Did I make a frivolous home purchase?

[younginvestor2013]

I am under contract on a condo in Chicago and broke the “3 times your income” rule as a ceiling for your purchase price. Perhaps I am feeling a bit of “buyer’s remorse” but I think I made the right choice. What do you guys think? Perhaps I am looking for a little bit of justification....but I am looking for your honest opinion.

I currently make 60,000 with bonus and spent about 215K on the condo. I just had my year end review at work, and anticipate being promoted within the next year, when I will be grossing about $70-75K all in. Including my 20% downpayment money, I have a NW of about $315K.

I do consider myself conservative and have been saving 15% + of my gross income since graduating college (almost 3 years ago)….I was looking at condos in my price range of $180K, but I could see myself out growing them in a year or two. The condo I bought is 10% below the most recent comp in Nov 2013. It is a newer building, and has low assessments/HOA fees and comes with a spot in the parking garage.

I don’t own a car, but plan to rent the space out for $150 a month as that is what spaces go for in the building. I plan to roll over about $500/600 a month from my brokerage account until I am promoted, then my monthly payments will fit right in with my budget where I won't have to roll money over and can save 15+% of my gross income. I am “justifying” this because:

interest rates are on the rise
home values are on the rise
the unit/building has all features I want + low assessments
If I am promoted in 1 year and only have to “roll over” $600/month for 1 year, that is only $7,200 or 2% of my net worth.
I will begin to build equity
I am buying at the lowest comp in the building. The Chicago market has seen a big trend upward in pricing, so I anticipate holding and renting if I move (or selling if the market warrants it) and profiting
If I want to move and rent it out, I will still have assets for downpayments on another property.
I still have a sizable nest egg for potential career changes, bumps, or other emergencies in the future.
My biggest fear is that I won’t be able to rent it out due to HOA rental cap should XYZ life change occur and require me to move out or leave Chicago.

 

[W2R]

I would not have spent that much making your salary, and in fact was making slightly more than your salary when I bought my present home for $160K. I did not even look at anything over $200K, even though the mortgage broker would have been glad to find a mortgage for me that would cover that much..

But what is done, is done! Enjoy it and try to save money in other ways.

 

[Andre1969]

Well, if you're currently making $60K and the condo was $215K, that's around 3.58x your salary, so not *too* bad IMO. But, if you're putting 20% down, the mortgage would only be around $172K, which is only 2.87x your salary.

I bought my first home, a condo, back in late 1994, for $84,000, and at the time I was only making about $22K at my full time job, plus another $5-6K at a part time job. So, I was around that 3x my salary thing too at the time. I put down 5%, so I financed $79,800.

What hurt me though, was that I was young and dumb, and got suckered into a high interest rate. And then, most everything else ended up costing easily twice what I had budgeted for...electricity, cable, phone, groceries, added fuel for driving further to work, plus all the running around I was doing, because most of my friends were further away. And, in my low income bracket, that didn't leave me with very much disposable income, and since I was in a lower tax bracket, the tax writeoff wasn't as beneficial.

In my opinion, I think you'll be fine. At least, a lot better off than I was when I bought my condo!

 

[ChiliPepr]

I think the house = (3 * income) is a bit horse pucky... because you have other factors...

If your interest on a 30 year fixed is 4%, for $172k loan, p&i is $821. That same loan at 6% interest is $1,031.

Also, if you did buy around chicago you may have to buy further away from your job to get down to $180k, you would then have to concider additional transportation costs and travel time.

You did not say how much the condo fees are, but if you are currently renting, and saving $750 a month (which is 15% of gross) you should be ok.

When I was 24 I bought a $130k condo with 10.375% interest and was paying over a grand in P&I with $100 in condo fees. I was making about $50K at the time, so I fell into the 3*salary rule, but my expenses were a higher percentage of my salary than yours will be.

 

[ERD50]

It maybe a bit of a stretch, but you clearly have thought it through, so it doesn't sound to me like something to stress over.

If I followed, you actually have enough savings to pay off the mortgage (not suggesting that of course, just framing the situation).

As others have said, a lower cost place could increase your commute costs, and actual expenses are the key, not the 'purchase price' - that's just one number.

But you need to actually draw from savings to make the month? That does not sound like the mortgage company would have given you a mortgage? Do you have expenses they were not aware of (maybe they just went from your income)?

So it's a little scary to be counting on a promotion to make the month (but as you say, a draw down of 2% per year certainly isn't a killer). You are pretty solid in other ways. Things will very likely work out for you, but I would keep those 'plan B' ideas on hand, in the unlikely case something goes south.

I'm also curious about 'HOA rental caps'? How does that work, and why (I assume to protect current owners from living in a place mostly occupied by renters)?

-ERD50

 

[jerome len]

You sound like you're making a responsible decision for the right reasons. You have back up capital in your net worth, home prices and interest rates are rising and it's not really smart to buy a home that you would outgrow in a year or two. So, there is always risk but you're taking a smart approach so if I were you I'd go ahead. Good Luck.

 

[Mulligan]

I would not have spent that much making your salary, and in fact was making slightly more than your salary when I bought my present home for $160K. I did not even look at anything over $200K, even though the mortgage broker would have been glad to find a mortgage for me that would cover that much..

But what is done, is done! Enjoy it and try to save money in other ways.

Your conservative financial attitude would fit well here in MO, if you ever pull the plug, W2R! Concerning OP, you live in a different real estate world from me. Most people here stay in the 2x salary range, but that is impossible in high cost areas. You have a plan, so things will be fine, and buyers remorse is natural. I get it with anything over $500 let alone a house or a car.

 

[FIREd]

I think you are stretching a bit, especially by counting on the bonus and the promotion to make this work. On the other hand, you are buying in a fairly liquid market (large city with a diversified economy) and your net worth is high enough to provide significant backing.

I am also thinking about purchasing a condo. We are looking at a price range ~ 1.5 times our income. But we'll have a significant downpayment, so the mortgage would likely be in the order of our annual income. Did you have any trouble finding a lender? Despite our excellent credit scores, I am finding that getting a mortgage on a condo is a lot less straightforward than getting a mortgage on a single family home. Getting a mortgage through USAA, we were able to buy our house with 10% down but they are asking almost 50% down for the condo.

 

[Texas Proud]

I would look at it a bit different than what others have said...

MONTHLY PAYMENTS.... yep, that is where I would go... and that is not what a good number of people here would do...

As Chili pointed out, interest rates are a lot lower today than at any other time in recent memory (and not so recent)... that means you can afford a higher purchasing price and still be making the same monthly payments..


I would have looked at how much it would cost me to rent a place.... I would then compare it to how much it costs to own this place... including the HOA fees (which can be a killer)... if the delta is not that great, then you make a great decision.... if it is.... and it will take a stretch for you to make it... maybe not...

I will say that the decision like you are making is not common to most folks... NYC, Chicago, Boston etc. are not the same as most of the rest of the country... you do not need a car to get around... that savings can be added to housing costs and in most cases usually is... I knew some people who paid 50% of their income in housing costs when I was in NYC...

 

[younginvestor2013]

Thanks for your responses. They have made me feel more comfortable.

I think the main reason I am posting this here is because my dad is in major disagreement with my decision, even though he isn't coming out blatantly saying that. My NW is where it is at 24 because of him.

To answer your questions ...

Similar units in my building are being rented out for $1,500.
My "all in" costs will be about $1,450, excluding electricity and cable. So I'd be cash flow positive if I rented it out.

The HOA of $229 includes common area maintenance, gas (and heat), water, common area insurance, etc.
I obtained a 4.5% interest rate, which was the best I can do (trust me I talked with a lot of lenders). Rates are a bit higher on condos.

My monthly payment including P&I, insurance, taxes, electicity, insurance, HOA (everything) is looking to be all in around $1,500-1,550, depending on whether I want to get cable TV or not, which will hopefully be offset by $150 in garage rental income.

Many HOA boards put a cap at 50 or 60% of the units that can be rented mainly because 1) banks start to give worse financing to potential buyers once the rental to ownership ratio meets a certain threshold and 2) because they don't want the building to be mostly renters.

I feel that the $500-600 a month for a year or so is irrelevant to the "big picture" given my assets, age, and (likely) increasng salary.

Realistically, only a certain percentage of that $500-600 a month will be "thrown away" via interest. As we all know, the concept of amortization is such that more interest is paid at the beginning of the loan...so a portion of that $500-600 will be "thrown away" on interest where I won't build equity. But I would be throwing away my whole rent payment if I don't own. Of course, this whole paragraph and argument is only relevant in a market where RE market values are increasing year over year and there isn't a huge crash like we had in 06-08 and I will build equity vs lose equity.

If I chose to do so, I can reduce my roth 401K contributions to virtually nil and not have to move money over from my brokerage account. I am chosing not to do this because 1) I don't want to miss out on my 3% employer match and 2) I want to take advantage of the long term tax advantages by contributing at such a young age.

Further to my point #2 above, I am contemplating just maxing out my Roth 401K this year and moving even more money over per month from my brokerage so as to maximize long term roth 401k benefits.


You can tell I have thought things through, eh?

 

[Brooks Saddle]

You're fine. Enjoy your life.

 

[Meadbh]

I think you have thought this through quite well and are making a good decision. You are buying in a rising market and locking in a low interest rate. You will be motivated to get that promotion, too! One thing you should anticipate is rising HOA fees over time. A low HOA fee is common in new builds but after a few years when maintenance needs increase, significant increases can be expected. Keep informed about the size of the reserve fund and read the reserve fund studies. Consider volunteering for the HOA board as good management is the best way to protect the value of your investment.

Enjoy your new home!

 

[samclem]

You are spending a high percentage of your monthly income on your living quarters. You've made a number of assumptions regarding your costs that seem on the optimistic side (e.g. can the HOA put the kabosh in the future to renting out parking spaces?). Spending on this decreases the amount of money you have available to invest. If you choose to look on the condo as an investment (as your post implies), and you think that it's a good deal, just realize that it's a very concentrated investment (one condo--not a REIT, etc. And Chicago is not without risk, regardless of recent price history), has high cost (those condo fees) and limited liquidity.

OTOH, if you are sure you found the best "deal" (lowest price for the amenities you want), then enjoy it. I agree that interest rates will go up (might hurt resale . . .), so if you are willing to lock in to a long-term relationship with a condo, then this is probably the best time. You've got to live somewhere.

I am so lucky that I spent most of my life in low cost areas. I didn't want the things offered by these areas, and I'm glad I didn't have to pay for them.

 

[clifp]

It looks like your housing costs are $18-19K which is a bit over 30% of your gross salary. That is well below the guidelines of most lenders of 40%. If you end up making $75K next year than you are spend <25% on housing which I think is quite low.. I spent my whole life in expensive places LA, the SF Bay Area, and Honolulu so perceptions of what is cheap vary widely.

 

[RenoJay]

Chicago is such a fun city and you'll have a place you can enjoy for a while. I think you're fine and just having some natural anxiety

 

[jkern]

First, the 3X your income rule was established when interest rates were high.

Second, the rule was to provide an ideal percentage of income going to housing. In high cost areas, that rule rarely applies. Here in the SF Bay Area, it is not uncommon to purchase a home 4 to 6 times your income. Unfortunately, a larger percentage of income goes to housing, especially when buying your first or second home.

I think you are just fine.

 

[Mulligan]

First, the 3X your income rule was established when interest rates were high.

Second, the rule was to provide an ideal percentage of income going to housing. In high cost areas, that rule rarely applies. Here in the SF Bay Area, it is not uncommon to purchase a home 4 to 6 times your income. Unfortunately, a larger percentage of income goes to housing, especially when buying your first or second home.

I think you are just fine.

I don't dispute what your say, but I cannot wrap my mind around a mortgage 4-6 times income, especially at the lower end of income. When I retired, I shortly afterward refinanced the balance back into a 30 year which was about $100k. This is about 1.3 X annual income, so my monthly P&I and escrow is a little under $725. This is about 15% of my net monthly income. Five times annual income would swallow up 50% of my income leaving me $2500 for all my house bills, transportation, food, etc.. I don't see any money for any type of entertainment. I realize a person has to do what they must, but I would be a nervous wreck trying to make the math work unless I knew a substantial raise was on the horizon.

 

[W2R]

I don't dispute what your say, but I cannot wrap my mind around a mortgage 4-6 times income, especially at the lower end of income. When I retired, I shortly afterward refinanced the balance back into a 30 year which was about $100k. This is about 1.3 X annual income, so my monthly P&I and escrow is a little under $725. This is about 15% of my net monthly income. Five times annual income would swallow up 50% of my income leaving me $2500 for all my house bills, transportation, food, etc.. I don't see any money for any type of entertainment. I realize a person has to do what they must, but I would be a nervous wreck trying to make the math work unless I knew a substantial raise was on the horizon.

+1 Plus, I think it might be hard to feel confident about getting a raise at all, these days.

 

[samclem]

First, the 3X your income rule was established when interest rates were high.

Second, the rule was to provide an ideal percentage of income going to housing. In high cost areas, that rule rarely applies. Here in the SF Bay Area, it is not uncommon to purchase a home 4 to 6 times your income. Unfortunately, a larger percentage of income goes to housing, especially when buying your first or second home.

I think you are just fine.

The OP might turn out to be fine. But reducing monthly savings in order to spend more on housing will likely have a cost (delaying the time when savings goals are met). Just because "everyone" (in my little high-cost enclave) is doing it" won't reduce the impact of the actions.

A condo might turn out to be a good investment, outstripping the appreciation of other available investments. If we think that will be the case, why not sell stocks and other investments to buy a yet bigger one? Because it's an undiversified "bet" and it makes good sense to minimize that kind of investment.

But, like I wrote, a person has to live somewhere. I just feel a lot better separating my investments from my shelter, optimizing the "value" of each independently. There's no right or wrong answer: Lots of people choose a more expensive car, house, etc than is strictly required, and that is fine.

 

[jkern]

I don't dispute what your say, but I cannot wrap my mind around a mortgage 4-6 times income, especially at the lower end of income. When I retired, I shortly afterward refinanced the balance back into a 30 year which was about $100k. This is about 1.3 X annual income, so my monthly P&I and escrow is a little under $725. This is about 15% of my net monthly income. Five times annual income would swallow up 50% of my income leaving me $2500 for all my house bills, transportation, food, etc.. I don't see any money for any type of entertainment. I realize a person has to do what they must, but I would be a nervous wreck trying to make the math work unless I knew a substantial raise was on the horizon.

In a lower cost area you have a choice on how much to spend on housing. I've lived in the Bay Area for over 50 years and virtually everyone starts out with a high percentage of their income going towards housing (including renting too). I'm certainly not advocating a large mortgage when nearing retirement. However, when starting out it's easy to make sacrifices for your first or second home.

I guess I'm just envious when people think a home is too expensive when it's 2 or 3 times their income!

 

[W2R]

Similar units in my building are being rented out for $1,500.

Here's an idea, which you'll probably hate but which your father might like.

Can you possibly get a roommate and charge him $700 plus half the utilities? Then put that $700 towards paying off some of the cost of your condo so that you can refinance later with lower monthly payments.

Sure, roommates are no fun. But, it wouldn't have to be forever.

 

[Socal Tom]

I thin you are fine,
I've never heard the 3x rule, but I'm in California, 6x is closer to normal here. You are young, your salary will go up, and you will be in your 3x rule soon. I bought my first home(condo) about a year out of college , it's was about 5x my earnings with an interest rate of 8.5% ( that was a good rate in the 90s). The payment took 1/2 my income, but 8 years later I sold it for 50k more than I paid, bought a house with the down payment, and I'm better off. It's easier to struggle when you are young.
Tom

 

[Dash man]

You obviously know how to manage your money, so you'll be fine. Keep enough in your emergency fund to cover living expenses for a year in case of a job loss, and you'll sleep better at night.

 

[gozer]

I've never heard the 3x rule, but I'm in California, 6x is closer to normal here.

*cough* *choke* *wheeze* 6x?! Holy crap. The most I have ever mortgaged is about 1x.

 

[Mulligan]

*cough* *choke* *wheeze* 6x?! Holy crap. The most I have ever mortgaged is about 1x.

Well Gozer, go to the bank, get a loan for that amount and try it.....who knows you may come to appreciate it. Otherwise with a 1x loan I am going to consider you a person living in flyover country like myself!