When will the housing crisis end? When will home prices rebound? Will another decline in housing prices occur?
Given the fall in home prices – something that people thought could never happen on such a scale – it is reasonable for people to be a bit nervous about buying a home. Home prices are down on average more than 20%, and in some places they are down 30% or more. So have we fixed the problems that lead us to where we are?
Sadly, no. There was a time when a lender would require an individual have a 20% down-payment before qualifying for a loan. The reason is obvious from the current mess. If an individual has put a substantial amount of his own money into a home, he is less likely to walk away from his mortgage than if he has no money invested. Seeing others just walk away when they are under water, many individuals who would normally never consider defaulting on their mortgages are now turning in the keys. Some see neighbors walk out on a large mortgage and feel like suckers if they stay and continue making payments even though they make plenty of money to do so. The actions of the government do not help the matter any by making assistance and loan modifications only available to those who are behind on their mortgages. Per usual, those who are responsible and sacrifice to keep their payments up-to-date are seen as unneeding of assistance, while those who are falling behind are seen as needy and therefore get loan modifications.
One would think though that lenders, having been burned before, are now much more strict on their requirements right? Once again, the answer is “no.” I am currently in the process of selling a home and am asking a very modest price. In a recent offer, I was shocked to see that not only was the offer well below my very reasonable asking price, but the closing costs were to be paid by me as well. I suggested a counter offer to my realtor which did not include closing costs, but she informed me that unless I cover closing costs, the couple will not be able to make the deal. Apparently the loan is for 100% of the house, and they do not have the money for closing costs. So apparently, while in past generations people would need to scrape together $20,000-$40,000 as a down-payment to qualify for a loan, people now are buying houses who can’t even raise $3500 in closing costs!
If the individuals had the money, but just wanted to save the closing costs because it is a buyers market, that would be one thing. The fact that they are unable to scrape together the closing costs shows that they are clearly not ready to buy a house. Houses have unpredictable expenses and require a great deal of money for upkeep. Equipment is needed to maintain the yard. Items such as hot water heaters, air conditioners, and refrigerators need to be replaced. Roofs need to be repaired and replaced, windows need to be painted periodically, and driveways need to be maintained.
If one buys a house and is not prepared, what should be a blessing becomes a curse. Before buying a house, one should at least do the following:
1. Have an emergency fund of at least 6 months worth of expenses. This will be used for living expenses if out of work, but will also come in handy by allowing the homeowners to take care of unexpected expenses like broken heaters without going into debt.
2. One’s take-home pay should be at least four times the monthly payment for the house. This ensures that you will have enough wiggle room to easily afford the mortgage payments and still take care of other bills. Without this cushion, you may find yourself going into debt to pay for other necessities. Note that if houses in your area are expensive enough to require a loan with a payment that exceeds 25% of your take-home pay, you’ll need to save up a down-payment until the loan balance will be small enough. An alternative would be to buy a smaller townhouse, condo, or house and then save and trade-up as you go. Remember that your parents probably took years to get into the house you grew up in. They did not start out with a four-bedroom with a pool.
3. Save up at least a 20% down payment. This will both show that you have enough extra income to afford the house and prevent the need to buy private mortgage insurance (PMI). PMI is an insurance policy that pays the lender if you default and costs a couple of extra hundred dollars each month. If you do default, your credit will still be obliterated, so there is no good reason to pay for PMI.
4. Take out only a fixed-rate loan with as short a term as possible. If you pay for the house over 15 years rather than 30, you’ll get a lower interest rate and save tens of thousands of dollars over the life of the loan. Plus, you’ll no longer have a house payment when it is time to put the kids through college.
By avoiding house fever and buying a house that you can afford, when you are ready, your house will be a blessing rather than a curse.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.