Chicago, IL

By A.B. Dada

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It’s been a long while since I last discussed the rules one should follow before finalizing the closing on purchasing a house or a condo.  Since I last talked about it, I’ve reviewed my old rules and added some new ones.  This declining housing market is a great way to learn about how to protect yourself in the future from bad decisions.

Rule #1: Ignore Family and Friends.  The sub-part of this rule is “especially if they work in real estate or banking.”  I know quite a few friends who were pushed into buying a house, because of the way family and friends berated them for being renters.  What shocks me is that these friends don’t harbor great resentment and hurt that they were conned into making the biggest mistake of their lives for the next 7 years.  Family and friends can not, and should not, ever entice you to making huge financial decisions.  Whether it is what stock to buy or fund to invest it, or what to do with your living arrangements, family and friends should never be cheerleaders but naysayers.  You want them to give you the bad side of what your decision might bring you, not the good side.

Rule #2: Look at the comparative financial comparisons. If you are buying a house that costs more than 120X what renting a similar house would cost, you’re throwing money away.  If a $300,000 house costs $1500 per month to rent, renting makes much more sense than buying.  As this multiple gets bigger, it means more money you’ll be throwing away that you’ll never gain in equity.  As this multiple gets smaller, it means the house could actually be cash flow positive if you needed to rent.

Rule #3: Look at your realistic financial situation. I highly recommend buying a home that costs no more than 3X your annual income.  The problem with this figure is that it does not include insurance, property taxes, maintenance and other costs such as utilities and filling the rooms.  The 3X number should be a cap, but not a goal.  If you make $60,000 per year, don’t look at anything more than $180,000, and preferably far less.  One more addition to this rule is to try to only use one income earner’s salary for this calculation.  If you make $50,000 per year and your spouse makes $40,000, I’d recommend using one of those numbers for the 3X maximum, preferably the smaller income!  Why is this?  If one of you should lose your jobs, you’ll still be solid in making your mortgage payments.  I prefer to not exceed 33% of gross monthly income as a total of principal, interest, taxes, insurance and basic maintenance.  25% is a better figure, if possible.

Rule #4: Do not listen to people who make money from your transactions. Real estate agents are NEVER your friend.  Mortgage brokers aren’t either.  These people will profit only if you close a deal, so it is in their best interest to persuade you to do so.  I prefer to negate what an industry agent says to try to consider the flipside.  If a real estate agent says “Now is the best time to buy,” I tell myself “Now is the worst time to buy” and try to solve that with proof.  If they say “They’re not making any more land,” I tell myself “They are developing more land.”  In the past 4 years, almost all of these agent adages proved to be false, so the negation rule would have saved millions the calamity of buying too much house.

Rule #5: Never get an adjustable rate mortgage. It doesn’t matter if you qualify for one and that it might save you a little money in the short run.  Get a fixed rate loan.  If you don’t qualify, don’t buy.

Rule #6: Never get a 0% down loan.  I recommend against even a 3% loan.  If you can not save 20% down over the years you are renting, you’re living beyond your means.  Get more roommates.  Cut your living expenses.  By putting 20%, you are insuring against market declines which happen cyclically.  20% is just a start, the more you put down, the easier life will be.

Rule #7: Ignore the tax breaks or deducations for home ownership. The IRS is not one to give good tax breaks.  They let business owners write off large SUVs, but that ignores the cost of maintenance and fuel.  They give parents a write off for children, but the write off is less than the cost of caring for a child.  They give homeowners a break on interest, but many homeowners are upside down on their homes for years because of the easy money policies from the same people who control the IRS.

Rule #8: Consider the lifetime costs of where you want to live. We’ve seen gas hit $4.30 per gallon in the Midwest.  If you have to drive 30 miles round trip to work, 60 miles per day, with an average car getting 20 mpg, you’re blowing almost $15 per day in just fuel costs, not including other maintenance.  That’s up to $5000 a year in overall maintenance and fuel supplies.  How much will you lose per year living far from work?  Also, consider the time you lose in the distance.  A “great deal” on a home does not mean you will save money or time.

Rule #9: Consider the anchor a home straps to your feet. The moment you buy a home, it reduces your chance of improvement in your career.  Those who are mobile (renters, usually) can change cities in a heartbeat, just paying the cost to break a lease.  If your job takes you elsewhere, you can do it on a whim.  Owners are stuck paying a mortgage until the house sells, if it does at all.  Many employers also know who is a renter or an owner, and you may miss pay raises or advancements once they know they have you trapped under your home’s mortgage.

Rule #10: Homeownership is not the American Dream. The American Dream is having the opportunity to work hard and do better than the previous generation.  Homeownership does not give you roots or stability, it actually takes away from both.

For most people who pay a mortgage, they are much further back in reaching their goals because they broke one or many or all of these rules.  If you want to be happy, follow the rules perfectly, and you’ll see that homeownership is not always beneficial, and many times it is destructive to one’s goals for their lives.

Related posts:

1. Sellers won’t give their house away: smart.
2. My fears about buying a home
3. I’m buying my Christmas present early: a nice small vault.
4. Foreclosures, and more bad government ideas
5. What if no one can afford to live there?
6. Scary Housing Bubble Mortgage Calculator
7. Mortgage Short Sale: Forgiveness of Debt and the 1099
8. Looking for a Starter Home? Rent.
9. Giveth, then taketh away: laws and unintended consequences
10. Buying in a declining market