Home Buying Follies
I read an article in a local newspaper last weekend describing — celebrating, really — a couple’s first home purchase and how they achieved it. For me, it was a litany of pretty much everything that you should not do when buying a home. The article was meant to be inspiring, but for me it was horrifying.
For the umpteenth time, I remind you that buying a home is simply out of reach for too many. So it is with a heavy heart that I relay this tale of new homeownership. A fine young couple realized the dream of their first home together, and here I am raining on their real estate parade.
Very Low Down Payment. The couple’s mortgage required only a 5% down payment. (I presume that this was an FHA-insured mortgage.) Look, I do get it. Houses cost way too much and even if your monthly budget can swing the mortgage payment, it can take eons to produce the standard 20% down payment.
As a financial planner, I am okay with as little as a 10% down payment, even though that comes with the added cost of private mortgage insurance (PMI). But not having enough slack in your budget to save at least that much suggests to me that you may not have the financial capacity to carry a home over time. That certainly seemed to be the case for this couple, as we will see.
Another pitfall of a very low down payment is that you run the risk of the home being “under water” if housing prices wobble; that is, the market value of the home being less than your outstanding mortgage. This is especially a threat in today’s high-ish interest rate environment. If you have no reason to sell, it’s not a problem. But what if you unexpectedly must relocate for your career? What if your needs change?
Very low or no equity will also make it more challenging to refinance the mortgage when (if?) interest rates fall unless they have cash to bring to the table by then.
Not Enough Savings. Here’s a quote that will keep a financial planner up at night. To buy the home, the couple “used up all of their personal savings.” I mean, come on! Are you trying to give me a stroke? The one thing that any homeowner will tell you is that the ongoing costs of owning a home are high, especially in the beginning when you are in the throes of New Home Renovation Fever. (And also discovering all the things that the seller forgot to mention, as we will see later.) Oh, the number of times I have had someone tell me that they were happily debt free…until they bought a house.
Perhaps compounding the error, the couple drained a retirement account to come up with the down payment. Now it could be the case that they availed themselves of the rule that allows you to withdraw up to $10,000 penalty-free from a Roth IRA for a first-time home purchase. But it sure didn’t sound that way.
Oddly, the buyer justified the use of these funds by stating that the account “wasn’t really making any money.” Which opens up a whole other avenue of inquiry: Given how the stock market has performed over the last five-plus years, how is she investing her retirement account such that she has not benefited?
Paying For Points. This may or may not be an error in the long run, but it surely was another sign that they were not financially prepared for this purchase. Paying for points means that you make a lump sum payment to a lender to reduce the mortgage rate. For example, if your purchase price is $250,000 (about what the house in this article cost), paying 1% of the price ($2500) would typically reduce the mortgage rate by .25 percentage points, say from 6.25% to 6.00%. Paying for points can work out economically if you hold the home over a long period of time.
In this case, the couple paid for points (with savings that they clearly did not have to spare) because they said they would have struggled with the monthly mortgage payment otherwise. (Remember the low 5% down payment. Aside from creating an obviously higher monthly payment, they will be paying for mortgage insurance.)
Bought “As Is.” People, have you not yet learned that this is a recipe for financial disaster? No one sells a house “as is” when it is in mint condition. The buyers did have an inspection after going into contract, but as the contract specified “as is,” this was mostly for their own information. There would be no wiggling out of the sale if they did not like what the inspection revealed. (Did I mention that this was an old house in what agents euphemistically refer to as “estate condition”?) Buying “as is” is fine if you are a deep-pocketed developer. But not for the rest of us, and certainly not this pair.
I really hate to be such a scrooge. Buying a home in this market is tough and the circumstances of the purchase are simply not always going to be ideal. I fully accept that. But please don’t let your emotional desire to get into a home cloud your better judgment and threaten your financial security (and peace of mind).
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