4 Home-Buying Strategies (None of Which We Followed)
A conversation with my 5-year-old as we are pulling out of the garage slowly, as I always do because our two-car garage is tight with both vehicles parked inside…
Rooney: Why are you going so slow?
Me: So I don’t hit the side of the garage door as I pull out.
Rooney: Would we need to buy another house?
Me: No. It would probably hurt the car more than the house, and anyway houses are expensive.
Rooney: How much was our house?
Me: (hesitantly knowing she wouldn’t comprehend that large of a number) $215,000.
Rooney: Did you have the money to pay for it?
Me: (immediately sensing a humbling moment coming) No, we had to borrow it from the bank, and now we pay the bank back every month probably until you are out of college. (I'm always looking for a teaching moment.)
End of conversation...
It’s like she intuitively knew that we shouldn’t have bought the house if we didn’t have the money for it...and that owing other people money isn’t smart. Sure, mortgages are commonplace these days, but I found it remarkable that she could ask such curious questions at the age of 5.
I’m willing to share our mistakes with her (and you) in hopes that they will be avoided in the future. The home-buying experience will be the largest purchase we'll ever make, which makes it worth pursuing with caution.
But, how do you put together a home-buying strategy that’s realistic and practical for your situation?
Wipe your feet on the home-buying guidelines welcome mat and make yourself at home. I've found four home-buying strategies to try on and see which one fits.
[You might be interested in: Thinking of Buying a House?]
Knowing your own budget and the additional expenses that come with buying a home will help set you up for a home purchase you can enjoy for years to come.
The first three strategies below are from the lender's perspective (assuming you are not paying cash for your home). The fourth strategy is from the buyer's perspective based on your take-home pay. It's conservative, but will give you the most lifestyle freedom based on your situation. Let's dive in...
1. Three Times Your Gross Income (very general rule)
There doesn’t seem to be much math behind this rule other than multiplying your gross income by three and shopping for a home at that price or below. If your gross household income is $100,000 per year, you can buy a $300,000 home.
I'd say this is the roughest starting point you can find. It sort of works, although I think we can do better...the other three strategies are a little more detailed.
2. Mortgage Payment: 28% of Gross Income
This calculation includes the mortgage payment (including the principal, interest, taxes, and insurance). It’s also based on gross income per month. Since it's based off gross income, what percentage of your take-home pay do you think that would be (assuming a $5,000 gross income per month)?
- Gross income per month: $5,000
- Mortgage payment maximum: $5,000 x .28 = $1,400
- Take-home pay (assuming 25% of gross goes toward taxes, retirement, and other benefits offered by your employer): $5,000 x .75 = $3,750
- Mortgage payment as percentage of take-home pay: $1,400 / $3,750 = 37.33%
It’s better to work from the borrower’s side of the table (Your side)
The lender is going to find you the maximum amount of loan where they believe you won’t default on the mortgage. Any amount smaller than that is OK. But, buying a home is an emotional decision, and it’s all too easy to start looking at homes just a little outside your initial price point and before you know it, you’ve found your dream home and it’s just a few 30, 40, 50 thousand dollars more than you planned on spending.
If you own a home in this situation, my guess is that you feel the strain on the rest of your lifestyle, or those lifestyle items are what cause the accumulation of credit card debt.
3. Qualified Mortgage Rule: 43%
This rule takes into consideration PITI (principal, interest, taxes, and insurance) as well as your other monthly debt obligations, and compares that to your gross income.
Gross monthly income $,5000 x .43 = $2,150.
Factors included in the 43% Qualified Mortgage Rule
- Other debt obligations
Since this rule is considering your other debt obligations, its purpose is to ensure that you are not overextending yourself on your home where you might not be able to pay your other creditors. However, it’s still a generous rule for home affordability.
You might not default on your mortgage payments, but you will likely be strapped for cash and stifle your lifestyle while trying to keep up with the expenses associated with buying that home.
4. 20% Down Payment / PITI No More Than 25% of Take-Home Pay
If we are considering housing as a part of a needed expense that fits within our budget instead of dominating it, then let's look conservatively at all housing expenses taking up no more than 25% of our take-home pay. This should help us find a housing budget well within our means that won’t cannibalize the rest of our budget or other long-term financial goals.
Budget items to consider before home ownership
- Mortgage (principal plus interest)
- Homeowner’s insurance (we must protect this house!)
- Property taxes (because you gotta pay the tax man)
- Private mortgage insurance (if equity in home is less than 20%, there's a fee for that)
- Homeowners association fees (townhomes, etc., if applicable)
- Maintenance (1% of total cost of home: $200K home = $2,000 annual maintenance budget)
If we are considering a home mortgage that is less than the bank is offering, then we can calculate our budget not based on gross income, but rather on our take-home pay. If we figure out what 25% of our take-home pay is, and try to create a home buying strategy from that number, we will be armed with a much better strategy going into the home-buying process.
If our take-home pay is $5,000 per month, then our maximum housing budget would be:
$5,000 x .25 = $1,250
I used a detailed mortgage calculator to figure out the details. I input the maintenance costs as HOA dues at 1% as described above.
I came up with the ability to buy a $195,000 home on a $1,250 housing budget per month.
Monthly Housing Expenses
- Mortgage = $744.77
- Homeowner’s Insurance = $56.88
- Property taxes = $284.38
- Maintenance = $162.50
- TOTAL = $1,248.52
This again assumes you are putting 20% down to avoid Private Mortgage Insurance (PMI). 20% down would mean you’re saving up $44,850 for the down payment as well as realtor fees of 3%.
In our personal situation, we weren’t thinking of any of this when we were looking to buy a home. The only thing we were considering financially was getting as much house for the amount the bank told us we qualified for.
The home-buying process is intense. It can consume you, looking at dozens of homes online and a handful in person. If you don’t sit down to figure out what you can truly afford before starting, it’s easy to get swept under the current of the housing market.
My advice would be to have your own budget in tact before talking to the bank or realtor. And then don’t budge on your budget. You’ve intentionally calculated your budget based on the rest of your financial goals and a conservative monthly budget.
We happened to work our way out of our poor home purchase decision, and we like our home, but it came with a lot of stress, worry, and sacrifice of other things throughout the first five years of home ownership. Avoid our mistakes and make an intentional plan for your home purchase.