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Chris

How much is too much house?

Earlier this week I mentioned that one of the most often ways people get themselves into a struggling financial situation is they allow their car payments or house payments to be larger than what they can afford.

If you did not read the post on Car Payments you can check it out here.

The stage of life that I am currently in (early to mid 20's) is extremely foundational. I find that a lot of financial (mis)behavior habits go into effect around this time in a person's life. Usually after graduation you will find yourself with more cash than you ever have had before. For the first year or two you are allowed much freedom and seem to spend money on whatever you want, whenever you want it.

However, this might work out for the first year or two but this develops a habit that is not easily broken. As you get into later years you begin to commit to more financial obligations, which leaves you strapped and in a tight situation. This is the turning point and usually people will resort to using unsecured debt as an option which puts them in bondage that they cannot break free of for many many years.

More times than not, this "financial obligation" that leaves you in a tight situation is usually caused by the house. Because your house payment might end up being too much for your take home pay, it leaves you extremely tight in all other areas of life. And if this is combined with a lack of adamant budget and preparation its seems like there is no other choice but to turn to debt.

Now on the flip side I want to offer a guardrail to guide your house buying decision that may come up in the near future. This is not scriptural this is just what I believe to be wise after listening to many financial "guru's" over the years.

House Rule #1: Do not have a house payment that is more than 25% of your household take home pay.

When I get opposition to this from people my age it is always because they want to have a standard of living that is comparable to what their parents have. The only problem with that is it took their parents 20+ years to obtain that, which should not be obtained within the first few years of working.

I want to provide an easy to understand grid that might help put some skin on this rule. The assumptions to this grid is 100% financing (which I do not recommend but will talk about later) and an interest rate at 6.5%.

30 Year Fixed Loan

Annual Income	Monthly Income After Taxes	Monthly Payment	House Value
$30,000	$1,875	$468.75	$74,161.32
$35,000	$2,188	$546.88	$86,521.54
$40,000	$2,500	$625.00	$98,881.76
$45,000	$2,813	$703.13	$111,241.98
$50,000	$3,125	$781.25	$123,602.20
$55,000	$3,438	$859.38	$135,962.42
$60,000	$3,750	$937.50	$148,322.64
$65,000	$4,063	$1,015.63	$160,682.86
$70,000	$4,375	$1,093.75	$173,043.08
$75,000	$4,688	$1,171.88	$185,403.30
$80,000	$5,000	$1,250.00	$197,763.52
$85,000	$5,313	$1,328.13	$210,123.74
$90,000	$5,625	$1,406.25	$222,483.96
$95,000	$5,938	$1,484.38	$234,844.19
$100,000	$6,250	$1,562.50	$247,204.41

15 Year Fixed Loan

Annual Income	Monthly Income After Taxes	Monthly Payment	House Value
$30,000	$1,875	$468.75	$53,810.82
$35,000	$2,188	$546.88	$62,779.29
$40,000	$2,500	$625.00	$71,747.76
$45,000	$2,813	$703.13	$80,716.23
$50,000	$3,125	$781.25	$89,684.70
$55,000	$3,438	$859.38	$98,653.17
$60,000	$3,750	$937.50	$107,621.64
$65,000	$4,063	$1,015.63	$116,590.11
$70,000	$4,375	$1,093.75	$125,558.58
$75,000	$4,688	$1,171.88	$134,527.05
$80,000	$5,000	$1,250.00	$143,495.51
$85,000	$5,313	$1,328.13	$152,463.98
$90,000	$5,625	$1,406.25	$161,432.45
$95,000	$5,938	$1,484.38	$170,400.92
$100,000	$6,250	$1,562.50	$179,369.39

Use this grid as a guideline when deciding how much house too buy. I do not care how good of a deal you get on a $200,000 house. If you cannot afford it, it will end up put you into a financial mess. When this is the case you cannot even enjoy living in the awesome house because things are so tight financially.

The Planning Process

Having a plan is the most basic core principle that I try to teach. If you strip back all the practical application, all of the "theology of money," all stories or illustrations, I am basically saying to have a plan.

Tell your money where to go instead of wondering where it went.

Hopefully if you hear anything, you will hear this. Now, I am about to expand on logistical planning. Most people who know me will be surprised to hear me say this next statement but it is the truth and I don't really say it that often.

You can only plan so much.

I am serious.

There are 3 basic stages in personal finance planning:

1.) Short Term Planning
2.) Mid Range Planning
3.) Long Term

Long term planning is roughly anything over a year away. There are many things that we should be planning for that are a year away or over. An example of Long Term Planning is retirement. I think you should be planning from this and early on in fact. Another example is a new (to you) car. This will come up at some point, you might as well be prepared for it.

I also think there are things that come up within a year that you should plan for in advance; these are mid range planning items. Christmas, Birthdays, Vacations, Real Estate Taxes, etc. all fall under this. We know these things come up, we need to plan for them.

Next is short term planning. I do not want you to plan for monthly expenditures in advance. Each month is new. Each month things will change. For example my gas expense has now changed because it is football season and I go to all the Clemson games. This has increased my monthly gas expenditures a great deal, which effects my planning in other areas. Another example is you might know you need to get an oil change this next month, that changes your car maintenance category, which might change something else.

Let's say you had a friend who was about to play a game of chess. And let's say you are a chess expert and he came to you and ask for help. You would not give him step by step instructions on moves he should make. This is not a wise thing to do when playing chess because things change rapidly. The same is true with finances. You can have a basic goal/intent to take the queen or put the king in checkmate, but how you get there is a changing process.

It is a good thing to make goals and plans, but the details will be changing. It is important that we understand this so that we will not be frustrated with a process where change is inevitable.

Never Have a Car Payment

If you have a car payment, you need to get rid of it. As a philosophy of mine I try to avoid anything that requires a recurring monthly payment. I understand some things are inevitable but I want to stress that a car payment is not one of them.

From talking to financial counselors many times when people are struggling and broken in their financial life, it is often because they find themselves in a lousy car situation or buying too much house. I will talk about buying too much house later this week, but for now let me stick to the car.

What I mean by a lousy car situation is they bought a new car and have been paying huge payments on it rather than paying cash, and now that they are in trouble financially because there was no buffer for life to happen they find that their car is worth LESS than what they still owe on it.

This happens far too often.

My advice and philosophy on this is pretty simple. I have 2 basic "car rules."

Car Rule #1: Don't buy new. My suggestion and personal philosophy is to get a 2 year old car. The reason for this is strictly numerical. As soon as you drive a new car off the lot it is taking a huge chunk of value off. In fact a large percentage of the value gets taken off in the first 2 years. By buying a car after 2 years you have avoided taking a huge depreciation hit.

Car Rule #2: Make payments to yourself.

Right now I am driving a 99 Honda Accord that does not have payments. Yet I am paying a $350 car payment to myself. There is a reason for this. It is smart. I can either make payments later and have a lot of that going to interest and be making someone else money, or I can make payments to myself now in my money market account that earns 5.05% and have interest coming in. Then when it is time to buy my 2 year old car I will have the money to pay cash for it. Side note: If you have cash you can get a major deal on a car, especially when looking to buy from individuals. When you show them you have cash and can give it to them as soon as they agree that is extremely enticing.

If you are thinking: "But I need to buy a car now but have no money saved up. What do I do?"

I will answer your question by giving you 2 scenarios and you can decide for yourself which is better.

Normally we buy:

$18,000 car; 7 years at 10%; payments of $300; value after 7 years, $800

Or we could buy instead:

$6,000 car; 7 years at 10%; payments of $100; value after 7 years, $400.
The other $200 per month is saved at 10% (mutual fund) for 7 years = $24,190

Now who may the right choice:

At Year Seven
The car is fully depreciated, in either plan, but in the 2nd plan:

Savings $24,190
One year old car for cash <$16,000>
Left in savings $ 8,190

No Car Payments!

Another Seven Years
Saving $300 per month from year 7 to year 14
plus interest on $8,190 (10% return) the car is fully depreciated again.

Savings $52,245
One year old car for cash <$25,000>
Left in savings $27,245

No Car Payments!

Which scenario do you choose?

After 14 years you are in a position where you are set up to never have to make another car payment just because of a decision you made 14 years ago.

It is a shift of thinking from, "I will always have a car payment" to "I never want a car payment."

Use the compound interest factor for your advantage and not against you. It is powerful either way.

Signs your financial System are Working

I wanted to offer up some encouragement to all who I have not had the pleasure of speaking with in person or through e-mail. I have heard really AWESOME things about people making commitments to handle their money wiser.

This allows them to be better stewards, better givers, better providers, and have actual freedom to do what God calls them to rather than be stuck in a position where they HAVE to earn a paycheck from a job they are not passionate about.

I wanted to list some signs that your financial system is working so that you may encouraged and continue what you are working towards:

1.) Paying car insurance quarterly or biannually without a hitch

2.) Giving e an offering to your local church not longer HURTS to write that check.

3.) Presents are a joy to buy for people.

4.) Getting to see monthly interest incurred from your 4.3%+ Interest Rate saving account. (If you do not have one of these, please sign up with ING Direct immediately.)

5.) No longer have stress when bills come in.

6.) You know that you have a plan financially if "life" happens.

7.) You are actually choosing to be at your job, rather than stuck at it.

And so many more! Having freedom with your finances is exactly what it sounds like. Freedom. It allows us to live life differently; I know too many people that are in bondage in their financial life which causes them to not be able to devote their lives to the calling they are called to because our money and hearts really are connected.

The Unexpected

In everything in life we must account for the unexpected. I would call it foolish to not do this. Most times when we have an emergency it is a major life changing event. However, when we have not set ourselves up for success financially to get through these types of events not only do we have a major LIFE crisis, but we also have a MONEY crisis.

This adds tons of unnecessary stress that could have been avoided. The reason why I seem to be harping on the need of an Emergency Fund a lot is for a couple reasons:

1.) It is the 1st step the I advise people to do. So if you wanted to ask me what your first step to financial freedom is I would advise to save up $1,000 (basic) emergency fund or $500 if your income is under $20,000.

2.) The other reason is because I see scripture advising us in this direction. Proverbs 21:20 "In the house of the wise are stores of choice food and oil, but a foolish man devours all he has."

It is literally foolish to devour all you have. So if you are living paycheck to paycheck and all your money comes in, then all your money goes out, scripture calls this foolish. This is why my first step is to break the chain and develop an emergency fund.