Monday, October 13, 2008

Rule #19: Too Much House

  • Don't Buy Too Much House

I think this rule has never been truer than now, during a financial crisis of historic proportions. It remains to be seen how the credit crunch will play out, but why did it happen in the first place? People bought too much house. There will be lots of debate over why that happened and whose fault it was, but it all comes down to people buying houses they could not afford.

Not everyone "couldn't afford" the kind of houses they were buying-- some chose to spend lots of money on other things and run up credit card bills, in effect choosing not to be able to afford their house.

And some people, even if they could afford the house they bought a few years ago, are going to find themselves in trouble now if they lose their jobs or can't borrow more money to spend.

Think about it: everyone has things they can cut back on if times get tough. You can cut back on entertainment, meals out, new clothes, new cars, etc. But for most of us, our housing payments are the biggest chunk of our expenses. They're also the hardest to cut back on: you have to either sell your house, rent it out and move into a smaller one, or take in roommates to make extra money, leaving aside dire options like destroying your credit by going into foreclosure. Even in a good real estate market, these things take time and cost money. In a bad real estate market, they may not be possible.

Back in the heady days of the real estate boom, people would always say that home buyers, at least younger ones, shouldn't feel bad about stretching to buy the best possible house they could. It seemed like a safe bet when you could reasonably assume that your home's value would go up quickly and that your earning potential would steadily increase. But now I'm sure a lot of people wish they had been much more conservative.

Where do I fit into this? I went from paying $850 a month for rent and utilities for a tiny studio to about $1,800 a month for the mortgage, common charges, taxes and utilities for a 2-bedroom. (It's actually been more than that due to an escrow error for my property taxes that has been difficult to fix.) So did I buy too much house? (The rule also applies to Too Much Condo!)

I am saving less cash each month than I used to, even though I have gotten 2 raises since I was renting that have helped make up the difference. But given how much the value of my investments has fallen, I'd love to be saving more. I am exactly in the position I described above, where I could definitely make some lifestyle changes to save money, but they'd make nowhere near as big a dent as having lower housing costs. But I have no debt other than my mortgage, and I'm still maximizing retirement savings through 401k and Roth IRA contributions-- my budget is balanced.

Here's another important thing: my home, I think, will turn out to have been a very good investment. The cash I put into it would have lost its value in investments right now, but based on the current housing market in New York City, my condo's value has more or less held steady if not increased slightly since I bought it (based on price per square foot of recent sales in the neighborhood), and I don't think it will fall as precipitously as the stock market has. I could rent it out and turn a small profit. Or I could take in a roommate if I needed to.

I'm not being a Pollyanna about the real estate market: if I had to sell my condo any time soon, I'd be in big trouble, because there's just too much on the market and my place isn't that special. But I put 20% down, I have a 30-year fixed mortgage at a good rate, and as long as I stay employed, I can make my payments while still saving money. All this is because I bought a modest home that I knew I could afford, not what a mortgage broker told me I could afford.

21 comments:

Anonymous said...

I heard from a few (older, conservative) financial advisers that the rule of thumb for housing is that one should buy a house that is 2.5 times one's annual income. Always put 20% down, which equals to a year of income. And spend no more than 1/3 of income on mortgage. Anyone buying more than 5 times his/her annual income of a house is asking for trouble.

Susy said...

I completely agree. I think it's interesting that nowadays people say, "Oh, we're having another child so we need a bigger home". My grandparents raised a family with 4 kids in a 2 bedroom house, no problem. I wonder when we decided we needed so much space.

Mr Chiots and I bought a small 2-bedroom home within our price range. It is rather small, especially since we run 2 businesses out of it, but we love that it costs less to heat in the winter & cool in the summer. Utilities & taxes also get bigger with the house.

Our home will be paid off in 2-3 years (8-9 years after buying) and many of our friends that purchased large and have moved to larger homes will be paying on their home for the next 25-28 years. That seems really scary to me to be roped in to that kind of payments for that long.

Anonymous said...

My monthly mortgage, gas, electric and water bills come to below 15% of our income. It was closer to 25% when we first moved in which was affordable at the time. However needing only 15% of ones budget to cover those expenses makes life so much simpler to manage.

Miss M said...

Living in a high cost area means whether renting or buying, you're paying too much for housing. My mortgage has become more manageable as my income has increased, but it's still a hefty portion of my income. Anytime I lament how much we're spending on housing Mr M points out that we'd be paying the same to rent. Given how teeny tiny my house is, it's kind of funny to think that I bought too much house.

Whitney said...

Whitney T from Zillow here. Great post. It's alarming how many people are overextended on their homes. Zillow data shows that among people who bought within the past five years, 29% are under water on their mortgages (owe more than the home is worth. Scary.

Hopefully the present economic crisis will remind people of the benefits of living simply, and within their means.

Anonymous said...

So here's an interesting (or maybe not) conundrum. In May, I made a contingent offer to purchase a home that would be built for me. I only made a $1K deposit in earnest money.
Since then, my house has still not sold, I went through a six week stint of unemployment, and am now working a six month contract instead of full-time employment. In the mean time, the builder calls me every week to discuss colors, doors, counters, floors, etc. I've gotten to know him and his family.
I'm a single mom, and I'm no longer comfortable spending $300K on a house for me and my son. I make just slightly over $100K a year in Des Moines, IA.
I do not have 20% down payment.
In fact, I would be much more comfortable with a $200K or less home.
There are two choices here. I can do the right thing for EVERYONE and follow through with building the house, buy the house, and live as frugally as possible, hoping that I pick up another contract within a few weeks of the current one ending.
Or I can do the right thing for myself and my child. Which is go to the builder, tell him I'm not longer comfortable with this agreement, and give up my $1K.
It's possible that they can build me a smaller house in a neighborhood that's not as nice with regular counters and nothing fancy. But the builder could also suffer a great deal financially if they don't sell the house that's already almost done.
I could be passive aggressive and not accept any offers until the builder is forced to sell the house to someone else.
It seems clear to me that I need to do something that does not hurt my family or our future.
Making that first honest move to let the builder know I'm not in a good place, hurting his family to help save my own, is not just about money. It's about people's lives and their families and knowing my word is mud.
This sucks.

petunia said...

@ madame x, ugh looks like you have a spammer with "alencoope" how annoying.

@anonymous I think you should walk away. I've lost about $1k in my time walking away from real estate offers on earnest payments, legal payments. I would blame how quickly people are pressured to decide for the cold feet. They'll find another buyer. You don't want to be house poor, that would probably be worse...you are smart for rethinking.

FruGal said...

This is the first time I've visited your site (I found it via the link on alwaystheplanner's site). It looks great, you have got so much great information and interesting content - I'm definitely going to keep reading along.

I think you're right about your condo being a good long-term investment. As long as people can ride out the storm for now and keep paying your bills on time, they should come out alright in the end. The big problem will be people who cannot keep making their payments as their budgets get squeezed, or those who need to refinance in the short time - finding a cheap mortgage will be very difficult for a little while.

Ensoleille said...

@ Anonymous --

In the current slump with the housing market, talk with your builder -- you said you'd be more comfortable with a 200k home, it is possible that your builder can still make some compromises on what he's working on for you, as well as cut his price.

I'm sure he would rather make the sale for less profit than lose the sale altogether...builders are hurting for work and sales right now, so you might be able to strike a bargain.

If he's unwilling to compromise with you, then like petunia said, walk away.

Anonymous said...

This is the anon house buyer.

I don't want to ask the builder to make compromises because 1)It's being built in a development with minimum requirements. 2)The house will be done in about two weeks, so it's too late at this point.

I spoke with my mortgage broker this morning, and she agreed with me that I should walk away from the $1K, and not make any more contingent offers, or put any earnest money down until my house has a firm offer. She agreed that a $200K ceiling would be more appropriate considering my aversion for risk (Again, I'm a single mom). She thinks my personal comfort level is more important than getting a new mortgage through her bank.

I'm so fortunate to have a great mortgage person, and if I didn't think it would be considered spam, I'd post her name and contact info.

Thanks for the feedback!

Anonymous said...

This is anon again, one more comment. If I simply wait it out and my house doesn't sell before the builder has another buyer (the house is technically on the market since it's contingent, and it's listed on realtor.com), I'll even get my earnest money back.

Miss M said...

@ Whitney, well your site says I'm not underwater yet but since the house across the street is a similar size and listed at $140k less than what I paid, I'm pretty sure we're swimming. Even 40% down wouldn't have saved us, oh well, live and learn and don't buy in LA!

plonkee said...

I'm kind of in exactly the same situation. Probably buying was a rubbish idea finacially speaking. From a personal happiness point of view, it's one of the best decisions I've ever made.

Tim said...

i think the too much house rule needs to have a caveat. I would much rather buy a larger house, based off of my plan for having kids or my inlaws living with us. In that case, yes at the time it is too much house, but for our objectives it is not. so where is the line?

Anonymous said...

I bought a HUD foreclosure house with $100 down plus the closing costs. On top of that the major repairs for the house were financed with the mortgage. The note, which is all inclusive (principal, interest, taxes, homeowners insurance) is about $50 less what I was paying for a 2 bedroom apt in my area. That goes to balance out the increase in the utility bill. The house is 3 bd 2 br.

I am single but I always have my family over during the holidays and my mom may be coming to live with me. Even though the house is big for one person, its full for most times of the year. I'm sort of the "matriac" big sis in my family. Financially wise I did not buy too much house, its 1.5 time my current income. The plan is to pay it off in 5 yrs. When/if I do get married, I can rent the house and make a couple of hundred dollars. Its a really cute house. Heck, may be hubby would move in with me...2 incomes would make a world of difference. (Unless I marry the likes of my ex. We both earn the same, he lives at home with his parents and does not contribute a dime yet his months are always way longer than his money. Said the economy would collapse if people quit spending. **Gasp** He must not be in tune with what is going on).

I did rake up some CC debt though for some minor updates. By my calculations, I should be debt free by this time next year. I am debating taking a roommate to accelerate the time but I kinda like my privacy, and I dont know how they'd appreciate when my family shows up. I've got a part time job lined up in January so that should help accelerate the CC pay off time. Currently all my "found money" is going towards paying off the debt.

That said, I do need to quit yo-yo'ing with debt. This time last year I was totally debt free after paying off 12k debt in a year. Now I have a car note on top of the CC debt. This has to end.

Anonymous said...

Des Moines house buyer - I always thought that IA was a much less expensive part of the country - I'm being nosy here but with a $100k income why couldn't you save 20% to put down on the house? I make $50k/year and saved 20% down ($56k) in 5 years in CA.

GI Jane said...

Great post. I fall in the category of having too much house in this horrible real estate market. I finally got an offer and can't wait to be done with it. GI Jane
www.gijanefinances.wordpress.com

whitestone said...

When folks are encouraged to take out 100% loans there is bound to be disaster. Four years ago we sold a hse in CA and the first offer was from a young couple with a 105% loan. Their income? Selling window treatments. We declined their offer and told them we were doing them a favor. They cried. I wonder if their mortgage co encouraged them to buy a similar house down the street and where are they now.

Kemkem said...

Great site! I would say to anon: walk away from the 1k deposit. Better than being stuck with a house you can't afford later. I did the same thing with our first builder when we moved to Texas. I had a 5k deposit on a golf course view on a big lot. At that point, l was going to sell my house in Los Angeles and move, so, it would have been an affordable house, but later changed my mind and decided to rent the house (still not sure if that was a good thing!) and realized it would have been too much to handle. I admit l lied to the builder and said l wasn't getting transferred after all..shame on me l know, but they had been so nice. Long story short, the house was built to my specs and sold within 2 months of me backing out. I got a house that was almost 115,000 less in the same subdivision, not a golf course view but a bigger lot. Believe it or not, thanks to some snafu, l was refunded all the money instead of just 2/3 of my deposit. It might have had to do with me roping my boss into writing a letter on my behalf about the job transfer. Now, l am so glad. l have a deadbeat tenant in LA that l'm trying to get rid of and l wouldn't have made it had l gone with the first house!

bugbear said...

@ the person who wanted to get a roommate but wasn't sure how a roommate would take to his family coming:

you could work that out. mention that you have your family over for the holidays and that that should be expected. outline what that would entail. It might turn out that (a) your roommate is going to be elsewhere anyways
(b) you might really get along with him/her and feel comfortable with them being around for the holidays, and vice versa

(c) you get a slightly grumpy, but forewarned roommate who decides to make himself scarce during the holidays even if he wasn't planning normally on being away.

Anonymous said...

MOW, you are livg in a dream world if you think your condo is worth the same as you paid for it. Recent comps mean nothing in this market. I suggest you get an appraisal done and you'll see the truth.