Starting to look at buying a house, aren’t you? I knew it. Well, as a long-time real estate broker, former real estate rehabber, investor, homeowner, and a man who made a lot of money and lost a lot as well, I have two sentiments for you of equal importance: Congratulations! And Look Out!
Congratulations!
Just the decision to buy a personal residence or investment property is a life-changing event. You start seeing things differently. As an owner, you tend to care more. A sound in the attic or a wheeze in your air conditioner might be more disturbing than before. But as you work through your added responsibility and interest in your home’s condition, you’ll develop a sense of pride in maintaining both your house and your aesthetic neighborhood. You become a part of the fabric of American society. And I mean that.
If you’ve bought well, you’ve started a vehicle for increasing financial stature, net worth, social prestige, and eventual retirement. That’s if you’ve bought wisely. And they say you make money in real estate when you buy, not when you sell. This means buy low, sell high, but it’s about more than just price. The ability to afford your payments has now been spotlighted, and it’s important to remember that.
Look Out!
Many people got into their unwieldy mortgages and now suffer a long list of consequences for several reasons. Homebuyers believed that if they qualified for a loan, they could afford the house. During the boom, many were excited by the prospect of higher mortgages, as long as they had lower interest rates.
One problem was the adjustable-rate mortgage. You might start with a rate you can afford, but in a year, two, three, or four, that rate could increase dramatically. A good friend lost his house when his payment went from about $1,200 to over $3,000 after just one year. He was qualified for the $1,200, not the $3,000. He went through an extremely painful, confusing three years, even facing a threat to his marriage. It was a humbling, reinvention period just to get his feet back on the ground and rebuild his confidence.
In his case, it was simple – there was no way to keep the house. But in other cases, it’s not so clear-cut. Some have been able to hold on longer but still feel the squeeze. Adjustable rates were all the rage, but what about buyers whose payments grow to uncomfortable levels, yet they manage to make it every month? This group is often overlooked. They hold on because of a strong ethical sense, because they don’t want to move, and because of concerns about their credit, which can affect employment.
For these families, what is the opportunity cost of keeping their home? What vacations, educational opportunities, or family activities do they miss to maintain their loan commitment?
What about lost precious time? Perhaps they work extra hours to make ends meet. While the first example suffered obvious social, financial, and personal consequences, this latter group endures significant opportunity loss.
And what about those who have a payment they can afford but suffer from negative equity? Their payment may be manageable, but their home value has decreased. For these homeowners, the worst-case scenario may not be selling, but it’s still uncomfortable.
How to Avoid the Pitfalls of Home Buying
All of this can be avoided if you buy well. Buying well means assessing how well the home meets your current and future needs, predicting the market’s potential impact on your home’s value, and determining how much house you can realistically afford each month.
The last point is the key. Many people trusted government guidelines, but that’s not always wise. Now, this isn’t a manifesto or a rallying cry against government, but it’s a wake-up call to rely on your own judgment when making major decisions that affect your life and the lives of others.
Government Formulas
Everyone assumes that government criteria are foolproof, but that should only be a starting point for your decision-making process. The Federal Housing Administration (FHA) insures home loans that meet specific criteria to encourage homeownership by boosting banks’ confidence in making loans. FHA guidelines state that your total housing payment, or PITI (Principal, Interest, Taxes, and Insurance), should not exceed 31% of your gross monthly income.
But what if life throws you a curveball? What if you lose your job, face medical expenses, or have other financial goals? What if your family grows and expenses rise?
The FHA’s criteria may be helpful but aren’t a guarantee. Trusting them blindly isn’t a safe bet. The vested interests in real estate have influenced how we approach housing costs, and they haven’t earned back our trust. Too many real estate agents and mortgage brokers convinced buyers to stretch their limits just to earn a commission.
That said, if you’re in the business today, after all the bubble burst hoopla, you’re likely more committed to real estate as a profession rather than a quick-cash scheme.
So, place your trust in big brother at your own peril.
Aaaaah, That’s Better!
Your best yardstick for determining what you can afford is your own comfort level. It’s about what you can realistically spend on housing, factoring in your income, and your life priorities like saving, family trips, education, and more.
This is a process you’ll enjoy. You’ll learn something about your values along the way and may become more self-aware for it. The Golden Age of Conspicuous Consumption led to big houses, fancy cars, and expensive restaurants, but it also came with high divorce rates, time away from family, and a heavily medicated population. Thankfully, that frantic spending is hopefully behind us.
While we’re still paying for the aftermath, the new generation has learned from the past. They place more value on simple pleasures like time, flexibility, and serenity. If that means a smaller house where you can afford to fix the air conditioner when it breaks, then so be it.
Keeping up with the Joneses was a frantic race. But opting for a simple, frugal picnic in the park? That’s the real win.