Money mistakes made by young, educated and affluent families were a direct cause of our current economic turmoil. If families fail to learn from those home buying mistakes, we are doomed to repeat the consequences.
Last July, economists from the St. Louis Fed came to a startling conclusion when researching the causes of the housing collapse. The political narrative regarding the most recent recession was split between banks preying on weak borrowers through risky banking practices and homebuyers over-extending their finances to fulfill their dreams for homeownership. The Fed studied the demographics of families facing foreclosure and found consumer over-reach was the main culprit.
Most home buying advice centers around how to put together the cash, income and credit score needed to buy the house you want. Sometimes, this advice increases the odds that a family will exceed their financial abilities.
Ask the Seller to Pay Closing Costs
Seller paid closing costs are common in home sale agreements, but is it a smart idea?
There is a reason why families need a giant hoard of cash in order to purchase a home. It’s a financial barrier meant to weed out those that can afford a home from those that cannot. What does it say about your ability to afford a home if you need the buyer to bridge that barrier for you? If you can afford the financial commitment of a mortgage, you should be able to save up and pay closing costs.
I’m not saying that you are doomed if don’t pay closing costs. However, saving up for your own closing costs is a good way to test your financial abilities.
If you are itching for a seller concession, consider asking for the seller to pay your points, your PMI or a home warranty. These concessions lower your monthly expense obligations and will benefit you long-term, not just removing a barrier to homeownership that makes sense.
Use Alternative Income Sources to Pay Closing Costs
For all the same reasons above, the closing cost barrier is useless if you are using your 401k, IRA, tax return or inheritance left to you by your step uncle. Reliance on these unusual money sources for your closing costs should be an indication to that you may be stretching your finances too thin. Perhaps, saving up for the closing costs is all a matter of inevitability, but skirting the barrier means potentially risking your family’s finances. You should weigh the trade-off carefully.
Fail to Realize Timing Risks
If you are taking out a 30-year mortgage, you need to plan on paying for your house for 30 years.
Often, families get a 30-year mortgage to lower monthly costs, but plan on owning the house for only 7 to 10 years. A similar mistake is going with alternative financing, because of the same short-term homeownership expectancy. Whenever you borrow for one time horizon, but plan on a different time horizon, you are taking a great risk.
Think of it this way. You are a contractor that just landed a lucrative long-term, 10-year deal. To match your new income, you take out a 10-year mortgage. What’s your financial risk if after 10 years, you can’t sell the home? Not much, you now own the house free and clear.
Now, what if you plan on selling in 10 years, took out a 30-year mortgage on a bigger home for the same cost? It’s a much greater risk to your family.
I’m not saying that you can’t take out a 30-year mortgage when you plan on staying in the house for only 10. What you should do is ensure that you have the finances in place to continue paying that mortgage all the way to the 360th payment, regardless of your sale plans.
Rely on the Mortgage Company to Tell You What You Can Afford
There is a perception that banks want to lend you too much to squeeze every last red penny out of your wallet. While predatory lending does occur, it’s not as common as the average family believes. In reality, you are the only one in the room that knows if you can afford a mortgage.
Banks need to rely on imperfect information like your pay stub and your credit report to make lending decisions. These sources of information are usually not a clear picture of your true financial situation. For example, your creditors may not report all your actual payment history or your paycheck might be inflated because of a one-time bonus. They don’t actually know what your budget looks like, what your financial plans are or what your monthly bills look like.
You are the best person to determine what you can afford. Don’t make your largest financial decision based on what a lender, who has less information, will lend to you.
Over the last few years, many young families have lost their homes to foreclosure. Avoid money mistakes and lower your chances of becoming one of them.