Help a Reader: Buying a House

Here's an email I recently received from a reader:

My husband and I are both in our late 20s. He has a masters in business and is currently working on getting his CPA. I work as an engineer. Together we make over $120K a year.

We have no school loans, credit card or car loans. We are very aggressive in our savings for retirement and between mutual funds and 401K have over $200K saved up that we never plan on touching until we are ready for retirement.

My question is we are looking to upgrade our house. Some good deals can be found in our area (Midwest) and we have owned our home for 5 years. It’s valued at ~130K and we have about $80K left on the mortgage.
Since we are (God willing) planning on starting a family in the next 2-3 years, what is realistic price range for buying a home? What should be the max range we are willing to spend? I don’t need a lavish 4,000 square foot house or anything. What size home is good for a hopefully large family? I grew up sharing a room, so kids are OK to bunk together.

How do people plan out their mortgage, knowing that kids are down the road and potentially my income could stop to raise a family? Although we could probably afford a down payment on a large house now, how will the upkeep and taxes change on a single income? When your readers were raising a family did you drastically change the amount you put away each month? Any advice would be helpful.

What's your advice for her?

Comments

[Kurt @ Money Counselor]

In a vacuum, your questions are challenging to answer specifically. If I were you, I'd sit down as a couple and sketch out a very long term--say 20 years--budget. You need to factor in assumptions for family size, income, retirement savings, non-retirement savings, college savings, whether you want to go single income when kids come along, etc.--all the Big Picture goals you have. Once this is done, you'll be able to better zero in on how much house payment (plus taxes, upkeep, etc.) fits in your budget, consistent with meeting all of your goals. You may find that the first time through the exercise, there's not enough room in your long-term budget to pay for the sort of house you think you want. That's when the fun begins: negotiating, prioritizing, making trade-offs. If you really want the house, you have to sacrifice something somewhere. Given the time frame, this is of course rough, but I think would at least help you bracket how much house you can afford while meeting all of your other goals.

Good luck!

[Des]

A good conservative rule of thumb is no more than 2x your annual income on a house. In your case, that would be $240k. However, if you are planning to go to one income in the near future, you might also want to work up a potential future budget and see how different mortgage payments fit into it.

You might also consider why you are looking to "upgrade". If you just need some more space or amenities an addition or remodel may be cheaper than moving.

[Brent]

We are in a similar situation, going from a 1200 sq ft bungalow to a 2700 colonial after finding out we are pregnant.

We were lucky to have multiple offers on our house so if you think you will have equity to roll into your next house I HIGHLY recommend getting your mortgage payment as low as possible so that you have as much wiggle room as possible, this means putting at least 20% down to avoid PMI.

Once you have your estimated taxes, insurance and mortgage payment estimated, I would take the difference from what you currently pay and add on higher heating/cooling bills. Use your current house as a baseline and then with all the 'new' costs for the new house, you should be able to figure out what is left over for the baby or only 1 income.

You will never know what the future holds but you will never go wrong with keeping your costs low as possible. I like to live as best as possible with making sure to maximize my retirement savings and 'cushion' for emergencies. I feel we live a very good lifestyle but are able to save more because we have no other debt.

[RichUncle EL]

I would say if you want a big family in the future you are going to need at least a 4 bedroom house. The price range of the house is figured out by taking 30% of your husband's income and that will be your monthly payment for a home. After you have the down payment you can easily find calculators online that will tell you the purchase price you can afford based on your income and down payment info. Good Luck.

[Apex]

1. Houses are Consumption

Many people think houses to live in are investments. They are wrong. The fact that they retain or even gain value over time fools people into thinking they are investments, but don't be fooled. If they were investments then the more house you could buy the richer you would be and over time you would want to keep upgrading your house just like you add to your 401-k because that's what you do with investments. It doesn't work that way because they are consumption. The more house you buy, the poorer you will be.

2. Don't buy too big.

My personal opinion is that 2000-2500 square feet is plenty of house for a typical family.

3. Think of it as rent.

Many people think renting is throwing money away and buying a house prevents that. For the first 10 years almost your entire mortgage payment will be going to interest, insurance, and taxes. Take 90% of your payment and consider that the same as rent. How much would you be willing to pay in rent? Whatever 90% of your house payment is, that's your rent. That money is completely gone. It's not earning you any return. If you put a large amount into a down payment that is also money that is no longer getting you the return it once was. Houses are likely to be seeing very little appreciation for years to come so the return on that down payment is also likely to be very little. The return you lost from your down payment is also rent that you are now paying.

4. Consider long term goals.

Meet objectives like a safe neighborhood that you like with good schools. I am sure there are other goals that are important to you. Think about those and balance those with how it impacts your finances. Realize that no matter where you live, and who the owner is that you are paying rent for shelter. Meet your long term goals, while minimizing the rent.

[Peter]

First of all, congratulation on being aggressive with you savings for retirement.

2x-3x annual salary house is what I desire. If you think, you will quit working after 2-3 years, you should take that into account when you do the calculations. So let us say, you decide to quit working, and your household annual salary becomes 80K in the next 2-3 years, you should aim for 160-240K house now, and plan for 20% down payment.

[Old Limey]

Currently homes should not be though of as an investment. They used to be but now there are thousand of homes underwater, sitting empty, and depreciating every day. The "Ownership Society" promoted by a prior administration sounded good but the fact is that not all Americans have, or will ever have the financial capabilities of being able to be homeowners. The couple in question are already homeowners, have good educations and good careers. The question is: "How Large do they consider a Large family". In my own case I had a vasectomy after our third child arrived, and personally I think that three was a good upper limit in my day but in today's world, two may be more appropriate for many reasons. A 4br, 2ba home should be appropriate and leave money over that can go towards retirement, educational, and vacation expenses.

[Apex]

To follow up on Old Limey's comments.

As far as when is a good time to buy, no one can answer that question with certainty until the time has passed.

And based on time passed, I can state that on a national average basis now is a better time than at any time in the last 10 years because house values according to case-shiller are now at 2002 levels.

As a real estate investor, I can also say that I am fairly confident on the low end of the market (under 200K in most markets) that prices are near their lows as long as interest rates do not sky rocket (and the Fed is still talking 2014 before they consider raising rates). The reason for that is that good investors are not going to let them fall much further because they make too much financial sense to buy and rent at the current prices.

It's also the case that permits for new starts on single family housing has started to slightly tick up and permits on multi-family houses has started to pick up considerably. It makes too much sense to rent out these units for them to go down much further, and investors are actually starting to build multi-family units to rent because rents are rising and demand is outstripping supply at the low end.

That doesn't mean they have to appreciate from here, but the depreciation on the low end is mostly over. Any other minor depreciation from here will just be noise.

As Old Limey said, that still doesn't make them an investment. It's just that the risk of more downside on the low end is very limited. Mid to High end could very well have some more pain. That market looks to be a couple years behind the low end cycle.

[MC]

If you can, try to reign in your "wants" as much as you can. Nothing will affect your future financial position more. I'm 50 years old and now own my basic ranch house outright, my kids are almost grown up, and I don't have any debt or money worries. I certainly do not regret my decision 10 years ago to not trade up to a McMansion! The last thing I would want at this point in my life is a too large house that had sucked up most of my savings but is difficult to sell for anywhere what I paid.

Also, kids are really hard on a house--hardwood floors, carpets, walls, the yard. In 20 years a fancy place will need refurbishing just as badly as a basic place, so why pay for the pricey finishes? I would recommend looking for a <15 year old 4BR/3Ba house with a good workable layout of rooms, in a good school district, an established neighborhood, and near a park.

[jim]

I generally agree with Peter as far as planning to spend maybe up to 2-3 times your husbands income. That assumes you quit work at least temporarily when you have kids.

You and your husband need to decide your plan. Will you stop work or not? Thats a big factor. How many kids do you plan to have? 'large' is not specific. Is that 3 or 6 kids or 8?

I would figure out the plan as far as working and # of kids. Then figure a budget based on your expected income and costs.

[jim]

"Although we could probably afford a down payment on a large house now, how will the upkeep and taxes change on a single income?"

I think what you mean is how will upkeep and taxes differ with a larger house versus your current house. Home upkeep and taxes don't relate to your income level.

Taxes should be documented in some way. Usually if you look at Zillow it will quote the tax reats for homes. So you can look at potential homes in your area and see how property taxes vary. Rules for property taxes vary a lot from state to state so again its hard to say. You might look into how your state does taxes or ask a realtor. Generally its a given that more expensive homes have higher tax bills. But it can also vary a lot from one end of a city to another based on local levies or school districts. Cross a street into a different county and taxes could change a lot.

Upkeep on homes depends on the homes. It all depends on the condition of the home. Generally larger homes have higher bills. Utilities can vary as well depending on age of home and efficiency.

As a general rule of thumb you might assume your bill might double if you bought a home twice the size. But it varies so widely you really have to look at the specifics for the home in question. A new 2500 sq ft home in a cheap tax area with efficient heating may cost you less than an older 1000 sq ft home with poor insulation and high tax rates.

[WorkSaveLive]

Frankly there are two ways to do this:
1) Buy now based on your income today and figure everything else out as it comes. OR
2) Plan ahead and be prepared.

If you truly believe that you're going to stay at home, then I don't think it's wise to buy a house based on your current income. Do you have any projections of what your husbands income will be once he earns his CPA?

Frankly, if it were ME, I would save aggressively for the next 2-3 years (until it's time to start a family), use the money you've saved and the equity you have in your house and pay CASH for the next house. If you can't pay 100% my guess is you could still buy a $200k house and put $100k down (especially considering you have $50k equity in the house and that is naturally going to become more as you pay your monthly payments).

You're asking great questions about the size and those sorts of things but at the end of the day it comes down to $$$$ and how much you can spend. If you only have a mortgage of $100k (a $200k house though), will you be able to afford that payment with you being a stay at home mom? If you can't, then you need to go lower.

Knowing the price you can pay will determine the rest.

Also, the property taxes won't change on the home based on a single income. Those remain the same regardless. But if you own a more expensive house then those will go up.

[Shawn]

Finances involve so many variables that there is not a right or wrong answer to this. Many places will offer a rule of thumb formula (usually bad advice) for purchasing a home but the truth is that no one except you and your husband know what your situation is.

Let’s look at a few variables that would make your situation different from another:
- How big is a big family? As Brent pointed out, some couples consider three kids a large family and some want six or seven kids.
- Where are you buying? Taxes on two houses the same size can be drastically different ten miles from each other if one is inside of a large city limit and the other is not. House prices in one area can drastically change from one location to another.
- Are you prepared for unexpected expenses? It sounds like you have retirement saving down very well. Do you have emergency funds built up in the event that the A/C goes out?

We can keep going with the variables involved in purchasing a home and personal finances. Everyone has different financial situations, financial tolerances, and different wants & needs.

I don’t agree fully on the fact that a house is not an investment. An investment is not guaranteed to have positive gains. A good example would be your retirement savings. If you have a portion of your money in a mutual fund or stock and that stock goes down, it is still an investment. The fact is, now is a better time than four or five years ago to purchase a house as far as an investment is concerned. The problem is that a home has to be sold or rented to realize an investment profit.

I would start by working on what you think your budget would look like after you purchase another home. Go ahead and reduce your household income by taking your salary out of the equation. What you have left should be used to start your planning. You will not be able to correctly forecast how much children will cost you. There are so many things that may or may not turn up over time. Use your best guess and factor that in. Unfortunately, we cannot foresee the future so we must make educated guesses.

If possible, try to start living on just one income. See if it is compatible with your lifestyle and put the money you don’t spend in an account earmarked for a home purchase.

http://themoneywars.com

[Christa]

I agree with many of the suggestions, but the one that stuck out is working out a housing value based on 30% of your husband's income. This amount should leave you in a comfortable place to afford average lifestyle costs. Of course, this is just an average amount to consider; you'll also want to factor in your own lifestyle choices, like do you want to eat out a lot or other things. Good luck!

[Bill]

I was in a very similar situation to you when I purchased a home in 2010. Because of the inexpensive home prices, low interest rates, homebuyer tax credit, and the high transactions costs when selling a home we decided to look for a home that we could live in indefinitely even though we had no children at the time. First I didn't think of a budget before looking for a home to purchase. My wife and I made a list of the things we needed/wanted in a home and only then went to look at the market for pricing information. Our list went something like this.

Needs 3 bedrooms Want 4
Needs 1.5 bathrooms Want 2
Needs a yard Want less than an acre of land
Needs to be on a side street
Needs useable kitchen and living room Want open concept combo of the two
Want a garage
Needs no major renovations Want <10 years old
Needs to be in set A of towns Want it to be in subset of A
etc

We then did some internet searching for generic homes with those attributes and found that the average price was around 350k.

Only then did we work on the budget side of things. Was 350k a reasonable amount for us to spend? If it was too much we'd go back and tone down some of the things we wanted to only meet the things we needed. It turns out we were comfortable with that price level and it's impact on our budget.

Step two was to actually go and look at homes in the price range and see what various attributes cost. After looking at many homes we determined that a garage was not worth the added cost to us. We also found that new higher end kitchens look very pretty but were not worth the added expense to us. The difference between a home with granite countertops and stainless steel appliances and a modern but simpler kitchen style is enormous. In addition one of our main goals in purchasing a home was that all of the space we were getting would be functional. It turns out that in our area almost all new construction is of a similar style (Colonial) and they all include a formal dining room to which we assigned very little value. After this second round of price discovery we made further refinements to our search criteria and ended up buying a home for 270k. It had all of our needs most of our wants and didn't include any of the wasteful features we wouldn't appreciate.

I guess that boils down to think about what you actually want and need in a house not how much you can afford, then shop around to make sure you are spending your money efficiently purchasing a home with features you actually value. If you need more than you can afford then that's a separate issue but in my experience the majority of people who set a budget first and then buy a home to fit that end up overconsuming. When I go to the store to buy a a sweater I don't think of a budget first, say $50, and then find the best sweater I can at the $50 price level. I think of what I need/want and then look for the cheapest sweater that fits my criteria. If I decided to upgrade because something between $50 and the cheapest is a better value then that's fine.

Just for comparison my income was about 125k and my wife's was approximately 40k at the time we bought our home. The 350k price that we targeted was approximately 20% of my personal gross income, the home we bought is only about 15% of my gross income. We wanted to keep our costs in that range to provide for flexibility if my wife wanted to stop working or go part time when we have children. Our home is 2600 sq ft with 4 bedrooms. We wanted space for 3-4 children and we actually ended up at the high end of what we think is reasonable for that size family.

[Luis]

Paying cash for a house may make more sense if interest rates were higher.

Personally, I'm waiting until the house gets too small with kids before moving out. If that time comes after 2014 and interest rates rise up, then you may then need to pay for it all in cash.

You should be in a more liquid position. High net worth is great but the illiquid home equity and retirement accounts need to be balanced with some liquid investment accounts.

[Matt]

A couple of things

Determine how many kid you want will determine the size house. If you say 4 and he says 2 then you have some serious discussion ahead of you. My wife and I were in same wave lenght of 2 to possibly 3. Since we started out in a 3 beadroom 800 sq. ft bungalow and had two boys they have always shared a room and have not had problems.( the house was so small they needed to share a room) Girls would be different in that they may NEED to have a seperate room especially in the teen years.

Can you start the family in the current house and THEN figure out what you really want to do before they get to school? Alot of people do that. We did an moved into a 1800 sq ft. house and love the school district.

Starting a family is a major undertaking in cost that you don't want to make a decision on what you want to do based on possibilities. Too much house is too much stress if you have 6 kids and a questionable economy.

[JimL]

Just thinking that you could save as much as possible over the next three years and then use that as the "upgrade" amount, leaving you with the same size mortgage you currently have (provided you can afford the current mortgage on just one income).

[Easychange]

Good advice. I'll add just One word: quadruplets.

[choco]

Aside from the finance angle, have you thought about the school district? Maybe you can afford a good private school but a school district with a good elementary, junior and secondary high school could save you lots of money down the road. You can find school ratings on line. Our home buying experience led us to great schools where our kids are really happy. One thing to be careful of is that all schools in a "good" school district are not all great. You really have to do your homework and find the boundaries between one school and another even within a school district. One street in the wrong direction and your kids could be forced to go a one of the less desirable schools in a "good" school district. We were really careful but we were able to line up some great schools for our kids all the way till they graduate high school. We don't have a lot of money and can't afford expensive schools so good public schools are our
solution. Hope this line of thinking helps.

[Kelli-Money Help]

When buying a house do not spend more than 25% of your combined take home. Make sure you are able to make a 20% downpayment as well.

The size of the house depends on many factors, i.e. family size, how you use the house, how much time you spend in the house, your finances etc. I would think a 2500-3500 square foot house would be plenty for a starter home. Focus more on the location of the house and the specific amenities rather than square footage. Just don't buy more house than you need. More house means more maintenance, more to furnish and more to heat/cool.