What Is The Most Your House Should Cost?

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[The following is a partial transcript of this episode of The Scott Alan Turner Show. Listen to the full episode to hear this story, listener questions, money hacks, and inspiring stories of people that are changing their financial lives. Subscribe to the free podcast on iTunes or Google Play]

Spring is here and with home buyers are out in force. But this force can lead some to the dark side of money mistakes. Come to the light my friends!

Jen sent in a question to The Scott Alan Turner Show

“Once my emergency fund is established I’d like to start saving for a house. It seems like there’s not really a ‘rule of thumb’ when it comes to determining what you can afford, right? I’ve heard 2x your income, but I live right outside NYC in Hoboken and it’s at least $600,000 for a 2 bedroom here so looks like I’ll be saving for a while!”

Everyone has heard of Spring fever. You know with Spring fever comes New House Fever. THE FEVER! And the fever leads many people to making huge financial mistakes. Let’s try to keep the fever down to 99 degrees instead of 105 and going to the emergency room, ok?

One of my many money moron moments was the purchase of my first home. I put 5% down. From day one I was what is called ‘underwater’. If I had to sell the house, I would have owed $10,000+ out of pocket. Which I didn’t have.

My wife Katie – same thing. She had a first and second mortgage on her townhouse. I think she put almost nothing down.

We call that normal. That’s what just about everyone does.

In a rush to get into a house, most people will not spend 30 minutes figuring out the smartest amount of

• how much house to buy,
• how much to put down,
• how much to pay each month,
• and how much to expect in maintenance.

The difference is a house that is a blessing or a curse. A home vs. a house of horrors. More importantly, going on vacation for the next five years, or having staycations.

I believe having a bullet proof plan, is smarter than using the rules of thumb (which I call rules of dumb). Let’s not bet the farm on them.

Before I explain a better way to figure out the range of house prices, here’s the rules of dumb for house. It can vary between 2x your annual income, to 4–5x your annual income if you have no debts and no other financial obligations.

That could be $100,000 to $250,000, for someone making $50,000 a year. You know that’s a huge difference. That’s a condo vs. a two-story house with a two-car garage around here.

A beautiful disaster is to use the rules of dumb to come up with a number. And a person’s brain will find ways to rationalize overspending. Or find ways to make it work.

• We’ll eat out less.
• We won’t take vacation this year
• We’ll get raises next year
• We’ll Airbnb it once a month to help out
• We’ll stop retirement or college funding for a while
• The kids will get out of daycare next year and start kindergarten. Oops! We’re having another baby. How did that happen?

Do the opposite of looking at a price range first.

Someone who is barely managing to pay $1,500 in rent, that’s probably the top end of the mortgage payment. And probably too much because there is $300 of maintenance in there at least. More like a $1,200 mortgage. So how much is that over 30 years at whatever the interest rate is? That’s the maximum amount of house.

That avoids the fever. Stay away from the bigger homes with the shelves in the closets. That’s the next house. Or go to the container store and put in your own shelves. Or watch Kobiashi Maru on Netflix. Tidy things up magically. She would tell people to put up a concrete wall in front of the closet. Make it a tornado shelter.

Let’s not kid ourselves, few people save up 20% for a house down payment. A $250,000 average home price in America, that would take $50,000. Plus, closing costs, moving costs, new furniture, and a new dog to fill up the back yard. Now we’re at $60,000. We don’t even have the dog’s chew toys yet.

Get at least 10% down to avoid being underwater on the house. Owing more than it is worth. Because if someone has to sell the house for reasons they can’t even imagine would happen:

• Loss of income
• job move
• the neighbors are Russian spies

they don’t have to think about taking on a huge debt, foreclosure, or bankruptcy.

Expect the best, prepare for the worst. You know that the more you save up and put down, the bigger, better, badder house you can get. Because by the time you save up that much you’ll have a tip-top credit score, and you won’t be paying Private Mortgage Insurance. That’s a junk fee if you put less than 20% down. It’s more of your hard earned money that can go towards the mortgage. Which is a good thing.

And be wary of FHA loans. FHA loans let people get a house with only 3.5% down. That’s not much less than what I put down on my first house. But the Mortgage Insurance Premium (MIP) – the junk fees – get stuck to the mortgage. And MIP keeps getting paid and paid and paid for a long time. It can’t be shaken off unless someone refinances or sells the house. Which adds up to thousands to tens-of-thousands in junk fees over the life of the mortgage.

It’s better financially to be patient, save up the 10% – at least – and get a conventional mortgage.

To qualify for the best mortgage rates you need a ‘very good’ credit score. Generally, that’s a 740 or higher. If you have a lower credit score it makes more sense to take 6–12 months and work to get it to where you’ll get the best rates. Over a long period of paying down a mortgage that can be tens-of-thousands in saved interest.

So if you’re looking to buy outside of NYC for $600,000 or way outside of Dallas for $60,000 – which is a pretty nice double wide – figure out the cash flow first. Then the price range, and then how much down payment. Preferably 20%, but at least 10%. Because the rules and cookie cutter advice doesn’t work for someone living in NYC. Because the rules and cookie cutter advice doesn’t work for someone that never travels and has a bigger housing budget. And because the rules and cookie cutter advice doesn’t work when you put together a solid plan for your specific situation.

And know you can always add shelves to the closets later and fill them up with stuff. Just don’t tell Kobayashi Maru I said that.

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