We just bought a house! We finally reached the apex of the American dream, or became enslaved by the “golden handcuffs” as some would say- HAHA! Regardless of your perspective on renting vs. owning, we waded into the world of home ownership last week, and will share our insights and financial strategies associated with this “mega” purchase as first time home-owners, as well as some “house hacks” below:
Buying too much house can be one of the biggest financial mistakes that a person can make. Remember 2008? Many people purchased homes with nothing down, along with a payment that was a huge percentage of monthly take-home pay. When the economy tanked, home values plunged, and a lot of people woke up under-water on their homes. As Warren Buffett says, “When the tide goes out, you find out who was skinny dipping.” We wanted to come up with a guideline to help you make a financially “smart” purchase. When we found a house we liked, we came up with the 1/3rd Rule of House Buying.
The 1/3rd Rule of House Buying is Simple.
Put simply your mortgage payment should be no more than 1/3rd of your take home pay (after taxes, social security, pre-tax retirement etc.). If you opt to pay less than 1/3rd of take home pay, then by all means do so! This rule is not set in stone. I would never criticize on someone for paying 34% of their take home, but as a general rule, shooting for 1/3rd of your take-home pay will help ensure your financial success.
Loan Term
Some financial “experts” harp that you should never take out more than a 15 year mortgage. As a young millennial family, we realize that this may not be an option for many of you- it certainly wasn’t for us! However, it is important to take out as short of a mortgage term as possible when considering home prices.
The longer the loan duration, the more money the bank will make off you. With that being said, mortgage rates are still at an all-time low. A 30 year mortgage at the current ~4% interest is far more tenable than the 15% many of the older readers will remember from the past.
We took out a 30 year conventional mortgage, but will pay it off like it’s a 20 year loan. We took out the longer loan as a risk reduction strategy. If my wife or I lost our job, we wouldn’t have to make the larger monthly mortgage payment and could re-group to get our income back up before we started chucking huge sums of money at the house again.
Another way to minimize your home ownership risk is to ensure you have a disaster fund prior to buying the house. We had a robust emergency fund prior to buying, and we teach you how to build up a disaster fund here.
Down Payment
Once again, many people in the finance world strongly recommend you put at least 20% down on a home purchase, and once again for most Millennials and first-time home buyers in general this isn’t an option.
If you have the cash (beyond your emergency fund) to put towards a down-payment, defiantly do it! This will save you from paying PMI (Private Mortgage Insurance). If you don’t have the full 20%, you will have to pay PMI until you reach 20%. This typically runs about $50-$75 per $100K you borrow for a house.
Don’t ever finance a “no money down” house. Put as much down as possible, shooting for at least 5-10% like we did.
House Hacks
We chose this house for more than just finding the right price. We plan to hack our house (nice ring to it eh?) by renting out the mega-shed located on the property for boat and RV storage. Our intention is to have this passive income pay for most if not all of the mortgage.
Additionally, we plan to start a hobby (self-sustainable) farm on our 3 acre property. We did this with the goal of reducing our monthly expenses on food, and quite likely, entertainment. We also hope to cultivate healthy eating habits with fresh fruits and produce. Our house also came with a wood-burner, which should drastically reduce our energy expense.
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Do you own a home? What advice would you give a first-time home-buyer?
A third is even stretching it. I think that in many cases 25% is more realistic of a goal.
On both homes that I’ve owned, I started with a 30-year and then refinanced a couple of years in when the rates dropped, to 15-year mortgages.
I’m also traditional in that I put 20% down both times. The first was from an inheritance and the second was rolling the equity over that had built from the value of the house rising plus the equity built simply from making payments. I was lucky to be able to do this both times.
Agreed!! Nice- PMI sucks!
In addition to worrying about how much your mortgage will be, consider how much repairs will be. If it’s a newer house, you’re probably fine. Still, consider the age of the appliances (including the hot water heater) and make sure you can cover things going wrong.
Our mortgage is very small — not even 1/10 of our pre-tax income. But we have a lot of other expenses and a lot of repairs come up. That’s because we could only afford an older place, and a lot of things go wrong. We’ve replaced all 3 toilets (two in the house, one in the guest house where my in-laws live), the hot water heater, the dishwasher, two faucets (one of them twice), installed HVAC in the guest house, put insulation in the attic and had myriad random repairs done. In four friggin’ years.
And none of that takes into account the cost of pricey summer electric bills in Phoenix.
We’re reaching a plateau where most of the stuff that can break has. So pretty soon we should hit a point where things are quiet for a few years. Still, it something homeowners need to consider.
I hear you on the older house! Our new house was built in 1880 so it comes with the charm and the headaches. Glad to hear you are nearing the plateau!
In addition to the mortgage, the taxes, insurance, utilities, and maintenance can really add up.
I had a friend a few years ago who sold his company and decided to build a McMansion. He bought two adjacent lots, tore down the existing houses, and built his monstrosity.
He paid cash, but the problem was he severely underestimated all the ongoing expenses. And because he no longer had an income after selling his company, those costs had to be funded from his investment portfolio.
It’s an extreme example, but you’re always better staying conservative.
And I’m skeptical when I hear people justify paying too much by calling it an investment. Most people purchase homes based on emotion not logic. For most of us, our home is a lifestyle purchase not an investment.
Agreed! Those extra expenses fall along a huge spectrum based on location, etc.
Wow! Your friend’s McMansion follows the same story line a lot of people trudge through. Unless you generate rental income, a home is rarely a “great” investment. However, the eventual lack of a mortgage is typically the biggest piece of the financial independence plan.
Your home looks beautiful! We’re in the process of buying our first home, and according to the chart, it’s about a 1/3 of what we could be buying.
The price point made me a lot less nervous about the mortgage and total expenses though! I ran through the worst possible case scenario (both hubs and I lose our jobs, everything goes to hell, etc) and realized that I can make all the payments on this house just by upping my freelancing a little. Huge peace of mind!
I figure if we *really* need more house, we can always move up in the future – I suspect moving “down” is a lot harder.
Thanks! We are enjoying our “country retreat.”
Wow! Sounds like you are in a great place with your side-hustle- congrats! Based off of the amount of crap we drug to this new house, I’d agree that we couldn’t move down in house unless it burned down first! 😉