April 23, 2015
I am a big believer in home ownership, but only if it makes financial sense. If you answer yes to any of these questions you are better off renting:
Is there any chance you would want to move within five or so years? It costs a lot of money to sell a home, starting with the typical 6% commission you will owe your real estate agent. Then there are moving costs and transfer fees in some areas. Add it all up and I think it’s smart to expect you will use around 10% of the sale price just to cover all your sales-related expenses. The sooner you sell the less likely you will have built up enough equity to cover those costs.
Is your credit score below 740? A FICO credit score of at least 740 is going to put you in the position to land the best loan deal. Anything below that and I would recommend taking the time to get your score higher before you shop for a house. Qualifying for a mortgage that is just an eighth or a quarter point lower because of a solid credit score can save you tens of thousands of dollars in interest costs over the life of a loan.
Do you have less than eight months of living expenses set aside in an emergency fund? I know that’s a high bar. For a reason: your peace of mind. Until you have this safety cushion in place I don’t want you taking on any big financial obligations. And it gets no bigger than a mortgage.
Will you be making a down payment of less than 20%? Yes, I am well aware lenders will be happy to give you a mortgage with a down payment of as little as 3% or so. Don’t fall for it. When you make a low down payment you often will be hit with a higher interest rate. And any mortgage (other than a VA-backed loan) that is for more than 80% of the purchase price will require that you have private mortgage insurance. The bottom line is that low down payment mortgages end up costing you a lot. And most important, I think saving up for a down payment is an important step: it requires patience and resolve. And the ability to save! That’s just the sort of person who gets my approval to buy a home.
Answer Yes or No to the follow statements.
I pay all my credit card bills in full each month.
I have an eight-month emergency savings fund separate from my checking or other bank accounts.
The car I am driving was paid for with cash, or a loan that was no more than three years, and I sure didn’t lease!
I am contributing at least 10% of my gross salary to a retirement plan at work, or I am saving at least that much in an IRA and/or regular taxable account.
I have a long-term asset allocation plan for my retirement investments, and once a year I check to see if I need to do any rebalancing to stay on target with my allocation goals.
I have term life insurance to provide protection to those who are dependent on my income.
I have a will, a trust, an advance directive (living will), and have appointed someone to be my health care proxy.
So how did you do?
If you answered yes to every item, congratulations. If you are working on improving on a few items, I say congratulations as well.
As long as you are comitted to truly creating financial security, I applaud you. If that means you are paying down your credit card balances, or are building up your emergency fun with automated payments, that’s more than fine. You are on your way!
But if you found yourself saying No to any of those questions, and you’re not working on moving to Yes, then I want you to stand in your truth. No matter how good you feel, you have some work to do before you can honestly know what you are on solid financial ground.