Should I buy a home?
November 29, 2009 6:16 PM   Subscribe

I'm looking to buy a home, am I ready to finance this?

I have about $35k in private student loans at 5.25%, no other debt. I've been pre-approved for $150k at 5% for a 30 yr fixed and I currently have about $25k in cash. The homes I'm looking for are between $140k-175k, with most being on the low-end of that band. On the high end I'd be paying just shy of 25% of my monthly take home pay, which seems like a lot.

I'm a first time buyer so it looks like I would get the tax credit along with being able to deduct interest payments.

I would only be in trouble if I were to lose my job within the year, as I plan on using all but $5k for down payment and closing costs. I'll still be saving around $300 a month. I'm young and single, I would expect my salary to rise in the field I'm in, but the economic collapse taught me that nothing is set in stone. Any thoughts on how if this is a good idea or not? Am I missing anything?
posted by anonymous to Work & Money (14 answers total) 3 users marked this as a favorite
Is the 25% of the take home pay combining both the private student loans and the mortgage payments? Or is the 25% only the mortgage payments?

If it's the former I would say you are skirting the edge of very risky. If it's the latter I would say you have fallen off the ledge and are going to go bankrupt.

Frankly I would focus on eliminating the student debt and building up a larger cash reserve with which to buy property in the future.

You are correct to worry about the safety of your job. Unfortunately you don't tell us either your profession or the area you live in, both of which points are critical points to be considered in the "how risky is my job" question. If you're an auto worker in Detroit your job is a lot riskier than if you're a solar power systems engineer in Phoenix.

posted by dfriedman at 6:22 PM on November 29, 2009

You haven't told us whether you are currently renting an apartment or a house. Owning a house also means you are responsible for the cost of maintenance and repairs, and that can add up. Also you'll be paying a lot more for utilties with a house. Just a few things to keep in mind.
posted by MaryDellamorte at 6:33 PM on November 29, 2009

Your current salary is a major input to this equation, which seems to be missing from the question.
posted by jeffamaphone at 7:15 PM on November 29, 2009

It doesn't seem like you have 20% to put down, so you'll also be paying for mortgage insurance (PMI); factor that in. The guidelines seem to be: your monthly mortgage payment, taxes, and insurance shouldn't be more than 33% of your gross (pre-tax) salary (this is called your "front-end" debt to income ratio). Total house payments plus additional monthly debt shouldn't exceed 38% of your gross salary (the "back-end" ratio).

The interest payment deductions sound pretty good, but you have to itemize to get them. Without itemizing, you already get more than 11k through the standard deduction, so you won't come out as far ahead as it seems.

Look into FHA loans instead of an adjustable rate mortgage. They have looser debt-to-income requirements, limit the closing costs that lenders can charge you, and will insist on an inspection to make sure you get a house in decent condition so there are no "leaky surprises". Down payments with FHA loans can be as low as 3.5%, I think.

Keep in mind, you may be able to get the seller to pay some or all of your closing costs ("seller concessions"). It's always worth asking. Look for properties with a guest suite, finished basement, or other dwelling that might be rented out. Lenders will give you more leeway because they can count on your renting out the space to help make the mortgage payments.

Good luck!
posted by fatllama at 7:17 PM on November 29, 2009

I would absolutely buy now. Interest rates are low. Housing prices are low.

If you wait and save up more money, you will be shooting yourself in the foot. By the time you get around to buying, either housing prices will have gone up, or interest rates will have gone up, or both. In any case it's likely your money won't go as far in the future as it will now. Spending 25% of your take-home pay on housing is reasonable.
posted by selfmedicating at 7:37 PM on November 29, 2009

I would absolutely not buy now. . . the market is currently being propped up by govt tax credit and interest rates that are being held lower than they should be. The govt is just trying to get your money into the system.

Likely, the govt will pull out these silly incentives around 2010 Q2 and this market will fall further towards fundamental (Wage and rent: price ratio) levels, like it always does-- just like bad debt always needs to burn off.

The time to buy is when the economy is ready for it, not when the govt really hopes you do.
posted by No New Diamonds Please at 8:06 PM on November 29, 2009

Paying off the student loan first would be getting 5.25 % on your investment and be the fiscally conservative approach. Paying at least 20% down will avoid paying PMI and greatly reduce the cost of interest over the life of the loan. Even if you start with a 30 year mortgage, switching, at some point, in some way, to 15 years, will save a great deal of money in interest. How long could you be out of work - perhaps due to injury ? You should have savings equal to your expenses for that time. Owning a home is a significant impediment to moving to take a new job.
Borrowing money to buy a house you will live in should be considered a fairly expensive way to get the living situation you want and not a real estate investment.
posted by llc at 8:24 PM on November 29, 2009

I would absolutely not buy now. . . the market is currently being propped up by govt tax credit and interest rates that are being held lower than they should be. The govt is just trying to get your money into the system.

This is probably true. Maybe it's a bad time to buy, but it's a great time to borrow.
posted by fatllama at 9:37 PM on November 29, 2009

Doesn't really matter what housing prices are, if you intend to stay in the house for a while. It's not like housing prices are going to drop half their value.
posted by gjc at 5:55 AM on November 30, 2009

I'm thinking the housing market is a little too dicey to jump in at the moment, particularly when you can knock out most of your debt immediately. You don't say what your loan payment is, but depending on the situation you could save up to $350-375 a month in payments and $10k in interest over ten years if you were to get rid of that. This would not only give you a lot more flexibility in your monthly budget, but would enable you to take on a larger mortgage without changing your debt ratio.
posted by valkyryn at 6:37 AM on November 30, 2009

I will disagree with others on paying down student loans as 5.25% > 5%. Degrees don't appreciate in value but homes do. Most people's net worth is tied to their homes and it is pretty clear that the government would throw away money in maintaining this rather than let home values deteriorate to a natural level.

Given the tax benefits from these types of loans and the interest rates, the money is essentially free. It would make sense to pay as little a month as possible. In the regard it would seem to me the best course of action would be to put as little as possible as a down payment and put the rest of the money in an ETF or something that generates returns better than 5.25% which shouldn't be hard to do.

If someone else can explain why paying down cheap debt is a good thing please do, but it seems to me that paying down the student loans first while not being the worst idea, is probably not the best.
posted by geoff. at 8:09 AM on November 30, 2009

Pay off the student loan, and then save until you have 20% down and can avoid PMI. That is what I would do in your position, anyway.

It is a mistake to try and time the market. You should buy when your personal finances make it the right thing to do, and you have found a place that you want to live in for a significant period of time that you can afford — not a moment before. If you want an investment there are lots of good buys out there in the equities markets; don't make the mistake of sinking all your money into one highly illiquid speculative asset if you don't really want to own a house.

The tax incentives aren't unwelcome (speaking as a homeowner) but anyone considering buying a house in order to take advantage of them is insane. The $11k first-time credit and the amount you'll save in interest deductions over the standard deduction are trifling compared to what you will need to be ready to pay for maintenance, should something go wrong with your house.

In addition to 20% down, I'd also strongly (and I mean this in the sense of "if there was a way I could have this made a legal requirement on pain of death, I would") recommend having another 5-10% in cash, set aside for maintenance and problems that you'll inevitably encounter. Even a good home inspection only goes so far. This is doubly or triply so if you're looking at REO/as-is properties (which is where a lot of the really tempting deals are right now).

There is a bit of 'gold rush fever' going on in residental RE right now that I suspect may produce a second round of foreclosures down the road, due to people jumping the gun and buying houses that they aren't quite financially ready for. Get your debt situation squared away, get a nice pile of cash for repairs and expenses, and then you'll be in a good position to take advantage of the best deals out there.
posted by Kadin2048 at 8:24 AM on November 30, 2009

If someone else can explain why paying down cheap debt is a good thing please do

The reason I'd pay down the student loan isn't because of the interest rate (which is good), it's because of the monthly payments. The OP is talking about paying 25% of their income in mortgage payments alone (and seems hesitant about it): that's presumably before property taxes and insurance, and then when they add their student loan payments — my gut feeling is that they're going to feel squeezed. And that's just not a good feeling.

So even though the student loan is "cheap money," it might very well be worth paying it off, so that they can free up that income stream for other purposes. Most people operate their personal finances based on cash flow, so eliminating a monthly payment is practically as good as getting a raise for that amount.

N.B.: This all goes out the window if the student loan payments can be deferred, or if the minimum payment is very low to the point of triviality. But assuming that it's a significant monthly expense I think it makes sense to get rid of it before signing up for a large new monthly payment.
posted by Kadin2048 at 8:37 AM on November 30, 2009

You should keep shopping for the best combination of interest and fees. I've consistently gotten better interest rate, lower fees, and in-house processing from my credit union. The market is uncertain, and nobody is going to be able to accurately predict what's next, so buy a house you really want to live in. In your circumstances, a 2 - 4 family house, or a house where you could easily have a roommate or 2, would make sense. Houses always need repairs, and you'll also be paying for insurance and taxes.
posted by theora55 at 1:21 PM on November 30, 2009

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