I have helped a ton of people go through the home buying process and every time the same story is the same. They come in with a general ballpark in their head of what they can afford and they are way off. Why? Because they confuse the max loan they can get approved for with what they can actually afford. Let me tell you, there is normally a big difference between the two.
I want to help you avoid making this big mistake of taking on too much house by walking you through the numbers.
To do this, I will use some common numbers we are seeing in our environment today. I will do an example for the midwest and prices I am seeing, as well as California as many of my clients are there.
Midwest (Middle Class Family)
- $600,000 house
- Puts down $50,000
- Gets a mortgage for $550,000 at 6.5%
- Also they have PMI because they put down less than 20% (Fyi, PMI is an added on interest if you do not have 20% down but can go away once you get 20% equity built)
Let’s look at the numbers for this scenario. This mortgage + PMI, property taxes, insurance, and PMI would cost $4,285 a month in Indiana (near me). That is with lower property taxes than most places, no HOA fees, and then PMI on the lower end of $250 per month. Then you still have utilities, garbage, etc. So would expect closer to $4,750 at the minimum.
This is step 1, understanding your true monthly cost. I often see people just see the cost of principal and interest and think that will be their total cost. It won’t, it will be much higher.
Then let’s look at how long it will take to get rid of PMI.
To get rid of it, you need 20% equity. So you would need to get to the point where you have $120,000 of equity in this home. You can do that through paying down the mortgage and from appreciation of the home.
You would get to that 20% in 9ish years with no appreciation, or if you have 3-4% yearly appreciation you could get there in about 3-5 years depending on the rate. Not horrible!
Also, I want to have you look at this chart. Do you see how slowly you build equity? Almost all of the payments you are making go towards interest in the beginning. After 5 years, you will only have built $31,000 of equity (without appreciation), even though you have paid about $200,000. This is why you should be buying homes only when you think you will live there for awhile or if you will turn it into a rental when you leave.
Now, how much would this house cost over 30 years?
The answer is about $1,287,345 over 30 years. But if we estimate a 3.8% return (the average), then the home will be worth $1,836,842.23. So not bad, but not great. Under $600k of growth pre any maintenance, upkeep, etc. Not an amazing return, but obviously better than the alternative, renting.
California (Middle Class Family)
We will make this one a little simpler.
- $1,500,000 home
- 20% down so $300,000
- No PMI since we put 20% down
Let’s look at the numbers on this one. For a $1.2 mil mortgage, at 6.5%, with 20% down, and no PMI, you would have a cost of $8,638 a month before any utilities. So let’s say it’s $9,250 a month even though it would probably be higher.
How much will this cost over 30 years? About $2,731,143 again before any other added costs. But what would it be worth in 30 years? We would estimate that it would be worth around $4,592,105.58 based on 3.8% growth. Not bad!
The goal of this is to help make people aware of the dollar cost per month so you know what you can reasonably afford in your budget. The other goal is show you the true cost over 30 years. It is expensive, the numbers don’t always look amazing. And if you hold for a short amount of time, you build very little equity! All of these facts are a huge reason why this is a choice about you and what you want.
DO not rush into anything unless you are ready and really want to own a home. They are expensive and can take a lot of time!