Importance of a mortgage: Eighth in a series of financial tools to master
Mortgage is usually the primary method of accruing net wealth
Welcome back!
In this post, we will be covering the importance of a mortgage. This is the eighth in a series of financial tools to master. If you’ve missed any of the previous posts, please see the links at the bottom of this post.
Buying a home is typically the primary method of accruing net wealth for most Americans. It is for most people, the biggest purchase they’ll make in their lifetime. According to a recent Federal Reserve study, average homeowner has 40 times the net wealth of an average renter.
There are three main reasons for this discrepancy. First reason is homeowners are ‘forced to save’ each month when they’re paying the mortgage. Even if first few years’ payments are negligible in reducing the principal amount that was borrowed, over time, the principal amount will be reduced. Second reason is home may appreciate in value over several years, whereas renting does not. Lastly, third reason is the profit from the sale of the primary residence (if lived in it for at least two years) should be tax exempt.
My wife and I bought three homes in our lifetime, so far.
One was a co-op in NYC which we sold at profit of about $110k after 4 1/2 years. Second was a condo in Hawaii which we sold at profit of about $115k after two years. The last was a townhome in Pennsylvania which we sold for profit of about $25k after 14 years.
As you can see in these examples, we made out like bandits in Hawaii considering the time lived there, and we did good in NYC. At least the townhome in Pennsylvania didn’t lose money. Moral of these stories is that sometimes you win and sometimes you lose, but with real estate, you won’t lose money in most cases.
On top of accruing wealth, you would’ve lived in your own place, where there is pride of ownership. There’s something about getting your new home’s keys and opening it after the closing! We’re thankful we got to do it three different times!
Keys to getting a mortgage and other useful tips when buying a home:
- Make sure you have good credit history.
The previous post covered the importance of a good credit history. Be sure this is the case before buying your home. You want to get the best rate available. You’ll only get that with excellent credit.
- Make sure you have 20% down payment.
A mortgage insurance is an added fee of roughly 0.5% to 2.25% you pay on top of your mortgage payment, when down payment is less than 20% of the purchase price. The actual mortgage insurance rate depends on borrower’s credit history, amount of down payment, and other factors, but it is, nonetheless, an added fee.
On a $300,000 home, this mortgage insurance would be $250 per month extra, if the rate was 1% of your borrowed amount. Bottom line: save up 20% for down payment.
- Buy enough house and not the biggest house you can afford.
It’s easy to be enamored of a newly built home or something newer that catches your eye. Home ownership is a great idea IF you don’t become house poor! Buy enough of a home but don’t overextend!
You want to enjoy your home ownership and not be held captive by your home!
Buying a home isn’t just the price of that home. You’ll have to add in all these additional fees in addition to the down payment, at closing:
- Lender origination, underwriting and application fees
- Title fee
- Survey and appraisal fee
- State recording fees
- Prepaid homeowner property taxes, home insurance, and interest
- Private mortgage insurance (this should be avoided if possible)
- Escrow fees
- Pest or mold inspection
- Home inspection
- HOA fees, if applicable
All in all, these fees may add $6000 to as much as $15000 to your closing costs!
- Think about selling your home down the road.
Would you buy your home at that time? Is it in a desirable school district? Is it in a flood zone? Is it next to a power line? Think how a prospective buyer would evaluate your home when you need to sell it. You have to be objectively assessing your home. Think how others will judge this home...
By the way, don’t think you’ll never sell your home. Most Americans will sell their home in about 13 years, according to a study in 2018.
- Have emergency fund ready.
Most experts will recommend 1% of the value of your home for routine maintenance. Think about all the things that can go wrong, and they always do, when you least expect it.
Appliances will need replacement or repairs. Your roof may need repairs. Your deck the same. The list goes on and on...
We had all these things repaired or fixed in our homes at one time or another: 2 water heaters, roof, deck, flooring, 2 toilets, windows, pest issues, water drains, etc.
If you don’t prepare for it, you’ll be scrambling to fix these emergencies!
There was a time when we had $38 in our checking/savings accounts after buying our first home! Don’t make the same mistake we made.
Another option to consider is getting a home warranty plan, which covers major components in your home. Prices will typically be around $500-$600 per year depending on what coverage you’re buying...
- Consider a 15 year mortgage (if possible), or pay additional principal amount.
Getting a 15 year mortgage vs a 30 year mortgage will save you around 60% in total interest over the life of the loan. If this is not an option, make plans to pay additional payments toward your principal. In some cases, a 30 year mortgage interest is roughly two thirds of the borrowed amount!
In conclusion:
Home ownership and getting a mortgage is a rite of passage for most people. Home ownership is an integral path to becoming financially secure and financially independent.
Follow the tips above:
- Save 20% or more for down payment.
- Have emergency fund ready.
- Don’t buy too much house, but enough house.
- Build your credit history.
Thank you all for reading!
Jake
Wandering Money Pig
If you missed the post ‘Importance of a checking account...’, please click here.
If you missed the post ‘Importance of a savings account...’, please click here.
If you missed the post ‘Importance of a budget...’, please click here.
If you missed the post ‘Importance of a retirement account...’, please click here.
If you missed the post ‘Importance of a brokerage account...’, please click here.
If you missed the post ‘Importance of insurance...’, please click here.
If you missed the post ‘Importance of good credit...’, please click here.
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