My Plea to Future Home Buyers

by Chris Tecmire

Castle

 

I’ve purchased two houses in my young life.  One I did well and one I did not.

 

House 1: 

Didn’t realize what I was getting into

Paid too much

Lost money when I sold it (in a good market)

Had collection agency call me

Crushed my credit score

Doubled my credit card balances during this time

House 2:

Spent half as much

Enabled me to pay off the rest of my debt

Enabled me to increase my savings account substantially

No late payments – fits into a very comfortable monthly budget

 

One purchase made my life easier and one caused me nothing but stress and financial turmoil.  I’ve been on both sides of the fence on this one.  I’ve learned from my own experiences, but maybe even more impactful, I’ve learned from the mistakes of others in my job at a bank.  I’ve seen what the wrong choice can do, the ripples that it can cause throughout your entire life.  I’ve seen people with six-figure incomes being called by our collections department, running up massive credit card debt, or filing bankruptcy in large part due to the home that they bought.

Your home is the biggest, most important purchase that you will make, so you need to make sure you do it right.  Here is my plea to all you future home buyers.

 

What NOT to do when buying a home

 

1.  Don’t buy what you can “afford”

How do most people determine how much home they can afford?  Working at the bank, I see this all the time.  Most people do one of two things.

1) They take the bank’s word for it.

The bank or mortgage company that you contact will most likely have some sort of underwriting guidelines as to how much house they’ll finance for you.  The guidelines vary from bank to bank, but the industry standard usually allows around 28% of your gross monthly income to go toward your housing expense (including escrow) .  So, if you make $4,000 per month, then you can “afford” a $1,120 per month payment.  Other factors are, of course, considered during the process, but if you have good credit and reasonable debt levels, this ratio will be a guiding force in the bank’s decision.

Here’s the problem.  The bank doesn’t know everything about your finances.  They know your credit report, your income, and most of your debt, but they don’t know your lifestyle.  Don’t leave the decision up to the bank.  They’re not considering how much you spend at the grocery store, what your next vacation is going to cost, or how you’re going to be able to save for retirement.  They’re worried about whether they think you’ll be able to pay them back, not whether this is a smart move on your part.

Not to mention, just because there’s a guideline for how much you should spend on your home doesn’t mean you need to follow it.  My wife and I ended up spending less than 1/2 of what the ratios say we can afford and it’s worked out well.  I personally believe that the guidelines are high.

2) They look at their budget, find out how much is left over for a mortgage payment, and use up every penny.

Let’s say that your budget has a $1000 per month hole in it.  You could do one of several things.  You could plug that hole with $600 of house payments and use the rest to pay off debt or invest, you could designate $800 – $1000 for house payments and save anything leftover, or you could end up falling in love with a house and “stretch” to a $1200 per month payment, assuming that you’ll cut back in other areas.

Here’s the problem.  You’re going to need that extra money one of these days.  Once you’ve locked yourself into this mortgage, it’s a fixed cost that isn’t going anywhere unless you’re able to sell (no easy task right now).  Be conservative.  You can always buy more house later if you need.  You can’t always go back.

Also, make sure that you’ve already worked a savings and retirement plan into your budget before determining how much extra money is left for a home.

 

2.  Don’t get a 30 year mortgage

Plea #1 and plea #2 are connected.  It’s easy to fall in love with your dream home and apply for a 30 year mortgage because it’s the only way you can “afford” it, but my advice is to look only for homes that you can afford using a 15 year mortgage (or less).

There are two reasons.  First, you don’t want to be burdened with a mortgage for 30 years.  You want to be debt free, so the shorter the amortization of the loan, the quicker you will reach your goal.  Second, the amount of interest you will save by switching from a 30 year mortgage to a 15 year mortgage is remarkable.  Here’s an example.

In the case of a $200,000 mortgage at 4.5% (let’s say the rates would be the same), a 30 year mortgage will cost you an additional $89,416 over the life of the loan!

 

3.  Don’t think of it as just another monthly payment

Think of your purchase in terms of the whole kit-n-kaboodle.  A $200,000 house doesn’t cost $1000/month – it costs $200,000 in cash.  I know people who are worried about making sure that they cut out a 50 cent coupon for Cap’n Crunch, but don’t blink an eye at their $200,000 mortgage*.  Why?  Because we tend to think of our mortgage as just another monthly payment instead of what it is - a TON of money.

When you head to Target to purchase a coffee maker, you don’t think of it in terms of monthly payments.  Instead, you think, “do I have $60 to buy this coffee maker?”  However, when we consider large purchases like cars and houses, we think almost exclusively in terms of monthly payments, which deceives us of what the true cost is.  Did you know that adding $25,000 to your house budget will only cost you a little over $100 per month?  $100 per month doesn’t sound so bad, but $25,000 plus interest should make you sit down and think about it for awhile.

When you go to the bank and sign the loan documents, think of it as cash changing hands, because it is.  In essence the bank is giving you $200,000 in cash to purchase your home.  You are giving them an IOU.  If you imagine having to pay them back $200,000 + interest (more on that in a second) you may have a different perspective on the transaction and the contract that you’re signing.

 

4.  Don’t forget the interest, property taxes, and insurance

As we saw in Plea #2, interest plays a big part in your mortgage.  The bank asks for something in return for loaning us the money to buy our dream home.  So, let’s take Plea #3 one step further…don’t just think of the full purchase price of the home, consider all the interest too.  The full cost of a $200,000 home at 4.5% interest for 30 years is actually $364,813.42.  Would you have changed your mind if you had thought about it in those terms to begin with?

Also, when you’re calculating your payments make sure you include the taxes and insurance or you’ll be sorely disappointed when those big bills arrive in your mailbox.

 

 

I can sum up my plea to future home buyers in two words – “Be Careful”.

Your home can be the anchor of your personal financial statement, your most important asset, appreciating in value, and gaining equity every year…

OR it can be the anchor that pulls you deeper and deeper into debt.

Remember, dream homes are usually most dreamy the day you move in – a dream home can turn into a nightmare in a hurry.

Shelter is, on average, our #1 largest expense and it’s not really all that close.  Therefore, it’s also the one area where you can make the biggest splash in your budget.  All of our choices have consequences.  However, the consequences of this choice will echo throughout your whole lifestyle for years to come.  Be careful.

SFF Piggy Logo

 

* Footnote from a previous paragraph:   I’m fully aware that certain areas of the country and the world are much more expensive than the rural area that I live in and that $200,000 is a drop in the bucket to those folks, but the point is still the same.

Image: FreeDigitalPhotos.net

{ 18 comments… read them below or add one }

Jamie July 11, 2012 at 8:36 am

You just HAD to post this as my husband and I are looking for a new house… :o ) We have been to the bank, and they told us what we can “afford” but we are going to take it a step further and reduce that number by just over half, probably about 60%, as our top number, because the area we want to live in and the house we want to have (at least an acre) kind of dictates that. Gave ourselves a good pat on the back when our realtor told us we were smart for not looking at the top dollar the bank told us we could afford!

We’ve found a house that we do like, but circumstances are keeping us from putting in an offer right now. I’ve calculated the monthly estimates, and found that the difference between our monthly expenses and monthly income is about $600-$700 (everything not including groceries, gas, savings, and retirement – which I didn’t think of savings and retirement until I read your article). This number was guestimating expenses on the high side and income on the low side (my husband doesn’t have a set work schedule like I do, so his paycheck can change every week). I’m just having a hard time figuring out if that $600 is a good amount to have.

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Colleen July 11, 2012 at 11:14 am

Hey Chris – Great post! There’s one other thing that many (especially) first time home buyers forget, you have to furnish the house. The bigger the house, the more rooms to fill and the more debt you incur. This can also happen when moving from a smaller first home to a larger second or third home.

One of the smartest decisions that we ever made was to cut more than $200,000 off the amount that the bank “told” us we could afford when we purchased our last house. And in hindsight (9 years later), we bought waaaay more house than we needed then and way more house than we need now. Buyers beware!!!!!

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Chris Tecmire July 11, 2012 at 1:22 pm

Great point Colleen. We all could afford to downsize our homes a bit. Furniture and “stuff” is expensive. Thanks for the comment!

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Vicki July 11, 2012 at 9:11 pm

And not only furniture… then you have to pay to heat that big house!

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Chris Tecmire July 12, 2012 at 7:17 am

Absolutely. My heating bills are already expensive enough and my house is only 1300 sq ft. I can’t imagine heating some of these big, new houses. I think I’d cry a little each month when I got the bill :)

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Jill Tomlin July 11, 2012 at 12:25 pm

SO GLAD YOU WROTE THIS!! My husband Jamey and I are in the same boat as Jamie that already posted. We decided the same, try to only spend half of what we were approved for, but it’s difficult to find houses in our area within our (1/2) price range and with the specifications we want that’s not a short sale or already being bid on! Good luck to you Jamie! Hope you get your house!! THANKS AGAIN CHRIS!!

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Chris Tecmire July 11, 2012 at 1:21 pm

You’re welcome Jill – hopefully the article helps you on your search. Look everywhere, call the local banks to see if they have a list of foreclosures. I know our bank does and they love to get rid of their properties as soon as possible. But, above all, if you can – be patient. Don’t jump into something you’ll regret later. Good luck and God Bless!

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Jamie July 11, 2012 at 2:51 pm

Jill, our search has been tough because we want to be in a certain area, and with our budget and the size of the area, there really isn’t much available. We’re also limited, because we want to get an FHA Rural Devlopment loan, which inlcudes no money down (which will really help us out), but that means we have to live so far outside of the city also. The current house we had was basically a shell, we had to update EVERYTHING, and while we wouldn’t want to completely do that, the bank has also limited us on what we can do (it has to be “liveable”) so that also puts a limit on what we can get. Ay ay ay!

We’re on a bit of a hold right now, just due to circumstances beyond our control, but I just can’t wait to get closer to actually getting one!

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Jamie July 11, 2012 at 2:55 pm

One of the houses we’re kind of looking at getting is a short sale, which I was and still am kind of worried about at this point, but, I think I saw this tip on tv, is to get a realtor that has actually done short sales or one that is a specialist in them, because they have worked with the banks and understand the process and may be able to help you get a better bang for your buck. Our realtor has done them, and she said there was a short sale house listed for over $100,000, which sold for less than $40,000. That would be nice to happen to us, but it’s hard to tell right now.

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Kevin Jones July 11, 2012 at 9:45 pm

Very well written article. I hope that some folks read it and learn from your mistakes and successes. Buying a house is no small task and it is important to know as much as possible. Remember you are the only one actually looking out for your best interests. Not the bank, real estate agents or anyone else.

Thanks for posting.

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Chris Tecmire July 12, 2012 at 7:20 am

You’re right about the bank and realtors. It’s not that they’re trying to deceive you – they’re just not as invested in your financial life as you are. They have their own worries (like profit). Thanks for the comment.

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Jamie July 31, 2012 at 3:55 pm

Someone at work just gave me the tip of taking your monthly payment, dividing it by 12, and applying it to your monthly payment to help you get a little bit ahead each month. She said this person applied it to the principal, but I don’t know what that means :)

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Chris Tecmire August 1, 2012 at 11:55 pm

Jamie, any method you decide to use to pay a little extra each month is a good one. Paying extra can save you thousands of dollars in interest over the long-haul since you’ll pay off your mortgage years earlier. Any extra money that is paid over the minimum monthly payment will be applied to the principal (or the balance of the loan). Your monthly payment is made up of two components – interest paid to the bank and principal paid to the balance of the loan to pay it off. When you first start out with a 30 year mortgage, very little is paid toward the principal – nearly all of your money goes toward interest owed to the bank. The amount of interest paid decreases slightly each month, but it takes years before the majority of your monthly payment is being applied to the balance, so anything extra you can afford to pay is good. It’ll go toward the principal and help you get rid of your debt that much quicker. Another good reason to leave plenty of wiggle room in your budget when buying/renting a home :)

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Lisa August 7, 2012 at 4:01 pm

We have lived in 2 home prior to the one we are in now, one we built at near the top of our then budget and then moved to one stretching our budget for a better size, garage, land etc. Then 2 months after moving in we found out we were pregnant-with Twins! We re-evaluated everything and in the end decided to sell after living there 2 years and buy a short sale that was listed at $150,000.00 less than we sold for. We took the equity we had and put that toward it and finally have a manageable payment-one we can do on one income with tight budgeting. Needless to say you don’t ever know what is coming down the road for you and being at the top is never good, we live in the smallest, least expensive house and feel the most at ease. Be careful is an understatement-don’t assume income will always go up, assume the worst and you will be okay.

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Chris Tecmire August 7, 2012 at 6:00 pm

Amen. Think about all those people who thought the American economy was just going to keep rolling forever, so they bought expensive homes at the height of the market in 2006. I’ve seen A LOT of them at the bank that I work for. I don’t blame them for not seeing where the real estate market was headed, because very few saw it coming, but it’s a great example of the importance of living below your means so that you can withstand the upcoming bumps in the road. Glad you figured it out when you did.

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Sam August 21, 2012 at 2:37 pm

I made the mistake of buying too much house and I’m regretting it now as I try to sell it during a recession. I wish I had seen an article like this a few years ago. Take heed people, this man knows what he’s talking about. I bought a new house and didn’t consider the costs involved just to move in such as buying appliances, furniture and window shades. Not to mention the costs involved in heating/cooling, maintenance/repair and additional tools to care for the 1 acre. I have learned my lesson and will follow this advice next time. Here’s to downsizing!!! Thank you for this excellent article.

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Chris Tecmire August 21, 2012 at 5:46 pm

Thanks for the comment Sam! I know that you’re not alone in buying too much home…in fact, the boat is pretty much full. Hang in there. Often times the most effective lessons are those that come from our Ooops. I know I’ve had several of those that have helped to make me more financially aware for the future.

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