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Buying a home is a big deal, and a bad purchase can haunt you for years. Just ask anyone who bought a home before the mortgage crisis.
One minute, everything’s coming up roses. The next, it’s making a beeline for rock bottom. That’s a history no one wants to repeat.
It’s also just one reason Dave recommends waiting until you’re out of debt with a healthy emergency fund before buying a home. A market slump freaks you out a whole lot less when you’ve got money in the bank and no extra bills to pay.
The good news is, we can learn a lot from the past. Here are four crash-proof lessons to help you make a confident home purchase.
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Lesson 1: Forget What the Bank Wants to Loan You
In the years leading up to the crash, banks handed out mortgages like candy. The ability to actually repay the loan didn’t really seem to matter. As a result, the number of foreclosure filings skyrocketed by 225% between 2006 and 2008, according to RealtyTrac.
Fortunately, credit standards have tightened considerably since then. But that doesn’t mean you can count on the bank to look out for your best interest. You still may qualify for more than your budget can handle.
That’s why it pays to crunch your own affordability numbers. Avoid biting off more than you can chew by keeping your mortgage payment to 25% or less of your monthly take-home pay.
Bonus Points: Do you and your spouse both bring home a paycheck? Consider buying a home you could afford on just one income. That way it won’t strain your budget if one of you loses a job or wants to work as a stay-at-home parent.
Lesson 2: Just Say No to Risky Mortgage Options
Adjustable rate mortgages (ARMs) were another factor that fueled the foreclosure crisis. They reeled buyers in with low interest rates for the first few years. But when the initial period was over, interest rates—and monthly payments—shot up.
That left many folks holding a tiger by the tail. Any plans they had to sell or refinance their home before the fixed-rate period expired were dashed by plummeting home values. Stuck with a mortgage they could no longer afford to pay, many homeowners defaulted on their loans.
There’s never a good reason to take on that kind of risk. Your mortgage payment takes up the biggest chunk of real estate in your budget. It should be predictable. Play it safe by sticking with a fixed-rate mortgage.
Bonus Points: Thirty-year mortgages are the norm, but you’ll save a ton of money over the life of loan with a 15-year term. Consider this: A $200,000 mortgage with a 4.5% fixed interest rate will cost you nearly $90,000 more if you stretch it across 30 years instead of 15.
Lesson 3: Look Beyond the Here and Now
During the real estate boom of the early 2000s, it was easy to buy a home with plans for a quick turnaround.
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But that short-term vision left lots of people stuck for the long haul when the recession hit. Families outgrew small spaces and couldn’t move out of less-than-desirable school districts. Owners who planned on using home equity to finance major repairs could no longer afford to fix ’er up.
We’re not saying you should go for the gold right out of the home-buying gate. But it is important to consider future needs when buying a home today. For instance:
- Will your family still fit in this home in five or 10 years?
- Are you happy with the neighborhood and local schools?
- Can you cash flow any repairs or renovations you want to tackle?
Bonus Points: Team up with a pro who’s been through market ups and downs and lived to tell it. An experienced real estate agent can help you ask the tough questions and guide you to homes with long-term resale value. They can also recommend a qualified home inspector so big-ticket repairs don’t catch your budget by surprise after you’ve signed on the dotted line.
Lesson 4: Don’t Skimp on Your Down Payment
Scraping cash together for a big down payment is no easy task. But it’s totally worth the effort!
Here’s why: Let’s say you buy a $200,000 home with 3%—or $6,000—down. Then the market takes a sharp turn, and your home value drops by $25,000. All of a sudden, you’re upside down on your mortgage, owing more than your home is worth. If you had put 20%—or $40,000—down instead, you’d have a healthy margin of home equity, even in the face of a downturn.
A low down payment may sound tempting, especially if high rent makes it tough to save. But waiting until you have enough cash to put at least 10–20% down on a home will leave you in a much better equity position if the market changes.
Bonus Points: Use Dave’s favorite home-buying strategy and pay 100% cash for your home. It may take more time and patience to save up that kind of dough, but people like you do it every day. And just imagine the peace of mind you’ll have knowing any future mortgage crisis has nothing on you!
Related: Read more about how to pay off your mortgage early in three easy steps.