Five reasons why you can’t afford to buy a home

It seems like lots of people I talk to these days are thinking about buying a home. Perhaps it’s the season, or the particular intersection of age and socio-economic background in the circles I travel in. Perhaps it’s coincidence. I don’t know. It’s crossed my mind too.

The desire to own one’s own domicile can be very powerful, and there is nothing wrong with the impulse, or even acting on it. But the desire, if left unchecked, can lead to irrational behavior and poor decisions.

From crunching lots of numbers, I’m of the opinion that many people can’t afford to own a home, at least not without signing themselves up for too much risk. I feel compelled to offer this sobering, cautious approach as a balance against the prevailing winds of those saying that you can afford anything (with creative financing, of course).

If I need to be a killjoy to keep you from a situation where you go to bed each night terrified that you’re in over your head, well, that’s a price I’m willing to pay.

So here are five reasons why you probably can’t afford to buy a home:

1) You don’t have at least a 10% down payment (preferably 20%)

Having a big down payment is good for all the usual reasons (increased equity, less to pay later, etc.) But there’s also a psychological argument that’s more compelling: When you save up a large down payment, you are showing discipline, building trust in yourself that you can afford the financial burden of home ownership. It’s akin to “dating your home”: you’ll have to continue to put in this money once you buy (as part of the mortgage payment), so this tests to see if you are ready to go to the next step.

I’d love to say that you shouldn’t bother with a mortgage, and just save up until you can buy the home outright. And people do it, for sure. But I think that if you can’t save up in a few years (and most people can’t) all that extra time spent paying rent plus saving for the down payment feels pedantic and unnecessary.

I love the 20% down idea, not just because it’s a nice round number, but because having 20% means that you don’t need Private Mortgage Insurance (or PMI), an extra payment designed to protect the lender when you have less than 20% equity. It seems simpler to wait until you have 20%, and then save yourself the payment and hassle.

Then again, renting at $1,000 a month for a while just to save $100 a month in PMI isn’t a good deal either. So 10% minimum seems like a good minimum to work with.

2) You can’t afford the home without external help

By external help, I’m talking about a source in addition to the mortgage lender.

Getting a loan for the down payment isn’t the same thing as having a down payment saved up. There is a purpose to having a down payment; it’s not just an annoying prerequisite of the bank.

I’d also argue that if someone is helping you with the monthly mortgage payments (a parent or someone who isn’t living there with you) you’re probably not quite in a position to buy. I’m not saying that you should be totally self-sufficient, but it seems like relying on someone else to help pay for where you live isn’t a tenable position. What if that help goes away? What if you run into difficulties? Do you want to jeopardize that relationship over this?

3) You can’t afford the payments on a 15 year fixed-rate mortgage

When you get a mortgage, you have the option of setting the length of time that the mortgage needs to paid back: 15, 20, or 30 years. (We’re not going to discuss non-fixed rate mortgages here. For details on why, see the Subprime Mortgage Crisis.) With a shorter time frame, the payments are higher, but you get the benefit of paying much less over the long term.

Let’s say you took out a $200,000 loan at 5% interest. Let’s say that you took out two of them, one at a 15 year term and the other at a 30 year term. (Interest rates will differ based on the term, but not significantly for us here.) On the 15 year,  you’ll pay about $1,800 a month, while on the 30 years, you’ll pay about $1,250 a month. So the 30 year mortgage saves you $550 a month, or about 30% of your payment.

But at the same time, over the whole life of the 30 year loan, you’ll pay $456,000, versus $323,000 for the 15 year loan. So by saving 30% each month, you end up paying 40% more over the life of the loan! That’s paying $133,000 extra on a loan that’s only for $200,000! (Check my work please.)

I’m not saying you have to get a 15 year fixed mortgage. Personally, I think splitting the difference and going for a 20 year is fine. But there’s a huge difference between 5 extra years and 15 extra years. If you want to give yourself 15 extra years of payment to give yourself “wiggle room,” that seems like a whole lot of wiggle room.

If you’re talking about hardship, well that’s another section header…

4) You don’t have a full emergency fund

If you lost your job for a few months, would you fall behind on your payments? Not if you had an emergency fund. If you don’t have at least six months of expenses in the bank, you aren’t ready to buy a home. Ideally you want this before you even start thinking about a down payment.

Do not be tempted to use your emergency fund for the down payment! That’s like canceling your car insurance in order to afford to buy a car! You need the emergency fund more than you need to own a home.

5) You are not able to contribute to a “home fund”

I actually go one step further than just the emergency fund and recommend that people have a dedicated “home fund” that they pay into each month. This fund is to be used for home repairs, property taxes (if not built into the mortgage) and other expenses that go along with owning a home.

A separate home fund is important is because home maintenance is guaranteed, not an emergency. You will need to replace the roof eventually, you will need to buy a new boiler eventually, your washer/dryer will break eventually. Just because you don’t know when these are going to happen doesn’t mean that they aren’t going to happen. Save the emergency fund for true emergencies.

That’s a lot of money

If all of this sounds like a lot of money, you’d be right. Home ownership is incredibly expensive, which is why I don’t think most people can afford it. With a more than one income household, it starts to become more achievable, but it’s still out of reach for many. (Some areas are certainly easier than others, I admit.)

What bothers me is that even after the housing crisis in this country, people are still claiming that you can buy a home without some or all of these prerequisites. I think this is disingenuous bordering on criminal. You can buy a home without any of the above, but it’s extremely risky. Just because you can doesn’t mean it’s a good idea.

I want to stress the difficulty of home owning not to discourage you, but to rightsize your expectations. If you let your emotional attachment to owning a home get in the way of your good judgement, you’re going to buy something you can’t afford. And when you buy something you can’t afford, you’re more likely to run into trouble, possibly big trouble. And I would rather you rent for your entire life than have your home taken away.

Be safe, be cautious, and your home will be your sanctuary. Isn’t that the whole point?

Do you think I’m being too cautious here? I’d love to hear your thoughts, especially if you’ve been through the process of buying.