Home buying can be a trap. The best laid financial plans can self destruct over a beautiful view from a backyard deck, a flowing open floor plan or a luxurious master bath. Yes, I know we enter the home buying process with our budgets set and heart in check. No real estate agent or mortgage lender will get us to move from our firm price limit. Yeah, right. So why is the home buying process fraught with overspending and how can this be avoided?
First, home buying is a very personal and emotion-filled process. Where do we want to raise our kids? Are the schools of good quality? Is the neighborhood safe? Is it convenient to work and church and other activities? These are all reasonable questions, but also very personal in nature. It’s no longer just a monetary transaction. It involves your loved ones. We want the best for them. That’s an admirable thought, but it can lead us to making emotional , instead of reasoned, decisions. (For more, see: Are You Ready to Buy a House?)
We Justify Our Wants
We justify our wants with statements like:
- “We’ll be here a long time. We should get what we want.” Ever hear of a job change, job loss or illness changing your plans? Maybe you have another child and the house gets small real quick. Maybe the neighborhood changes and not for the better. Everyone hates moving and we vow to not do it again for a long, long time. Then suddenly, for any number of reasons, a realtor is putting a for sale sign on your front lawn. Maybe the “long term” wasn’t so long after all.
- “Real estate always goes up. What a great investment.” Really? Remember 2007? Enough said.
- “They’re not making any more real estate. I better buy now.” True, God’s not making more real estate. But there are a lot of new houses for sale every day. In 2017, there were about 608,000 homes sold. You don’t need real estate to be created. There is plenty around to be purchased and the listings are changing every day.
- “But the bank said I could spend $xxx,xxx.” Do you let the grocery store tell you how much you’ll spend this week for food? Of course not. Then don’t let a builder, realtor or lender do it. It’s your money. You decide. Unfortunately, this exact situation happened to me once. I obtained a pre-approval letter from a mortgage lender prior to house shopping. When I showed it to a builder and agent (to prove I was an eligible buyer) they were both shocked that I didn’t want to spend the full amount of the pre-approval. My response: I found a different builder and agent. In truth, we want what we want. There’s nothing wrong with that, until what we want isn’t in our best interest. Trying to justify it with fancy sounding ideas and opinions doesn’t change the facts.
Mortgage Math is Not Your Friend
Finally, mortgage math often works against us. Rates are so low and terms so long that a change in price doesn’t seem to have much impact in the payment. But what is the long-term impact? Let’s say you increase your loan amount by $25,000 to pay for the new sun room or upgraded kitchen. At 4% on a 30-year loan, the monthly payment goes up “only” $119.35. Pretty affordable, right? That doesn’t sound like too much of a financial impact. Don’t stop your calculations now. Run the numbers all the way out. Thirty years of an extra $119.35 per month is a total of almost $43,000. Quite a bit more than the $25,000 you spent.
We’re almost done - just one more calculation to go. Instead of the upgrade, suppose you invested the $119.35 per month for the same 30 years. Assuming a modest 8% long-term return, your $119.35 monthly payments would grow to nearly $178,000 over 30 years. I hope you like the granite counter tops. (For more, see: Top Tips for First-Time Home Buyers.)
So what’s the cure? How do we inoculate ourselves against emotional overspending on our home?
Set your limit through a formula, not some arbitrary number. It’s important to go into the buying process already certain on your budget. But we know how hard it is to stick to it when you start seeing actual houses. To help us keep to the budget, it’s important to have a formula to define the limits. When we set a limit arbitrarily, it doesn’t have the same sense of certainty that a formula provides. I recommend my coaching clients limit the monthly payment (including insurance and tax escrows) to 25% of their take home pay.
Further, this should be on a 15-year, fixed rate mortgage. Skip the 30-year (and now 40-year) options. The interest rates are higher, and do you really want to make 360 (or 480) payments on anything? Skip the adjustable-rate mortgages, too. If rates happen to drop in the future, you can always refinance. Refinancing is much quicker and cheaper than just a few years ago. If rates rise, you’ll be glad you have the fixed rate. Set your spending limit with thought-out reasons and you’re more likely to stick with it.
See your housing in the context of your life goals, not just a pretty place to live now. As with every big financial decision, it’s important to consider first how it fits into your overall life goals. For example, if your goal is early retirement in 10 years, then an expensive home (with its high mortgage and maintenance costs) may prevent it from happening. Maybe you’d like an eventual career change to a dream job in another city. Does buying the house you’re considering get you closer to your goal or push it farther away? When we see things in a broader context, it helps to keep today’s emotions in check. We understand that no matter how pretty the house or the view, it won’t help us move closer to our bigger goals. Sometimes an emotional cold shower is just what we need to make sound financial decisions.
Consider the opportunity costs. As we saw in the example above, it’s not just the increased interest cost and a higher monthly payment you’ll get with blowing the budget, it’s also what you could have done with the money instead. Instead of just seeing the bigger house, consider the possibility of a bigger investment account balance or retiring a few years earlier, too. Suddenly, you may have a change of heart about the house you’re about to buy.
Start looking at property well below your budget, not right at it. Too often we tend to start looking at homes at the top of our budget. Then we see another option costing just a little bit more and our attention is turned to it instead. Next thing you know the budget it shot. Instead, look first at properties 10% to 20% below your top budget amount. Then if you see some properties costing just a bit more, you can consider them without going over the amount you want to spend. You may end up with a nicer home than you originally considered, but still stay within (or under) budget.
Keep Your Emotions and Budget in Check
Buying a home doesn’t have to cause a financial meltdown. Nor does it have to cost you your long-term dreams. If you enter the house buying process with a defined plan, and view your wants with a long-term perspective, you can successfully purchase the right house. So enjoy the process of looking at homes and getting excited about purchasing one. Just don’t let the excitement lead you into a financial trap. (For more from this author, see: 10 Reasons People Don’t Create a Budget.)