When Not to Buy a House
by Steve Leung | Contact Steve Leung w/ Questions
You've probably heard all the perks about buying a house and how it's the centerpiece of the American Dream. But the American Dream is less about possessing the house itself than the improvement you expect in your lifestyle when you own a home.
As a real estate agent, I want you to be deliriously happy after buying a home. To me, that means there are times when I recommend to clients that buying a house isn't the right way to go yet, particularly when the financial risk of keeping your home takes away from the enjoyment of it.
Here are five times when I counsel clients to wait on buying a house.
1. You're uncertain about your job.
Having a stable income is paramount in ensuring that your home doesn't turn into a financial burden, and almost everyone needs to work to bring in that money.
But if your company is considering layoffs in your division or moving their headquarters — or you're considering a career change — you may be forced into selling or renting out your home in short order. Doing so is time-consuming and costs money.
You may be mentally prepared to sell your house quickly, but the market may not be so kind, and you might have to take a large loss in order to do so.
2. You have bad credit right now.
When you take out a mortgage to buy a house, your lender charges you interest every month for the privilege, but when you have bad credit, your lender will charge you a lot more.
Why? Because people with bad credit cost lenders money by not paying promptly or not paying at all. And what they charge you may end up being several hundred dollars a month! Bad credit is any FICO score below the national average 720.
But I want you to know that if you're there, you're not alone. The good news is that with a few months of "good behavior" you can increase your FICO score and save yourself all that money.
3. You're already in a lot of debt.
I not only want you to be deliriously happy after buying a home, I also want you to be able to keep it for as long as you want to. The total of a lot of student loans, credit cards, car payments, that $50,000 your folks lent you, etc.: all of this not only hurts your ability to buy a house but also your ability to keep it.
The challenge is that if you take on more debt in the form of a mortgage, you may take away your ability to pay off other more expensive debt. At that point, you're basically paying a lot of money for money you no longer have — a lose-lose scenario.
For people in this situation, the rule of thumb is to pay off your debt with the highest interest rate first and be careful taking on new debt.
Now, lenders will come up with all sorts of creative ways to let you max out your debt-to-income ratio — their focus is earning money on top of the loan they sell you. Since I don't sell loans, I can help you run the numbers so that you only take on as much debt as you're comfortable with, while keeping some money in reserve for the unexpected.
Remember, my goal is to help you enjoy your new home. If you take on too much responsibility with debt, you may be forced to sell on terms you won't like. (Lenders aren't bashful about this.)
4. The only way you can afford the house is using an exotic mortgage.
Can you imagine a world where everyone had to buy a house using only cash on hand? Very few people would own a home if the world were like that.
Lenders know this and have come up with a number of loan types (they call them products) that ostensibly help people get into their dream houses. The most notorious of these loans is the option ARM, sometimes called a "pick a payment" mortgage. The possibility of negative amortization from this loan means you pay less monthly but end up owning less of your house every month too.
I would never do business with someone who recommended one of these loans to my clients, and I recommend you don't do business with anyone who tries to sell one to you.
5. You don't have some reserves after your down payment and closing costs.
Buying your home is only the first step. The freedom that comes with home ownership also comes with additional costs like property taxes, special assessments, home maintenance and repair work, none of which were applicable when renting.
I'd argue that if you're stretched to the point where you have zero savings left over to take care of unforeseen expenses after purchasing your home, you risk a lot of unnecessary stress, losing your house or having it fall into disrepair.
The amount you have in reserve doesn't have to be huge, but a couple month's worth of your mortgage in a readily available form like a high-yield savings account, or even stocks, can ease your mind.
Purchasing a house is a major financial decision that stretches the finances of many families, but there's a difference between having to pack your lunch versus risking foreclosure because of a bad month.
There are a lot of folks who want to you stretch to buy a more expensive house than you need or one sooner than you might be comfortable with. My real estate advice is geared so that you're in a position to own and enjoy your home for a long time.
(c) Steve Leung for the Silicon Valley Real Estate Blog at 1SiliconValley.com
Recommended Reading:
- Empowering Yourself Through Your Credit Rating
- How Much Should You Allocate as a Down Payment?
- How Much House Can I Afford? (Part 1 of 2)
- How Much House Can I Afford? (Part 2 of 2)
- 4 Ways the Silicon Valley Real Estate Market Is Correcting
- Subscribe to Our Silicon Valley Real Estate Newsletter
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February 01, 2007 | Filed under: Bay Area Real Estate, Home Buyers
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Also remember that mortgage lenders have been quite willing to let you get into a dangeroulsy tight financial situation in order in order for them to make more money. However, now that 17 sub-prime mortgage lenders have gone under since mid-December it does look like most lenders are becoming more cautious. There’s a lot of corruption in the mortgage industry that is hopefully getting shaken out. That will also reduce the number of available buyers which will hopefully help to moderate home prices over the next few years.
So if a mortgage broker tells you that it’s just fine if your housing costs ( mortgage payments, insurance, prop tax) are 33% of your gross income you must be very wary. In the ‘old days’ (before the late 90s) that ratio was 25% and that was pretty strictly adhered to by lenders. Its been floating up in recent years, first to 28% and now it’s often 33%.
Your reason listed for not buying a house are all the reason FOR buying a house.
First of all…if someone has bad credit; by buying a home their credit score will go up within a few months because of their 1st and 2nd Mortgage they have.
Also why would someone want to make a down payment in the first place?
Why not put that money in the Shanghai or Karachi stock market (last year they both went up over 80%).
This is a great time to buy a home:
#1) We are in a down market..homes are languishing on the market for at least 6 months now…you can get a great deal now..versus only a few years ago homes were in a bidding war.
#2) Either your gonna pay the rent to the landlord and own nothing after your done….or you can buy a home, get that that mortgage and as home prices rise and your equity goes up….when you move you will have made a profit from buying your house.
Buying a home is a great choice to make.
Of course you dont want to buy more-home-than-you-can-afford.
Mortgage professionals are the good guys..previous comments mentioned corruption in the industry.
That ‘corruption’ is there so its easier for more people to qualify to buy a home.
Jay,
I think you must have mistyped your name because I’m pretty sure it is David Lereah. Either you’re him or you’ve been smoking the same type of stuff he has been smokin.
For example item #2.
#2) Either your gonna pay the rent to the landlord and own nothing after your done….or you can buy a home, get that that mortgage and as home prices rise and your equity goes up….when you move you will have made a profit from buying your house.
- In most areas it isn’t too hard to find a place that is cheaper to rent than buy. I’ve lived in 5 different states in the last 10 years and time and time again it was not too much work to find a nice rental that was cheaper than a mortgage payment (sane mortgage like a 15 or 30 year fixed).
- You’re assuming that home prices are going to rise and we’re not going to see something similar to Japan’s market.
- You’re again assuming that the home prices rise (if they’re rise at all) enough to recoop your purchase price plus all associated fees.
Congrats on the Carnival win! This is good, solid home buying advice, and I think it improves our credibility as real estate professionals if we don’t do the David Lereah “it’s always a good time to buy” song and dance. Number 6 on your list might be, “If you’re only going to be in the home a few years.”
Steve,
This is a very tought-provoking article and makes a lot of great points.
Is there evil in the mortgage and real estate world? Of course. But, then there is in every possible business (Enron?). The key is to work with someone that you trust — and know your limitations.
It often amazes me how much someone will tell me (as a licensed agent in Ohio) about themselves in a 30 second phone call. Last week, in 30 seconds a woman told me their house had black mold and that it was making them all very sick, they had to move, they had bad credit, etc.
What did she just do? She just set herself up to be taken advantage of. Fortunately, she called me and I explained to her what she had just done — and you could hear the alarms going off in her head. How many people had she called before me? I don’t know.
The most important thing to do is to find people that you TRUST in this business and work with them.
The wide-variety of houses on the market, and the wide-variety of mortgages are not in and of themselves a bad thing. But when matched with “evil” people they can be. Unfortunately, we tend to hear so much more about the bad ones than the good ones.
Toby
Steve,
Excellent post. This will be my Carnival choice for Toward Better Life Carnival #6, which will post on My Wealth Builder later today.
Thanks Super Saver!
Steve
Reason number 6 not to buy: Home prices have doubled in the past five years in your area, fuelled by aggressive lending to people who wouldn’t ordinarily been able to afford these high prices. Now that this type of lending is drying up and credit is being crunched, and more recent homebuyers are going into foreclosure because their payments adjusted to reality and the buyers aren’t there anymore, prices are flat. But prices will continue to decline as banks revert to the pre-boom lending environment.
Now you know you can keep renting for significantly less than owning. Also, the Fed has moved away from rate-tightening, so mortgage rates should remain low as the economy continues to slow. In two years, you’ll be able to have your pick of homes from desperate sellers, for less than you would have paid today, and you’ll have a bigger down payment to boot!
Hi Seamus, that’s an awesome handle! Your arguments sound persuasive, but there’s actually data showing that the foreclosure rate here in the Bay Area and Silicon Valley is statistically much lower. I have an article about this titled California Mortgage Defaults Hit 8-Year High.
It basically says that high-paying jobs (not even including stock and option bonuses) allow personal savings and keep the market here competitive. And that the foreclosure rate on default remains low because most owners can afford to make other arrangements.
If you’re an avid reader here, you’ll know that I don’t advocate aggressive lending and am pretty old-school about my opinion on down payments. I know a lot of responsible people who want to use their money elsewhere, and that’s fine, but it takes a lot of discipline to keep a good investment reserve.
Also, a couple things about renting vs. owning. I’d need figures to do more than handwaving, but because of the high salaries in the area, the tax deduction really does matter even when you factor in the possibility of AMT. The savings based on your tax rate is significant and offsets much of the cost. (Accountant for details, but I am someone who’s been through it.) Rental prices here have increased significantly as well offsetting many of the monetary arguments and bolstering some emotional ones.
There’s no question a disciplined saver can accumulate more money for a down payment over time.
But if you’re going to base your purchasing decision on what the Fed will do in two years, I have a financial advisor at the Las Vegas Bellagio who’d like to meet you at the craps table for some equally good advice.
Steve, thank you for your very reasonable response.
I’m should clarify that I’m not trying to base my decision on the Fed’s actions — I’m just trying to glean how their actions will impact rates, because the real estate boosters have been screaming “Buy now before rates go up!” for five years. My primary thought is that a lot of homes have zoomed in price the last few years; a RE agent friend of mine told me last summer, “$800,000 is the new $600,000, and you need to buy before $1,000,000 is the new $800,000.”
By the standard 20% down rule, and the need to have a fund for repairs and furnishing, someone in the BA really needs about $200k in the bank before buying a house. But in the past few years, as lenders have gotten aggressive, that price of entry has dropped considerably, in some cases to $0. We have to admit that way, way fewer households are going to be able to afford $800k homes if that minimum capital for entry goes back up to $200k. Even with all that starting capital, you’re talking about $5k+ in monthly expenses before upkeep or quake insurance.
And as for the AMT, my wife and I are already paying it without even holding a mortgage. We’re already at our minimum possible tax with only a baby and some fairly modest charitable contributions to deduct!
So, if our rent is relatively low (yes, rents are generally higher, but still far lower than the cost of ownership), home prices are still close to the top of the market, recent homebuyers are stressed, and we can’t possibly lower our tax bill, why would we — or any dual-income families still renting — buy a house in the Bay Area in 2007?
Thanks for writing with more details, Seamus! “You need to buy…” those are my four favorite words :-) Sarcasm doesn’t come out well over print so I’ll just be explicit.
My opinion as an agent is that the only thing you need to do is what’s right for you, your family and how comfortable you are with risk (i.e. what you’re prepared to do, what you want to avoid, and as a corollary, what your time horizon is). Yes, it is conceivable to be priced out of the market, but if that’s a conscious decision you make, then you can plan ahead to try and mitigate that.
So with that in mind, yes, interest rates have gone up over the past few years. But the only thing you can predict about the Fed is that they have an anti-inflation bias. September 11 (down), the job market (inverse), oil spikes (inverse), and other unforeseen events could all impact rates.
If you’re sailing a boat, you would need to ensure you have the right provisions for your journey and ensure you’re not sailing into danger. The ocean is the ocean and she’ll do what she does! If you get a mortgage, you can lock in the ocean for a period of time which may outlast your boat.
Boats are expensive though, right? Yes, it’s a lot of money; yes, it is an important place where you put your money; yes, you want its value to increase. But it’s both investment and use. If hypothetically your baby grew up (son or daughter?) and wanted to paint his room Giants orange and you only treated your house was an investment, you’d never do it. But you care for your children and you consider it anyway knowing that you’ll never get an A’s fan to buy your house. Would you do that in an investment property?
That’s how I see the difference between a home, a rental, and an investment property. One is use and investment, the other is pure investment.
I phrase the question, “Are you buying at the right time?” differently. I ask, “What are events that will necessitate selling the property?” because the price of the house only matters AT THOSE POINTS. Otherwise, you’re locked in for the period you’ve chosen, with a possible ARM reset which you can plan for.
With salaries at Bay Area levels and job growth at sustainable percentages, there are many ways to be financially stable with a 10% down payment and keeping investment reserves elsewhere. My opinion is that the key is for the difference in money to be there (i.e. invested somewhere) and not for it to go into “stuff” that has a low resale return.
I’m old school because I see people look at 0% as if it’s a right and not a marketing tool. It’s okay to do 0% if you’ll be staying in the house for a while and understand the ramifications of not having upfront equity. (Can explain.)
I’d argue, instead, that more qualified people are making stronger offers on better properties. (I used the word “better” for which there’s no measurement, just experience.) Those who waited out 2005 are sensing more weakness than there is and running into competitive offers from all the latent money sitting in stock around Silicon Valley.
I need to take this phone call but I’ll be back to answer the rest of your post! Very thought-provoking!
Cheers,
Steve
Whew, long day. There is no short answer to your question because it’s based on a couple assumptions.
The first is that all recent homebuyers are in trouble. For people who couldn’t afford houses and somehow managed because of an exotic mortgage, that may be the case.
For people who planned to live in their houses for a realistic period of time and locked in rates or planned for their rate increases, they are unaffected by any short term impact.
Are home prices at the top of the market? Your question assumes that a market has to go down and won’t get back to where you bought at — and that your needs won’t be fulfilled in the mean time.
I’m writing an article about market data as we speak which will help illustrate my point, but until that’s published, I offer that the stock market is higher today than during the most recent bubble. If you held your stock through that period, you would be unaffected. If you panicked or invested in an area with poor fundamentals, you lost a lot of money.
The Central Valley is an example of a place with poor fundamentals. There weren’t enough high-paying jobs to support those prices and that many houses.
If you’re worried the bottom will fall out of the market, think about the price your co-workers and bosses would pay for a house.
Think about the rental lifestyle and how people treat rentals vs. taking ownership. Think about not having physical or financial control over where you live. More importantly, think about the averages over the period of time your family would stay in that house to make it a stable home.
I’d argue that for all the rationality with which your questions are presented, the opinions are actually colored emotionally by fear of a catastrophic downside. What I’m saying is that, yes, no purchase this large is risk-free, but with good preparation and an understanding of your own needs, you can mitigate any major downside risks while improving your lifestyle.
It’s late, I’m tired, and we can pick this up again.
Cheers,
Steve
Steve, you’re a good man. Thanks for your response.
I appreciate it!
Steve
Very Insightful post. As a soon-to-be first time buyer, this is great information to consider.