Be Smart About Buying a Home
Many people take it for granted that homeownership is a path to guaranteed financial stability. According to NerdWallet.com’s 2017 Home Buyer Reality Report, however, buying a home actually made almost 1 of every 10 respondents in their survey feel less financially secure.
How could this be? Unfortunately there is such a thing as being “house poor.” This is when you have to spend so much of your income on your home’s mortgage, insurance, taxes, fees and maintenance that you have practically no cash leftover for any of life’s other big-ticket expenses.
Now, it is a fact that owning a home is more affordable than renting in most areas of the United States. But just as you can burn through your savings by renting an extravagantly pricey apartment, you can easily put yourself in a bind by pushing your homebuying budget to its limit.
An effective house-hunt begins with getting preapproved for a home loan because the preapproval sets your budget and shows the seller you have the financing to back up your offer. Having a mortgage preapproval in hand gives you a major advantage when you go out to find your new home, but you still need to be smart. There are two different ways to think of a preapproval — a wrong way, and a right way.
The Wrong Way: A Coupon for Free Money
Let’s say you open your mailbox one day and find a coupon for your favorite grocery store. It’s the best kind of coupon there is: $50 to spend on whatever you want, no minimum purchase amount necessary.
The timing is perfect, too, because you just happen to be broke at the moment. You go to the store and put together a basket of groceries that will add up as close to $50 as possible without actually going over the limit. At the register, the sales tax brings the total up to $49.01, so you throw a candy bar in that brings it up to $49.90. You can only use the coupon once, so you want to make sure you get the most out of it!
This behavior makes good economic sense because it would be a waste if you didn’t use up as much of the coupon as you could. What’s dangerous, however, is when people apply this thinking to a mortgage preapproval.
Joe and the “Six-Figure Coupon”
Suppose a young man named Joe Borrower starts looking at real estate listings online and sees that he can get a three-bedroom home in a decent neighborhood for about $250,000. It’s the right kind of home for his needs, and according to a couple online mortgage calculators, the estimated monthly payments would be about the same as what he is paying now for rent.
When Joe gets preapproved for a mortgage, however, he finds out he can qualify for a home loan of $350,000. Excited, he immediately begins to look at much bigger houses. But why? His income hasn’t increased, his family size hasn’t suddenly gone up, and his savings certainly haven’t spontaneously grown into a larger down payment!
A bigger mortgage means a bigger monthly payment, and a larger home means larger maintenance costs. If Joe borrows an extra $100,000 for a home just because he can, he will have to adjust his whole lifestyle to account for the additional money he will spend on housing every month. That means less money for eating out at restaurants, going on vacations, shopping online or saving for retirement.
It’s great that Joe has more room in his buying budget than he expected, but he shouldn’t rush into purchasing more home than he can handle. A mortgage preapproval is not like a six-figure coupon — just because you can get a larger mortgage, doesn’t mean you should.
The Right Way: Borrowing a Friend’s Car
Imagine you want to go on a road trip, but there’s one little detail standing between you and the open road: You don’t have a car. Luckily, your friend Amy is willing to lend you her car for 24 hours. All you have to do is return it with a full tank of gas.
If Joe Borrower was in your position, his first thought might be to look at a map online to see how far he could possibly drive while still being able to return the car on time. According to the terms Amy set when she loaned the car, Joe could drive a full 800 miles before he had to turn around and start driving back.
But does this sound like a fun road trip? Of course not! Joe hasn’t left any time for sightseeing, eating or sleeping, and he also hasn’t considered how much gasoline he is going to have to buy for that 1,600-mile round trip. Don’t you know, Joe? Just because you can drive a certain maximum distance, doesn’t mean that’s how far you should go!
Instead of pushing the trip to the limit, it makes much more sense to focus on where you want to go. It needs to be someplace you’ll enjoy, and it needs to be close enough that it won’t take too much time or cost too much gas to get there.
Use the same logic when you shop for a home. Your new home should meet all your needs, and it should be affordable enough that it won’t exceed your mortgage preapproval and it won’t cost you more than you will be comfortable paying for the home’s mortgage, maintenance and so on.
The Road to Financial Stability
Once again, the reality is that even though the costs of homeownership are more complicated than paying rent, owning a home is cheaper than leasing one in most parts of the United States. When you lease a home, all those costs for insurance, taxes and so forth are added into your rent along with a profit margin for your landlord, which is precisely what makes renting so expensive.
The key is to simply think twice before pushing your homebuying budget to the limit. You won’t be “missing out” if you don’t buy the most expensive home you possibly can, because the best way to build your personal wealth is to make sure you never overextend yourself. If you can be just as happy with a less expensive home, then getting a smaller home loan may be the best thing for your financial security.