How Much Home Can You Really Afford?

How Much Home Can You Really Afford. Being house poor because you spent too much on your mortage will wreck havoc on your budget.

I recently spoke with a friend who is purchasing a new home. She had two scenarios to choose from and wanted my advice.

She is purchasing a condo in downtown Phoenix. It is within walking distance of her work and the light rail system. The size (around 1,000 square feet) and location are perfect for her needs. Both units were built in the early 80’s and have the same layout and floor design.

Option 1:

  • As is condo, with the original cabinets and color scheme from the early 80’s. This unit has never been remodeled and will need a little bit of TLC to make it look fresh and new. The kitchen, floors, and bathroom will all need to be redone at some point.

Option 2:

  • Exactly the same unit, but with an interior remodel done within the last 2-3 years. It looks significantly better and won’t need any additional work for the next couple of years.

The price difference is $20,000-$25,000.

My friend is like me and wants to go with the cheaper model.

All of her friends were trying to convince her to purchase the new model.  She called me because she knew exactly what I would say and wanted to hear that her logic wasn’t crazy.

I should also mention that with the cheaper unit she has a plan to pay it off in 5-7 years.

So what would you do?

It is very easy to look at the small price difference and assume it is an immaterial number and worth going with the remodeled home.

However, being home rich, but money poor is my worst nightmare.

I’d much rather have a smaller, functional home and still be able to live life than dump all of my resources into a home.

As we talked through the decision, one of the things that stood out to me was that she would essentially be paying over $20,000 to remodel a 1,000 square foot home.

Prior to selling our rental, we completely remodeled a 1,550 square foot home for less than $7,000 out of pocket.  Check out my post on how to manage a home remodel.

I do have to mention that at the time my husband sold custom cabinets and granite, so we go those products at cost. Aaron did all of the installation himself and easily saved us $5,000 with all of the work he did.

Because of his connections in the industry, we got some very good deals on the flooring and painting, but still paying $20,000 for a remodel on a smaller home seems really high to me.

Aaron is going to walk through the home and give her a rough estimate, but based on her description I think she could remodel the home herself for less than $10,000 over the next couple of years.

My friend isn’t afraid of a little bit of hard work and within our group of friends has access to people with a lot of skills.

She will be able to save up and pay for the renovations in cash as she goes while having a low house payment.

My friend is also the type that literally sleeps in her home. She is gone on outdoor adventures virtually every weekend and has activities most nights of the week.

She is more interested in functional comfort, not a grand showroom.

To me the choice was obvious. Go with the cheaper home and do minor renovations over the next five years as needed.

A home purchase is very personal. This is the place that you’ll be spending large chunks of time and for many people is a reflection of who they are.

Because of this attitude, it is very easy to bite off more than you can chew when purchasing a home.

Most lenders will give you an upper limit on your mortgage loan that quite frankly is often criminal. Just because you qualify for a large mortgage, doesn’t mean you can actually afford the payment.

Most financial planners recommend a housing payment of less than 25% of your take home pay.

Not gross pay – Take home pay!

I know that in certain areas with huge housing costs this seems impossible. I also know for people on lower incomes this seems impossible as well.

Individual situations may vary, but the closer you can stay to the 25% guideline the easier it will make your financial situation.

Having a nice home has become a huge status symbol.

It is drilled into us that home debt is the good kind of debt.

Between these two attitudes, it is easy to see why people often over-extend themselves when making housing chooses.

There is no such thing as good debt.

Debt is debt – even on an appreciating asset.

Let’s talk numbers.

These are real numbers from my home.

Aaron and I purchased our home in 2010, I can’t remember the exact loan, but know it was right around $225,000. We are in a nice neighborhood in Gilbert. Our home isn’t fancy, but it is nice and works well with our lifestyle.

I can’t remember our exact original payment but know it was around $1,450 (so approximately $1,200 without escrow) until I refinanced it and decreased our payment to the current amount, which is $1,109.

We pay escrow of $249.65, which means that my actual loan payment is $859.35.

Even though I have paid our loan down to around $136,000 I’m still paying more each month toward interest then I am principal.

My last payment was $399.39 towards the principal and $459.96 towards interest.

My home isn’t crazy expensive, but I’m still paying almost $500 each month in interest. This is with a 4% interest rate. I can’t imagine how much worse it would be with a higher interest rate.

That is a lot of money when you start adding it up. I could easily find better things to spend $6,000 per year on.

There really is no such thing as good debt.

If you are in debt you are paying interest. Everyone knows this intellectually, but when was the last time you pulled out your mortgage statement and actually looked at the numbers.

Take it a step further and add up how much you paid in interest for the last year. I bet it will make you sick to your stomach.

If you can keep your loan payments to less than 25% of your take home pay, the ratio’s start looking significantly better. Yes, $500 per month is a lot of money each month for interest, but it is a number we can easily afford to pay.

Prior to purchasing a home or signing a lease, sit down and take an honest look at your budget. Just because you have house fever doesn’t mean that you can actually afford the payment.

Once you sign your loan documents, you are on the hook and the bank isn’t going to care about the random emergencies that come into your life.  Your emergency fund will only last so long if you dip into it each month.

You must make the payment every single month.

Be honest with yourself about your ability to pay a large home payment. Don’t get so caught up in appearances that you over-extend yourself and end up house poor.

There is nothing worse than a large amount of debt constantly looming over your head.

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