Part 2 of 6 of Wela’s series on buying a house.
What was your favorite game show as a kid?
Your answer might range from Guts to Legend of The Hidden Temple to Jeopardy or even Wheel of Fortune.
For me it was The Price Is Right. I have vivid memories of watching Bob Barker with his skinny microphone on that one hour show. I remember the cameras panning the crowd with each group wearing their “team” shirts.
I’ll never forget the legendary intro: “Joe Smith, come on down! You are the next contestant on The Price Is Right.”
My favorite game was Hole in One which makes since now that I’m an avid golfer.
Or what about Plinko! The contestant have to guess the price of these smaller prizes, and with each correct guess they get the prize but they also get a Plinko chip… the real prize. Then as the contestant drops the Plinko chip down the board, everyone holds their breath to see how that last bounce is going to end up!
I was also a fan of Punch-A-Bunch. The contestant gets to guess whether the price of a prize is higher or lower than what is shown. With each right guess they get one punch for the punch out board. Then as they punch a hole they get an option to take the dollar amount on the card within the hole or go for another hole.
I could go on all day looking back at the games that were played on Price Is Right.
There was really no wrong answer with that question. I mean, some of those Nickelodeon game shows were killer!
Remember the show “What Would You Do?” or “Figure It Out” or “Double Dare?” Man, all those were great, and there is no way you chose a bad option.
Enough of the reminiscing. Time to get back to the Price Is Right.
The only way that a contestant is able to play one of these awesome games is if they first win the bidding on a price of some item against three other competitors (four in total).
The kicker, though, is that when making your guess you cannot go over the price of the actual item. The $1 bid was always an exciting guess, because they always won if the other three people guessed over the price.
But what the hell is the point of all this? How does it tie into buying a house?
When buying a house we don’t want to be one of those people that goes above the fair price. Even more importantly, we don’t want to be the person that goes above our own price.
If we over price the house, not only do we lose before the game of owning a home even starts, we could lose a lot more. The good news is that unlike on The Price is Right where you’d likely just make a guess, we can actually follow several steps so that we don’t lose on the opening bid.
The shiny ball effect
We fall into a trap when we start the home buying process. In our first post of this home buying series we talked about identifying a location, putting barriers up and not going outside that area.
Well now that we have the barriers around the area that we want to look, we have to put up a price barrier.
The issue with this is that it is easier said than done. I have done it, some of you all have done it, and I bet others will definitely do it. We set a price in our mind for the home we want to purchase and then we start looking. As we begin to look we get attracted to those shiny homes that sit just out of our price range.
This leads to us pushing out our price barrier further and further, until we fall in love with that one home which sits well outside the original price range we originally set… and in all honesty what we needed.
After buying the expensive house, we go through a six-month honeymoon of loving the house, and then reality sits in. That mortgage we are paying, which has caused us to cut back on other activities in our life, doesn’t go away. It continues well past the honeymoon phase.
We get distracted by ‘shiny balls,’ and we shift our attention to that shiny house forgetting about the barriers we had originally put up for ourselves.
The problem with buying a home and truly understanding what we can afford, may not actually have to do with knowing the price. Instead, the issue may really be our self-control.
Dogs are man’s best friend. We love our little furry animals, but we know that we are always going to be smarter than them. Yet, we as humans still fall into the same trap that we laugh at when watching our lovable pets play.
Your dog might be playing fetch perfectly fine with the dull tennis ball. Then he see another dog playing with a fresh tennis ball, and he begins to chase that ball.
Don’t let yourself fall into the same traps our furry friends do. We are smarter than that.
The double-edged sword
Okay, so maybe you are rolling your eyes and saying that I don’t know what I am talking about.
If that’s the case, then good! That means you aren’t falling prey to the assumed problem. Or you at least don’t know if you are.
The real problem is actually two-fold.
First is that we don’t know how much house we can truly afford. Despite being able to Google “how much house can I afford” and getting pages of calculators to help us, we still don’t know which one is right.
I took this onto myself and tested multiple of the calculators and even used the one that we provide for users on www.yourwela.com.
Here is what I found when trying to determine how much house a hypothetical person could afford. I was going based on the broad assumptions of someone having an annual salary of $70,000 while having a little debt still ($100 per month). I also assumed annual insurance costs of $1,000 and annual property taxes of $4,500 (because this person is going to live inside that Atlanta perimeter).
|Calculator Provider||Calculated Home Price|
|Bankrate (a bit more confusing)||$340,176|
Looking at this chart we now know how much house we can buy, right?! That is a $50,000 diversion in price between the lowest we can afford and the highest that we can afford! That’s big.
What this does, though, is gives us a good starting point to then take some of the actions that we talk about further in this post.
Be careful, though. The other edge of this double-edged sword is that even when we determine the price of the house we can afford, we don’t always take into account the actual monthly mortgage payment.
We sometimes say that the above numbers are a good range, but we then go to our bank. After talking with our local banker we begin to get starry eyed because what the bank might allow you to borrow could be enough for a house well outside this range.
Ok, ok… what do we do then?
The simple answer to this is to focus more on the monthly mortgage payment you will have as opposed to the price of the house or the amount that your bank is willing to loan you.
Remember what we have talked about in the past. We talked about this acronym TSL. It means taxes, savings and life. It is a way for us to break out our money. We should put 30% of our gross income towards taxes. 20% of our gross income towards savings. And then 50% of our gross income towards life.
Within that life category we have to incorporate the cost of shelter, which means our mortgage. This also includes food, utilities and discretionary spending including traveling.
We must be cognizant of this because if we get too wrapped up in the idea of owning that big shiny house, then we may also have to be extremely comfortable spending every last second there. If we spend all of our 50% life budget on our monthly mortgage, then we won’t have any discretionary spending ability and we aren’t going to be able to leave.
Remember the bigger the house the more money it takes to maintain it. You’ll also need to save towards emergencies that arise from the house. More house means more opportunity to spend money fixing it.
All of these things must be taken into account because they will all eat into that 50% life spending that we have.
Action is spurred by knowledge
I can’t speak on exactly how the other providers calculated what home price was affordable for individual, but I can explain how we look at it.
What we do is take your gross salary, so let’s use $100,000 to make numbers easy. We believe that nobody should have a mortgage payment that is greater than 28% of there gross income.
This means that your annual mortgage payments should not exceed $28,000. We don’t want to forget about insurance and property taxes, though. So, let’s say insurance is $1,000 per year and property taxes are $3,000 per year.
This now leaves us with an ability to get a mortgage that consists of interest and principal of no more than $24,000 per year (or $2,000 per month).
We then have to take into account how much you are going to put down on the house. We suggest that you should save until you are able to put down 20% on the home.
With those numbers we then calculate how much house you can afford, and the necessary down payment. Really the down payment works as a lever. If you put less down then you can afford a lower priced house, and if you put more down then you can afford a higher priced home.
So, with this calculation we can assume an affordable house would be about $523,000. But if we can’t put down 20% this price goes down a bit. For instance if we can only put down 10% then the calculation would say we can afford a $465,000 house.
We have to go one more step. Although the above calculation takes into account a mortgage rate of 4% we have to make sure that mortgage payment fits into our budget.
Using our TSL rule means that us making $100,000 per year results in us being able to spend $50,000 per year on life (or $4,166 per month).
With the $465,000 home and 10% down we would have a starting mortgage balance of $418,500
And at a 4% mortgage our principal and interest payment would be $1,997 per month. Plus $83 a month for insurance and $250 per month for taxes. This results in monthly payments of $2,330.
The result of this house leaves us with $1,836 per month to live off of. That includes food, travel and going out. If your current lifestyle calls for more than this, you will have to cut spending in other areas, make more money in your job or look for a less expensive house.
The other things that help make things a little less stressful would be to already have an emergency reserve that is built up with 3-6 months worth of expenses. And already having other debt paid off like student loan debt and any credit card debt.
Be the $1 bet, rather than the over bet
Now we know not only how to determine the price of a house we can afford, but also how to determine what price won’t break the bank for our budget.
It’s easy to get caught in the shiny ball effect. But if you are able to take a step back before signing the stacks upon stacks of paper during closing, you will put yourself in a better position.
By taking the route of betting $1 on the original item, means that you are more likely to be in the Price Is Right’s Showcase Showdown.
Going over the amount of what you can afford not only keeps you from the opportunity of being in the Showcase Showdown, but more so keeps you from being able to play later on.
We all want to be the next contestant on the Price Is Right, and by using our knowledge of that game we can now better understand which home will call us down.