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Today I have a guest post from JT over at JustMakingCents.com. He writes about how he went from $15,000 in college loans to financially retiring in his 30s, drawing on lessons learned from over 15 years on Wall Street. He also shares his experience teaching his children about money. Enjoy!
Your kitchen looks great. You wiped that countertop down to a sparkling gem and picked the perfect Pandora station to play. Since your friends will be over in half an hour, you dial up your favorite takeout and order 5 large pizzas. After you order, you check how many friends RSVP’d.
…Something sound not quite right?
Order food before you know how many mouths to feed? Silly as that sounds, many of us do the same thing with one of the most important financial decisions of our lives:
Buying a house
Right now, you might be considering buying a house. You might feel like you should because your friend is buying one, or it just feels like it’s time. Something else to consider, however, is that a house is one of the most expensive things you’ll ever buy, which means it’s also the thing most likely to help or hurt your finances.
So before you make the jump, consider these 4 reasons why you might want to wait:
1. You Don’t Know What You Need Yet
If you buy too soon, you’re trying to shoehorn life’s uncertainty into a confined house cost and size. The general rule is a 28% mortgage/income ratio. However, I recommend this equation instead:
(C)areer + (M)arriage + (K)ids = House
Early on, you have too few of the above variables solved. So if you’re buying too early, the equation looks like this:
? + ? + ? = $189,400 3bd/2ba house
Career: You may hate your job and want to switch to a more rewarding but lower paying career. You may be laid off before you’ve really acquired marketable skills. You’re still trying to figure it out early on. So make sure you’re in the career you want to be in for the long haul first.
Marriage: You may realize you’d rather be single or come out of a long-term relationship that just didn’t work out. Or you may marry someone who is from another state and wants to move back. Relationships change the entire equation.
Kids: You could struggle to have one, or be surprised with quadruplets. Or, heaven forbid, there could be unexpected health emergencies. One of the biggest financial mistakes is buying too much house.
The point is you don’t know how much space or rooms you’ll need yet. And much of what determines your need is beyond your control, and therefore, ability to predict.
2. You Don’t Know What You Want Yet
You may have an idea of what you want, but until you know who and how many people are “showing up” in your household, you want to make sure you don’t tie yourself down.
With big life changes also comes changes to what you prioritize. You may think you want to live in that loft apartment for the rest of your life, but may realize later that having a backyard better suits your family.
3. It Might Hinder Your Career Progress
Early on, it’s crucial to accumulate skills and invest as much as you can. Not all companies have an upward, logical progression. For many, getting more responsibilities or money means leaving for a different company, and sometimes for a new city. So avoid tying your twenties down with a thirty-year mortgage commitment.
(Finding success in your career? Read about how to grow your money here.)
4. It Might Be Worse For Your Finances
We’ve gone through practical reasons why to consider holding off, but how about when it comes to your money? Let’s look at the average college graduate:
The average starting salary of a college graduate: $50,651
The median home price, according to Zillow: $189,400. This equates to $1,060 a month.*
The median apartment rental, according to the US Census Bureau: $934
*Assuming 10% down (The average downpayment for first-time home buyers.) and a 4%, 30-yr mortgage, the monthly payment is $1,154 including PMI, home insurance, and taxes. The income tax benefit is around $94, so your net monthly payment is $1,060.
Based on the numbers above, a recent college graduate would qualify to buy a house based on mortgage lending calculations (the 28% mortgage/income threshold that I recommend you ignore for now), but again, the question is not “can you?” but “should you?”
On average, the monthly difference between renting and buying is $126, which equates to $1,512 a year. That could go toward your student loans, your retirement, or a larger down payment later, getting you closer to the 20% minimum to avoid PMI (required mortgage insurance if your downpayment is less than 20%). Don’t forget money for emergencies.
You’re wondering: aren’t homes good investments? Sort of. Capital appreciation is nice, but cash flow is much better. Simply put: Is it putting money in your pocket or taking from it? In this case, a house is taking $126 from your pocket each and every month.
So…When Should You Buy?
Here’s my suggestion: When you can solve C + M + K = House, or by age 37. So if you can solve the equation at age 32, it’s a great time to buy. If the equation hasn’t clarified, then consider buying at age 37 (both assume that you can afford to put down 20% and have money left over every month to save).
Why 37? You want to time your last mortgage payment to run out before or when you’re eligible for your full social security benefits (I’m assuming that you’re taking out a 30-year mortgage). Since social security payments will probably be less than your salary, you’ll want to reduce your housing costs as well.
I couldn’t solve that equation until I was 35. I got married at 29 and lived in NYC. It wasn’t until after our second child was born that we realized we wanted to be near my wife’s parents in Philadelphia. In the meantime, we paid off my student loans, invested aggressively so that we could put 20% down, and made $45,000 worth of renovations without taking on more debt. We bought much less than the ratio told us we could afford and financially retired in our 30s.
What About a 15 or 20 Year Mortgage?
Sometimes, it may make sense to get a 15 or 20-year mortgage. While they mature faster than a 30 year, you will pay more per month. I recommend these options for buyers older than 37 or for a younger buyer who can solve the equation (C + M + K = House) AND has an income that allows for this higher payment, the ability to max out a 401k, and has enough cash left each month for emergencies.
Dream or Nightmare?
Buying a house may feel like the American Dream, but it can be a nightmare if you’ve bought before you’re ready. When you’re early in your career, your flexibility is your biggest asset, so carefully consider before committing to a mortgage. Waiting can establish your footing so that the house you do buy will be set on a solid financial foundation.
Have buyer’s remorse? Read about how to identify and deal with big financial mistakes here.