What percentage of your total annual income can you safely commit to the overall cost of your housing -- your mortgage, taxes, insurance, etc.?
Banks will often use a number ranging between 29 percent and 36 percent of your total income, but I believe that that's just too high, because that range doesn't take into account the cost of maintenance, which is about 4 percent of the purchase price per year. I tend to lean toward a more conservative number: 25 percent. Given the state of the real estate market today, you are much better off being as conservative as possible.
And you now want to avoid, like the plague, one of the worst pieces of advice once commonly given to young people, namely, "You should buy as much home as you can." That is a horrible piece of advice today. Not only do you end up stretching out your mortgage payments for a longer period, but your property taxes are often higher, your heating costs are higher, all of your costs of maintenance are higher and, so, you really end up stretched. I would buy smaller and smarter using a more conservative financial structure.
OK, you've saved your money and you're ready to plunk down 20 percent on a home. Should you opt for a 15-year mortgage from the start, or are you better off with the traditional 30-year mortgage, which you can prepay early as your cash flow allows?
I tend to lean more toward the traditional 30-year mortgage that has no prepayment penalties. That's the option that gives you the most flexibility.
For the typical homeowner, things don't always simply boil down to just paying off the mortgage. Most people are simultaneously trying to fund their 401(k)s or 403(b)s. They're setting aside some money for emergency savings, they're buying life insurance if they have a child, and they've a lot of other draws from their paycheck. What personal finance is really all about is developing good habits over time. So, what a 30-year mortgage gives you is a level of certainty, and it's a practical investment which you can easily turn into a 20- or 15-year mortgage as your circumstances allow.
Now, I know that there's this "primal instinct" among people to try and get rid of their mortgage -- and getting out of debt is a good thing -- but you also need to put money into things like stocks, bonds, money market mutual funds and so on. You need to practice good money habits and you need to be diversified.
Why? Because if you have a job in a town and you own a home in that same town, and if you direct all of your extra cash flow toward getting rid of your mortgage as fast as possible, you become very vulnerable to what happens to your town and to the local economy. You need to seriously consider what can happen to you and your financial security if you should ever lose your job and the local economy tanks and your town's housing prices then go down. Instead of having diversified your money in other investments and savings, you have just put all of your extra cash flow into paying down your mortgage early.
When it comes to credit cards, which, in your opinion, is the better choice for consumers: a no-fee card with a low interest rate or a credit card that offers some kind of a lucrative rewards program?
The only credit card offers that have really paid off for people are the ones with the free airline miles. For people who are disciplined, this reward offer can make quite a bit of sense.