5 Essential Rules to Unlock Your Dream Home

So I bought a house with a friend and her mother.... A few years later, I focused on the next step in my incremental dreams: still owning with my friend but minus her mom. With our share of the gain from the sale of the first place, we were able to make the move—the new house was a modest 1,000 square feet, but as far as I was concerned it was a palace. Sure, just a few blocks away were majestic dwellings with sweeping views of the San Francisco Bay, but those were other people's dreams. People with a lot more money than I had. I was thrilled with what I could afford.

Jump ahead to today, and even though I'm wealthier, I'm still a practical dreamer. I don't need some fantasy mansion. I buy what I need, as opposed to what I can afford. That approach has never let me down, and I'm certain it can work for you.

Sure, it's fun to check out luscious magazine spreads, but don't base your housing dreams on someone else's. If what you can swing is a $1,500 monthly mortgage, there's no point in setting your sights—for now, anyway—on the $5 million Malibu beachfront property or the 10,000-square-foot Central Park penthouse.

Create a dream you can achieve, the next step that works for you. If you're renting a small studio, dream about a condo of your own. If your family has grown and your house hasn't, dream about a place with one more bedroom and a backyard big enough for the jungle gym your kids want.

Even the most clear-eyed dream takes money. And money is typically what keeps us from converting dreams to reality. If you really want to change your housing situation, you need to commit to saving, and that demands patience as well as discipline. Depending on your current financial situation and the scope of what you want, saving enough for a down payment may take a few years.

But remember: Your dream starts coming true the minute you commit to socking away money. Every month you put something aside, spending less in order to save more, puts you a month closer to the dream. One benefit of the rise in interest rates is that your savings can earn more. Check out the deals offered by online banks that have high-yield savings accounts.

Don't go in over your head all the while praying that conditions you can't control will adapt perfectly to your needs. Your mortgage or renovation budget should not be based on the hope that at some vague, blissful moment down the road you'll have a higher income so you can pay off a loan, or you'll be able to sell at a huge profit because real estate values have soared.

There is simply no guarantee that's how things will work out. A scheme that requires holding your breath for the financial planets to align in your favor can become a disaster.

Most of us want more space than we have. We hit the listings in pursuit of our bigger and better place. I say slow down and take another look. How about dreaming of turning what you have into what you want—that is, renovating rather than moving? It can make great financial sense. For instance, if you bought a house or refinanced a mortgage in the past few years, trading up now for a new home would push up the interest rate on the loan.

Add to that the commission to the broker who sells the old place and the closing costs on the new one, and you're talking serious outlay. And don't forget moving costs, or the fact that a more expensive house means higher property taxes and insurance. Not so dreamy after all, eh?

So before you make the open-house rounds, sit down right where you are and consider what you have. Do you really need a new house—or would the problem be solved by a beautifully redone bathroom or an extra bedroom for guests? Renovating rather than relocating can be the smarter financial move, with one caveat: Don't go too far beyond the neighborhood's basic level, upgrading to the point where you have a Taj Mahal bursting its boundaries on a block of ranch-house subdivisions.

The rule still applies. Go for what you want, but don't go overboard. Find your practical dream.

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