My Formula for Buying a House

I've posted my thoughts on how to buy a house in a few places on this blog, but it's always been as part of another post. This time, I'm just going to list the recommendation I give whenever anyone asks me my point-of-view on buying a house:

• Live in (or move to) a cheaper area of the country. (And after retirement, you may want to save more by retiring in a foreign country.)
• Buy a house you can easily afford, putting at least 20% down.
• Put extra payments into your budget.
• Put bonuses, gifts, second job income and all other "extra" sources of money into paying off the loan.
• Become debt free in 7-10 years.

This is what we've done and we now have our mortgage paid off. There are a lot of advantages to owning your own house free and clear and if you follow the tips above, you can be on your way to doing the same.

Comments

[Jesse]

I'm curious to know how things changed once you had your house paid off? How did it change your perspective? What were you able to do with the extra money? How has that worked out for you? I try and convince people that the house being paid off means more than just saving the tax-deductible (maybe) interest. It has a lot to do with...well, what I'm hoping you'll maybe address!

[FMF]

Jesse --

Wow, that's a big question -- and for me, it's probably a series. ;-) But here's a short list off the top of my head about what being debt free has given us:

1. It's allowed us to be much less stressed out. No monthly payments, no fights over where to find the money to meet a payment, etc.

2. It's given us financial flexibility. Whoever is reading this -- imagine what life would be like with no debt payments. Now, think you'd have a bit more flexibility? ;-)

3. It's allowed us to give more. We've always been givers, but not having any debt allowed us to take the excess and give some substantial amounts to causes we believe in.

4. It's allowed us to save more. We plow a good amount in to saving and we fully fund my 401k.

That's it for now. Did I hit the topic(s) you wanted me to?

[Harsha]

first house and for living, accepted, buy any time. If you are buying for investment options, time the purchase.
There are periods of cycles where prices remain stagnant without significant change.

[J.D. @ Get Rich Slowly]

Hm. I'm on a commenting spree here, aren't I?

First let me say that of all the personal finance blogs I've begun reading since I started Get Rich Slowly, it's yours I admire most. In fact, if I'd been aware of its presence earlier, I might not have started one of my own! You have excellent information and sound premises.

To the topic at hand:

You're spot on with your advice. My wife and I bought our first house in 1994. We made extra payments for a while, and then re-financed to a fifteen year loan. We had paid the mortgage down quite a ways and had only nine years remaining (though we could have finished in four) when we stumbled upon our dream house.

Now this house really is our dream house, but it cost us a pretty penny to get it. Our current mortgage costs us nearly double what we were paying each month before. And it's a thirty year mortgage. Two years ago, I wasn't as well-educated about personal finance, or I probably wouldn't have made this choice. Sometimes I regret the purchase because it will be some time before we can begin making extra payments or refinance to a shorter term. (Mostly I'm glad we have the house, though -- it's like living in a paradise.)

Part of being frugal and building long-term wealth is learning to be satisfied with what you have, and being satisfied with your house can make a HUGE difference.

[Barry]

Is there a certain interest rate at which you would not recommend paying off early? I refinanced to a 4.75%, 15-year mortgage during the 2002 recession. I could easily pay ahead on the mortgage, but I am saving aggressively, so as long as I can make more than 4.75% (after tax) on my investments, this seems like a good decision. I would not borrow money to invest, but now that I have the loan, I'm inclined to keep it a while...

[FMF]

Barry -- Where are you investing that you can earn 5% or more guaranteed?

Personally, I just wanted to be rid of debt, so that's why I paid off my house. Yeah, maybe if I was paying 4.75% and making 10% (guaranteed) I might reconsider, but I don't think that's an option.

[sylvan]

Look at treasurydirect.gov, specifically 6month t-bills are right about 5% currently. (IMHO the U.S. Treasury is about as safe a place to put your principle as you can find.) And if you live under a state income tax, notice that t-bills are exempt.

Now 5% income, on which you will pay federal income tax, is barely enough to offset 4.75% mortgage interest which you can (usually) deduct from your income. But it does provide an option to maintain liquidity without the mortgage costing you much if anything.

The treasury also offers longer term investment options, some of which are indexed for inflation (TIPS and I-Bonds) and some of which delay income tax for up to 30 years (see I-Bonds).

Being out of debt is great. Probably there is nothing better. For me that isn't an option for a few more years.

But currently I'm sitting on more than enough t-bills to pay off a 3.5% autoloan (13 of 36 months left) but not even 10% of what it would take to pay off my 4.625% mortgage (16 of 20 years left). I figure the t-bills are as good as money in the bank, and will cover my living expenses for a few months should bad times happen (I'm shooting for at least six months of expenses and up to full year). And since I actually make money over the auto loan and even the house payment, I'll hold the treasuries until it makes sense to do something else.

sdb

[FMF]

That measly spread is nowhere near what I'd need to keep any debt. Why?

1. It's a wash, really, you're not making anything.

2. I'd rather get out from under the debt -- and owe nothing to anyone.

3. There's a cost of time associated with managing and maintaining debt and my time's valuable. I just wouldn't want to mess with it -- I have better things to do.

4. The strategy sounds at least plausible on paper (or, in this case, in text), but while I've heard the argument a thousand times how someone has a way to keep their debt and at least break even on some sort of investment, I've NEVER seen it executed correctly. Something ALWAYS happens to derail the plan -- and the breakeven/gain is never realized.

[tim]

I have nothing against paying down a mortgage, but not at the cost of diversification. Our first house we paid 25% down on a 15 year mortgage, paid extra each month and when it came time to buy our next house we had significant equity.

The second house we put the minimum 20% down on a 30 year mortgage and don't make additional principal payments. Our monthly payment is about $600 on a nice old victorian era 2 story. That's less than a 2 BR apartment rents for in our area. We used the extra money from the sale of the first house to pay for remodeling and repairs on our current home.

Our mortgage is the only debt we have.

We invest the max in our roth-iras and put significant amounts in our state's 529 plan for our kid's college, put regular amounts in our money market for large expenses, i-bonds for emergencies, and a balanced index mutual fund for long term growth.

We couldn't do any of those things if we focused solely on paying down our mortgage.

Almost any money manager will tell you the most important investment decision is to diversify.

Don't focus on paying down your mortgage unless you can already do all the other things I mentioned above. In addition, don't accelerate paying down your mortgage if you have other, higher interest debt, such as car loans and credit card balances.

[dezza]

Greetings from Hong Kong. Great website you have here.

I am in my late 20s and am interested in buying a home in the next 3-4 years in HK. While I will be taking your "put at least 20% down" advice, my investments at present are in the Hang Seng exchange which have done well for me in the last year. My question is this: should I sell all of my shares to pay the 20% downpayment? Or should I wait until I can comfortably afford to sell only a smaller portion of my shares to pay the downpayment? What are your thoughts on this? Keep in mind Hong Kong has no capital gains taxes.

Thanks for your hlep.

[dezza]

Forgot to mention that I'm on an expat contract here and thus don't have gov retirement assistance to fall back on when I retire..which is why I am saving/investing almost 50% of my salary for retirement purposes...thanks.

[SOK]

hi,

this is not a ad for my blog.

like your site very much. agree with everything you said. often time though, family/emotional ties play with our common sense emotional ties and was wondering if you had any advice for me in that regard.

we bought a condo fresh after getting my first job and b/c of my relatively high salary (i'm a physician) the bank was happy to lend us the money, no pmi, 0 down. we are happy with our place but will likely move in the next 5 years (thus the 5/1 mortgage that we have). with a bad housing market, student loans (i have over $200,000), and family obligations... 20% down on our next home is well... going to be difficult. we are in the midst of saving for the down (we just finished our emergency fund) but... would you think it a good reason to do something drastic? change to interest only, saving the difference in the monthlies to be used for a down later? try to sell soon, take a hit and rent? i'm just curious to your opinion. thank you.

[FMF]

My two cents:

It probably is time to do something drastic -- but not in the ways you're suggesting. Can you:

1. Sell anything (boat, old car, etc.) to come up with cash?

2. Can you cut expenses? Almost everyone can find savings if the HAVE to.

3. Can you work overtime and get paid more?

4. Can your wife work?

[Deborah]

We did the moving up thing, which I have some regrets about. I love my home, it is a dream home, but I think if I was to do it over I would do it differently, or maybe not. Big indecision right now. I do not like the carrying costs of our home, mainly $3500 taxes, $2000 strata fees, high utility costs due to size, I think about $2500.

Huge wage cuts for my husband and not getting the income I expected changed our expected income a lot, so the home ended up being a lot more expensive relative to income. We've been paying on this home 4 years and have 11 to go. We'd been home owners for 10 years previously. I guess we'd have 5-6 years if our income had not been so drastically affected.

Bottom line, 25 years of huge payments, I do mean huge, takes away way too much quality of life. However, we do have a good nest egg in our home which will be very good for retirement.

A lessor home would save us about 25-40% of those carrying costs.

[FamilyFinanceBlog]

In Orange County, CA, average household income is around $70k, but the median home price is more around $675k. That's a factor of 10, folks. It's amazing that anyone can still afford to live here. We think forward to buying a house instead of our 2 bedroom condo, but we don't really see how that is going to happen, and we make more than the average household income.

We probably couldn't move to a cheaper place in the country since my job is fairly specialized, and limited to bigger cities (not 100% true, but fairly true.) We would also move away from a family of 30 people who live within 10 miles and 50 people who live within 100. But there are always trade offs in life, and we're making them even though sometimes it feels like they are made to us!

[7million7years]

I presume that you are (a) either retired with enough savings to fund your ideal lifestyle for the reat of your life, or (b) you are still working on your retirement, therefore, using the spare equity in your house (remember the 20% rule? it says that you shouldn't have more than 20% of your Net Worth 'invested' in your house) to support leveraged investments (as safe and secure as you can find, of course)?

Strikes me that now that BOTH money and real-estate are on sale that it would be a good time to go shopping for investent bargains?