they are funneling $500 into retirement accounts — $400 in a 401(k) and $100 into a Roth IRA.

Since the Lums don't need a tax shelter right now, they should put more money in a Roth IRA, where the money grows tax-free, than in the 401(k), which is tax-deferred, Adams said. He recommended putting $400 a month into the Roth IRA and $100 into the 401(k).

"You guys are good savers," he said at a meeting with the Lums at his Honolulu office. "The good news is if you continue your rate of savings ... "

"We'll be millionaires!" Kristy said.

"Oh, wow," Michael said.

Their existing retirement savings, plus $500 a month into a portfolio making 8.8 percent on average a year, should give the Lums $1.9 million in 30 years, Adams said. That's equivalent to $900,000 in today's dollars, he said. The portfolio would be invested 80 percent in stocks and 20 percent in bonds.

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