How to buy a home like a Millionaire!
Are you asking yourself, “How much home can I afford?” With so much conflicting information on the internet about when to buy and how much you can afford, this guide is intended to cut through all the noise and provide you with four, easy-to-use steps to help you buy your home like a millionaire!
This guide relies heavily on the studies of Thomas J. Stanley, Ph.D., millionaire researcher with decades of experience studying and marketing to millionaires in America. Unlike other guides out there, where the writer merely gives their opinion, this blog post relies on the tried and true principles of the average millionaire in America based on scholarly research.
So rather than simply relying on someone else’s best guess, or forging your own path to wisely purchasing a home, follow hundreds of millionaires in America that have done it well.
But First, Do You REALLY Want to be Rich?
This is an honest question. Most people say they want to be rich or think they do. However, according to Thomas Stanley in The Millionaire Next Door,
“Most of us want to be wealthy, but most of us do not spend the time, energy, and money required to enhance our changes of realizing this goal.”
Case in point: Most people know that it’s in their best financial interest to buy the least expensive home they can afford, pay it off, and live in it for a long time, interest free. In practice, however, the average homeowner in America tries to get into the largest house they can qualify for. Worse yet, they let the bank tell them how much they can afford to pay!
It’s like going to a car dealership and asking the salesperson which car you qualify to purchase. They’re going to stretch the terms and up the APR as much as humanly possible in order to sell you the most expensive car on the lot.
Likewise, the bank can tell you what you qualify for, but they honestly don’t care if you pay back your loan because it’s insured against default by the federal government. If you default, the bank still gets their money.
Consequently, it’s in the bank’s best interest to lend you the most they possibly can so they can get the biggest commission and most amount of interest from the loan that they can.
There is a better way:
But first, some words of wisdom:
If you can’t afford a home without following these simple steps, you can’t afford to buy!
Can’t afford a home in your area? No sweat.
Either buy somewhere more affordable or rent until you have all four steps covered. You may hate me now, but you’ll thank me for this later when everyone else is freaking out that there’s a recession and you’re sitting pretty.
1. Get Out of Debt
You’ve got school loans, credit card bills, and two car notes. You’re just trying to live the American Dream. And you feel that buying your next home is just the next logical step. However, the short and sweet of it is, it’s just not the right time for you.
The Forbes 400 (400 wealthiest people in America) were asked the question, ‘What is the most important key to building wealth?’
Their number one answer:
Becoming and Staying Debt Free.
If 75% of the Forbes 400 believe it, you should too. Which means, you need to focus on getting out of debt first, instead of piling more of it on.
For more info on how to get out of debt, check out Dave Ramsey’s 7 Baby Steps.
2. Have a Large Down Payment
Before buying that beautiful home in the Owl Creek Subdivision, make sure you have a large down payment of 10% – 20% of the total purchase price of the home. You will be much more likely to be approved for the home you want.
There is also an “ouch” moment that happens in your brain when you liquidate all that cash in your account to buy a home. It’s your brain realizing that these aren’t just numbers on a piece of paper, they are dollars leaving your account. This can help you settle on a more affordable home, which is a good thing.
Additionally, if you start saving up the amount you are hoping to pay in a mortgage payment every month, it will help you get a feel for how well you can handle that size of a payment before getting in over your head.
Lastly, a large down payment builds in equity on the front-end. So if the market drops 10% year-over-year and you want to move, you’re not stuck in something you can’t sell. This way, whether you stay where you are or move to get that new dream job, you will have something others don’t… a choice.
3. Get a 15-Year Fixed-Rate Mortgage
Due to compounding interest, paying the first 20% off of a loan only takes about 4 years on a 15-year mortgage, but it takes 10 years to pay off that same amount on a 30-year mortgage!
If you didn’t read the above sub-heading, the key here is fixed-rate. The last thing you need is an interest rate that goes up over time or a balloon payment the year you get laid off from your job. Ouch!
4. Your Mortgage Should Be 25% or Less of Your Take-Home Pay
Did all the air just get sucked out of the room, or was that just me?
Yes, you read that correctly. Most conventional loans already have a 28/36 rule in order to get approved. That means the mortgage company won’t let you have more than 28% of your income going to mortgage debt and no more than 36% of your total income going to all debts combined (including the mortgage).
However, this rule is after taxes.
Instead, you should take Dave Ramsey’s advice on home buying and calculate your monthly payment based on your take home pay, instead of pre-tax dollars. This results in a much more manageable payment for you, especially if you are in a higher tax bracket. While it might mean choosing a home in Rivendell Woods over Brookview Forest, you’ll thank me for it later.
Want a quicker way to figure out how much home you can afford?
According to Thomas J. Stanley, Ph.D., in his book Stop Acting Rich,
“The market value of the home you purchase should be less than three times your household’s total annual realized income.”
So don’t spend more than three times what you make in a year.
Following Stanley’s reasoning, if you and your spouse make $100k per year X 3 = No more than $300k should go towards your home.
However, if you make $100k/year, you’re likely only taking home about $82k/year after taxes.
Plugging that into the equation from #4 above, you need to multiply your after tax income ($82k) by 25% and divide it by 12 (months in a year) to arrive at a payment of no more than $1,708/mo.
At current interest rates, that equates to about a $240k mortgage on a 15-year loan.
So really, if you take your current annual income, multiple it by 2.5x, you’ll be very close to what your maximum budget should look like when purchasing a home.
Home Buying Equation: Annual Household Income X 2 = Max. Purchase Price of your Home
For the ultra-conservative, Stanley tells his readers in The Millionaire Next Door,
“If you’re not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s total annual realized income.”
As a CPA and a Realtor, I recommend this philosophy to my clients above all others.
So instead of wondering, “how much home can I afford?” Use this simple equation and you’re 80% there!
As stated above, if you can’t afford to buy a home by using this formula, you either need to buy somewhere more affordable or simply rent for the time being. If Warren Buffet can live below his means, so can you.
Happy House Hunting!