Buying a new home can be a scary proposition. After all, you'll be committed to the mortgage longer than it takes to raise a child. But a new home purchase can be the single smartest financial move you ever make when done right.
According to MSN money, the stock market has historically outperformed real estate as an investment, when adjusted for inflation. Real estate grows at about 10% and the stock market at about 11%. That means you need to do some important planning to secure a higher than average return on your real estate investment.
Let's look at the story of Mark and Janice, a couple in their thirties. Each has a secure, long-term job. The two have decided to buy a home and know how to maximize their housing investment.
When the couple was first married, they did not feel ready to settle down. Being a wise couple, the two knew they would want to buy a home eventually, so they decided to keep low-value used cars and use the savings to sock away $350 per month towards a future home purchase.
Now Mark and Janice have reached their thirties and have $42,000 saved. They feel ready to start their house hunt. The couple's financial planner told them to look for a house valued around $210,000 so that they could use their $42,000 as a 20% down payment.
Mortgage Payment Calculators
The couple also checked a mortgage calculator online. But they found that the calculator recommended they apply for both a first mortgage and a second “piggy back” loan, so they could buy a more expensive house and still avoid paying Private Mortgage Insurance (PMI).
But the pair has a child and both work full time. The couple pays $260 per week in daycare costs, but the mortgage calculator did not consider the daycare expenses. If they entered the childcare cost as a credit payment, they found the amount of house they could afford dropped drastically.
Initially, the calculator indicated they could afford a home of $285,844. When daycare was factored in, it dropped to $225,486. Being smart enough to save a down payment, the two were also smart enough to know the calculator was giving them bad advice.
Mark and Janice also looked to the Federal Housing Administration (FHA) for guidance. They saw that an FHA loan only requires them to come up with 3.5% down payment under a first-time homebuyer loan. The FHA program would let the pair buy a $300,000 home with only $10,500 down.
The two realized that such a small down payment would tie them to the house until they could pay the loan down for at least three years and develop equity in the property. That line of thought also assumed they didn't have to dip into their savings to pay the extra monthly interest fees and PMI. By staying within the 80% loan to value ratio, Mark and Janice felt confident they could still afford the house and would be in a better position to buy a second home if they needed to move.
Working Out the Numbers Ahead of Time
After finding interest rates were about 5%, the couple estimated that they would have a monthly mortgage payment of about $901.68, not including taxes or insurance. They knew they wanted to buy in their hometown, so they called the Town Hall and found out that yearly taxes would be about $2,000 or $167 per month. Insurance would cost them about $60 per month, so their total expected monthly payment would be $1,128.53, if they qualified for the best interest rate.
The couple also worked out estimates at 5.75% and 6.25% ($1,207.07 and $1,261.07 respectively) to make sure they could still afford the payment even if interest rates climbed while they were still home hunting. Armed with this information, the pair set out to find the cheapest house in the best neighborhood they could afford, another excellent piece of advice given by their financial planner.
The Pay Off
In the end, the pair's careful planning paid off well. They were able to apply $200 more to their mortgage every month and paid the house of years ahead of time. They used the month they saved on interest fees and used it to save money towards their daughter's college tuition and a comfortable retirement for them both. The careful planning for their first home influenced the rest of their financial lives, ensuring them a stable and happy life.