For many of us, our house represents a significant portion of our net worth and mortgage payments dominate our monthly cash flow obligations. Therefore, the way we purchase and finance our homes can impact our finances for decades. Ideally, it would be better to minimize the number of housing purchases we make in order to reduce risk and build equity, but job relocation and changing needs at different stages of our lives sometimes require a change in housing. The ebbs and flows of the residential real estate market due to supply and demand make things even more complicated and create market risk. When making housing decisions, here are some key points to consider:
Due to the long-term nature of mortgage finance and limited liquidity risk of real property, we have to make sure mortgage payments and other costs fit comfortably into our financial plan. The mortgage industry considers many financial factors when approving a loan, one of which is the Front-End Debt-to-Income Ratio. Divide your proposed monthly housing payment (including taxes and insurance) by your monthly gross income, if the result is at or below 28%, then you fall within the normal “rule of thumb” limits. Ideally, I prefer my clients’ front-end ratio to fall below 25% if possible, to allow for unforeseen future circumstances, especially when using both spouses’ incomes for qualification.
2. Down payment
There are ways to purchase a home with very little down, but I encourage clients to invest the traditional 20% if they are able. With at least 20% equity in the home, you should be adequately protected in a down market. If something changes and you have to sell, it’s no fun at all being upside down.
If home improvement is not your hobby, avoid older homes that may be in disrepair. Consider a home warranty, and keep track of maintenance expenses for tax purposes.
We prefer our clients have their home paid off prior to retirement, if possible. A paid off home reduces cash flow needs in order to preserve retirement assets.
If we maintain an affordable mortgage, this allows us to spend money as needed on the upkeep of our homes. Just like anything, if you don’t regularly maintain the equipment and other components of your house, it can cause irreversible damage to its value.
Your home is an important piece to your financial portfolio. As such, make decisions carefully and seek guidance from professionals when making any changes. I’m always happy to speak with current and potential clients about their financial situations and help provide an unbiased opinion, so feel free to contact me.