It doesn’t matter who you are or where you come from or what you look like or where you love. It doesn’t matter whether you’re black or white or Hispanic or Asian or Native American or young or old or rich or poor, able, disabled, gay or straight, you can buy a house here in America if you’re willing to try.
Okay, okay, I admit I stole most of that from former President Obama’s speech. But my point is, in spite of the countless regulations that were placed to prevent the next housing crisis, it’s still relatively easy to buy a house. The real challenge is keeping the house (and your shirt).
In a 2013 study entitled “Patterns of homeownership, delinquency, and foreclosure among youngest baby boomers,” conducted by the U.S. Bureau of Labor and Statistics, certain patterns can be observed about the “American Nightmare”:
- Hispanics are more likely to lose their homes compared to both Blacks and Non-Black, non-Hispanics.
- Those who did not graduate from high school were over three times more likely to have been delinquent on their mortgage, compared with college graduates.
- As education increases, homeowners are less likely to lose their home to foreclosure.
- Men and women who were separated, divorced, or widowed are more likely to lose their home to foreclosure.
Of course, I’m not going to tell you to change your color, get a Ph.D., or never marry. Instead, we’ll talk about…
When is the right time to buy a house?
Far too many people are enamored by images consisting of a four-bedroom house in the suburbs, a private yard with a pool surrounded by a white picket fence, and a nice car or two in the garage. People are rushing to buy a home only to end up prematurely selling the house, or worse, getting foreclosed because they cannot afford the payments.
The following guidelines should not only help you keep your home, but also put you in a strong financial position to continue building wealth. In this way, your American dream won’t turn into a nightmare.
You have money in the bank
We bought our house with 20 percent downpayment. It took a lot of sacrifices to save that kind of money, but it’s all worth it considering all the benefits. Putting 20% down has allowed us to avoid paying private mortgage insurance (PMI), which typically cost between one half to one percent of the entire loan amount. We also have a lower mortgage payment as a result of borrowing less money. Not to mention getting a lower interest rate.
Granted, there are crazy housing markets like that of the San Francisco Bay Area where prices have skyrocketed. In that kind of market, it’s virtually impossible for “normal” people to put 20% down. Totally depends on your particular situation, but I’d personally avoid buying in such markets. If you’re single, consider renting with a roommate— so you can save like crazy. This way, you’d be able to perform a domestic geographical arbitrage later by buying elsewhere!
Otherwise, the closer you are to the 20% gold standard the better as you’d be able to build equity more quickly.
Don’t throw everything you have on the downpayment either– it’s very important that you have adequate savings in the form of an emergency fund. This fund is one of the things that will ensure that you can continue paying your mortgage even if something happens to your income.
Your debt-to-income ratio is low
One of the factors lenders use to determine if you get approved for a loan is the debt-to-income ratio (DTI). The lower your ratio, the better the chances of qualifying.
To calculate your DTI, divide your monthly debt payments by your gross (pre-tax) income. For example, if you pay $500 towards debt every month and you have an income of $5,000, then your DTI ratio is 10%.
If you’re the type who shells out $1,000 monthly on a car, $800 towards student loan and pay the minimum $200 towards credit cards on a $4,000 income, your DTI ratio is 50%– you’re unlikely to get your dream home. It’s either you sell the car, pay off some debts, or find another source of income to decrease the ratio. If not, consider living in the car– it will be financial suicide to buy a house.
Most lenders will hand you a loan with their eyes closed if your DTI is less than 35%. However, this only means that they think you’ll be able to make the payments– not whether you can comfortably make the payments!
If you want to become wealthy, you should spend no greater than 25 percent of your take-home pay on housing costs (including property taxes and insurance) like my wife and I did. In this way, you’ll have money left when the water heater or air conditioner breaks, and other emergencies. You’ll have more money to put into retirement, kids’ education, vacations, and other goals.
Coincidentally, that’s the same percentage that debt-hating Dave Ramsey recommends (I didn’t know him when we bought our house).
You have an excellent credit score
Your credit rating may be the single most important piece of financial information you have to obtain a mortgage at the best interest rate. Lenders will not only look at your ability to pay back the loan, they will also scrutinize your past behavior towards debt payments.
A low credit score means you have a bad payment behavior– lenders see you as a credit risk. You may still qualify to get a mortgage, but they will slap you with higher interest rates that can cost you tens of thousands of dollars in the long run.
Assuming the prime rate is 3.4%, you could end up paying an extra 1.5 points over someone with an excellent 760-850 FICO score if your credit sucks. You’d pay a total of $232,095 in interest payments over the life of a $250,000 30-year fixed rate loan, yikes!
Note that people with zero credit score (not the same as low credit score) can still get a mortgage in a process called manual underwriting. The process is more cumbersome and can cost more than its automated counterpart.
You have a stable income
Lenders will ask for your pay stubs, so make sure your income is stable before you borrow money. If you plan on moving to another company or starting your own business, you may want to postpone buying a house for the meantime. Remember, buying a house is a long-term commitment.
You may also want to strengthen your financial position by diversifying your cash flow. Make new investments or open another source of income. That way, if you find that your primary income is no longer enough, it will not jeopardize your mortgage payments. You still have an alternative source to tap into.
When my wife and I were shopping for a house, we made sure that we can still afford the payments if either of us loses our jobs. Having this extra margin of safety can give you peace of mind especially during an economic recession, which will likely happen if you plan on living in the house for a long time.
You have a stable relationship
This tip, surprisingly, is one that has been ignored in most or all personal finance articles that I’ve read over the web. It can apply to single people if being in close proximity to other family members is important to you. You may not want to buy a house if you are a widow and your daughter is moving to another state, for example.
Out of the million divorces a year in the United States, many homes end up in foreclosure, to be sold below market value by very motivated sellers. The data doesn’t favor couples who are in unstable relationships. Like I’ve mentioned, people who were separated, divorced, or widowed are more likely to lose their homes to foreclosure.
Yes, you can enter into a pre-purchase or prenuptial agreement to agree that the house must be sold if either partner aborts the relationship. But still, I don’t think you want to buy a house together with someone you cannot trust, let alone marry!
The Bottom Line
Housing is one of the biggest expenses you will incur in your lifetime. No amount of day-to-day budgeting can compensate for your unaffordable housing costs. While it’s not the best investment you can make, it comes with many benefits.
Besides having a roof over your head, owning your own home sets you up for building wealth. For starters, it is a great hedge against inflation because you’re locking the significant portion of your housing costs. Your mortgage payment remains the same while rental prices continue to go up, year after year.
The caveat is you need to stay in the house for an extended period of time. Otherwise, you won’t be able to recoup the thousands of dollars you would have spent on closing costs and real estate commissions.
Our house turned out to be a blessing
My wife and I bought and moved to our newly constructed house in 2005. Prior to this, we were living in an apartment with a faulty electrical wiring. It burnt just a few days after we moved to the new house (while we still have the lease)– one of our neighbors died in the fire. So it turned out to be the best decision that my wife and I ever made as the action literally saved our lives!