Cash is king. That’s what John Chladek teaches his MBA students during his personal finance course at Rockhurst University’s Helzberg School of Management in Kansas City, Mo.
If someone is thinking about buying a house, his advice is to wait until their house payments, homeowner’s insurance and property taxes won’t be more than 25 percent of their take home pay.
“And if you have a variable income as a carpenter, freelance graphic designer or waitress, you should go with your worst-case scenario. Don’t take your best month and say you can afford a mortgage. Go with your worst month in income and then you will be OK,” says Chladek, who also is president of Chladek Wealth Management in Leawood, Kan.
Importance of an Emergency Fund
Even with interest rates still historically low and home prices that are rising but haven’t skyrocketed yet, he still suggests potential home buyers building up an emergency fund of three to six months that can pay for all your living expenses before delving into homeownership.
“I look at an emergency fund as something that can help if you were to lose your job. Hopefully, you could find a new job within those six months,” he said. “Saving does require great discipline. But then it teaches you to continue that savings once you have the house.”
There are a lot of things that people don’t consider about owning a home because they have been renting for a while. Taking a serious look at all the expenses that come with home ownership should be one of the first steps taken before signing any loans.
When it Comes to a Home, Consider Going Big
Kate King, owner/founder/Certified Financial Planner at The KFK Group in Irvine, Calif., says she is a very conservative in her financial planning career.
“I do feel differently about your principal residence. It is a more emotional decision. I do tend to think that if you can afford it to go for it and buy the bigger home and buy it now,” she says. “It can motivate you to work harder.”
In fact, she and her husband just bought a bigger house last week.
“We weren’t going to. But our loan agent and real estate agent pushed us. They said we were being silly trying to downsize. It was a good decision to buy the bigger house that will be grow into. We can afford it just fine. We almost made a poor decision by buying a smaller house,” she says.
If you plan on buying a house, a lot of people rush into it — especially young families with kids. “They get antsy to get into a bigger place with a bigger yard,” she says. “But sometimes once they get into it, they realize that there are so many other expenses involved in owning a home. They are now responsible for maintenance, replacing appliances when they break, fixing the roof, and a whole bunch of other things that cost money.”
She tells her clients to take a step back.
How Much Home can I Afford?
What can they really afford? It’s not just what your monthly mortgage will be. Just because you can afford the principal and interest, that doesn’t mean you can afford being a homeowner.
“There’s so much more to it,” she said. “If you can continue to pay the maximum amount into your retirement account and be able to save some money month after month for your kids’ college or for your own emergency fund, then you can afford the mortgage.”
In California and other parts of the country, many people are taking out 3, 5, 7 and 10-year interest-only loans because they can afford the monthly payments. King says to beware and understand your future plans if you go with these types of loans.
“Ideally, you should be able to afford the 30-year fixed mortgages even if you aren’t going to go through with that type of loan,” she says. “However, the rates are so low for the interest-only loans, if you know you aren’t going to stay in your house for more than five years, then look into it to see if it’s a better plan for you and your family.”
She emphasizes that a house is not a short-term investment and shouldn’t be viewed that way.
“Owning a house is good for a lot of reasons. But sometimes, people should wait until they are more comfortable with all that goes into homeownership,” she says.