How to avoid buying a home you cannot afford.
It happens all the time, I read an article and I’m left with more questions than answers. In this series, we break down trending terms or concepts that need a little more explanation.
Today: Rising Home Sales
“U.S. Existing-Home Sales Rose 20.7% in June (2020)” — WSJ
When I read this, my first thought was: “We are in a recession, people are losing jobs, and yet home sales are up? What is going on?”
In an upcoming blog, I’ll discuss in detail why I think this is occurring and what this rising home sales trend means for you.
For now, this piece is dedicated to anyone asking themselves:
The term “real estate” is so holistic. The first order of magnitude breaks real estate down into two camps, (1) residential real estate and (2) commercial real estate.
A quick and dirty explanation is that residential real estate is 1–4 unit family dwellings and commercial real estate is everything else. Many people think residential real estate is only single family residences (SFRs) but it includes all 1–4 unit family dwellings: SFRs, duplexes, triplexes, and four-plexes (also known as a “quadruplex”).
Permanent financing for the residential side of our industry follows the typical FHA, 15-year and 30-year mortgages. These days, Americans are benefiting from historically low rates thanks to our friend, Mr. Jerome Powell.
For the week ending July 30, the average interest rate for a 30-year fixed-rate mortgage was 2.99% with 0.8 points paid, according to Freddie Mac.
Residential real estate financing and commercial real estate (CRE) financing play in the same playground, but in completely different sandboxes. If you want advice on CRE financing, call or email me at firstname.lastname@example.org.
This is a bad question because the answer is, “no one knows with certainty.”
The better question is,
“is now the right time for me to buy this house?”
The main point is to control what you can control in this decision. You have ZERO control over market fluctuations. You might get lucky. You might time it horribly wrong.
Question: What is it that I can control?
Answer: The dollar amount of your monthly mortgage payment obligation.
No one knows with 100% accuracy where home prices will go next. However, you can be 100% sure that your mortgage payment will be due on the 1st of each month.
It’s simply a formula to determine what your monthly payment is going to be and any capital advisor / loan officer would be happy to calculate it for you.
The basic rule-of-thumb is that your mortgage debt-to-income ratio should be below 40% (and the lower the better).
That means that if you calculate what your fixed monthly mortgage payment will be for principal, interest, taxes, and insurance (PITI) and divide that by your current gross monthly income of your household, the calculator output should be 0.40 or lower.
If it’s higher, I strongly advise offering a lower price for the home or purchasing a less costly home.
Side note: even if you pay taxes and insurance annually or semi-annually, you should still divide the annual payment by 12 months and attribute that value to your PITI calculation.
Also remember, your payment is fixed. It will be the same amount due at the 1st of the month whether you like it or not, regardless of whether your home value went up or down since you bought it. (This is true unless you get a variable / adjustable rate loan. Please never get a variable / adjustable rate loan unless you’re a super sophisticated real estate professional. Hello 2008 Great Recession.)
If you remember anything from this blog, it’s this: “my total monthly mortgage payment should be less than 40% of my gross monthly income.”
I know buying a home can be a very emotional decision. Hopefully the nuggets above can help shift the focus from emotional to financial and you can rest easy knowing that you’re making a sound financial decision for you.
Best of luck out there my friends and I look forward to discussing soon why home sale activity is increasing and what this trend means for you.
I’m happy to engage with you in the comments so that everyone can learn. If you prefer to share privately, feel free to email me at email@example.com.
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