Just because you can afford a specific home, does not mean it is the most responsible financial decision.
Just because you can afford a specific home, does not mean it is the most responsible financial decision. Many consumers fall prey to shopping for a home using the figure on a mortgage pre-approval and nothing else, maxing out their credit and their resources in the process. If the average homebuyer were to adopt another philosophy, he would be poising himself to building long-term wealth, without the same strain on his credit or his wallet.
Old School Real Estate vs. New School of Thought
Traditionally, a customer visits a lender, fills out a mortgage application and leaves with a pre-approval letter. From here, he creates his home shopping budget by adding his down payment to his pre-approval. For instance, a borrower who was approved for a $200,000 loan and had a $20,000 down payment would have a $220,000 home buying budget.
In contrast, if that same buyer were to shop for half of the amount pre-approved for while maintaining his $20,000 down payment; his budget would be a more fiscally responsible $120,000. By shopping for a less expensive home, the buyer is creating a solid foundation for long-term wealth building by reducing his liability.
A House is a Liability
Anything you finance with interest is a liability, and a house is no exception. Interest is the money you pay to a bank for the privilege of using your own money in advance. Therefore, the less expensive your mortgage, the less liability you carry.
Timing is Everything
Financing terms are almost as important as the price of a home. Even with a low interest rate, homes financed over 30-years could have been bought two times over when studying the amortization tables. Following this line of thinking, taking out a 15-year mortgage opposed to a 30-year mortgage changes the game.
Most buyers are payment focused. If the payment fits into his or her monthly budget, it is deemed affordable. However, the lowest possible payment is not always the most responsible road. Fifteen-year mortgages mean higher payments, lower interest rates and make paying off your liability an inherent priority.
The Bottom Line
By taking out a mortgage that is half of what you can “afford”, you put yourself in the driver’s seat to create long-term wealth. For example, if you buy a home for $160,000 and pay that home off in 15 years, you walk away with approximately $160,000 of profit — possibly more. Then, you can buy a $320,000 house with a $160,000 down payment and still only have a $160,000 mortgage. If you pay that property off in 15-years, you have doubled your profit. In the meantime, as your income grows, you have excess capital to invest and save outside of merely using your home as an investment.
How much home you can afford should actually come down to how much home you should be buying, and it is a rarity for those numbers to meet. Financing a less expensive home, over a shorter period is the real key to responsible home buying. Live modestly now to live wealthier later.