You have been told that owning your own home is the American dream. Although this is true to some extent, you must carefully and systematically go about the process of buying a home so that it does not become a nightmare. There are several guidelines to consider when buying a home.
1. Decide how much of a mortgage payment you can afford.
I believe most people do this, but they don’t always go about it correctly. First of all, it is human nature to “cheat” how much you can afford so that you can get a bigger house. But it is important that you stay within certain calculations. Your mortgage payment should be no more than 25% of your monthly take home pay. The mortgage, taxes and insurance should be no more than 30-35%. Another good idea is to use only the husband’s income to calculate the percentages. That way, if the wife wants to stay home with the kids, you won’t have to sell your house because of the mortgage payment being too high.
2. Type of mortgage.
I always recommend a fixed rate mortgage. Stay away from adjustable rates. Since interest rates are so low right now, it will only adjust up. Even if you think you will only be in the house for less than three years, things happen in life and you may just still be there (or you can’t find a buyer). Also, the term should be no longer than 15 years. No more 30 year mortgages. I’ll explain why later. The thing to remember is a 15 year (or less), fixed rate mortgage. Also make sure that the loan allows for prepayment of principal.
3. Why not a 30 year mortgage?
Allow me to give an example of two couples. Each couple just bought a house at a 5% interest rate. Now, let’s take a look at the next 30 years. Couple A bought a $150,000 house on a 30 year fixed rate mortgage. Couple B bought a $60,000 house on a 7 year fixed rate mortgage. After 7 years, Couple B has a $60,000 paid for house, having paid $11,231 in interest. Couple A will have $131,900 left on their mortgage, having paid $49,557 in interest. Couple B then buys a $150,000 house, putting down $60,000 as a down payment on a 12 year fixed rate (5%) mortage.
At the end of those 12 years (19 years total), couple B has a $150,000 paid for house, having paid another $29,869 in interest for a total of $41,100 in interest over 19 years. Couple A will have $81,600 left on their mortgage, having paid $115,223 in interest after 19 years. The payments for both couples over this time has been around $800. Couple B invests that $800 in good growth stock mutual funds over the final 11 years since they no longer have to send it to the mortgage company. Assuming a return rate of 10%, they will have approximately $191,000!
To summarize, at the end of 30 years Couple A will have a $150,000 paid for house, have paid $139,889 in interest, and $0 in extra savings. Couple B will have a $150,000 paid for house, have paid $41,000 in interest, and approximately $191,000 in extra savings. The only difference in this situation is delaying buying the $150,000 home for 7 years. Does that 30 year mortgage still sound good to you?
Bottom line, a home is a great investment. It can be a great goal and dream to achieve if you do it correctly. Follow the above guidelines, and your dream home will be just that, a dream. Don’t let it become a nightmare.