Buying a home is often one of the biggest financial decisions Americans will make during their lifetime. Homeownership is often viewed as a sign of success in America, and for many people there's nothing quite like the feeling of knowing that you're in control of your own domain.
But buying a home isn't something that consumers should take lightly. It's a major responsibility that can have big repercussions if you aren't careful. Here are five of the most common personal finance mistakes that current and prospective homeowners should be careful to avoid.
1. Buying too much house for your pocketbook
It's perhaps the cardinal sin of the home buying process: purchasing a home that you can't afford and/or don't need.
Americans sometimes let their enthusiasm for homeownership get the best of their common sense. According to a survey commissioned by the nonprofit John D. and Catherine T. MacArthur Foundation last year, 52% of Americans have made at least once major sacrifice over the previous three years to ensure that their mortgage or rent got paid. Sacrifices noted in the survey included getting a second job, deferring saving for retirement, or running up credit card debt. Purchasing too much home could mean having to downsize later, and there's no guarantee that housing prices will be favorable when you decide to sell.
The solution is pretty obvious: Buy only the amount of home you'll need. Most banks don't want consumers spending more than 28% of their gross income on their monthly mortgage, so you should probably use this as a guide when looking at homes to purchase.
2. Not having an emergency savings account
One major personal finance mistake that a majority of Americans make is failing to save up an adequate emergency savings account. This is especially dangerous for homeowners. According to a survey released by GoBankingRates in October:
- 21% of Americans didn't have a savings account.
- 28% had a savings account with $0 in it.
- 13% had a savings account with less than $1,000.
Add this up, and we're looking at 62% of Americans with less than $1,000 in savings to cover an emergency. Be mindful that this survey wasn't targeted at homeowners; it was merely a representative survey to gauge the financial preparedness of Americans in case of an emergency -- and most failed.
Owning a home can be quite expensive, though the costs can be lumpy at times. When buying a home, you'll want to factor in the costs for homeowners insurance, property taxes, and perhaps private mortgage insurance if you can't put at least 20% down. But you should also have money set aside for emergency maintenance, like plumbing or roofing repairs. Some of the more expensive fixes can cost you four or five digits, so you need to have money set aside to cover those bills.
3. Failing to shop around for the best mortgage rate
If you want to give yourself a long-term headache, then ignore your opportunity to shop around for the best mortgage rate.
In 2013, the Consumer Financial Protection Bureau surveyed mortgage borrowers across America and found that nearly half (47%) don't compare lenders and simply assume that they're getting the best rate. Additionally, the report showed that 70% of borrowers filled out an application with just a single lender rather than multiple lenders to see which one offered the best deal.
Skipping the shopping-around step might save you some time, but it'll probably cost you in the long run. If you knocked just 0.25% off a 30-year mortgage on a $150,000 loan and merely made the minimum payments over those 30 years, then you'd save yourself more than $7,500 over the life of the loan. In reality, if you have good or excellent credit, then lenders are often willing to fight for your business, and they may offer you a reduced rate to win it.
4. Using your HELOC as a piggy bank
Along the same lines as buying too much home is the idea of using your home as your own personal piggy bank by pulling out a home equity line of credit, or HELOC.
The beauty of a HELOC in today's market, in which home prices can only seem to go up, is that it's incredibly easy to access. But it's really a personal-finance trap. Taking out a HELOC means giving up a percentage of ownership in your home to someone else while paying interest on what you just handed back. Making matters even more troublesome, HELOC interest rates tend to be higher than standard mortgage rates -- or they'll be offered at a below-market rate that adjusts higher within a few years. For homeowners who aren't prepared, a HELOC that suddenly adjusts higher can create sticker shock when the monthly payment comes due.
There are some rarer instances when using a HELOC makes sense, such as when you're renovating your home. However, a HELOC is generally a financial instrument you're best off avoiding.
5. Expecting your home to be the foundation of your retirement savings
A final personal finance mistake that homeowners should avoid is counting on your primary residence to power your nest egg.
It's not hard to understand why so many Americans are banking on their home to fund their retirement. Between 1997 and 2007 home values essentially doubled, even when adjusted for inflation. Of course, we know how that story turned out: The bubble burst, and home values deflated even faster than they rose.
Based on research from Robert Shiller in Irrational Exuberance, home prices have historically tended to track the national inflation rate very closely. Between 1890 and 1990, home prices outpaced inflation by just 0.2% per year. Between 1950 and 1997 they outperformed by less than 0.1%. History suggests that a primary residence works better as a store of value than as a creator of value, which means homeowners should treat it as such. Even if your home is your most valuable asset, you're better off saving and investing as much as possible in order to create a reliable stream of income when you retire.