Dave Ramsey is someone a lot of people follow for financial advise. Lately he’s been showing up A LOT in my Facebook stream pushing his thoughts on mortgages, home ownership and credit. Some of his ideas, I don’t totally disagree with. In fact, I shared a post that came from his group encouraging people to continue to pay rent and make their mortgage payments during the pandemic if at all possible (ie nothing is for free). However, I don’t support what he instructs his followers who are considering buying a home and I also have an issue with anyone who pushes their “team of vetted real estate agents”…I would be really surprised if there is not some sort of financial relationship associated with this referral arrangement.
Let’s take a look at what he encourages his followers to do with regards to buying a home or getting a mortgage.
DR: Your total mortgage payment should only be 25% of your take home pay. The total mortgage payment includes the principal and interest, property taxes, home owners insurance and possibly mortgage insurance. Your take home pay is your net-income after taxes, insurance, 401(k) or any other deductions you may have. Guidelines for mortgages as to what percentage of income is allowed to be used towards mortgages and all other debts (aka debt-to-income ratios) vary quite a bit depending on the credit profile, amount of equity or down payment for the home as well as the current lending environment. I do prefer that people are not “house poor” by biting off a bigger mortgage payment just because they qualify for the payment based on the current lending guidelines, however 25% of the net-income is pretty restrictive, especially with my next point…
DR: You should only use a 15 year amortized mortgage. The 15 year mortgage typically offers a slightly better interest rate (roughly 0.25%) than the more popular 30 year amortized mortgage. Even with this improvement in interest rate, the mortgage payment is significantly higher than the 30 year mortgage because the term is cut in half. I personally prefer the 30 year mortgage as it provides you flexibility with your mortgage payment as you can always make the same 15 year payment by paying more towards principal and pay off your mortgage in the same time as a 15 year. The 30 year mortgage also provides more flexibility by allowing you to make the additional principal payments (as I just referenced) or the additional monthly funds can be used towards paying off other debts or building your retirement WHILE you are own a home that you’re building equity in. In addition, if you have the 30 year and you wind up needing some wiggle-room due to a financial emergency, you have the smaller 30 year payment vs being stuck with the larger 15 year mortgage payment.
DR: You should have a 20% down payment before you buy a home. Having a 20% down payment allows you to avoid private mortgage insurance with a conventional mortgage. It will not avoid mortgage insurance if you require an FHA mortgage. USDA and VA mortgages do not have monthly mortgage insurance, however there is a one time funding fee. I’m assuming he’s referencing a conventional mortgage and depending on the credit score, down payment and program, the mortgage insurance may not be a huge amount AND with a conventional mortgage, the monthly private mortgage insurance (often referred to as pmi) automatically drops off when the loan amount reaches 78% of the value of the home based on when the insurance was obtained (value = the lesser of the appraised value or sales price). The biggest reason to not wait for having the 20% down payment before you consider buying a home is that the housing market will most likely out pace your savings or investment account. Home prices have been increasing dramatically over the last few years. The home you could buy today with 5 or 10 percent down payment will most likely cost far more by the time you have 20% down (plus closing cost and reserves) saved up. There is a cost of waiting by delaying your home purchase to save up the larger down payment.
I think it’s so important to have a budget and know how much you can afford for a monthly payment. Just because you can qualify for a mega-mortgage payment doesn’t mean that you should. It could also be very costly in the long run to to try to wait until everything is financially perfect (ie you qualify for 15 year mortgage with 20% down payment with a mortgage that’s only 25% of your net income).
Click here for a follow up post where I share examples of Dave’s theories on mortgages and when followed, how it impacts what one can buy for a home.
Glad to see you bring up DR .. the vetted group of agents bugs me too, for the same reason. I do think they have to go through his training program to get referrals so that’s probably how he profits but I don’t know for sure.
He does the same with mortgage lenders too. ;/