Home Buying Advice: Qualifying for a Mortgage vs What You Can Really Afford

Ahh, buying a home. It’s both scary and exciting at the same time and this is the time of year that doing it is in full swing. Whether you’re shopping for your very first home or you’ve got a few houses under your belt, it’s easy to get caught up in the shopping frenzy. What could be more interesting than touring someone else’s home that you could purchase and make your own? Well, perhaps buying a lot and working with an architect or builder to design your own new place, but either way, it stirs the imagination.

In all the emotions that revolve around choosing how many bedrooms and bathrooms your house has, the siding, fixtures, and everything else, there is a reality of how much it will cost and how you will pay for it. What impact will buying or building this new place have on your regular monthly expenses as well as your long term financial health? When you reach the point of asking yourself the all-important question of “Can I afford this?”, it’s critical to remember a few key points.

Just Because You Qualify For the Mortgage Doesn’t Mean You Can Afford It

Mortgage lenders are there to make money, which ultimately means getting you in the biggest, most expensive mortgage they can possibly qualify you for. This doesn’t mean they’re all out to get you, far from it. Some lenders are much better than others about not letting you get in too deep but they are harder to find. Just be aware that they have a profit motive to get you into a mortgage if they can and they will only consider your financial situation as far as their regulatory and underwriting rules require them to. They’re depending on YOU to put the brakes on when it comes to whether you max out your mortgage or not.

Why shouldn’t you max out your mortgage and get the biggest, best house you possibly can? There are a LOT of reasons not to do that, too many to cover in a single blog post. Suffice to say that if you’re carrying your maximum debt load and something, anything, comes along and trips you up financially, the fall will HURT and you’ll have a devil of a time trying to pick it all up and walk again.

Expenses Mortgage Lenders Don’t Ask About

Your family financial picture certainly includes housing expenses but if this is your first time buying a home, you need to know that the mortgage isn’t the only expense you’ll have. If you’ve previously been a renter, you’ve had the luxury of calling the landlord or property manager to get things repaired or replaced at their expense, not yours. Now that you’ll be the homeowner, there’s nobody else to call; it’s on YOU to fix it or replace it as needed and that costs time and money, sometimes a great deal of it. Lenders don’t ask you if you’ve put back money to cover repairs.

If this is not your first home buying rodeo, then you know the sort of repair expenses I’m talking about. If you’re upgrading to a bigger, more expensive home, keep in mind those repair expenses will get bigger right along with it.

Are you looking for a home that is much larger in square footage than you previously had, possibly because your family is growing? Remember, with larger square footage comes larger utility bills; heating and cooling 1,500sq/ft is a vastly different situation than 3,000+sq/ft. Can you handle going from a $200/month electric bill to $500+/month along with that bigger mortgage payment?

What about retirement savings? Nope, they don’t ask about that. Why not? Because it would reduce the size of the mortgage they put you in. Retirement is your concern, not theirs.

How about other things like braces for the kids, saving up for a replacement vehicle or car repairs? Or how about saving to send your kids to college? Nope, those aren’t on the checklist for a mortgage lender either since that would, again, reduce the size of the mortgage you can afford.

I could go on with a list like this but hopefully you get the idea. There are many, many more demands on your money than just the mortgage and there are items that have a higher priority than just getting the biggest house you can possibly afford. If you put yourself in a situation where you are “mortgage poor” and have no money left to do anything else, other aspects of your life will suffer for it.

Consider Talking With A Fee-Only Financial Planner Before Buying

It’s always a good idea to get an objective third party to look at your financial picture before you begin shopping for that new home. Why a Fee-Only Financial Planner though? A fee-only planner won’t try to sell you anything; they will take a complete look at your financial life to help you determine what you can REALLY afford by considering all your other goals and financial demands, not just what size mortgage you can qualify for. Remember, life is full of other goals and priorities that need financial resources beyond just the mortgage payment.

How can a Fee-Only Financial Planner help me?

A Fee-Only Financial Planner is basically an expert financial consultant who doesn’t sell anything but advice. Your planner will take a cold, hard look at your current situation, work with you to define the goals you want to reach in life, and then build a plan to help you achieve those goals. Your personal plan will guide you in saving, investing, and using your money as a vehicle to reach your desired goals.

Most people don’t need a financial planner for managing their day-to-day finances; they know how to write the rent check or pay the credit card bill. But there are times in life where hiring an objective expert can be of tremendous help:

•    You’re getting married and/or having kids
It can be stressful to blend two financial lives. Add kids to the mix, and you may find yourself pulling out your hair trying to figure it all out. A financial planner can help you address issues of insurance, assets, money management, college savings accounts and more.
 
•    You’re planning for retirement
Investments are a big part of retirement saving. A financial planner can help you decide how to invest, along with the best ways to withdraw funds upon retirement. Proper planning ensures you’ll pay the least amount of taxes as possible and that your funds will last as long as you need them to.

•    You’re facing a financial crisis
Nobody wants to be in this position. But whether the crisis is caused by job loss, illness, legal problems or any other misfortune, a planner who isn’t trying to sell you anything can be a great asset in helping you make sound financial decisions.

•    You’re buying or selling a home
Any sort of home-sale transaction can be scary. Consulting a planner for advice can provide you with recommendations and information on everything from your loan, household expenses beyond the loan, and the tax implications of becoming a homeowner. Knowing what you can really afford when shopping for a home can be more important than knowing how much of a loan you can qualify for.

•    You’ve received a financial windfall
If you’ve come into some unexpected money, a financial planner can manage your larger nest egg and help you figure out the best ways to invest. Whether it’s an inheritance, a large pension payout, insurance settlement, or even lottery winnings, a financial planner can help you plan for how to use some of it, as well as save and invest the rest.

•    You’ve lost a spouse
The death of a loved one is often followed by hurried financial decisions. A financial planner will be able to look at the situation with a calm and critical eye, and offer you advice that will benefit you in the long run. Talking to a financial planner early on can help you avoid the chaos entirely by making sure all the proper paperwork is done in advance, sparing the ones left behind a great deal of headache and heartache.

This list isn’t comprehensive by any means, but these are frequently reasons why someone will seek out a financial planner. Keep in mind, a plan is just a static document, a guidebook, and life changes all the time. Once a plan is created, a good planner will ask you to come back in, generally on an annual basis at least, so they can see if your progress is on course and to make necessary alterations. Even without major changes like those noted above, all plans will “drift” as time goes on. It’s important to revisit yours periodically to make sure you stay on track. 
 

“Budget” and “Cash Flow”: Why these should not be considered dirty words

It seems to happen every time. In any given conversation with people who aren’t in money-related professions (accountant, financial advisor, bookkeeper, tax preparer, etc.), when the words “budget” or “cash flow statement” come up, they get a look on their face as if someone shoved a handful of Sour Patch Kids™ in their mouth.

Even when talking with someone in money-related fields, when it comes to their own personal budget or cash flow, they get that same look. They KNOW the value of these things and they know the difference between them, but when thinking about them in their own personal lives, they get the screaming heebie-jeebies just like everyone else. Well, except perhaps for the really nerdy among us that like that sort of thing.

Why is that negative reaction the most common? Let’s take a closer look at these two important financial statements to make it easier to understand why they’re so useful and not as frightening as people think.

Cash Flow

A cash flow statement, either personal or business, is merely a breakdown of what money came in, what money went out, and what it was spent on during a given period. Notice the past tense used in all those; that’s on purpose. A standard cash flow statement is simply a historical record of what actually happened to the money for a particular period of time. It passes no judgements, it should tell no lies; it merely says, “this is what YOU did with YOUR money, good, bad, or indifferent”.

Knowing what your money got spent on and where it came from is critically important. If you don’t know your true situation of where it came from and where it went, you have no way, other than gut instinct, to guide your own money behavior. When it comes to money, human gut instinct is notoriously bad.

I’m not suggesting that you track every penny that comes and goes every day for the rest of your life. I would be the world’s biggest hypocrite if I said that. But sometimes doing exactly that for a month or two, or even a quarter, IS necessary to see just what’s happening with your money and if it lines up with what your instinct told you.

Budget

Budgets are the tool we use to (hopefully) tell our money where it should go and what it should do so that it behaves in a constructive manner. We want our money working for us, to do things like pay off debt or save for a future expense, and of course pay our regular monthly living expenses like food, utilities, entertainment and dining out.

The budget is an aspirational document and it looks to the future. It’s what we want to happen with our money and our lives going forward. It’s something we use to remind ourselves when we’re considering blowing a pile of money on an impromptu weekend trip to the beach, that we have other uses and goals for that money and maybe we shouldn’t be blowing it. If we really want a trip to the beach, we should introduce it in the budget and allocate some money towards a savings goal that is earmarked for that sort of thing.

We build the budget when we’re in our logical, thoughtful, and down-to-earth mode so that we can use it to reinforce our goals of saving for tomorrow, rather than spending for today. It’s ok to dream while budgeting; it is an aspirational document after all. But those dreams should be grounded in the reality that there is only so much money to go around and there are priorities to be addressed.

Not such dirty words

Maybe it’s the tedious nature of tracking money to build a cash flow statement that makes people hate it. Maybe it’s the guilt that may occur when realizing just how much has gone to impulse buys or inconsequential purchases.  Perhaps it’s the Peter Pan feeling of not wanting to grow up and make rational, sometimes sacrificial, decisions about how to budget our money that keeps people from doing it with any seriousness.

I can only speculate on why budgeting and cash flow awareness aren’t a bigger thing in people’s financial lives. I can, however, give you one cold, hard truth: those people that do a budget and keep an eye on their cash flow have a much better chance of achieving their goals and generally end up wealthier than the ones who don’t do it.

Saving and Investing Tips for the Control Freak

Hello, my name is Ronnie and I am a control freak ...

<insert chorus of "Welcome Ronnie" from the rest of my assembled control freak brethren>

If there were such a thing as Control Freaks Anonymous (I don't think there is but I could be wrong), we would begin by reciting the Serenity Prayer:

"God, grant me the serenity to accept the things I cannot change,
The courage to change the things I can,
And the wisdom to know the difference." 

As a recovering control freak, I have to constantly be on guard for letting my desire to control things outstrip my ability to actually do so. This is seldom more true than in the world of saving and investing, where there is much beyond my control and very little (comparatively) within it.

When swimming in the sea of our financial lives, the ability to recognize that which we cannot control is key and sometimes there are nuances to that recognition. For example, I can't control market interest rates, as I am not in sole control of the Federal Reserve. I can however control, through research, where I put my money in order to get the best interest rate available to me.

Given what's been going on the last few weeks and months in the global economy, I thought the timing might be right for reminding myself and my fellow control freaks about a few of the things we can and cannot control in our saving and investing activities. Let's begin with the things we can't control, since those are the most unpleasant and we want them out of the way first:

What We Can't Control

  • Market volatility - The market and its corresponding indices covered in the media (Dow, S&P, NASDAQ, etc.) are going to change every minute of every hour of every trading day and there's not a thing we can do about it. Like a perpetual roller coaster, we must resign ourselves to the ride if we're going to be in the market at all. Whether you should be in the market at all is a topic for a different day...
  • Interest Rates - See previous example. The savers among us would love to see higher interest rates, the borrowers want to keep it lower. Suffice to acknowledge that we can't control the prevailing rates and move on as best we can.
  • Wall Street and Corporate Behavior - The big banks, investment firms, corporate CEO's, and their executives are going to do what they're going to do, which is to do their best to squeeze as much money out of the system (and us) for themselves as possible, in any way they can come up with. It may be illegal or immoral, but they're going to do it and we won't know about it until after the fact.
  •  Taxes, Now and in the Future - Taxes are a necessary evil of modern life and you're going to have to pay them. Sooner or later and in some form or another, you'll pay them and you can't let avoiding taxes control your every decision. What rate you might pay for a given circumstance, particularly when thinking about a retirement horizon that might be 30 years away, is ridiculous to consider since nobody knows what the situation will be then. Remember, you can be guided by tax implications but your actions should not be dictated by them.

 Now that is by no means an exhaustive list of what we cannot control (feel free to add your own in the comments below) but it's a few highlights. The trick is to truly realize we can't control them and not let that get in our way emotionally or psychologically. Now let's shift to the more pleasant things, that which we can control.

What We Can Control

  • Spending - All spending is discretionary to one extent or another. Sure there are expenses you can't avoid like food, clothing, shelter, etc., but you can control how much you spend on them. Some expenses are fixed in the short term but can be changed later, like being 6 months into a 12 month lease on an apartment; you can't control it for the remaining 6 months but you could move somewhere less expensive later. You don't need the latest iPhone and you won't die of starvation if you don't shop at Whole Foods. Spending is something you have a great deal of control over.

    *Side Note: never,ever, be ashamed or embarrassed about clipping and using coupons. Whether things are very tight for you or you're rolling in money, coupons are awesome if you can use them for the things you want, particularly groceries and meals out.
     
  • Saving - When combined with changes in Spending, our ability to save is our most powerful investment tool. We control what we do with our savings in terms of our emergency fund and where we put it to have easy access but still get a decent interest rate. We control where and how much we devote to retirement savings, our kid's college fund, or just saving for a new car or improvements to the home.
  • Income - We have a degree of control over our income, whether that's asking for a raise in our current job, a promotion, changing companies, getting some extra education and changing careers, or, in a pinch, getting a 2nd job delivering pizza. One way or another, we do have some control over our income and using that control will impact other areas of our lives, notably Saving and Spending.
  • Taxes - Yes, you read that right. Taxes shows up in both categories because while you can't control them to the point of never paying them, you do have some degree of control over when and how much you might have to pay, depending on your individual circumstances. Deferring income to a subsequent year, using a ROTH IRA instead of a Traditional IRA, judicious use of an FSA or an HSA for healthcare expenses, etc. Your accountant or financial planner can give you some advice on this sort of thing but there is some control to be had. It's not ultimate control, but it's better than nothing.

The thing we control freaks must admit and adjust to is that much of life is beyond our direct control. We must accept that fact and let it go, being content to control what we can to achieve our desired outcomes. In saving and investing, like many other things in adult life, there is no option to take our marbles and just go home, refusing to play the game. To have any chance at things like a reasonably comfortable retirement, a decent roof over our heads, etc., we must play the game the best way we can. This sentiment is summed up very succinctly, at least for me, by one of my favorite movies in the following line:

"There's no sense asking if the air's good when there's nothing else to breathe ..." Henry II, "The Lion In Winter"