Last month I wrote about advice I’ve been seeing popping up in my Facebook feed from Dave Ramsey on mortgages. There are several points that I just don’t find realistic for the average person who wants to buy a home, such as only using a 15 year amortized mortgage with 20% down payment and limiting your mortgage payment to 25% of your take home pay. I promised that I would share a follow up post where I review different scenarios comparing his advise to real life scenarios.
I decided to go back a few years and base this post on some clients who I helped buy their first home back in 2019. For this scenario, let’s assume they are a couple with a mid-credit score of 680. One spouse has steady employment where they are paid a salary plus some overtime and the other has income that is hourly and has not been on their job for long. At the time, we’re only able use the salaried income of $5700 per month. They have around $5,000 in savings (not including a retirement account) and $485 per month in debt (for their car and student loans).
If this couple were to follow Dave’s recommendation, they would have a very difficult time saving up for a 20% down payment, let alone waiting to do this until they’re also debt free. Of course this would ideal…but while they’re trying to pay off debt and save up a significant sum of money, housing prices are trending higher.
According to Dave, this couple should not have a total mortgage payment (including property taxes and home owners insurance) of more than 25% of their take-home pay (after taxes and insurance). That would mean a total mortgage payment of no more than $1380. (The take home pay after taxes and insurance on $6700 were about $5520. 5520 x 25% = $1380).
NOTE: Rates posted below are from October 7, 2021 and are “expired”. Rates change constantly as they’re based on bonds (mortgage backed securties). For your personal rate quote for your home located anywhere in Washington state, please click here. To see a detailed Total Cost Analysis reviewing the cost of waiting to buy a home, click here.
If they stick to DR’s advice and opt for a 15 year conventional mortgage with a twenty percent down payment (second column above), with a mortgage payment no more than $1380 (including taxes and insurance); they qualify for a home price around $210,000. This is based on an interest rate of 2.375% (APR 2.734%) with discount points of 1.025%. They would need around $50,000 for fund for closing, including down payment and closing cost. Even back in 2019, you would have a challenging time finding a home at that price to raise a family.
If they opt to bend DR’s advice a bit and do a 30 year fixed with 30 year conventional mortgage with a 20% down payment (third column above) then the sales price they qualify for increases to $290,000. This is based on an interest rate of 3.125% (APR 3.282%) priced with 0.836 discount points. In 2019, this was still a very challenging price to find a home.
My clients were actually able to buy a home in Renton priced for $375,000 in 2019 using the Home Advantage down payment program we offer through the Washington State Housing Finance Commission. Their first mortgage was FHA and the down payment assistance is actually a second mortgage with 0% interest and no payments due that is tacked on to the end of the first mortgage (basically it’s paid off when the home is refinanced or sold). The FHA 30 year fixed mortgage has a rate of 3.875% (APR 4.931% includes upfront and monthly mortgage insurance). NOTE: The APR quoted in the chart above this scenario (fourth column) is “blending” the first mortgage of $368.207 and a second mortgage of $14,728. They only needed $5700 for total funds for closing and their total monthly mortgage payment, including property taxes, insurance and mortgage insurance is $2451.30.
The current estimated value of the home they purchased in 2019 for $375,000 is now estimated at $550,000 (fifth column). If they were to buy it today using an FHA mortgage with a minimum down payment of 3.5%, they would need around $33,000 for down payment and closing cost. The total estimated payment is $3194 based on an interest rate of 2.625% (APR 3.710%) priced with 0.713% in discount points. Unless they’ve received raises or have paid off some debt, they may not qualify for the same house today with the larger mortgage payment.
Instead, since they bought in 2019, they now are enjoying the benefits of having appreciation in their home with the growing equity. They would not have over $100,000 in home equity today if they were trying to save for 20% down payment. If they wanted, they can use some of the equity to buy their next home, pay off debts or improve their home. Again, an opportunity they would not have if they were strict followers of Mr. Ramsey.
I think it’s important to make informed decisions regarding your finances. A home is probably the largest asset and debts most people will have in their lifetimes. If you have a lot of assets, then following Dave’s advice may work for you…however if you’re not in that position, the cost of buying a home may outpace the amount most people can save to reach that “ideal” twenty percent down payment.
I also tend to lean towards the 30 year fixed mortgage over the 15 year fixed simply because you have more flexibility with the 30 year payment. If something were to happen to your health or employment, the payment you are scheduled to make is a lot lower with a 30 year. And you can always pay more towards the principal with a 30 year conventional mortgage to pay it off sooner. Personally, I would use the difference in payment to fund my retirement, pay off debts and build my savings before paying additional towards principal on my mortgage…but that’s just me 🙂
If you are considering buying or refinancing your home, I’m happy to help you!
NOTE: Rates quoted are from October 7, 2021 based on a 680 credit score and are subject to change. For your personal rate quote for a home located anywhere in Washington state, please click here. Tax benefit and net monthly payment is using a 12% tax bracket. Your tax benefit may vary. Please contact your CPA or income tax professional for more information.
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