Wednesday, May 21, 2014

How Big/How Nice of a House To Buy

Photo courtesy of David Castillo Dominici -

I struggled so much with this and to be honest I doubted my husband’s and my decision for a while because we did not start off with the popular concept of a starter home. However, I finally feel good about it. Your conclusion very well could be different than ours but the concepts and processes work the same. 

Maximum Mortgage Payment
Your maximum mortgage payment is your current rent expense, plus excess money and minus <additional costs of home ownership>. Excess money is the money left over both expenses and savings. Savings could be for retirement (you are taking full advantage of any corporate 401(k) and the maximum ROTH IRA contribution of $5,500, rrriiiighht?), emergencies, vacation, education or any number of other things. The point is that if you are purposefully growing your checking or savings account for a certain goal, that money is a savings expense, not excess money.

This could be a real eye opener. I suspect that a lot of people barely have any money left over at the end of the month, especially after savings goals. Potentially you’ll want to re-vamp your life style so you do have excess money. <Sweet Little Treats> is a great blog that shares creative ideas and recipes to maintain your budget while enjoying life. Start making those changes now to test the waters of how cheap you can go and potentially expand your future house budget.

How Much Money Do You Have to Put Down?
This question affects both the loan amount and whether or not you will pay PMI (private mortgage insurance).

The loan amount is a critical variable in determining your mortgage payment. Of course the lower the loan amount, whether because of a lower home value or a larger down payment, the more likely you will be able to afford a shorter term loan.

Generally to avoid PMI you need to put 20% of your home value down at closing. This can be quite difficult, especially for first time home buyers. If you have a strong credit score your lender may have a creative option. That is what happened with my husband and me, we did not have 20% down, but the bank waived the PMI requirement.   If you are going to have to pay PMI, be sure to add it into your additional costs of ownership when calculating your maximum mortgage payment.

Something else to keep in mind is your best alternative use for your money. As I mentioned, I didn’t put 20% down. In fact, we actually could have put more money down than we did. However, at the time we were getting 4% from our checking account and our loan interest was 3.75%. We decided we’d rather take the flexibility of having the money in the bank than putting it in the house. After all, if you put money in your house, the only way you can see the effect in your cash flow is by re-financing for a lower mortgage payment or by getting your loan paid off.

Planned Term of the Loan
Choose a 15 year (or less) mortgage! Maybe that won’t work for you. But I really do suggest this option if at all possible for you. Have you heard people complaining that it takes years of mortgage payments before you make substantial progress on cutting the principal loan amount? They are referring to 30 year mortgages. It feels amazing to think we will own our house in 12.5 years. It will be paid off before my unborn children are teenagers. I’ll still be in my 30’s. (All of this God willing that we stay on our same course.) That is really neat and a legacy worth passing. Plus you get a lower rate. Just think about it.

There are some other options, maybe a 20 year would work better for you or maybe you can manage a 7 or 10 year mortgage. I wanted to squeeze into a 10 year mortgage, but that just was not going to work.

What Interest Rate Do You Expect?
You will find a ton of results if you search “current mortgage rates.” If you are just thinking about buying a home, I’d say add 1% to the teaser rates you find and run with that as you play with the numbers. Giving any website your contact information to find out what rate you specifically could get can really lead to a lot of unwanted e-mails and phone calls. (Yes, speaking from experience.)

Calculating Your Maximum Loan Value
Looking for houses can be really overwhelming. It helps to find your limit and then assess your options below this limit. I already talked about finding your maximum mortgage payment, loan term and interest rate. I just played with the loan term and interest rate at to get a feel for the loan value I could take on within my maximum mortgage payment.

There is also a maximum of what the bank will actually loan you. In my experience, banks are willing to loan people way more than they should. I know there are complaints that banks are not granting enough loans in this economy but remember that if you live in America, you live in debt culture. Take charge of your own financial life and determine for yourself what is financially responsible.

For how long do you plan on living there?
There are two dynamics at play with this question and both are very important. If you change residences there are closing, moving and incidental costs that follow. Additionally depending on the market, if you buy and sell a home in a short period of time, you could end up losing money.
1)      For how long do you expect to live in the area?
Generally I think of careers in relation to this but this could even mean a different part of the city. For example, maybe you want to live close to downtown right now, but plan to move to a suburb with good schools after you have a baby. It may not make sense to purchase a down town condo just to then move into a house 2 years later.
2)     At the price point you are considering, how long will it take for you to outgrow the size or get fed up with the quality?
The most obvious instance of outgrowing a home is having children. My husband and I want kids, so when we bought our house, we purchased it with our unborn children in mind. If you plan on expanding your family, it may be tempting to just buy big and disregard quality. However, if you know yourself and you know that after a couple years of the kind of house you are considering you are going to itch for a new and better house, you should listen to that instinct. The solution may be planning on renovations, waiting until you have more saved or maybe you will just plan on moving after a couple years. My point is to put on a longer term perspective and think through your financial plan over the next 20 years. You can’t forecast everything, but at least take a little time to consider the timing of your second or third house so you are not surprised if you end up unsatisfied with your house after 3 years. I love that I can really see myself in the same house all the way to when our mortgage is paid. Of course my mortgage is 15 not 30 years so that makes it easier : ).   

What does the housing market look like?
Consider both the current and predicted market for the area you are looking at. You may want to stay in that apartment if prices just escalated 200%. Especially if it is probable that you will need to move within a couple years of your purchase. The last thing you want to do with a house is buy high and sell low.

The current economy is probably a little depressed or relatively flat, depending on where you are. When we bought our house 2.5 years ago, many people claimed that Oklahoma’s housing market was still in great shape in spite of the recent economic turmoil. For the most part I agreed, but in all my calculations of whether to buy or sell and what price point we should be looking at, I purposefully disregarded the possibility of gaining net worth by an increased home value. There are just a lot of unknowns relating the housing market, I didn’t want to bank of prices increasing. 

Where are interest rates at?
If I had to choose 1 factor that led me to buy a house, I would choose interest rates. Interest rates were also the largest contributor to our “buy a house for the long term” concept. It wouldn’t do me much good to tap a low rate on a house but then get slammed with a higher rate a couple years later when I progressed from my starter home. Something to consider.  

I’m not very up to date on current rates and projections, but here is an article from Forbes that could get you started.

Following your intuition
Have I overwhelmed you? I think I overwhelmed myself. But your home purchase will likely be the most expensive purchase you will make in your life. Your first home purchase may have a lower value than the 3rd house you buy in your lifetime, but that first one is the one where you are least prepared to purchase and it can set up your financial future. No pressure.

Really in spite of all of these dynamics, sometimes the best thing you can do is ask yourself how you feel. Do you feel anxious or stressed? Slow down. Are you confused? Let these things float around your brain and trust that you will come to a place of peace. When we were going through this my husband pointed out to me that we could reach “financial success” through a number of paths. And what if you make a mistake? You will get yourself back up, learn from it and keep living. 

Did this help you find your ideal price point/size? As always, leave a comment below, I'd love to hear from you.

Also related: Own or Rent?

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