By Victoria Rolfe
COVID -19 has brought about many changes to our world, and fear of it has prompted a range of reactions that make us rethink our lives. One of those gut reactions is to flee. This is understandable, especially if you are living in a highly populated area. That density of personal contact can leave you feeling very vulnerable and exposed right now. It’s only natural to want to get away.
Thus, we are now seeing a mass exodus of people moving out of the cities and into the suburbs and rural areas surrounding them. We certainly have seen it here in the Hudson Valley where I live, 100 miles from New York City.
And right away, my budget counselor mind kicks in. I worry a little when someone makes any kind of snap emotional decision to spend a large chunk of money, and it is especially worrisome in this uncertain economic time we find ourselves in.
So I put together these guidelines to help anyone who is contemplating making that big leap from renting to ownership (be it a house, condo, coop or apartment) to make an informed, financially sound decision.
How do you know when you are ready to buy a house? Well, some people think it’s just a matter of saving that down payment, but really a lot more preparedness needs to go into it.
First of all, how settled are you? Many young people move around quite a lot for job changes or other purposes, so even if they are very lucky enough to have that down payment at such a young age, it is not necessarily the best time to be putting down roots with home ownership.
Unless you are sure that you will be staying put for at least the next five years, buying a house is rarely a smart move financially. You will sink a lot of money into the act of buying the house, such as closing costs, realtor fees, inspections and lawyer’s fees.
Once you buy, there is the cost of moving in. Often on top of that, people will do some work to the house to make it more to their liking. And there is even the inevitable furnishing and decorating, especially if you are starting from scratch with nothing.
If you have put down a small down payment, you will typically not be gaining much equity in the house for the first few years at least, as most of these initial payments go towards to the interest on the mortgage. It is not until the principal starts to go down a little that the mortgage payments will start to chip away at it. And of course it also depends on the housing market. It could go down in value and put you in a situation of being “upside down” on your mortgage. That is actually owing more on it than the house is worth. This is what happened to all those people when the housing bubble burst in 2008.
Remember, then, it will take a while before you will get enough principal back when you sell to offset the costs you put in when buying. If you sell too soon, you will not only not gain any money on the sale, you will come out in the hole for your years of home ownership.
Next, other than that down payment you have saved up, how is your financial situation? Do you have any debt? If you do, it is very smart to pay it off before embarking on your homeownership journey. Do you have an emergency fund of three to six month’s expenses set aside? I would recommend at least six months of savings during this transition into home ownership, as you never know what will happen.
Is your job secure? You don’t want to take on all of these extra monthly expenses only to be caught high and dry, with a loss of income. This type of scenario sends people scrambling and can result in a disastrous situation.
Even if your job is secure, you have a good down payment saved up and you know you will be staying put, have you crunched the numbers to see of you can afford the cost of homeownership?
A common mistake people make is this line of thinking. “I am paying X (say $1,500 per month) on my rent so I might as well be paying that amount towards a mortgage and actually owning my own home.” The trouble with that is that you must consider all the other costs of ownership. Some things that were covered by your landlord before are now your responsibility. Have you thought about taxes, homeowner’s insurance, electricity, heat, TV, Internet, water, and rubbish removal?
In addition to all of these fixed expenses, if the house is yours, you are now responsible for the upkeep. And no matter what great shape that house was in when you bought it, something always needs attention. Sometimes it seems barely a month goes by without an unexpected household expense. Even non-household expenses can derail you if you are living on the edge, just making your monthly bills without a penny to spare. This is why it is so important to have that emergency fund set up before you move in.
Now what about that down payment? If you put down less than a 20% down payment, then you have to pay PMI. And although you are responsible for these premiums, this insurance does nothing to protect you. It is to protect the bank from losing the money they lent you should you default on your payments.
So, this brings us to a common question. How much of a down payment should you put down and how do you save up that kind of money? The answer to the first question is as much as possible, at the very least 20% (to avoid Private Mortgage Insurance (PMI). If it’s home ownership you are after, and not living in a bank-owned house that you are paying dearly for in interest payments, you should set your sights on the biggest chunk of money you can plop down.
Another way to keep your down payment at a higher percentage of the cost of the house is to buy a less expensive house. This way, that same down payment you have saved is now a larger percent of the total cost.
Here’s a dirty little secret the banks don’t want you to know. They will approve you for a mortgage that is really out of a comfortable price range for you. Why? Because they are really not interested in how comfortable you are making the payments. They are just looking to get the biggest mortgage for themselves: the more you borrow, the more interest payments they will get. So buy a house that you are comfortable with, monthly payment wise, not what the bank approves you for. Ideally this payment should be no more that 25% of your monthly income.
And one more thing on the subject of mortgages. The bank will automatically default to a 30-year-mortgage, but you are much better off getting a 15-year one. The more quickly you can get that house paid off, the less total interest you will pay on it. You can save yourself many thousands of dollars--even hundreds of thousands--by just doing this one thing..
And how does one save up for that mortgage? The same way I recommend you save up for anything else. Make it automatic! Open up an online account and set up automatic monthly payments going into it. Take the total amount you want to save and divide it by the months until you want to have the money. If you want to save up a $75,000 down payment in four years, that would mean you need to save about $1,500 per month
If your timeline for savings is actually more than five years, then you might want to consider investing part or all of the money into a low-cost, relatively safe mutual fund, such as an S&P 500.
Putting those payments away each month will also help you to live below your income and able to make all those extra expenses when you do move into that house.
Owning your own home is the American Dream, but please make sure you are fully ready for it before taking the plunge. Otherwise, it has the potential of turning into a nightmare!
Best of luck to you if you are embarking on this exciting new chapter of your life. Wishing you a bright future in your Home Sweet Home!
Victoria Rolfe is a family budget coach who has had a lifetime of experience in the art and joy of frugal living and its resulting financial freedom. She spent many years as a stay-at-home mom and home economist and rose successfully to the challenge of raising a family of four kids on a modest income without incurring debt. She did crazy things like paying for all their cars with cash, paying off their mortgage in ten years, buying their next house for cash, and sending all her kids to college with no student loans, while building a comfortable retirement nest egg for their own bright future.
She is now passionate about helping others to enter this beautiful world of peaceful and simple frugality and to achieve their own financial goals with the knowledge and personal finance skills that she has acquired. She writes a monthly blog, teaches via a series of light-hearted group presentations that she created, and sees clients in one-on-one personal meetings.
Visit her website and blog at brightfuture2budget4.weebly.com, or email her at brightfuture2budget4@gmail.com.