Test Drive Your Home Ownership Experience

Are you thinking about buying a house? With all the foreclosures and the housing market becoming more favorable for buyers, this may be a good time to buy. But how could you be sure that you’ll be ready? The standard answers might be something like this:

Your percentage of gross income that goes toward housing costs should not be more than 28% (see Front Ratio)
Your percentage of gross income that goes toward paying all recurring debt payments should not be more than 36% (see Back Ratio)

It’s important to control the amount of debt before adding more debt.

All this saying is that it’s important to control the amount of debt before adding more debt — i.e., a mortgage — to your portfolio. However, this does not take your other financial habits into account. Let’s assume that you:

Have a manageable level of debt payment at 5% of your gross income — i.e., car loan and student loan.
Saved enough money for a sizable down payment
Are saving money toward other important financial goals — e.g., retirement

To see if you’re ready to take on the mortgage, save the difference between the anticipated mortgage payment and rent each month.

But how can you be sure that you’ll be ready to make mortgage payment each month? The answer is to simulate your home ownership experience — test drive it! For example, let’s say you’re paying $800 a month in rent today, and you’re looking at a $1,000 monthly mortgage payment. To be conservative, we’re going to add a 20% premium on top of the mortgage to account for homeowner’s insurance, real estate taxes, private mortgage insurance (PMI), maintenance, and additional utility costs, for a total of $1,200.

Are you ready for a test drive? It’s easy. Since you’re paying $800 in rent, you have to save the $400 in a separate account — a high yield savings account is a good place to save the money, e.g., WTDirect Savings Account or eTrade. You should do this for at least a few months to see if you can adjust to the new lifestyle.

If you have no problem with the extra savings — That great! You’re financially ready and the extra money saved can go toward your down payment or emergency fund.
If you find yourself sacrificing savings for other financial goals — Then you are going to be “house poor“. You should look for a less expensive house, or find more ways to trim your expenses. You don’t want your house to become the financial barrier to your other goals.
If you are struggling to consistently save the difference – Then you should reevaluate your homeownership goal and financial priorities. May be a less expensive house, or a more frugal lifestyle is the solution, may be not.

Buying and owning a home is an exciting experience, but it’s not always the right choice for everyone. For home ownership to be rewarding the house should be both physically and financially comfortable.

9 Comments

Thrifty Femme
June 23, 2008, 8:28

I did this for a year before we bought our home, and it worked out very well. In my experience a 20% premium for homeowner’s insurance, real estate taxes, PMI, maintenance, and additional utility costs is too conservative. I would recommend a 30% – 60% premium if you live in a high real estate tax area and/or a high homeowner’s insurance area.
Sara
June 23, 2008, 17:59

I’m impressed. This is a simple solution that makes sense (provided long-term job viability is there). Plus, you can use the money saved up to pay down closing costs, invest in new home costs like landscaping and blinds, or put down more on the down payment.
Mr. Cheap
June 24, 2008, 0:03

Great post and suggestion! Thanks for the link.
WealthBoy
June 24, 2008, 5:09

Very good info Pinyo. I love articles that provide simple rule-of-thumb advice. It makes it very easy to follow and implement.
Pinyo
June 24, 2008, 7:21

@Thrifty Femme — Good point about adjusting it for your local condition. For my house, the property tax is relatively cheap at about $3,000 for a $600k property. I know out in Long Island, taxes are about 3-4 times higher for the same $600k property.
@Sara — Thank you. And don’t forget emergency fund. As a homeowner, you can’t miss a mortgage payment so having an EF is more important than ever. I have 3 months worth of mortgage payment saved in a separate account just in case.
@Mr. Cheap — No problem.
@WealthBoy — Thanks!
Writer's Wallet
June 24, 2008, 17:58

Great way to get an idea of whether or not you’ll be able to handle it. Very conservative too. Me likey.
Kevin@ReturnToManliness
June 25, 2008, 0:47

What a great idea on test driving whether or not you want to become a homeowner. In today’s crazy real estate market, there are so many people that will be renters for a long time.
The future homeowner really doesn’t know what they are getting into when they decide to buy a home until usually after they do it. This is huge mistake as it could ruin your credit for a long time if you make a bad decision up front.
skeptictank
June 25, 2008, 17:15

If you’re going to buy a house I’d suggest a separate house emergency fund. I’ve started putting $150/week into my house emergency fund. The goal is have enough money in there for a large emergency like needing to replace a roof or needing to replace plumbing (lots of homes built in earlier times have galvanized pipes and there are cases where most all of the pipes need to be replaced at once – happened to a neighbor a few years back) – I’m aiming to have $15K in the house emergency fund. Again, this is separate from the 6-months-of-living-expenses emergency fund. You don’t want to find yourself in a situation where your roof needs to be replaced immediately and then have to put the $12K cost on the credit card.
As someone who has lived in the same house for 17 years now I can tell you that maintenance will be higher than you expect. Don’t get yourself into a situation where you can barely afford the monthly payments + insurance + property taxes. You need to be able to set aside money for maintenance as well. The rule of thumb that I’ve heard is 2% of your house’s value every year.
Joseph
June 26, 2008, 12:07

This is a fantastic idea! I can’t believe I’ve never thought of it before. I’ll actually be bringing this up to my wife… we’re looking at purchasing a home in about a year. It’d be good for us to know for sure if we can do it. I’ll let you know what happens with this!