Buying a House...within your Means

By: Aaron Carlock

Purchasing a home can be the largest, most expensive undertaking you will face in your lifetime. With real estate prices experiencing double digit growth year over year for the past few years, it may even be our greatest investment. Most of us drive to the neighborhoods with the biggest, nicest homes and dream about one day living there. Our homes are our mark in this world, our castles. Given this, should we spare any expense when it comes to buying one? Most people fall into the routine of living in the most house they can afford. It becomes a matter of, 'if I make x and have y to spend on a home, I will look for a house that costs y' instead of 'I will look for a house that costs y minus what I don't need'. My article on living below your means looks at this phenomenon in more detail.

A house should be a place to live, not a place to die. In other words, choose a home that you will be happy living in for many years, not one that will stress you out with high mortgage payments. Choose one in a nice neighborhood that has great schools, allows you to live a comfortable life, and doesn't strap you for cash. In today's real estate environment it may be a pipe dream to find a home that doesn't strap you for cash, but opportunities exist around every corner. Whether it is buying a smaller home, one that needs a little work, or one with a smaller yard, you always have options. If you can't find a place that allows you to live comfortably while remaining affordable, then maybe you are not ready to own a home.

When buying, there are 10 things you must remember about a home:

1. It is an asset, not an investment.

2. Home expenses can eat your wallet and life.

3. Real estate taxes are calculated using percentages.

4. Home buying and selling has high transaction costs.

5. Size is less important than quality of living space.

6. Utilities increase with square footage.

7. Insurance increases with the price of the home.

8. Upkeep increases with the size of the home.

9. Do it for the kids; get a home in a great school district.

10. A home can loose its value!



Let's examine each item in this list. Number 1 is getting at the meaning of cash flow. The savviest of investors invest for cash flow, not appreciation. An investment in a home should be no different. If your house is not generating income, it is not an investment. Banking on appreciation is a risky business and should only be performed with risk capital. Risk capital is money that you can afford to lose. Since a place to live is a necessary thing in life, you are better off treating it like an asset. If you buy a home treating it like an asset instead of a speculative investment you are less likely to act irrationally and take unnecessary risks.

Number 2 - This point highlights that homes are not cheap. Mortgage payments, insurance payments, taxes, utilities, maintenance, lawn care, etc. all add up to a substantial amount and can really impact your budget. Buy a home at a price you feel comfortable with, one that will allow you to maintain your freedom to live life the way you want. That could mean changing your job, starting a business, or retiring. You should always avoid a situation where you lock yourself into something for an extended period of time. Buying a home at the top of your price range can really put the shackles on your freedom.

Number 3 - It is important to keep taxes in mind. Remember, death and taxes are the only things certain in life. The pricier the house, the more you will pay in taxes. You will always pay taxes on your home, even if you own it outright. I mention taxes because they are one of the most substantial expenses to owning a home, and they are often overlooked. If you have a house worth $300,000 expect to pay in the neighborhood of $5000-$7000 in taxes a year depending upon where you live. That is about $500 a month! Talk about a budget buster.

Number 4 - Buying a home for the short term is more risky because of high transaction costs. For a buyer, closing costs can be around 3-5% of the purchase price. That doesn't include the cost of moving which averages around $10,000 per move. If you are a seller using an agent, commissions are typically 6% and that doesn't include any legal, title, or survey fees. All the benefits of homeownership can quickly evaporate if you are in it for the short term.

Number 5 - I see so many houses built just to be BIG. They don't always look the best and have a lot of space that probably doesn't get much use. It's like everyone is in constant competition to have the biggest house. If you are a first time home buyer don't put too much value on space. You really need to live in a house before you know what your requirements are. Remember, you still pay for all the space you don't use. Besides, most people get more enjoyment out of a small house with character than a gargantuan 'Mc-Mansion'. The following items in the list highlight the other benefits to having a smaller house.

Number 6 - The size of the home you purchase can have a substantial impact on utility costs. It is safe to assume that the bigger the house, the bigger your utility payments. Remember, more than just the sales price determines the expense of a house. Utility payments can be a big 'gotcha' for first time homebuyers. So heed this warning and buy an efficient home without an excesses amount of space.

Number 7 - Insurance is generally pretty cheap for a home. If you live in a flood plain or other area prone to natural disaster it can become more substantial. The bottom line is that like most other household related expenses, insurance premiums increase with the value of your home.

Number 8 - Most people don't think about upkeep when they purchase a home. That 4 bedroom 4 bathroom house sounds wonderful until you have to clean 4 bathrooms. This holds true with lawn care also, the bigger the yard the more the work. A large house can be wonderful, but remember it takes a lot of work to keep it that way.

Number 9 - School districts are usually the biggest factor for homebuyers. This is for good reason; well educated kids grow into well educated adults. Society benefits from well educated people. One of the greatest gifts you can give your kids is an education. Besides being a huge positive for your kids, great school districts keep real estate prices from falling because they drive up demand for the area. So, even if you are a bachelor/bachelorette with no plans for kids, the price of one of your largest assets is safer in a great school district.

Number 10 - This is probably the most important point to remember, especially since home prices have recently gone through the roof. Your house may lose its value. This is usually what causes the most financial problems for people. Imagine someone who has stretched their budget so thin to afford a house and is unable to start a savings account. If they lose their primary source of income and can no longer make the payments they will need to either find another source of income or sell the house. If the house has decreased in value and they need money to make up the difference between their equity and market value they are probably in some deep trouble. This happens when one sacrifices a savings account for a home. It can also happen if there are no other options to generate the same level of income. Bad things can happen. Make sure you are able to weather the most difficult of storms when purchasing a home.

You may have noticed a common theme with these ten items. Sustainability is key to owning a home. Can you afford the mortgage while still saving/investing? What about the utilities, taxes, insurance, and upkeep? Take all of these things into consideration when purchasing a home. Always make sure that you are able to maintain and grow a savings account or investment portfolio. It is critical that you have a worst case scenario fall back plan. If you can't afford the home when you want to change jobs or start a business, then you might want to think twice before buying it. Despite all this doom and gloom, home ownership is one of the biggest factors of class distinction in America. You are much less likely to become wealthy if you don't own anything.

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