Feb 16, 2010

Save Big Money When Buying a House - Part 1 (Carole)

Your house is probably the most expensive single item you will ever buy.  Because of that, it only makes sense that it can also give you a tremendous opportunity to save a ton of money when you buy it.  If you save 50% on a $20 blouse you only save $10.  If you save 50% on a $200,000 house, you save $100,000!  That is some serious saved cash.  Conversely, being reckless or uninformed when buying a house can cost you the same kind of money.

Here is an important, basic piece of information that can help you save money when buying a house:

The 24% Rule:

Your monthly mortgage should be no more than 24% of your monthly take-home pay.  That means if you bring home $2,000/month then your monthly mortgage payment should not be more than $480.  If you bring home $5,000/month then your monthly mortgage payment should not be more than $1,200.   Take the time to figure out your own monthly take-home paycheck amount, and then multiply that dollar number by .24 to determine your upper limit for a monthly mortgage payment.  

Here is a simple mortgage calculator that will help you easily figure out the total amount you should spend on a house and still keep your mortgage payment within your money limit.

What if you already own a house?  Do the calculations anyway, and see where your mortgage payment falls compared with 24% of your monthly take-home pay.  Do you own a house that you can truly afford or is it too expensive? 

It’s good to know this information.

Interestingly, when David and I purchased our first home back in 1989, the rule-of-thumb on house payment percentage was 18%.  That is substantially different from today’s conventional wisdom of 24%.  I would guess there were a lot fewer foreclosures and short sales back in the 1980’s with that 18% number.    If you’ve ever been a homeowner, you know that your mortgage payment is not the total cost of home ownership.  In addition, there are:
1.     Property Taxes
2.     Homeowners Insurance
3.     Home Repairs
Just these three expenses add up to thousands more $$ every year.  Owning a house is certainly a worthwhile goal, but it is also expensive.  Be wise. 

I have only been a casual observer of homebuyers over the past couple of decades, but I think this raise in percentage from 18% to 24% has less to do with the rising cost of housing than with people’s desire to buy something bigger and fancier than in years past, and the personal motivation of most realtors and bankers to convince you that you should.   Our first realtor (back in 1989) told us that we could afford to buy ANY house in the town we lived in!  Wow, those were heady words -- I still remember them 21 years later!!  Who knows, maybe we could have.  But with three small children, student loans and a large business loan, we knew this would be a huge financial mistake!  We stuck to the 18% rule and bought something nice, but normal.  Many realtors will tell you anything.  However, after  they earn their hefty commission, you are on your own to pay that huge monthly payment.  

Amazingly, many of those who are currently facing foreclosure or a short sale bought homes that were priced FAR ABOVE the reasonable 24% rule.  Some folks purchased homes that require a monthly mortgage payment of nearly 50% of their take-home pay!  That is simply too much to be paying for a roof over your head.  Illness, reduced salary, job loss or an adjustable rate mortgage can push you into financial ruin very quickly with a house payment in this range. 

You just might want to consider using the smaller 18% number when purchasing your next home.  This will go a long way toward keeping your financial future secure.   Remember, the lower you can keep your monthly bills, the more money you can set aside to cover those inevitable rainy days and still carefully invest for your FABULOUS future. 

In my next post I will share simple ideas for saving big $ when buying a house.


Packrat said...

If I did the calculations correctly, this correlates closely to the old rule of never paying more for a house than what your income is for one year - but don't hold me to it. I'm terrible at figuring these things out.

When my husband and I were married in 1975, we were advised not to pay more for a house than what our annual salary was. This has held fairly true to what we can afford for a house payment (that includes taxes and insurance). This has given us a little breathing space so to speak. This way we can add a little extra to the principle each month.

Interestingly, when my brother was married 10 years later (1985) he was told not to spend more on a house than what their income was in two years. Talk about inflation!

Bart said...

Great post, TGM.

I'd love to buy a house we can stay in for the rest of our lives.

But we'll probably have to start out small again and move up when the time (and means) comes.

Or our kids can all share one room.

Nathan Pralle said...

Interesting, I had never heard the 24% rule; this is the sort of useful things that would be good to know in high school or early college, LONG before you get around to buying a house. Alas.

I just ran ours, and we're at 14%, so that's good. I cannot say how grateful I am that we bought a reasonably-priced, somewhat fixer-upper house RIGHT before the bubble started and just SAT on it and didn't fall for the, "Buy-buy-buy!" of the housing rush. Having a house payment that is very near our car payments is...lovely. It's probably one of the only good financial decisions I've ever made. :)

Emily C said...

Wow, what I've seen in the last few years has recommended no more than 35% of your take-home pay to your mortgage.

18% would make a huge difference.

Other good advice I read lately is never to get emotionally attached to a house, or you'll end up paying more than you should for privilege of getting that perfect house.

~Emily Meyer (from Vegas), now Coyne

Stefu said...

Great post! I believe that most experts currently advise not to spend more than 28% of your monthly gross income on a mortgage payment (or rent payment) and 36% of your monthly gross income for all debt payments.