How to Buy A House with a Mortgage

by · 12 comments

Owning a home – a.k.a. “The American Dream” – is considered by many as the true sign of “making it”.  There is a right way and a wrong way to make this dream a reality.  The last couple of years have shown that if you do not go about it the right way, you could end up with a real mess on your hands.  Foreclosures and short sales are at an all time high, so I wanted to discuss a few  tips to help you avoid negative housing situations.

Save for a down payment

It is possible to get a mortgage loan with very little down.  This could be considered good in certain circumstances, but overall it’s a bad thing.  It makes buyers think they can afford more than they can.  I suggest instead, saving up at least 20% for a down payment. So, if you’re looking at homes in the $100,000 range save until you have at least $20,000.  That sounds like a lot of money, because it is!

There are two advantages to this strategy: (1) it will insure that you will get a house you can afford.  If it takes you a couple of years to save up $20,000, it will appear clearer to you that you probably shouldn’t push yourself further by purchasing a $150,000 house.  Saving will also prevent you from making an impulse buy.  Trust me, you will want to think through a decision much more critically when you are writing a $20,000 check versus just coming up with $500 to cover closing costs. (2) it will help you avoid PMI insurance.  Most banks require that you pay for this insurance if you don’t have at least 20% down.  It protects them, not you, if you default.  For you PMI is a waste of your hard earned money.  PMI rates vary, but common amounts are $65-$70 per month on a $150,000 mortgage.  That’s money you could be putting to better use right? Like paying down credit card debt or saving for something awesome.

Monthly mortgage payment amount

This is extremely important.  If you want to do anything to get ahead financially (insert your favorite use for money here), it will be almost impossible if you are house poor.  For example, if 50% of your take home pay goes toward your mortgage, you will be lucky to cover the rest of your essentials such as food and utilities.  The math just doesn’t work. Instead keep monthly mortgage costs down below 25% of your gross income (after taxes).

Matt’s note: I suggest you keep you mortgage costs down to 10% of your monthly income, especially if you’re looking to buy in this amazing buyers market.

Here’s another tip if you’re a two income family – base the 25% rule on just one of your incomes.  Are you really comfortable assuming you’ll both be making the same income for the next 15-30 years?  I know we’re not!  Many young couples I’ve counseled start with two incomes then want to go down to one when a baby comes along.  When Mandy and I bought our first house, we kept our payment under 25% of our take home pay but we based it on both incomes.  When our oldest daughter was born and Mandy wanted to quit her job to stay home, it caused a problem.  All of a sudden our payment was closer to 30-35% of our take home pay.  It wasn’t killing us, but we could no longer accomplish many of the goals set when we had two incomes.  We ended up having to sell our house and move into something more economical.  It would have saved a lot of hassle to buy our current home the first time. Even if both spouses continue to work, you can always use the extra money to give, save, or do whatever you wish.

Shorter mortgage terms

This tip is simple math.  What law says you must take out a 30 year mortgage?  Hint: there isn’t one. Why is thirty years the standard?  Banks set that as the standard so they could make more money (interest on your debt).

Let’s look at an example.  If you take out a 30-year, $100,000 mortgage at 5%, your monthly payment will be $537.  The total interest you pay over 30 years will be $93,259!  If, instead, you took out a 15 year mortage, your monthly payment would be $791, but you would only pay $42,347 in interest over the life of the loan.  I don’t know about you, but $51,000 in savings is a lot of money to me!

Buying a home is a decision to think through very carefully.  Mandy and I learned these tips the hard way and my hope is that you don’t have to.

Use these tips to make sure your American Dream is a dream come true… and not a 30-year nightmare!

****



Betterment is one of my two favorite ways to earn interest on my savings! They have an awesome program for the Average Joe to save and invest simply and effectively. There are no minimum balance requirements and no transaction fees. Read my Betterment Review or open an account to get started earning now.

1 UltimateSmartMoney

Buying a home can be very stressful. It really helps if you can down pay minimum of 20%. My current mortgage is about 30% of my net income. I guess this is too high because it is stressing me out little bit. Also, before you buy a house, find out about property taxes because it usually increased if you buy in sellers market.

2 Mike Young

Thanks for the extra input. It is very true to be careful about property taxes, especially depending on where you live!

3 Carol@inthetrenches

Very nice article. Your work with young married couples sounds very beneficial and needed. Also, glad to see the ERE book on your shelf. Look forward to reading future articles.

4 Matt Jabs

Hi Carol, Jacob’s ERE book was awesome – I highly recommend it to people… mostly as a way to challenge perceived mindsets about personal finance.

5 Jan

Lesson learned. Acquiring a home shouldn’t be a burden. Do the math, and have the guts to take the next step.

6 Mike Young

Well said Jan!

7 Jon White

Good tips Mike. I admit that when I bought my condo in 2006 I broke every single one of your rules. I didn’t have a down payment, I didn’t know how much of my income was going to cover the mortgage each month, and I got a 30 year loan. Boy did I pay for it. I still live in it and enjoy it but I think back and wonder how much money I would have saved if I had been patient and saved up a down payment first and actually looked at all the costs associated with a home instead of making an impulse purchase. Thankfully we are able to put extra on the mortgage each month and we will have it paid off in less than 15 years! But I checked the other day and if we had just been making the minimums we would be anywhere from $10,000 to $20,000 underwater! So definitely take your time when buying a home and not rush things, that way your dream won’t become a nightmare.

8 Mike Young

You’re speaking my language Jon!

9 Richard Brown

Its shocking how a little extra each month can save you 15 years of mortgage payment and over 50 grand in interest! Amazing!

This is why I always tell people to break the numbers down and work everything out. Most people don’t realize how much money they are paying in interest or how much money they really have for leisure.

10 Mike Young

Exactly Richard. It is the mentality of how much per month instead of just how much. It causes many to pay alot of interest over their lives.

11 Kevin @ Debteye

I love the tip on basing your housing DTI based on 1 person instead of both. A lot of people go through financial hardship because their spouse lost their job.

Here’s another tip I wanted to add: Besides saving up for your 20% down-payment, you’re definitely going to want to save up more than that. Becoming a homeowner also entails a lot more expenses (furnishings, lawn care, utilities, etc).

12 Mike Young

Hi Kevin. Thanks for the input. You are correct, it is definitely a good idea to have other savings on hand. I should have been more clear that saving the 20% was just for the down payment, you will need savings for other things too such as new purchases and emergencies. Thanks again for your insight!

Previous post:

Next post: