Thinking About Buying a Home?
Before you find a realtor, have a conversation with your financial planner.
Owning a home can be one of the biggest wealth creators but it can also become a financial disaster for some. Your decisions around where to buy, when to buy, and how you finance the home will not only impact whether or not you end up making any money when you sell it but these decisions will have a significant impact on whether or not you reach your other financial goals. Many people don't consider if the new home will really make them happy but if it takes away from the things you really want to be doing it can make you very unhappy. Here are some of the things your financial planner should review with you so you can make an informed decision.
Will the new home really make you happy?
You should take advantage of your financial planner's impartial advice, after all they won't be swayed by a chef's kitchen or huge master closet. Working with you, they already know your big picture; things you like to do, what's important to you, your goals and dreams. They will help you consider the pros and cons of how the new home will impact your desired lifestyle. How long will the commute be? If it means going from a 30 minute commute to an hour commute each way, are you going to be happy adding an hour a day away from your family and the things you really want to be doing? Consider what kind of maintenance the home will require. If you don't plan to hire someone to maintain the yard or clean the home, doing maintenance can really take away from the time you should be spending having fun. Weekends are too short to spend hours mowing the lawn. If you do plan to hire people to take care of it consider the cost. A low maintenance yard can cost as little as a $100/month to maintain vs. a higher maintenance property costing $400 or more. That could mean $3,600 less you have a year to spend on vacations.
What are the risks?
Your realtor and websites like Zillow can tell you what the real estate market is like in the area you intend to buy. Knowing where we are in the economic cycle is just as important. When buying at the top of the economic cycle, you should consider making a larger down payment in case home values fall. You don't want to become underwater on the home, owing more than the home is worth. How secure is your job and your spouse's job? If one of you lost your job, can you afford the home on one income? Do you have an emergency fund to help you get through a period of unemployment? Unfortunately many homeowners resorted to dipping into their 401k to make their mortgage payments during the last recession and now are having to delay retirement to rebuild those savings.
How much home can you afford?
Mortgage companies require that your total debt payments not exceed 36% of your gross income. This would be a significantly higher portion of your take home pay. Just because you qualify to borrow a given amount, doesn't mean you should borrow that much. You should look at how various mortgage payments will affect your spending plan and your other goals. A good rule of thumb is to allocate 50% of your spending towards your living expenses, 30% towards your discretionary expenses and 20% towards your financial goals. The living expenses covers your needs; housing costs, utilities, transportation, food, etc. Your discretionary expenses are the things you want; vacations, movies, restaurants, etc. Financial goals include creating an emergency fund, paying off your debt or saving for retirement. When you calculate what your mortgage payment will be, look at how it fits in with your other expenses. Will you become house poor or do you still have enough income left over to pay for the things you want to do? Prioritize your goals. Having a bigger mortgage could delay retirement or make it more difficult to help pay for your child's college education. Your financial planner can show you the impact of different mortgage payment amounts on your financial plan.
Should you get a 30, 20 or 15 year mortgage?
Your financial planner should review the various mortgage term options with you. You should try to get the lowest term loan you can comfortably afford. With interest rates at all time lows you don't want to refinance a few years from now to get a shorter term loan. Let's say you plan to borrow $300,000.
|30 Year Mortgage||15 Year Mortgage|
|Your Monthly Payment||$1,265||$2,072|
|Total Interest Over the Life of the Loan||$191,017||$72,914|
In this example going with the 15 year term allows you to get a lower interest rate and would save you $118,103 in interest! Putting that money towards your retirement could mean retiring earlier.
There are many things to consider when buying a home and really what it all comes down to is whether you're going to be happy with the decision that you make. Research has shown that people make a decision about buying a home as soon as they walk in the front door. That just shows that our emotions play a huge part in the decision. It's so easy to be charmed by a home without making sure it's the right home for you. Put the odds in your favor by consulting an impartial party. Your financial planners knows your big picture better than any other impartial party you could consult.