Buying a home has been a major part of the American Dream, but for many people, it doesn’t make sense for financial or lifestyle reasons. There are some very good reasons to buy a home, but it is important to examine your reasons before making one of the biggest financial decisions of your life.
Here are 5 tips to help you decide if you’re ready to buy a home.
- Will you live there for more than 10 years?
- Is your total monthly housing cost less than 28% of your total monthly income?
- Did you save 20% down payment?
- Are you okay if your home value drops?
- Are you excited to buy?
Will you live there for more than 10 years?
When you buy a home, the long time horizon is important because of the huge fees involved in buying and selling a home. There are closing costs, taxes, furniture, realtor costs, and maintenance.
The closing costs of the home sale are approximately 10% of the home’s selling price. This means that if you sell your home for $300,000, closing could cost you $36,000 or more. And that’s just closing the costs!
If you move in a short period of time – say, four years – this fee will dwarf any stock gains you may have. Imagine you’re driving a car away from the parking lot: we all know it loses its value instantly. The same is true of your home, and it takes time to amortize (or spread) the costs over a long period of time.
Most people stay indoors for less than 8 years – this number is actually higher than it has been for several decades! Before the 2008 financial crisis, the average time Americans spent in their places was only about 4 years.
Don’t give in to peer pressure to buy a home if you might not stay there for long. If you know you want to transition in less than 10 years, you can potentially make more money by renting and investing in S&P index funds.
- general error: “I will not move for a few years. I have to buy so as not to throw money on the rent!”
- Reality: If you buy for a short period of time, when you factor in all the costs, you will almost certainly lose money.
Is your total monthly housing cost less than 28% of your total monthly income?
Your total housing costs must be less than 28% of your total income. When housing costs exceed 28%, you risk being overwhelmed with expenses if something goes wrong (eg unexpected repair, job loss, etc.). Use the 28/36 rule to see if you can afford housing.
This is an example:
- Suppose you make a total profit of $10,000 per month (that’s $120,000 annually, or before taxes).
- Assume your total housing costs are $2,000 per month. amazing! Your housing costs you 20% of your total income. You pass this test and you can afford your own housing.
- Note that the total housing costs include everything: Taxes, benefits, maintenance, furniture, electricity, water, even roof repair 7 years from now (his project).
Why gross income? I use the total because it’s easy to calculate. Everyone knows that their gross income and taxes complicate net income (different people choose different deductions). However, if you prefer to use net income, go for it! I love hearing people when they create their own view of their finances.
Exceptions to the 28/36 rule
- If you live in a HCOL (high cost of living) area like New York City or Los Angeles, many people expand the number from 28% to 35% or even 40%.
- If you don’t have any debt (for example, no car payments, student loans, or credit card debt), you might stretch the numbers a bit. I was thinking of going around 33%, but I’m conservative with my money.
- If your income is reasonably expected to rise soon, such as a promotion to a job, you can increase the numbers a bit. Again, I was conservatively considering going for 33%…maybe.
Did you save 20% down payment?
If you haven’t saved a 20% down payment, you’re not ready to buy a home.
why? Not just because of the PMI, which is an additional fee you’ll often pay when you take out a mortgage without the 20% discount.
The real reason to save 20% before you buy is a no-brainer: building a saving habit is crucial before You buy and have unexpected housing expenses like a broken water heater, roof, or unexpected taxes.
I often get frustrated with comments about how “impractical” this rule is. “How can I save 20%? This will take years!”
Yes. And that’s exactly why I’m saving now. Saving is a habit, best practiced before a mortgage is at risk.
If you write a comment like this, you are not ready to buy a house
Note: I don’t mean you should cut 20%. In some cases, such as low interest rates, many people deliberately choose to put in a small amount. But you should be able to..
Are you okay if your home value drops?
If you’re buying because you think the price of a home is always going up, reconsider: real estate isn’t always the best investment.
Here are some good reasons to buy a home
- You have kids and want to stay in your district and your school district and build memories in the same house for at least 10 years
- Your parents move in with you
- Want to design a house with your wife
- You love to fix the house and make it your own
- You just want!
Note what’s not on the list: “You need a higher home price.” Maybe it would – if so, great! Perhaps, once you factor in the expenses and opportunity cost, you can get a much better return on a simple S&P index fund.
Buy for the right reasons.
Are you excited to buy?
If you’re approaching home buying in a state of dread — like a heavy sense of obligation or peer pressure — just stop. You don’t need to buy and you should never feel guilty to rent it. I rent by choice.
If you are really excited to buy, you may be ready to buy.
Final thoughts on these rules
you don’t Need to follow any of these rules. Your money is yours.
In fact, I’m sure you can point to someone who bought a house at a 3% discount and did a good job.
But you rarely hear from people who have made tragic housing decisions. They simply disappear, not admitting their mistakes. Often, they don’t even know why they’re in trouble.
I hear from hundreds of them every month. And I can tell you that these rules will keep you away from the biggest source of financial problems for people who buy a home.
These are conservative rules that will keep you out of trouble. Yes, it may take longer to purchase. And yes, you may see people seemingly “skipping the line” and buying a home in front of you.
But for the biggest purchase of your life, I think you should be conservative. Take your time – no rush. Most of the time, when you hear people in a hurry to buy, it’s not an accurate consideration of the facts – it’s the fear of being “priced in” or an emotional outburst at seeing home addresses sell for more than they can afford.
Many people who end up in financial trouble skip these rules. Don’t be one of them.
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