Published in: Mortgages | May 8, 2020
By: Dana George
Taking on a new financial obligation before you're financially ready can cost you far more than it's worth.
"Learn from the mistakes of others. You can't live long enough to make them all yourself." This quote has been attributed to everyone from Benjamin Franklin, to Eleanor Roosevelt, to Oliver Wendell Holmes. And though I'm not sure who deserves credit, it's one of my favorites.
As someone who tends to learn by making mistakes, I've made some doozies. The biggest, dumbest thing I have ever done financially is to talk my husband into selling our small starter home to purchase a big, shiny new house. We were not ready. Life before that house was simple but relatively stress-free. The years that followed were full of regret and sleepless nights.
Here are some of the reasons we shouldn't have bought that house -- ones that you can learn from:
We depleted our savings to get into the house. Although I'd like to blame it on the fact that it was the 1980s and the entire nation was caught up in a "go big or go home" mentality, we were the ones who decided to throw caution to the wind. It came back and bit us in the budget.
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The tuition assistance we depended on for my husband to finish graduate school dried up, which meant we weren't bringing in enough money. Since nearly everything we were earning went into the new house, we had to rob Peter to pay Paul to finish paying for school. An emergency fund would have allowed us to pay for my husband's last few classes without going further into debt.
An emergency fund gets us through when money we'd counted on dries up, someone gets sick, has been laid off, or our home requires a sudden, unexpected repair.
Going into a new home with credit card debt is a recipe for disaster for two reasons: It's stressful to juggle mortgage payments alongside high-interest debt, and applying for a mortgage while carrying that debt can cost you big.
One of the most important things you should do before you buy a house is to get your credit score as high as possible. Carrying credit card debt has a big impact on the second biggest factor that's used to calculate your score: credit utilization. This is the ratio of your outstanding balances against your available credit. If you have a credit card with an available credit limit of $1,000 and owe $500, your ratio would be 50%. A high credit utilization worries lenders as it suggests you might be overly reliant on credit.
Consider this: At the time of writing, a person with fair credit might be able to get a 30-year mortgage for $300,000 with an APR of around 4%. Someone with good credit might qualify for the same mortgage with a 3% APR. The person with fair credit would pay about $1,430 a month and $215,600 in interest, while the person with good credit would pay $1,265 a month and $155,330 in interest. That's a savings of $60,270 over the course of the loan, just for having better credit.
We were only in this home for three years. What that meant for us financially was that we spent thousands of dollars on real estate agent fees and closing costs. Although the closing company cut us a check, it was not enough to cover the equity we brought over from our first home, moving costs, or any of the improvements we made to the property. We were simply not there long enough.
We learned our lesson. My husband's career meant we moved approximately once a year between 2006 and 2016. We were wise enough to rent, bank our money, and wait until we expected to be settled to purchase another home. No, we didn't build equity during that time, but we also didn't lose money by owning what should be a long-term investment for a short period of time. Like most investments, you don't want to sell too soon. A good rule of thumb is to be confident that you will be in your home for five to 10 years so that you can build equity.
When you take on a mortgage, it's easy to believe that you can trim all the fat out of your budget and commit to a higher monthly payment so you can afford a more expensive property. But -- in addition to having an emergency fund firmly in place -- you need to make sure your mortgage is low enough to allow for extras. No matter how much you like that koi pond in the backyard of a home, you will eventually resent having to give up hobbies, trips, and fun extras.
What we fell in love with was not a koi pond, but turrets that gave the house a Victorian vibe, a cool interior catwalk, and a huge master bedroom. We now refer to such flourishes as "jazz hands," but back then we were willing to convince ourselves that we could afford it. Our mortgage went from $419 per month to just over $1,200, which we decided we could handle. What we didn't account for was a water bill that would be well over $100 each month, property taxes that added hundreds of dollars to our monthly mortgage payment, and a sudden desire to have all the cool toys our new neighbors had. Oh, and there were those stinking tuition bills to cover.
Because our new house was in a more exclusive area, the cost of "irregular expenses," like insurance premiums, changed. I'm not sure why we didn't check on details like taxes, insurance, and utilities when we purchased this home, but you don't have to make the same mistake.
Don't buy a home until you factor in all the expenses associated with it. Ask how much taxes are, call your insurance agent to find out how much insurance premiums will run. If the house is not new, ask to see a copy of utility bills for the previous three months. Find out how much homeowner association dues are and which services they include. In short, ask so many questions that you irritate someone.
Like penicillin and Post-it Notes -- both invented by accident -- mistakes are not always a bad thing. But you'd sleep better at night if you can skip the five home-buying mistakes above.
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