Here’s a question I received from a reader over the weekend:
I have $50k in the bank, no debt, make 50k per year and am confident in a position that will pay 75k per year starting 06/10. Let’s assume that if the position doesn’t happen, I will take a second job to make up the difference.
I’ve never owned a home. Rent for me is one room in a house and just $400/mo. A place I buy would need to be on the eastside.
I’ve lived well below my means for years (and also been a Seattle Bubble reader for that amount of time). But in my current situation I’m seriously considering a first home. Your opinion on my situation would be appreciated.
– “Seattle Bill”
Here’s my advice for Bill:
1) Structure your budget around what you already have today, not what you might have sometime in the near future.
You’re making $50,000 today. That’s what you have to work with, not $75,000. If you buy today, setting your budget based on a future expectation of a massive increase in salary, you’re setting yourself up for failure.
Here’s what I recommend to anyone that is considering buying, in any market. First, go to your preferred mortgage broker, bank, or credit union and find out what kind of loans you are qualified for, how much you can borrow, and what your monthly payment would be. Getting a pre-qualification does not require you to commit to a lender or a loan, but will tell you for sure how much you can borrow.
For example, let’s say you were pre-qualified for a $250,000 loan, with a monthly principal + interest payment of $1,100. Add in probable taxes and insurance (we’ll say another $350 / month), and you’ve got a total monthly PITI obligation of $1,450. With a yearly salary of $50,000, that comes out to 34% of your gross income.
Here’s a simple affordability calculator I posted earlier this year to help you quickly calculate your own personal affordability situation.
Personally, my absolute upper limit would be 30%, but even that would come out to $1,250 a month for you, which is over three times what you’re paying right now. Figure out what you think you’d be comfortable with, and then force yourself to live with that budget for six months, saving the difference between your current rent and your expected monthly house payment.
If you succeed in living within that budget for six months, you’ll have a pretty good idea of what other sacrifices you’ll have to make to buy the house, and you’ll have another $5,000+ in the bank to help pay for closing costs or your down payment. If your salary does end up rising by 50%, either stick to what you could afford with $50k, or get pre-qualified again with the new salary, and “test drive” your budget again with the new salary.
2) If you decide to buy, pay a price that you think is fair for the house today (assume that it may stagnate or decrease in value in the future).
One surefire way to set yourself up for financial problems in the future is to rationalize your decision to buy a house by convincing yourself that it is a great financial investment.
There are plenty of great reasons to buy a house. Buy a house because you want a place that you have control over. Buy a house because you want stability. Buy a house because you want to plant a garden. Buy a house because you want to breed Irish Wolfhounds. Just don’t buy a house because you think it will make you money. Maybe it will, maybe it won’t, but that factor should not be a part of your decision-making process.
3) Keep your eye on bank-owned houses, and look for homes that need a little work.
There are definitely some good deals to be found out there today, but they’re not in the owner-occupied homes that have been “upgraded” with hardwood floors, granite countertops, and a fresh coat of paint on the outside. High curb appeal may sell a house fast, but it doesn’t sell a house at a good bargain. If you’re willing to put in a little bit of work, look for bank-owned fixers.
The Bottom Line: Know what you’re getting into.
Nobody can tell you what you should do, since no two people have the same financial situation. My recommendation is just that you do the research, critically evaluate your finances, and should you decide to buy, do so with realistic expectations.
So what’s your advice for Seattle Bill? Let’s hear from the commenters.