Buying your first home is one of the more difficult tasks in personal finance. It’s a huge investment decision that will impact both your bottom line and lifestyle for years to come.
This demanding process is made more stressful by the endless stream of well-intentioned, if sometimes dubious, advice flowing from everyone you know who has ever bought a house – parents, friends, co-workers, the guy sitting next to you on the plane and, of course, your real estate agent.
When my wife and I were looking for our first home in 2007 – the peak of the housing boom – our agent told us to stretch, to buy more house than we could afford at the time. On its face, this was terrible advice. Buying too much house can severely strain a family’s budget and hamper the ability to save for the future. But, given our particular situation, this proved to be solid guidance.
Call it the best bad financial advice I ever received.
So, should you buy more house than you can currently afford? To make that decision, you need to do something that doesn’t come easy. You must be rigorously honest with yourself about what you want in a home, how long you expect to stay in that house and, most importantly, how much your income will grow over the next decade.
Our agent argued that I was just starting out in a career that held the promise of steady income growth as I continued growing the business. What’s more, my family was growing. If I bought a smaller house based on my current earnings, he said, I’d regret it in five years when I was making notably more money. He predicted we’d get frustrated and go looking for a bigger, better place.
While the agent’s pitch targeted our emotions, there is some financial basis for his argument. Assuming that homes appreciate at an average 3% annually, it takes seven years to break even on the sale of a home. Why? Because you have to recoup such costs as closing costs, broker commissions, interest, taxes, upgrades and repairs. Furthermore, in the first ten years of a mortgage, the bulk of your monthly payment is interest. During this period, you are essentially paying rent to the bank.
Given the above, it doesn’t make sense to buy a house unless you honestly believe you will own it for at least five to seven years. If you think you might soon outgrow it, or be transferred to another city when you grab the next rung on the corporate ladder, keep renting.
What if your professional and personal futures are somewhat settled and clear? Should you make that stretch and buy more house than you can afford, knowing you will live there for fifteen or twenty years? Time for more honesty.
Ideally, you should spend a maximum 28% of your gross income on housing. That’s a big chunk of the budget pie – even before you “stretch.” But as your household income grows over the years, that percentage will shrink. In deciding how much house to buy now, you need to carefully consider how much your income will increase in the coming years and decades. Are you in a profession, such as teaching, that offers relative stability and slow, predictable, limited wage growth? If so, your long-term income outlook is very different from someone who owns a growing business or is ramping up as a salesperson.
I can’t emphasize enough the importance of doing your homework and being completely honest about your family prospects before you decide how much to spend on a home. Owning a home is one of life’s joys. Being house-poor is one of its true miseries.