Baby Step 3b: Getting a house

If you’ve already got a house and you’re not planning on getting another mortgage ever again, skip this week. Otherwise, onward!

While this is geared more towards young couples who are renting, there are some valuable things in here for people who may be moving up–or down–in house. Once you’ve paid off all your debts and built up your emergency fund, you can start saving for a house!

Now if you’re anything like my wife, all the blood just drained out of your face. “You want me to wait a billion years and pay cash for a house?” Well, yes, but I realize most people aren’t willing to rent for 5-7 years longer in order to not get a mortgage. In fact, most people don’t want to rent for an extra two years and buy a small-ish home–they want to go straight for the three bed, two bath, two car garage in the nice suburban neighborhood near where they grew up.

Well, to do that is going to take a lot more money than you’re going to have so the first rule is lower your expectations. You’re not going to get the fancy house…yet. Later, when you’re a bajillionaire, you can have the nicest house in town–but by then you probably won’t want it.

So if you’re not going to pay cash, and you’re not going to go $300,000 in debt to get what you want, then what do you do?

You put 20% down and get a 15 year mortgage that has a payment of about 25% of your take home pay. The 20% down portion gets rid of PMI, which will cost you about $50/month for every $100,000 you borrow. If you are going with manual underwriting because you’ve never had a credit score, or your credit score has fallen because you stopped borrowing money, the large down payment will also get you a better interest rate since the bank will have instant equity if they have to foreclose on you. Less risk == lower rate.

Capping your payment at 25% of your take home pay prevents you from becoming house poor and protects you from foreclosure and other financial difficulty. Our house payment ended up being about 12% of our take home pay based on some things I’ll cover in a later post.

Getting a 15 year mortgage does three things: First, it lets you get a much lower rate because the bank is risking it’s money for half the time. It’s less exposed to risk, so your rate is lower. The second thing it does is it makes you build equity faster because you’re paying more towards the principal every year. Lastly, it saves you a boatload of money over the long run. Let’s look at an example:

Let’s say you bought a house with a closing price of $187,500. You put 20% down, so you need to borrow $150,000. At the time of this writing, interest rates on a 30-year fixed rate mortgage are around 3.75%, and for a 15 year they are 3.125%

With the 30 year, your payments will be $695/month and you’ll pay $100,000 in interest.

With the 15 year, your payments will be $1045/month, but you’ll only pay $38,000 in interest.

You save $62,000! That’s a lot of ammo!

Now, I hear you over there in the back saying “Yeah, but it costs $350 a month more!” Phooey! That’s like saying your IRA costs you $416 a month!

It’s forced savings. You get the extra $350 a month back when you sell the house! Wednesday I’ll go a little bit further into the math around financing, but for now just know this: The longer you have a mortgage, the more your house costs you.

Tomorrow, I’ll go over the process we went through when buying our first home.