The ability to find a house in your budget isn’t complicated if you have the right financial tools. I have a lot of respect for Dave Ramsey and his team. But, when they offer advice that ends up putting a large percentage of potential homebuyers on the sideline, I think there’s a need for another viewpoint. Having been a mortgage lender for 40 years, I’ve found that not everything is as black and white as Dave Ramsey’s advice appears. Sometimes, there is a grey area that makes better financial sense.
Advice from a Dave Ramsey writer.
Allow me to offer a fairly recent example where a Dave Ramsey associate wrote an article suggesting that the best way to finance the purchase of a home is with a 15-year conventional mortgage with a monthly payment that doesn’t exceed 25 percent of your net income and you should avoid FHA and VA loans.
The writer also suggests that if you cannot purchase a home within these guidelines perhaps you need to lower your expectations of the type of home or location you want. Or, save more money and buy at a later date, especially if you’re a first-time home buyer.
While I truly appreciate the writer’s advice, there’s certainly room for an alternative viewpoint. Let’s break it down and see if there are some alternatives that could fit your personal situation.
Should I get a 15-year mortgage?
Let’s go in order, starting with the suggestion of a 15-year conventional mortgage. I completely agree with this, to a point. Yes, a 15-year mortgage can save you interest due to its shorter term and lower interest rate but, unless you put 20% down, you’ll need to pay monthly private mortgage insurance premiums. Also, this may put you out of reach (due to the higher monthly mortgage payment) of the homes that you’ll enjoy for many years or a home in an area that tends to appreciate better than other areas.
While I appreciate the writer’s intent on saving the consumer money on interest, it could cause the homebuyer to purchase something they don’t love and want to remain at or it simply doesn’t appreciate like other homes would, so they could be losing much more than they are saving.
Mortgage Payment Shouldn’t Exceed 25% of Take-Home Pay?
Clearly, nobody should put themselves into a financial situation that they cannot afford. But, the standard underwriting guideline is 28% of the GROSS income. To be perfectly clear, we’re talking about the total mortgage payment (PITIA: Principal, Interest, Taxes, Insurance & Association dues, if there are any) divided by your gross income.
Sure, limiting your total PITIA to 25% of your net income is going to leave you more money at the end of the month but will it put you in a similar situation as the 15-year mortgage (previously discussed) causing you to purchase a less desirable home?
Avoid FHA and VA Loans?
FHA (Federal Housing Administration) and VA (Veterans Administration) both offer the LENDER some protection in the event of a default of the mortgage. Because of that added protection, lenders can be more flexible with their qualification guidelines. This can and has benefited a LOT of people over the years.
Of course, that lender protection doesn’t come free. You, as the consumer, pay a fee in the form of a Mortgage Insurance Premium (MIP) for an FHA loan or a Funding Fee for a VA loan. These fees can be rather expensive, especially when FHA changed their guideline requiring MIP to be paid for the lifetime of the loan (for 30-year loans with less than 10% down). FHA’s MIP has an up-front fee of !.75% of the loan amount (which can, and usually is, added to the loan amount) plus a monthly fee which can run from .50% to .75% of the loan amount divided by 12 (depending on the loan amount and amount of down payment).
VA’s Funding Fee can run from 1.25% to 3.3% of the loan amount, up front, depending if this is their first time use of a VA loan and their down payment. This fee can, and usually is, included in the loan. There is no monthly VA Funding Fee. Despite the fact that this Funding Fee and FHA’s Up-Front MIP can be rolled into the mortgage, it’s still a cost that should be considered.
What Are the Benefits of an FHA or VA Loan?
One of the flexible guidelines associated with FHA or VA is the amount of funds required for a down payment. By putting less down, you may be saving valuable funds for moving, buying furniture or appliances, or leaving funds in an emergency account. Plus, real estate tends to consistently offer a good ROI (return on investment) when leveraged. See this article on creating wealth with this type of leverage.
Another benefit of utilizing an FHA loan is the flexibility with credit. Most of us have had something happen in our life (i.e. Medical issues, family emergencies, an accident, loss of employment, etc..) that adversely affected our credit. FHA’s credit score requirements are lower than traditional conventional financing options, even as low as 500 (with more down payment).
Debt to Income Ratios
Another area of flexibility is the debt-to-income (DTI) ratios. Conventional debt-to-income guidelines are 28/36 while FHA’s are 31/43. These ratios can be exceeded somewhat, often depending on your credit score, available assets, and/or amount of down payment. The first number (before the “/”) represents the total mortgage payments (including homeowners association fees) divided by your gross monthly income. The second number represents your total mortgage payments PLUS all other monthly debt obligations (including things such as child support) divided by your gross monthly income.
VA Loans
As for VA financing, I have no problem with the way those loans are structured. Sure, there’s an up-front Funding Fee (which can be added to the loan) but you’re buying a home with zero down payment. In fact, VA will even allow the seller to pay all your closing costs, meaning that you can probably buy a house more easily than you could rent one. Your real estate agent can help you negotiate that with the seller’s real estate agent.
Plus, VA tends to be more flexible when it comes to credit, and they don’t even use Debt-to-Income ratios. Instead, VA uses a residual income calculation to make sure that you have funds left over each month after your mortgage obligation is paid.
Should I Pay Rent and Save For a Larger Down Payment?
The Dave Ramsey writer suggests that waiting until you have a larger down payment may be the best route. Again, there’s nothing wrong with that advice, however, there are other things to consider. The first is that the market appreciation may outpace your savings ability. In the writer’s own article, she showed the median home purchase prices climbing $40,000 to $50,000 per year (see below).
If you have the ability to save that amount of money each year, then chances are, you already have the funds you need for a nice down payment. For the rest of us, the longer we sit on the sidelines, renting until we have enough money for a decent down payment, the market may have moved beyond our financial reach.
Getting Out of Debt: A Final Note
The one thing that Dave Ramsey, his team article writer, and I all can agree on is the need to be debt-free. Credit cards, Buy Now-Pay Later plans, 84-month car loans, etc.… have all made it very easy for us to purchase what we WANT instead of focusing on just what we really NEED. As a result, many of us have more month at the end of our money and look for more ways to make the equation work. Often this means getting another loan (i.e. Debt consolidation or home equity loan) which only eases the pain. It doesn’t fix the problem.
My website, www.OutsmartDebt.com, was created to show you how to improve your credit, how to understand and best utilize financing, how to build wealth, and, most importantly, how to relieve you of the burden of debt. So, I hope you’ll look around my website and choose the articles that best resonate with what your needs are.
