Overextended. Optimistic to a fault. Overly reliant. Does using alliteration to share these truths about past tense me make them sound any better? No? Didn’t think so.
I’ve shared it before, it’s no secret that I was absolutely not in the right position to purchase my first home when I did back in 2006. But I’ve learned a thing or two since then, most important being how you can evaluate your finances in order to make a SMART home purchase.
I didn’t capitalize the word SMART for emphasis — it’s actually an acronym that you can use to evaluate every investment or purchase you make!
But before we dive in, there’s a few things I wanted to note. First and foremost, where you live can dictate whether your money is better invested in a home, or somewhere else (like the stock market) — this is especially true if you live in a high cost area like San Francisco or New York. On the flip side, I live in Arizona, where the cost of homes is affordable and property taxes are low. More often than not, rental prices are more than financing a property; but this alone is not a good enough reason to make a home purchase.
Secondly, you’ve got to take into account that there are growing pains in the process of a house becoming a home when you decide to purchase. And those growing pains look like a leaky roof, a washer that’s on the fritz, a busted pipe, even something small like a broken cabinet… when you own the home — it’s on you to fix it. If you don’t have a habit of putting money in savings for a rainy day, owning a home will be challenging for you. (especially if there’s a leaky roof on that rainy day…)
Disclaimer! Everything you are about to read is my own personal financial philosophy: it is not mortgage guidelines. Many people make these decisions based on their own principles and guidelines. These are mine: My goal is to give you a pathway to success, and it’s just as important to know when NOT to buy a home as it is to know when to buy a home.
I live by the SMART acronym so I can make every single dollar that I earn work for me. Always remember to ask yourself,
S – What am I spending on a monthly basis?
Generally, I recommend 70% of your money should go towards your lifestyle expenses. This is everything that it takes to live and yes, it includes boring things like bills. Then, 20% towards principal reduction. Simply put, get after that debt! And most importantly, 10% into savings. If you’re fortunate enough to have no debt, put 30% into savings. Allocating my money in this way allows me to live without harsh restrictions and still save. Many budgets (and many diets) have taught me that I do best when things aren’t so rigid. You likely aren’t ready to buy a home if you haven’t made a practice of putting money in savings.
M – What am I making on a monthly basis?
You need to come up with the truest estimate of what you actually bring home month to month. Review NET income of the last two years, and get the average. This allows you to factor in things that overtime or bonuses if they are either a consistent or semi-consistent piece of you NET income. Once you have an average, do not overextend yourself in terms of what you can afford for a mortgage. It needs to fit well inside of the 70% of your income that you’ve allocated for lifestyle expenses — without being hopeful of a future raise or a consistent roommate.
A – What do I have in assets?
This can be anything that is liquid that you can withdraw from that doesn’t have a loan on it. A house is considered an asset, but it’s also a liability. So unless the intention is to sell the home prior to purchasing a new one, you can not count any of that equity towards your asset statement. If you are planning on selling, then you can use the equity (difference between what the house is worth and what you owe) as part of your asset plan. That 30% of your income that you put away (hopefully) would be considered an asset here as well.
R – What are both the risk and the potential return on this investment?
What am I giving up to invest in this? What is the potential upside? What happens to me if I invest these funds? How much do I think that I can make? Have an honest and practical grasp on the best and worst case scenario and set proper expectations.
T – How much time do I plan on keeping this investment or asset?
How long do you plan on keeping this investment? If it’s a primary residence, most people live in their homes now upwards of 10+ years. If it’s an investment property: is it for airbnb? Is it a long term buy and hold? Buy and flip? You need to have an intention AND a back up plan in case that plan does not work out for you.
Evaluating all of the SMART factors will give you a better understanding of where you’re at and how to make the best investment decisions. You work hard for your money, make it work for you! And if buying a home isn’t going to make your money work for you right now, that’s okay! Additional questions or more specific scenario related questions? — let us know in the comments below!