How much home can you afford in a COVID economy?
In my previous article, “Real Estate: 4 Reasons Why Home Prices Skyrocketed in 2020”, we discussed a few reasons behind the recent spike in home values. As someone with a growing family of my own, we spend just as much time on the Zillow app as we do Netflix nowadays. The competitive housing market has driven prices so high that we had to broaden our search criteria to include prices that make me feel uncomfortable talking about.
Instead of getting frustrated, I took a deeper dive into the financial landscape that has been created by COVID and broke down how much home we could actually afford, in today’s dollars. A combination of traditional personal finance guidelines, low interest rates, and common sense helped me become a more confident home shopper. Here are 5 factors to consider when creating your home buying budget:
1- Monthly Payment
With interest rates at all-time lows and lenders approving almost every applicant with decent credit and W2 income, the sky is the limit in terms of how much house you can buy. If you get pre-approved for an amount that makes you say, “that can’t be right”, it probably means you should proceed with caution.
The Dave Ramsey disciples will tell you to spend no more than 25% of your monthly take home pay on your mortgage payment (including real estate taxes and homeowner’s insurance). Dave has great principals, but often leans far left or right with his financial strategies and methods. In my opinion, there is no one number that fits everyone’s situation. Some things to consider are:
· Job stability (pro football = 0, utility company = 8, there is no 10 thanks to COVID)
· Outstanding debt (student loans, credit cards, auto payments)
· Family planning (paying for daycare/nanny, losing an income, family sitting for free)
2- Bills and Taxes
Oftentimes when people run the numbers, they forget to make adjustments to all of the bills that come with a new home purchase. A larger home will lead to larger electric, gas, water, sewage, garbage, home insurance, and tax bills. Be sure to account for these adjustments in your monthly budget before committing to the higher mortgage payment.
Depending on the area you live in, your monthly allotment to real estate taxes can vary significantly from one school district/county to the other. For example, in the Pittsburgh area, a homeowner in an average school district in Allegheny county can expect to pay almost twice the amount of a home located just outside the city in a neighboring county/school.
This tax amount (usually paid monthly out of your escrow account) can dramatically affect the amount of home you can purchase because this goes into the monthly payment calculation. Real estate taxes are usually calculated as a millage rate set by the township, school district, and county based on the value of the property. A more expensive house means you should expect to have a more expensive real estate tax bill (and monthly payment).
3- Furniture and Maintenance
A new home and more space means that you have more property to take care of and more rooms to furnish. An 80-gallon hot water tank in a 3 bath home costs more to replace than a 40-gallon tank used in a 1.5 bath townhouse. A bigger yard means you are spending more on lawn care, a new lawn mower, fuel, and tools to take care of it.
Inside the home, more square footage means you have more rooms to furnish. A formal dining room, a sitting room, an office, a breakfast nook, man cave, spare bedroom are just a few upgrades that are commonly sought after and should be considered as expenses when determining your overall affordability.
4- Emergency Fund
Throughout my studies of personal finance over the past decade, the emergency fund of three to six months has been the common recommendation. This number can be generated by adding up all of your monthly expenses (housing, transportation, food, etc.) and multiplying by a certain number of months which varies based on how you are compensated, job stability, and so on.
The emergency savings account value should increase accordingly with your new monthly budget. Many focus their new home savings on the down payment without first bulking up their emergency savings account. If COVID taught us one thing, it is to be prepared for anything!
5- Down Payment
A controversial topic in my eyes is the amount of money you should put down on a home. With rates so low, experts say you should put your money to work for you in an investment portfolio instead of a home down payment with a mortgage interest rate below 3%. The numbers make sense but I am not sold on it entirely.
Lending standards have allowed buyers to put as little as 3.5% down on a home. If you go this route, expect to pay a decent chunk in PMI (private mortgage insurance) and a higher overall monthly payment that is going straight into the bank’s pocket. These relaxed lending standards were created to give more people the opportunity to live the “American Dream” by lowering the barriers of entry to homeownership.
The risk you run with a 3.5% down payment is that if your house actually decreases in value, which CAN happen and was a contributing factor to many bankruptcies in the financial crisis of 2008, you end up owing more to the bank than the house is worth. Every property purchase carries different risks and it is good to review all of them before signing that contract.
For the current homeowners out there who are looking to upgrade, the good news is that while the prices of the homes you are shopping for have gone up, so did yours! If you are lucky enough to own a home right now, the increase in your home value can be used to offset the larger down payment needed for that upgraded home.
I recommend putting 20% down even though the economics tell me otherwise. Numbers look great on paper but human behavior doesn’t always match up to the math equations. Putting more money down means you pay less in PMI, less in bank interest, you likely won’t overspend on a house, bills will be lower, property taxes will be lower, you will live within or below your means and you will have more money to save and invest as life continues. Arguments can be made either way but if you add up all of those variables, it tends to make you more comfortable with the decision.
It is important to have a good team of experts around you to help with the largest financial transaction of your life (for most). Realtors and lenders are essential and great at what they do, however their compensation is directly tied to you spending as much money as possible. Parents and relatives can be trustworthy people in your corner but may not be up to date on the latest laws, policies and procedures in place since the financial crisis of 2008. In my opinion, a Certified Financial Planner? who has experience in real estate is a key piece of the puzzle. It might cost you money on the front end, but the long term effect on your wealth and peace of mind will pay for itself.
Original article:
https://www.all-proadvisors.com/articles/how-much-home-can-you-afford-in-a-covid-economy
Sources:
https://www.bankrate.com/calculators/mortgages/new-house-calculator.aspx
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