By Blanche Evans
When you are choosing a home, naturally you want to live in the nicest home that you can possibly afford. And you will get plenty of encouragement from your Realtor and your lender. They can each provide you with plenty of good reasons why you should buy at the top of your ability.
Most lenders now offer a variety of creative loan products from adjustable rate mortgages to hybrid loans to help you buy the most house that you can. Realtors will tell you that you will trade up eventually - why not buy your trade-up home now? You'll save money in new financing costs, closing costs (about 8 percent for sellers,) moving costs, Realtor and marketing fees, plus the awful hassle of moving. There is also the great unknown to consider. What will the housing market be like in a few years? No one knows. You might not be able to buy as nice a home then as you can now. All things considered - it's better to buy the most home that you can while you can.
Leading financial advisors, however, argue just the opposite. Their job is to help you build wealth, so they think in terms of return on investment vs risk. Homes offer a fair hedge against inflation, but that is about the most you can expect from them as investments. Rising home values are mostly offset by continuing maintenance costs, repairs and market fluctuations. But home ownership offers many more financial benefits than renting, so a financial planner will agree that you do need to buy a home. S/he will insist that you diversify your assets by creating or adding to a portfolio of cash reserves and other investments. This risk-managed approach positions you to do three things well: handle reversals in your finances such as a job loss, pursue other goals such as starting or adding to your family, and build wealth by investing in securities, all while enjoying occupancy in a nice home.
All the arguments from both sides are sound, so the solution lies in how to have your cake and eat it, too. That means buying the most home possible without becoming house poor. How you accomplish this goal depends on several things - how much you tell the lender, which loan you choose, how long you plan to stay in your home and what your other financial goals are.
Don't Tell Your Lender Everything
Lenders loan by guidelines so that their loans can be insured and their risks will be reduced. The amount of your loan will be determined by four basic criteria - income, assets, debts and the interest rate that you can lock in. Insurer guidelines state that you cannot spend more than 28% of your income on your mortgage and that your debts cannot exceed 8% of your income. Period.
According to Ric Edelman, author of The Truth About Money, Harper Collins, lender's qualify income as gross yearly pay, including overtime, part-time, seasonal pay, commissions, bonuses, and tips. Also included are dividends from investments, business income, pension or Social Security income, veterans benefits, alimony and child support.
But do you really want to count all this income? Think about it. Is overtime really a reliable source of income? Do you want to force yourself to work overtime every year for the rest of your career to hold on to your house? Of course not, so don't include overtime in your income statement. What about child support? How often has your check been late or failed to arrive at all? Again, don't count on it.
If your goal is to have your house and eat, too, keep some of your financials to yourself. See what kind of a loan you can qualify for based simply on your yearly salary without extra bonuses. And as far as dividends go, you could be reinvesting them to make your stock account grow. You don't need them as income for your house.
Editing your income statement can also give you bargaining room later, if you really decide to buy a home that is a little outside the lender guidelines, but there is something else you can do, too - choose a more favorable loan.
Use the Lender's Loan Products to Leverage More House
A 30-year fixed rate mortgage is the gold standard of the loan industry, but is it necessarily the right product for you? The answer lies in two things - how long you plan on occupying your new home and whether you are choosing a home slightly out of your edited income range.
If you are a first-time homebuyer, the odds are that you'll be in your home for about four years. If you are a second home buyer, plan on about 7 to 12 years of occupancy. The shorter time you occupy your home, the less time you have to eliminate interest payments and reduce your principal. Until principal is reduced, you aren't really building any equity in the home. Equity equals ownership. If you are not planning to stay in your house long, pay as little interest as possible up front. Don't pay points, and finance as much of the closing costs as possible.
A 30-year loan is a high risk loan for lenders. That's why your credit, debt and income picture have to be so upstanding to qualify for one. With that in mind, you can take a small risk and lower your payments with a variable interest rate. If you know you will only be in your home a short time, four or five years or less, choose a hybrid or adjustable rate loan which will be a point or lower than a fixed rate loan. Your monthly payments will be reduced, freeing your cash for other things.
Decide on Your Goals Before You Buy Your Home
You have other goals besides buying a home. What are they? Do you want to have children? Do you want to build wealth? Save for retirement or retire early?
Baby makes three, but three into two incomes doesn't go as far. Count on spending up to $25,000 on baby just in the first two years. That will be more difficult if one of you stays home or works shorter hours to parent.
Do you want to build wealth? Start investing or add to your investments? The authors of The Millionaire Next Door, Simon & Shuster, Ph.D's Thomas J. Stanley and William D. Danko, advise that you spend no more than twice your household income on a mortgage. If that leaves you safe financially, but short on a stylish home, you can compromise. You don't have to spend as much as the lender guidelines allow or pull in your belt as much as the authors suggest. Find out how much home you can qualify for and simply inform your Realtor that you'd like a home that is 10 or 15 percent less, or whatever percentage you are comfortable with.
You won't build wealth as quickly, but you can solve that by putting the difference between what you would have spent on a higher monthly payment and your actual payment into a dollar cost averaging fund. Add to it monthly - $100 or $200 a month will add up quickly into a nice investment and you won't miss it in the meanwhile. After all, you were going to spend the same amount on a house, weren't you?
Living in style is about more than having a big, expensive house. It's about being able to meet all your financial goals comfortably. And with the right compromises, you can do both.
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