Savings rate after purchase

[Mama]

Hello, I am having a dilemma and hoping you wise members of this forum can help out.

We want to buy a house. yes, I know, bad time, I love this site and agree with most discussed here.

We found a house where monthly PITI fits at .28 gross monthly. We have NO debt so the back ratio is fine too. We currently save 10% of gross monthly after rent and all other expenses (10% doesn't count "automatic" investments like 401K and 529 plans).

We almost bought the house, until my wife pulled the plug -- even though the new payment fits the .28 ratio, the jump from rent to PITI would wipe our 10% savings to 0%.

At this point I am stumped -- what is the expectation of disposable income (i.e. potential savings) if PITI fits the 28% bill? Either that ratio is wrong, or our cash flow is somehow off...I can't tell which one it is but the possibility of not growing savings bothers me...I am not maxing out the 401K, and while I could of course reduce the contributions I'm worried that that's not the right solution

Insights appreciated.

[jon]

Even ignoring trying to predict the future of the housing market, there is the issue of how much you save if the house prices are stable. Do you calculations assume that both spouses will always be working? That is a risky assumption. If not, then remember that your income will go up with inflation, whereas your mortgage payment will not. In a few years your income will again be 10% over your expenses. So the trade off is accepting a short-term loss of savings versus having to go through an extra move, and associated closing expenses, if a less expensive house does not meet your long term desires. You also have to look at how other expenses will change when you buy a house, but if you already have kids, then maybe that won't change so much.

[Mama]

jon, thanks.

I am trying to do the calculation in a "vacuum" -- i.e stable house price(not relevant since this is the first and only house we'll ever own), 0 inflation.
We have other hedges for negative inflation/loss of income...at least for some amount of time. What I am interested in is exactly what you hinted at -- do people really give up savings for a year or two and assume wage inflation?.
This seems very imprudent to me but maybe I'm just too concervative?! I guess the scenario I'm worried about is "maintenance related emergencies", kids needing braces, some such 2-3K expense -- we have enough savings to hold the house for a year with no income, but that assumes we really dont touch this until such a time comes. Of course, with positive inflation or two incomes things are a lot rosier but that's an unsage assumption like you said, no?

[Markor]

Maybe you're not frugal enough? Are most of your expenses really necessary?

My unconventional advice is to stop contributing to the 401K. When workers en masse dump money into the stock market without regard for current company values, watch out. Pay off the house instead. When my mortgage interest rate was 5.5%, I made a steady (i.e. risk-free) tax-free paperwork-free 4.5% return that way. There's a simple reason why financial advisors don't recommend this: they'd be out of a job. Once your house is paid off, you definitely don't need as much money to survive, unlike 401K contributors, who really don't know if that money will still exist next month.

[EconE]

[rose-colored-coolaid]

[Dave0]

Just because you fit some mortgage lender's standard ratio of 28% doesn't mean you can afford a mortgage worth that much. That's just what the lender has decided would be the MOST they would lend you. You should decide what you can afford, not your lender.

You definitely don't want a 0% savings rate, especially when owning a house. You need that savings rate to build up some emergency cash for when the water heater breaks, your roof needs to be replaced, etc. That savings rate will also be needed to replenish that fund after one of these major expenses hits you.

Also, don't stop contributing to your 401(k). Like RCC said, contributing enough to get your employer's matching contribution gives you a higher instant return than anything else you'd find out there.

Look at what you could cut out of your current spending in order to afford that house you want while still maintaining a 10% savings rate. If there is nothing you could cut out in trade for that house, find a cheaper house that you can afford.

[Markor]

[wreckingbull]

I think that you are really answering your own question. - The numbers don't add up. Don't give up that 10% savings. That is the golden goose.

I am a little curious about your other expenses though. What are your next three largest expenses each month? You say you have not debt, so we can rule out car payments.

[Mama]

Thanks guys, I guess what Dave0 wrote is a good reminder. I always see people talking about 30-40% of gross income liabilities so I had somehow remembered that 28% is the concervative estimate. But if that's an LOs max number, no wonder it's tight.

Wreckingbull, I considered posting my entire budget but am a little hesitant because of privacy concerns. Our two big expenses after housing are
1) food+daily necessities(inculdes everything which is not a recurring bill -- toiletries, pet food, diapers, etc) -- that's $1000/mo for a family of 5 +1 dog +1 cat. It does exclude emergency bills (vet, broken car, etc -- that's the 10% savings we're so afraid to lose)
2) Preschool 2 half days a week for one kid -$400 (being nice to my wife so she's not stuck with all 3 of them 7 days a week)
3) Not counting taxes (which would probably be #1) next thing would be transportation costs -- I use public transit but we do keep a car since it's hard to shop for 5 people without one -- insurance + gas+ buspass run close to 250$(you're right, no debt on the car itself).

Number 2) is clearly not a necessity and would probably be the first thing to go should my employer impose short work weeks or property taxes/energy/cost of living rises...but I wouldn't like to drop it just to get into a house... this is where it's not clear to me whether I'm not frugal enough or not aggressive enough in trying for a house(b/n preschool,401K and other small expenses, we can probably shed about 700-1K but none of these expenses seem too extravagant!?)

Anyway, thanks -- if people agree that losing the savings is silly clearly I need to weigh house cost/desire for one against comfort with entering the purchase with "bare bones" budget

[Markor]

There's a lot of sites dedicated to the art of frugality. Most people could be more frugal yet have a better life. Big bags of potato chips, 50 cents. Cans of soup for 30 cents. Today, free movie at the theater. This Thursday, free museum. Kids ride free on the bus on Sundays. I get most of the kids' clothes at Goodwill for $2 to $5 per item, shoes too, all in excellent condition. Espresso machine, $5, works great! Trader Joe's is often cheaper than major supermarkets and higher quality. Pawn shops for tools, and craiglist for furniture and cars. Be as frugal or as ambitious as necessary to comfortably live on no more than 75% of your take-home pay, I say. Most people with decent jobs can do it.

Odds are excellent that Seattle-area houses will be 15+% less this time next year. Rather than stop saving, I'd wait.

[wreckingbull]

You should be commended on the way you are approaching this. I think the take-home from your post is that we all have different lives, and thus very different expenses. Yours seem perfectly reasonable to me.

I do think that going from 20% to a 10% savings rate in order to buy a home can be reasonable. If that was your situation, my own advice may be different. I guess for me, I have really lived some serious ups and downs in life and when the downs hit, boy was I glad I had been saving during the prior years.

Good luck.

[davidlosh@davidlosh.com]

This is a great topic for today's Real Estate purchase.

If you get an employer match to a 401K great, take it. I read today that Mutual Funds are getting close to normal returns.

You have a lot of kids, which is a great thing, Kids, dogs, and the family are what make the world go around. They are also a good reason to settle on a home.

Buying the family home is best done in the winter. You can pick a school and be settled in before registration. The end of the year gives you choices of family home that really wants to sell and investors looking to unload.

You can live where ever you chose, but I prefer inside the city limits and North of Seattle proper.

What ever you decide to buy you should consider how you will pay it off. How much can you throw at the principle balance to get the loan to amortize quickly. Adding 10% of your payment to the principle balance per month can go a long way. Some people suggest making and extra payment per year. I would dedicate more than that.

You need a house that you can all get some space in or have the ability to have space in. Having a location like in Greenwood where there are parks, libraries, and community center with activities has worked for me in the past. Small house, big community can be a good combination.

Here's my reasoning about the location of North of Seattle: the investments that were made in the late 1990s and early 2000s are done. The investments in the South end still have the glimmer of hope for appreciation. Buying some one's dream of a future return for the price they paid, back then, may give a return if you pay the property off.

Some one who has leveraged into a second or multiple properties may need to get out. Once the market seriously starts to correct a long term hold for the investor may seem a bit dicey.

If it were me and I had a good down payment I might buy an investor's property on contract and take advantage in some of their years of front end interest payments.

No matter what, you will be dollars ahead by buying down the principle and that should be factored into your calculation.