My family and I were on a two-week vacation, and it was good being away for that time, but it was nice to come home. I love to travel, but there’s something about “coming home”. Coming back to your home, whether you own it or rent it, is a good feeling. “There’s no place like home”, right?
Owning a home is part of the American Dream. One problem we have in America is that too many people are house poor—they have a great income, but they get the biggest house the bank lets them get a loan for, and then they have no money for other things. I want you to own a home, but let’s do it right so you can enjoy the other aspects of your life as well.
Pay Off Your Mortgage Early!
Once you get to this step, step 6, you have 15% of your household income going to retirement accounts and you have started to save for your children’s college education. This step is about paying off your mortgage early! When you are done with this step, you will be 100% debt free!
This is the step where you need to be putting all extra income toward your mortgage. Your mortgage is most likely the largest expense that you have each month. This step should take you three to seven years to complete. Some of you are wondering how you can have a mortgage paid off in seven years, let alone three, and that’s understandable. Some of you took out the largest mortgage the bank would allow you to, and you’re spending 50% or 60% of your take-home pay on your mortgage, so you are going to have a hard time paying off your mortgage in seven years.
The Right Mortgage
Your mortgage should be a 15-year mortgage and around 25% of your take-home pay, depending on your income level. This includes your taxes and insurance on your house. Lenders are going to let you borrow more than 25% of your take-home pay because they know when you have a loan that’s tied to an asset that’s worth money you are going to make every effort you can to pay that loan and not default on it. The banks have done their homework. They know how much money they can loan you based on your down payment and your income to make sure they get their money back. If they didn’t know this, we would have a lot more bank failures in this country. You need to do your homework as well. Just because a bank says you can get a loan where the payment is 60% of your take-home pay doesn’t mean you should. The banks are not in the business of getting you a house. The banks are in the business of making money from your interest payments.
The reason you need your mortgage payment to be around 25% of your take-home pay is that you have other things you need to do with your money. The banks don’t care what you do with your money. They know you are going to pay them first. Let’s look at a couple making $70,000 a year. A bank will let them borrow enough so they can have a $2,100 per month principal and interest payment, which is 36% or your gross monthly income. This doesn’t include another $200-$800 for taxes and insurance, depending on where you live. Their take-home pay after taxes, benefits, and 401(k) contribution (15%) is around $4,000 a month. They could be paying over 60% of their take-home pay to their mortgage! That leaves $1,500 for the rest of their budget. Something ends up giving—most likely church/charity and retirement—or you end up borrowing to sustain your lifestyle.
If you are making $100,000 a year, your take-home pay is going to be around $6,000 a month, so spending 50% of that on your house payment can work for you. You still need to be careful that you don’t get suckered in by the banks who will loan you more than that. You will want to do other things with your money besides making a house payment.
I Already Messed Up
Some of you already have a mortgage that is 50% of your take-home pay. It’s not the other 50% of your budget that is causing you to go into debt or not save for retirement. It’s your mortgage! Some of you need to consider selling your house to get out of your unsustainable situation. I don’t recommend that for most people, but there are some cases where you need to sell your house. For most people, you need to deal with your current situation. You might need to work additional hours so you can afford your house. Refinancing into a longer-term mortgage than you currently have might enable you to “afford” your monthly payment but doing so stretches your mortgage out so long that the interest you pay is equal to what your house cost you. This is not a good strategy to build wealth! You need to consider selling your house and buying one that you can afford.
If you are in the market to buy a house, then sit down with your spouse or a friend so you know what your budget is when you are ready to purchase your house. Don’t get sucked in by the realtor or mortgage lender and purchase more house than you can afford. There are some good reasons to own a house, but I don’t want you to have a house that you can’t afford, because that causes you to not build wealth.
One of the reasons to own a house is it’s an asset that appreciates in value. There are some additional expenses associated with owning a house then there are with renting, so in some cases, it does not make sense to own a house just because it appreciates in value. Another reason to own a house is that it’s a hedge against inflation. Because of these two things and the fact that you do need a place to live, a house can be a good investment.
If you are currently renting, then keep renting until you can save up a good down payment. There is nothing wrong with renting. In some cases (even a lot of cases), renting is better for building wealth than owning is. Saving a down payment is done during step 3. We call this step 3b. Save for your down payment after you have your emergency fund in place. This will allow you to buy a home with a down payment and have an emergency fund in place for when life happens. When you are ready to buy, put at least 10% down on the house (the more the better, and most people should put 20% down), get a 15-year, fixed mortgage, and have your payment around 25% of your take-home pay. This will set you up for success and building wealth.