I appeared on CNN’s “Your Bottom Line” this past weekend to give advice to Michael Andrews, who has been looking to sell his home in Maryland and move up to a larger place before his son started kindergarten this fall. He and his wife bought in 2005, close to the top of the market. The problem: Prices are forecast to decline another 10 percent in Prince George’s County in 2010 because of an oversupply of homes on the market. Although sales are up over last year, and homes are on the market a shorter length of time, that may be because of more foreclosure sales, and banks agreeing to short sales.
The Andrews live in a family-oriented community with low crime and good schools. Michael works for the University of Maryland and his wife for the federal government. The last few years, the university has not offered cost-of-living increases, and even furloughed workers because of budget constraints. Michael told CNN that he can’t refinance, and that his mortgage interest rate is “kind of high.”
Television time constraints being what they are, I didn’t have a chance to give a full response to the Andrews’ situation. I thought I’d give it here, since so many homeowners are in a similar boat:
1) Before they consider a move, the Andrews should reinforce their financial foundation. They have
a “kind of high interest” loan and can’t refinance. Why can’t they refinance? Typically it’s an issue of inadequate income, excessive debt, negative equity or poor credit. If they are underwater on the loan, they don’t have a whole lot of options. But if the issue is excessive debt or poor credit, they can tackle those issues. Lenders typically look for a debt-to-income (DTI) ratio of roughly 40 percent – meaning all monthly debt payments are no more than 40 percent of monthly income. (So if someone earns $60,000 and takes home $5,000 each month, their debts should total no more than $2,000.)
The Andrews should eliminate all revolving debt (credit cards, car loans, home equity lines of credit),and save up at least six months living expenses in the event of a job loss. As they pay off debt and boost savings, their credit scores will organically improve.
2. The Andrews should look at the bigger picture and rank their priorities. Maybe it’s wiser to open a 529 college savings plan for their son than to buy a bigger home, because the cost of college continues to exceed inflation (and the amount most people are receiving in their investment returns). To reach the goal, you have to start early.
3. Remember the “hedonic treadmill.” Psychologically, very often the more we have the more we want; we get something – like a home – adapt to it, and want a bigger home. But the Andrews probably won’t enjoy a bigger home as much as they expect: There will be a higher mortgage payment, higher property taxes, utilities, insurance and maintenance costs, and possibly a longer commute. That may reduce the happiness they get from the purchase.
They should think about other uses for the money they would put into a bigger home. Research shows the money spent on experiences, and time with family and friends, makes us happier than the money spent on things. So they might find higher well-being spending the money on traveling, sporting or cultural events, or hosting barbecues for family or friends right in their own back yard.