Affording a Home
Q: My husband and I are in our early 30s, and after living expenses and debt payments, we have $1,500 left over each month. Our plan is to put this first toward credit cards (we owe $6,000) and then toward an emergency fund. Once we're out of credit card debt and have savings in place, should we put that $1,500 toward the $175,000 we owe in student loans? We'd like to save to buy a home—is that a financial no-no until we're completely debt-free?
A: Wow, your combined student loans are more than the median price for a home these days (about $172,000). You already have a huge mortgage, but it bought both of you a college degree, not a home.
Before we talk about those college loans, I want to applaud your paying down credit cards and building an emergency fund. You are speaking my language, girlfriend. The only tweak I'd offer is to split the extra $1,500 between debt and savings each month. You'll still have your credit cards paid off in about eight months, and starting a safety cushion can't wait.
Now let's talk about your plan's next phase. The four-year limit on undergraduate federal Stafford loans for dependent students is $31,000, so I'm guessing you have private student loans. I want you to focus on paying those down, even if it means delaying the home purchase for a few years.
One problem with private loans is they typically have a variable interest rate. Right now interest rates are very low. But with $175,000 in debt, you will be making payments for a long time, and eventually rates will rise. With these loans, you also need to be vigilant about making timely payments; as with credit cards, one late payment is the only excuse a lender needs to jack up the rate.
Your college debt will play a big role in whether you even qualify for a mortgage, and in the loan terms. One of the most important factors banks consider is your debt-to-income ratio. As a general rule, they don't want housing payments to be more than 28 percent of your gross monthly pay, and a mortgage shouldn't bring total debt to more than 36 percent. Estimate what your mortgage payment might be for a home in your area, then add that to what you pay each month for student loans and any other debt. If that figure is higher than 36 percent of your monthly salary, you know that decreasing your debts is the necessary first step before you focus on buying a home.
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Q: My husband and I owe $300,000 on our house (valued at $900,000), but that is our only debt. We have about $40,000 in mutual funds, so we have some emergency money, but our retirement account is only fair. Our annual income is about $325,000, and my husband will receive a $30,000 bonus at the end of the year. Should we pay our mortgage with it, invest in annuities or buy a resort property?
A: I'm confused. You and your husband make more than $300,000 a year and yet you have only $40,000 in mutual funds and a "fair" retirement account. What's up with that? It sounds like you do not have a handle on spending.
The money you have in mutual funds is not an emergency fund; it's an investment. Markets go up and down, and your $40,000 can become $30,000 before you know it. An emergency fund is money kept in a federally insured credit union or savings account; it is invested in safe deposits that do not fluctuate in value. You need to figure out where all your money is going and make sure you have eight months' worth of living expenses in an emergency fund. You need to pay off the current mortgage and boost your 401(k) and IRA contributions before you even think about buying a vacation home.
Keep Reading: Suze explains how to calculate what kind of a home you can afford to buy
Q: During the market boom, I locked into two adjustable-rate home loans that I can hardly handle now. I'm a single 34-year-old woman with a job that pays well, but I can't count on a raise, and I'm bringing in just enough to cover the mortgages and my living expenses. I'm looking for someone to rent a room for the extra income. In the meantime, do I ride this out and hope that the housing market makes an upturn, try to sell the place now, or what?
A: Hope is not a sound housing strategy. I still think real estate is a solid long-term investment—but only if you can afford what you bought. Let's be realistic about your situation. It's better to get out on your own terms than to be pushed into foreclosure because you were waiting for your luck to turn. It seems you were seduced, like so many buyers during the boom, into financing your home with two loans: a primary mortgage and a second mortgage that covered some or all of your down payment. The fact that both loans are adjustable is a huge concern. It sounds as though you've already been hit with one rate adjustment that boosted your costs, and another reset could happen relatively soon. You already feel pinched, but realize that things can still get worse.
If you can get rid of the property at a price that covers your mortgage cost and the 5 or 6 percent commission you will owe your real estate agent, sell and consider yourself lucky. You would be getting out relatively unscathed. Then you can move into a rental and start saving for a down payment so that, next time, you can buy with one standard loan. But if the price you can get today is less than what you owe on the mortgage, talk to your lender as soon as possible. The worst time to ask for leniency is after you're already behind on payments. You may be able to negotiate a deal where you lock into two fixed-rate loans at a better rate than your adjustables. If that doesn't pan out, ask about a short sale: You unload the house for the best price you can get, and the lender forgives the difference between what you owe and the sale price of the home in today's market. But lenders aren't exactly excited to take a loss, and even if they do agree to a short sale, you may have to pay tax on the forgiven amount. Learn more at HousingEducation.org, a terrific resource with plenty of useful information about home ownership.
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