Although buying a house is often seen as an important part of the American Dream, many people find it difficult to justify their lifestyle or financial goals. While there are many good reasons to purchase a house it is important to consider your motives before making one of the most significant financial decisions in your life.
These are five guidelines that will help you decide if it’s time to buy a home.
Are you willing to live there for at least 10 years?
Because of the high fees associated with buying and selling a home, it is important to have a long-term horizon when you are considering purchasing a house. Closing costs, taxes and furniture costs are all part of the process.
The closing costs to sell a house are approximately 10% of the house’s price. If you sell your house at $300,000. closing costs could be $36,000 or more. This is just the closing cost!
These fees can outweigh any equity gains you might have if you move within a very short time period, such as four years. Imagine driving your car off the lot. We all know it immediately loses value. Your house is the same. It takes time to spread out (or amortize) the costs over a long time.
The majority of people live in their home for less 8 years – a number that is higher than any time in many decades. The average time Americans stayed in their homes was 4 years before the 2008 financial crisis.
If you don’t plan to stay in the house for the long-term, resist the peer pressure not to buy. Renting and investing in S&P index funds will make you more money if you are certain that you’ll be moving in less than 10 years.
- Common error: “I’m not moving for several years.” I should purchase so that I don’t waste money on rent!
- Reality: When you take into account all costs, it is almost certain that you will lose money if you only buy for a very short time.
Are your monthly housing costs lower than 28% of what you earn?
Your total housing expenses should not exceed 28% of your gross monthly income. If housing costs exceed 28%, then you are at risk of becoming overwhelmed by expenses due to unexpected repairs, job loss, and so on. To determine if your housing is affordable, use the 28/36 Rule.
Here’s an example.
- Let’s say you earn $10,000 per month gross. That’s $120,000/year gross before taxes.
- Let’s say your monthly housing costs total $2,000 Great! Housing costs 20% of your gross monthly income. This test is passed and you are able to afford housing.
- It is important to note that the total housing cost includes all taxes, interest and maintenance. The roof repair will be done 7 years later (project it).
Gross income is important. Gross income is easy to calculate. Everybody knows their gross income. Taxes complicate net income (different people choose to deduct different amounts). If you prefer to use your net income, then go for it! I love it when people have their own views on finances.
Exceptions to the 28/36 Rule
- Many people will increase the 28% figure to 35%, or even 40% if they live in an HCOL (high-cost-of-living), area such as NYC or Los Angeles.
- You might be able to stretch the numbers slightly if you don’t have any debt, such as no student loans or car payments. Although I would consider dropping to 33%, I am conservative about my finances.
- You may be able to increase your income if you have reasonable expectations of a rise in your income, such as with a promotion. Another thing I would consider is going to 33 %…maybe.
Are you able to save 20% on your down payment?
You shouldn’t be able to save 20% for a down payment if you don’t want to purchase a house.
Why? Why?
It is counterintuitive to save 20% before you buy.
This rule is so “impractical” that I often get frustrated comments. “How can I save 20%?” It will take many years!”
It will. This is precisely why you need to start saving now. It is important to save before you have a mortgage.
Is it OK for your house to be worth less?
You might be buying a house because the price is always going up.
Here are some great reasons to purchase a house
- You have children and want to live in the same area and school district for as long as possible.
- Your parents will be moving in with your family
- You and your spouse want to build a house together
- You enjoy repairing and tweaking houses and making them your own.
- It’s all you want!
You’ll notice that there isn’t a “you need the price for the house to go higher” on the list. If it does, that’s great! You might have received a better return if you added in expenses and chance cost.
Make sure you are buying for the right reasons.
Are you looking forward to buying?
Stop approaching the purchase of a house with fear, such as a sense of obligation or peer pressure. Renting is not a sin. I choose to rent.
You might be ready to purchase if you are truly passionate about it.
These rules: Final thoughts
These rules don’t have to be followed. You have the right to your money.
You can, in fact, point me to someone who purchased a house with only 3% down and made it work.
People who make poor housing decisions will rarely be heard from again. They just disappear and never admit to their mistakes. They often don’t know why they got in trouble.
Every month, I hear from hundreds. These rules will help you avoid the most serious financial problems for those who purchase a house.
These conservative rules will help you stay out of trouble. They might take longer to purchase. You might also see other people “skipping the line” to buy a house faster than you.
However, conservative is the best way to go for the largest purchase of your entire life. You should take your time, there is no rush. People are often in a hurry to buy houses. It’s usually not due to a fear of being “priced out” and an emotional rush after seeing the headlines about houses that sell for more than they can afford.
These rules are often ignored by many people who find themselves in financial difficulties. Do not be one of these people.