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Wise Home Purchasing Decisions |
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Having owned my home for about 7 years now, I have learned some things that I thought worth passing on. Most of these I have learned the hard way. Hopefully you will benefit from my mistakes.
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Mortgages |
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How Much Can You Afford To Spend On Your New Home?
Most people find out how much they can borrow with a 30 year mortgage, add any equity from a previous home sale, and that becomes how much they can afford to spend on a new home. If someone would give you a 50 year mortgage, would you borrow more? This is a tactic that predatory car salesman have been using for years. Often times people that are inexperienced, or perhaps in a financially bad situation, buy a car based on what the monthly car payment amount would be. There is no better way to be taken advantage of. Since many cannot truly afford the car the salesman is hawking, they extend the number of terms (months) of the loan. It is not unusual for a car loan to be so long, that the owner is "upside down" for the majority of the loan. This means that they owe more than the car is worth. If they try to sell the car, they will have to come up with some additional money just to payoff the car. Even worse, should the car be totaled, many will find the insurance will not payoff their car loan, and again, they must cover the gap. Most informed consumers will acknowledge that this is a poor way to finance a car. Yet when it comes to purchasing a home, most do the very same thing.
So, how much should you spend? I am afraid I don't have the answer to that question. However, the correct answer is not the maximum anyone will loan you for the rest of your life. I made this same mistake myself. Fortunately, when I initially financed my home, I was self employed and the finance company determined my income conservatively, so they limited me more than a typical employee would be based on their annual salary.
When I refinanced about 3 1/2 years later, because interest rates were down so much, I was able to refinance with a 15 year mortgage. After 3 1/2 years, I had gained only about 7K in equity. With my 15 year mortgage, I gained more than that the first year. To give you an idea of how significant the savings can be, here is an example. Assume you are financing $200,000.00 at 6% for 15 or 30 years. After the first year's payments, you will have gained $8483.28 in equity with a 15 year mortgage, but only $2456.01 with a 30 year mortgage. That is a huge difference. Do keep in mind though that with the 15 year mortgage, you are paying less interest each payment, so your tax deduction will be less. However, also keep in mind that you also get a slightly better rate with a 15 year mortgage, than with a 30 year mortgage. Because of this drastic difference in equity growth:
Don't Get A 30 Year Mortgage, Get A 15 Year Mortgage Or Less
To see the difference for yourself, here is a link to a page that compares the two:
http://mortgages.interest.com/content/calculators/simple_js.asp
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Your Home's Cost Relative To Others In Your Neighborhood |
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Is your home the most expensive in your neighborhood?
You always hear that you shouldn't buy the most expensive home in the neighborhood. I knew that, but I darn near did that. My home may not have been the most expensive home in my neighborhood, but it was in the top 2-3%. Why does it matter? I can tell you a very specific way that it matters, appraisals!
When my home was appraised for my refinancing, it was compared to three other recently sold homes in my neighborhood. Since my home is one of the most expensive, all three of the homes were less expensive than mine. To determine the appraised value of my home, they compared my home to each, and added or deducted amounts for the pluses and minuses of each home to come up with the value of my home. Comparative house #1 doesn't have a fireplace in the master bedroom, but mine does, add $200. Their home has Corian counters and mine does not, subtract $150. They then determine what your home's value is. The problem is that they always use an amount less than what you would pay to get that same feature. My fence cost me about $5,000.00. They say, no one else is willing to pay that for a fence, we think it is worth $750. Since all of my comp homes were less expensive homes, and since my home is one of the most expensive in the neighborhood - how could it not be, my net increase in value over their home was a fraction of what it should be. Had there at least been one home in the comp that was more expensive than mine, then those deductions from its value would have been fractional to offset the comps against the lesser expensive home. But, as I said, all homes in my comp were less expensive. That is a statistically unfair way to appraise my home. Therefore, my home appraised for less than it should have.
In my case, this was only an appraisal for refinancing and it still appraised high enough to not cause any problems, but what will happen when I go to sell it and the buyer's appraiser does the same thing?
By the way, appraising a house is a crock of garbage. It is too subjective to have any merit. I actually tried to refinance my home with another lender before I did actually refinance, and they too appraised it. So, within about a 2 month span, I had two appraisals by two completely different companies and people. Of course they were signifincantly different. The amounts only varied by probably 7-8%, which is too much, but the adjustments were totally inconsistent with each other. One appraisal might not even ding me for not having something while the other did, and one might give me credit for something the other did not. Other than the address on the appraisals, you wouldn't have even thought they were for the same home. So:
Don't Buy One Of The Most Expensive Homes In A Neighborhood
In fact, based on the way they do it, by adding or deducting fractional amounts of value for the differences, you will come out much better if you have the least expensive home in the neighborhood. Next time I buy a new house in a neighborhood, mine will be the one everyone thinks should have never been allowed to be built because it wasn't expensive enough!
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House To Property Value Ratio |
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Is your house huge, but the property dinky?
You always hear what a great investment a home purchase is. People always act like it can only appreciate. I live in the Atlanta area, and I am constantly amazed how many expensive homes there are here. I cannot figure out what all these people do to make the money to pay for them. For the last several years, here, as well as many other regions in the U.S., home prices have escalated significantly. I had an opportunity to purchase one home in the Buckhead area back in 1998 for about $350K. I am sure now that the property alone would be worth at least $750K. The house itself is a throw away, It's the kind of home someone will buy, tear it down, and build a big mansion on the property. It happens all the time around here. Does it happen in your area?
That brings me to my next point. Typically, houses themselves become worthless. It is only the property that has long-lasting value. Think of the house you are wanting to buy right now. If you are the typical new homeowner these days, I am betting its gorgeous. It's probably very open and spacious, with lots of high or vaulted ceilings. How much would you rather buy a 1970's style ranch home with 8 foot ceilings? I am betting you wouldn't. In fact, there are a lot of people that won't. There is something about houses that makes them undesirable once they get to a certain point. Sure, there are the exceptions. The historical type houses that people just continue to fix up. But, most houses don't fall into this category and eventually they get to a point where they are just bulldozed. If you live in a rapid-growth part of the country, how many times have you seen construction in an area where old houses were that were just torn down to make room? Those houses were worthless. Eventually, the new home you are about to shell out all that money on will be too.
What will retain its value though, under most circumstances, is the property you own. That house I passed on in Buckhead would have made me a lot of money because of the property. Property doesn't depreciate. You always hear people say, real estate appreciates. I propose that truly, the property is appreciating, while the house itself is depreciating. Typically, the property appreciates faster than the house depreciates. Well, its been that way so far. I anticipate that will change in the next 50 years or less. Why? Because in the past, people tended to buy larger lots and smaller homes. That trend however has shifted in the last couple of decades. Now, we have cluster homes. If the term is unfamiliar to you, its a neighborhood where the lots are so small, the homes are clustered together. They literally may have 10 feet of yard. They are like a townhouse, except less convenient in that you still have to own a lawn mower. True, it only takes 10 minutes to mow the yard, and perhaps a weed trimmer would suffice.
Because of the shift in the ratio of the house value to the property value, I predict that some peoples home/property will actually depreciate once the style of their house is out of fashion, or it becomes old enough. Therefore I say:
To Maximize The Long Term Value Of Your Home, Maximize The Property to House Value Ratio
Try to spend as much on the property, and as little on the house as you can. You, or your heirs, will one day be rewarded for it. Yes, I know that's tough. Most of us want to live in a big gorgeous house.
I learned this principle on a visit to Truett Cathy's house one day a couple years ago. In case you are unfamiliar with the name, he is the owner and founder of Chik-fil-A, a fast food chain that is well regarded for its quality. This guy has to be loaded if he hasn't given it away. So, on my way to his house I wondered, what would the home of someone with this wealth look like? I envisioned mansions galore. However, Mr. Cathy is also know for his Christian beliefs and down to earthliness. Hmm, quite the puzzle. Would his house be all tricked out, or practical and modest. I arrived to a gated property. Just having the gate, you know there is a gate for a reason. Upon arriving at the house, it was clear, he hadn't spent his money on his house. It was a plain, one story, ranch style home from the 1950's or so. I never did get to go in it, so I have no clue how nice it was on the inside. But from the outside, it was incredibly modest for a man of his means. I am going to ballpark it at 2000-3000 square feet. While at the event at his home that night, he mentioned to everyone how he had lived in this same home since the 1960's, as I recall, and that he purchased it for something like $28K with all the property. I would guess the house was now worth $120K-ish, and the property? I don't know, it was big, and I mean hundreds of acres worth. There was an entire farm there. I wonder how much the property iteself was worth? I realized then and there, it was his property that really appreciated. In another 30 years, the house would probably be torn down. Truett Cathy did it right, and now you can too.
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