Beating Broke

Personal Finance from the Broke Perspective

Buying a House: How Much Can You Buy

By 10 Comments

This post on behalf of Emortgage Calculator

One of the more important parts of buying a house, is not over spending on the house that you plan on buying.  Despite all the headlines during the recent real estate boom and crash, people are still trying to buy much more house than they can reasonably afford.  When they do that, any little setback can be a disaster to their housing situation.  Think about it; if you’re already stretching to pay the mortgage, and you lose your job or have some other major expense, will you still be able to pay the mortgage next month?  Probably not.   And that’s where the trouble begins.

door keyMany will say that you shouldn’t buy a house where the mortgage payment accounts for more than 40% of your income.  Some will include the escrow and utilities into that equation, some do not.  Being the frugal fellow that I am, I suggest you shoot for a far smaller number than that.  If you want to truly be able to afford your house, the mortgage payment, including escrow (but not utilities), shouldn’t exceed 25% of your income.  If you really think about it, do you really want to pay any more than one quarter of your income on just your house?  How will you afford anything else, let alone pay down debt?

There are several ways that you can estimate how much house you can buy.  Your lender will tell you how much you can buy and still qualify for the loan, but that’s a terrible way to go about it.  They are only interested in completing the loan, not whether you can pay for it for 30 years.  Many of the real estate websites will have a loan calculator on their sites as well, which can give you a pretty close estimate.  If you’re in the UK, the Emortgage Calculator can help you estimate those costs.  Most calculators will ask you a few simple questions.  How much is the house worth (value), how much will you borrow (loan total), how long will you borrow it (Term), and at what interest rate (Rate).  Using those numbers, the calculator will amortize the loan, and return the estimated monthly payment on the mortgage.  Use that number, plus an estimated escrow amount (roughly 20-25% of the payment amount makes it a safe estimate), and you’ve got a number that you can use to determine if the house is too much house for you.  Then, you can continue on with shopping for a house.

A few other notes.  Yes, an “interest only” loan gives you a much smaller payment amount and may seem like a good way to get into a house that you otherwise couldn’t afford.  But, you’re only paying interest for that period.  When the interest only period ends, so does your affordable payment amount.  Then, you’re stuck with a much larger payment, and all of the principle of the loan.  Same goes for an “ARM”, or “Adjustable Rate Mortgage”.  The payment is nice and low before the first adjustment period, but when that adjustment happens, the payment can go up by a good amount.  Avoid both and stick with the conventional 15 or 30 year mortgages.  You’ll be glad you did.

photo credit: woodleywonderworks

Obligations of the Buyer

By 4 Comments

With all the news lately about people “walking away” from their mortgages, increasing bankruptcies, and debt consolidation/repayment schemes, I got to thinking about what the obligations of the buyer are.  And, also, the ways that we as a society have made it easy to sidestep those obligations.

Obligations

What are our obligations when we buy something?  Does buying a pack of gum carry different obligations than buying a house?  Naturally, we have obligations to ourselves as to the upkeep and use of that which we buy.  If I buy a house, I have an obligation to myself to do what I can to make that house last as long as possible and remain structurally sound.  If I buy a pack of gum, it’s a lesser commitment, but that obligation still exists as an obligation to not let my purchase go to waste and either chew the gum or give it to someone to chew.

What obligations to we have to the seller when we buy something?  There are two ways to look at this.  The first scenario involves paying cash for something.  If the full purchase price that was negotiated is satisfied, I don’t believe you have any obligation to the seller.  However, if the purchase involves debt of some sort, there are obligations that arise.  If you purchase with a credit card, there is an obligation to pay that debt to the credit card company.  The same is true for a mortgage, a car, and even a pack of gum.  Not only do you have an obligation to pay the debt, but you also have another obligation to yourself to learn what that debt is going to cost you.  This last obligation is the one that was most ignored during the fiasco that we like to call a housing bubble.  Many ignored the facts of what their new houses were going to cost and bought them anyways.

Sidesteps

In the pursuit of a consumerist society, these obligations can sometimes get in the way.  If I ignored the obligation to know the cost of debt and bought a house anyways, I likely entered into an agreement to pay a mortgage company a set amount each month.  Recently, it’s become popularized to demonize the banks that lent the money to people as the sole problem and, as a result, it’s become no big deal to merely “walk away” (default, or stop paying) on a mortgage.  The reasoning follows that it’s better to default on the mortgage than remain paying on a house that is worth less than what the purchase price was, or that has had payments adjusted higher.

Bankruptcy OK!In the same way, the obligation to pay credit card bills, auto loans, and most other consumer debt has been sidestepped.  It’s no longer a social stigma to declare bankruptcy.  Many, knowing they are about to file for bankruptcy, will go out and max out their credit lines in anticipation of the bankruptcy cleaning the slate.

As these sidesteps become more and more common, the social stigma will decrease even further.  If everybody is doing it, it’s hard to demonize something.  You might demonize your friend.  Or relative.

Of course, this isn’t to say that defaulting on a mortgage should never happen.  Or that bankruptcy should never be declared.  It happens.  It’s the rampant social acceptance of these situations that is troubling.  What happens when it becomes commonplace for mortgage borrowers to default?  The loans become more expensive.  The banks have to cover their costs to repossess the house, the staff to service the loan, and associated costs with trying to resell the house.  Where is that money going to come from?  They aren’t going to just pay it out of the kindness of their hearts.  They’ll pass it on to the customer.  Suddenly, mortgages will become even more front loaded with fees and interest.  When bankruptcies become more commonplace, credit availability is going to decrease.  We’ve already seen that recently.  People who could easily get a credit card before will be denied.

All of this is all the more reason to avoid debt whenever possible.  If society isn’t going to do it, hold yourself to your obligations as a buyer.  Obligate yourself to paying off your debt.  Then, obligate yourself to paying in cash from then on.

photo credit: EJP Photo

Mortgage Refinance Underway

By 5 Comments

A few weeks ago, I asked all of your advice on whether we should refinance our mortgage.  At the time, we had just begun thinking about it and were still working out the numbers.  As you can probably guess from the title of this article, we went ahead and did it.

So, here’s why.  Part of our hesitation was that we plan on being out of our house in less than two years and it would take about two and a half to earn the closing costs back with the saved interest.  I think Financial Samurai hit the nail on the head in the comments of that original post when he asked what % we were sure that we would be moving in the next two years.  And the truth of the matter is that we hadn’t planned on living in the house longer than 4 or 5 years and here we are going on 6 years.  So, yes we plan on moving, but there is a chance that we will end up not moving.  More importantly, I think we can earn back those closing costs a lot quicker by using the saved interest money to pay down other, higher interest, debt.  If we’re paying off debt at 14%, we’re saving quite a bit each month and that will add up fast.

We did a little bit better on the interest than I had thought.  Originally, I had estimated that we’d get about 4.375%, but we actually got in at 4.25%.  Every little bit helps.  Of course, the downside is that will end up paying a bit more than I had anticipated in closing costs.  Which isn’t great, but overall, the math is still very favorable to us.  We also reduced our monthly mortgage payment by about $130 or so.  That’s a pretty good chunk of change that can go towards our other, higher interest, debt.  We’ve got a few more pieces of paperwork to turn in and an official assessment to get before we can truly seal the deal, but all of that shouldn’t have any effect on the turnout.  I’m hoping that we can have it all finished up and we can be paying the lower mortgage payment sometime around October or November.

What about you guys?  Any of you taking advantage of the low rates to refinance your mortgages?