“I had rather be on my farm than be emperor of the world.”
When most people think of the home buying process, the thought conjures up a mix of excitement (“new home! Yay!”) and fear (“holy crap, this is a lot of money!”). There’s the fear of being uprooted from a place that you’re used to with anticipation of what a new location might bring for you and your family.
Of course, you might not be buying the house to live in. You may have seen my interview with CPA Mark Kohler and become motivated by his (and my) support of buying rental real estate and decided to get into the landlording business for yourself and as part of your retirement planning strategy.
No matter what the reason, barring a major medical expense, the purchase of a house is likely to be the most money intensive activity you ever undertake. Yet, for some reason, people like to delegate the house buying process to Monkey Brain, and then find themselves subsequently trapped in their house for years to come with no real options for getting out of the situation.
It’s altogether too easy to grab the closest Realtor you can find, spend a day or two driving around neighborhoods, find a house that you get emotionally attached to and ABSOLUTELY have to have, take the first mortgage deal you can, sign the paperwork, and boom! You’re a homeowner!
MONKEY BRAIN: “NEED THAT HOME. NEED FIFTEEN BEDROOMS FOR SWINGING AROUND IN!”
YOU: “That’s a little larger than we need, isn’t it?”
MONKEY BRAIN: “NO! HAVE TO HAVE THAT HOUSE! NEVER ANOTHER HOUSE LIKE THAT EVER EVER EVER!”
YOU: “There are 1,200 houses in this neighborhood alone!”
MONKEY BRAIN: “NO! BUILDER AND ENTIRE CREW BURIED WITH JIMMY HOFFA! THAT HOUSE IS COLLECTIBLE! CAN SELL IT ON EBAY LATER!”
In truth, there are very few cases where you’re going to have to simply pick up sticks and move somewhere else overnight. In many cases, you have some notice that you’ll need to move, and in many cases, you get to move when you choose to.
Here are some things to think about if you’re afforded the luxury of some time before you are going to move.
Pile up cash. There’s a crazy misperception out there that we should borrow as much as we can so that we can get a mortgage deduction on our taxes. There are two reasons why that’s fallacious:
You’re paying interest to a bank so that Uncle Sam can give you a small percentage of that money back. If you’re really driven to spend money in that manner, you can mail me a check for $1,000 a month, and I’ll gladly write you a check for $200 back!
The tax deduction only kicks in above your standard deduction. If you don’t itemize deductions enough to get above the standard deduction threshold, then there’s no mortgage interest deduction for you. If you’re above it, then you only get the deduction only to the extent that your mortgage interest contributes above the standard deduction. For all of the hoopla about the mortgage interest deduction, in 2009, only 1/4 of tax payers actually were able to claim it on their taxes! 67.4% of taxpayers own homes, meaning that only 37.1% of homeowners qualified for the deduction. Sad trombone!
Set your upper spending limit. This means that you’re setting a goal for spending less than a certain amount of money for your house. Let’s be honest. It’s in a mortgage lender’s best interest to give you as much loan as he or she can without having you default on the mortgage itself. The more money lent, the more interest earned, the nicer the car the banker gets to drive. It’s also in the Realtor’s interest to nudge you into a slightly more expensive house than you anticipated, since the Realtor gets a cut of whatever you pay for the house. Sure, they’ll tell you that they’re working for you, but there’s a conflict of interest. How much should that limit be? I don’t know. I don’t go by rules of thumb. Each person’s situation is slightly different—which is why using a financial planner is so important! If you set the goal to spend less than $X and stick to it, then you won’t be nudged higher by conflicted advice or by your emotions, which leads me to…
Don’t fall in love with a house. Once you fall in love in love with a house, you’re more likely to be poor at negotiating a good price and to give in to your emotions. You’ll fall prey to the endowment effect and later find yourself questioning why you paid so much. To read more about how the endowment effect affects your real estate purchases, you can read “Why You Should Buy a Foreclosure and Never Sell to an Investor.”
Familiarize yourself with neighborhoods where you might want to live. It’s going to be nearly impossible to know if the dogs bark in a certain neighborhood at 3 AM, but you can certainly do rush hour drives and find out how far or near conveniences you’ll desire are. You can take pictures of the neighborhoods over the span of a few weeks or months to see how things change. Do your potential neighbors care for their places? Find out the percentage of homes which are owned by investors versus occupants. You can do both online and on-the-ground research of areas so that you’re very well-versed in the pros and cons of each area before you put in offers.
Live now with the budget you’ll have after you purchase the house. If you’re in a place where the cost of living is lower or your house or rent payment is lower, then you’ll need to adjust your lifestyle to match your future budgetary needs. Getting adjusted to the new budget now will reduce the shock in the future; it’s hedonic adaptation in reverse and will help keep you from getting into debt. However, if the new home cost will be less, don’t get tempted to hop on the hedonic treadmill!
Are there things I missed out on in this list? Tell us about it in the comments below!