Dear Money & Crisis Reader,
Carl Richards’ job was helping people make smart financial choices.
He was a financial adviser… he had his own financial planning business… he even wrote personal finance advice for TheNew York Times…
Yet he fell into the exact same trap everyone else did during the housing boom.
He bought a house he couldn’t afford.
By his own estimation, he and his wife could just about manage a house in the region of $350,000. But their real estate agent, Mitch, had other plans.
Not long after Mitch picked them up in his gold Jaguar, they were looking at houses in the region of $400,000… $500,000… $600,000…
“It felt a little crazy to be shopping for houses that cost half a million dollars,” Carl wrote in a New York Times article a few years later. “But my income was growing rapidly.
“Everywhere I looked, people were being rewarded for buying as much house as they could possibly afford, and then some. There was this excitement in the air, almost like static. I started to think that if I didn’t buy a house right then, I would never be able to afford one.”
Eventually, Carl and his wife settled for a 3,500-square-foot home with a price tag of $575,000… and they had no problem getting a loan.
“We borrowed 100% of the purchase price. In fact, I was told I could borrow even more if I wanted. I had perfect credit and a solid income that was growing.
“But even so, when the lender approved us at 100%, it was more than I had expected. I remember thinking something like, Wow. I guess if they’re willing to lend it to us it must be OK.”
I’m sure you can see where this is going.
The bubble burst… Carl’s income, which was dependent on how much money he was managing, dropped by 20%… They lost their home.
It’s the same story we’ve heard a thousand times before, only the players are different.
But I didn’t dig up this story to shame Carl.
He’s a smart guy. Heck, he even wrote a book based on the lessons he learned so that others didn’t have to make the same mistakes he did.
But Carl’s tale is a firm reminder that our modern society is full of financial pitfalls… and anyone can fall into them.
Banks do not have your best interest at heart. Approving your loan is not a measure of your financial health or security. It’s a calculated risk that they have a better chance of making money on the loan than losing it.
You are the only person who can decide if you can afford a home or not.
3 Simple Rules for Buying a Home Without Breaking the Bank
Everybody’s financial situation is different. And whether or not you decide to buy a home is up to you.
But if you stick to these three simple rules to buy a house, you won’t bite off more than you can chew.
Rule #1: Keep your total housing payments below 30% of your after-tax income
Now, the traditional line of thinking is that your mortgage repayments should be 35–40% of your income before taxes.
But this is the type of overconfident nonsense that got us into the housing crisis in the first place.
Had folks been more realistic with their mortgages, millions of families across America wouldn’t have lost their homes when the recession hit.
Your total housing payment (including property taxes and insurance) should be no more than 25–30% of your after-tax income.
There’s no point running calculations off your before-tax income. You can’t pay your bills with money that’s already in Uncle Sam’s pocket.
Rule #2: Don’t be tempted by adjustable-rate loans
Opt instead for a secure, fixed-rate loan.
This will lock your interest rate at the same figure throughout the term of your loan. It won’t go down… but it won’t go up either.
It’s much easier to plan your finances when your repayments stay the same… and it won’t leave you vulnerable to massive interest hikes during a crisis.
Rule #3: Pay off all other debts before you even think about buying a house.
This is a no-brainer.
It makes no sense to take on the biggest chunk of debt in your life if you’re struggling to pay off the debts you already have.
Juggling too much debt is the fastest way to financial ruin. Clear your deck of any outstanding loans before you even start looking at homes.
Stick to these three rules and you’ll be better off than most American homeowners are. And remember, buying a house isn’t for everyone. Sometimes it makes more financial sense to rent than to buy.
What about you, reader? Are you a renter or a buyer? If you could go back in time, would you have done anything different? Shoot me an email if you have any questions or suggestions for future topics you’d like me to cover.
All the best,
Editor, Money & Crisis
Editor’s note: The strategies you read in Money & Crisis were developed with the help of Jim Rickards, the best-selling author of Currency Wars and The Death of Money.
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