Dave Ramsey likes to recommend buying a house with no mortgage. As in, 100% cash. When I first read this in Ramsey’s book, ‘Total Money Makover,’ I thought this was the dumbest suggestion I’d ever read. Because everybody knows that renting is just throwing money away. So, after a year of renting, my wife and I bought a house… with a mortgage. That was 5 years ago, so now I have 20/20 hindsight vision (or maybe 20/40 vision).
Extra Costs of Owning a Home
When you’re renting, a mortgage seems like an obvious choice since your mortgage payments on a similar sized home are pretty close to what your rent payments are, so you might as well be building equity with your monthly payments. But people usually forget about all the other costs of owning a home. It’s the whole greener grass in the other yard situation. You can’t see all the crab grass and weeds and dead spots in the other person’s yard til you’re standing in it. In addition to your mortgage payment, you have home insurance, property tax and home maintenance. Home maintenance can especially be a headache, since its so unpredictable. I think my roof, hot water heater and back door are currently conspiring to cause problems in the same 2 month period. Additionally, if you move from an apartment to a home, you’ll pick up higher utility bills.
Owning a Home Still Can Make Sense
Don’t toss all your dreams of owning a home just yet. Owning a home still has a lot of upsides. Once you remove your interest costs, home ownership is far cheaper than renting. For example, our property tax, home insurance and house maintenance is $6,000/yr, whereas rent on a similar house would be at least $10,000/yr. This is where buying a home in cash starts to look more attractive. If you want to buy a home in cash, you’ve got to save up for it. During those years that you’re saving up, you’ll be making interest work for you, not against you, as your house savings fund continues to earn you interest.
Saving Up for a Home is Easier Than You Think
If saving $100,000+ for a home sounds impossible, sit down and run the numbers. Figure how much you can set aside per month. If you were considering owning a home with a mortgage and all the extra expenses, you can at least start saving the difference.
Using the housing values in our area as an example, a 4 bedroom house costs roughly $150,000 with a $3,000 annual tax bill and a $1,000 annual insurance premium. A 15 year, 20% down mortgage on a house like this with taxes and insurance in escrow would come with a monthly payment of $1,162. You can rent a similar house for $800. Already you’ve got a difference of $360/month that you’d be able to stash into a house savings account. Toss in what you’re saving on house maintenance and you can easily be saving $500/month.
This spreadsheet should give you a rough idea of how fast you’ll reach your goal. Feel free to adjust the monthly savings and interest rate to your circumstances. For simplicity’s sake, the interest is compounded annually, instead of the more typical monthly or daily compounding. The more frequent compounding will just make your money grow faster. The 3% interest rate that I factored into the spreadsheet is higher than current bank rates. In order to get an interest rate this high, you’ll need to invest in medium range bond funds. Currently these yield between 2 and 3%, but whenever the Fed gets around to raising rates, the yields on these funds will go up as well. If you’re wanting more yield, you could go with a longer range bond fund, but the value of these bond funds fluctuate more and will see a bigger drop with a rate hike (bond values always move inversely to yield).
Investing in these is similar to setting up an IRA. Just make sure you keep your house savings out of your retirement account, or you’ll be penalized when you try to access the money before retirement.
The Better of Two Mortgages
To be clear, buying our house wasn’t a terrible move, even with the mortgage. This is partly because we went with Dave Ramsey’s second best suggestion- using 15 year mortgage. The biggest problem with mortgages is the thousands of dollars of interest that you pay every year. This problem is worse with a 30 year mortgage, since it prolongs the pain. Over the life of the loan, a 30 year mortgage will cost you well over twice as much in interest. Additionally, over the first two years of the mortgage we were DINKS (Dual Income, No Kids), making several extra payments on the mortgage. These extra payments accelerated the pay-down process and decreased the principle and the interest on the loan.
Despite the saying, hindsight isn’t 20/20. And since the grass always seems greener on the other side, I can’t say from personal experience that buying a house in cash would have been the best route. I also can’t determine if it’s the best route for you. What I do know is that the math says that it is possible. What I also know is that the smaller the mortgage, the better. Perhaps you can swing renting for an extra year or two so that you can put an extra $10,000 down, making that 15 year mortgage that much smaller. Just don’t go blindly into the mortgage, assuming that it’s the only option.
While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.