Owning a home is the American dream. It’s what many young professionals and couples strive for, and it is often seen as a mark of independence and success. In the wake of the Great Recession, Americans have also seen the ugliest side of home ownership, including tumbling home values and foreclosures. This has led to a modern stigma against homeownership and a lingering fear that owning a home, as incredible an accomplishment as it is personally, is not the best financial choice.
While the Great Recession did serve as a wake-up call for fiscal responsibility, it didn’t change the reality of owning a home and paying a mortgage. Owning a home and the loan that comes with it, brings many financial advantages, but there are risks and costs a person must be aware of. If a homeowner borrows responsibly, they can make the loan work for them.
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Understand What Loan You Can Afford
One of the biggest issues with the housing market crash, and one of the most common reasons for foreclosure, was people buying more house than they could really afford. Lenders have every incentive to max out a person. The higher the loan they give, the more they stand to make in interest and the longer they will have money coming in. Home loan lenders also have very little risk because the house is collateral. They can still recoup most of their money, and perhaps even take a profit, if a borrower defaults.
These sorts of lending practices were a major problem before the housing market collapse. Lenders offered loans that borrowers couldn’t afford, and the lenders knew very well the people they were lending to probably wouldn’t be able to pay off the loan. The loans looked very attractive on paper, with zero money down or interest-only monthly payments that were very low.
Borrowers at that time were led to believe that mortgages were pretty much free money when the exact opposite is true. When homes lost value, those people were trapped. They couldn’t sell the house because the sale price wouldn’t pay off the loan. They were underwater.
This situation is the perfect lesson in borrowing only what you can afford and buying a house responsibly. It’s true that home loans are cheap money. Compared to credit cards, they have extremely low interest rates, but that doesn’t lessen a borrower’s responsibility by any stretch. It is important to consider not just the monthly payment, but all of the factors of a loan and its repayment plan.
Additional Housing Expenses
Unlike renting where a person has rent and perhaps a few utilities, a homeowner is saddled with all of the utility and maintenance costs for a house. A good rule of thumb is to take 1 percent of the home’s value per year and add it on as maintenance expense. Keep in mind that occasionally, this expense can rise much higher due to unforeseen circumstances, so a person is wise to keep a safety net of cash for emergency repairs.
Houses have other costs as well that are separate from the loan but often included in the monthly payment. Taxes and insurance are usually rolled into a mortgage payment, so homeowners often don’t notice them as much. It is important not to forget these items when calculating what payment you can afford. Also realize that if you do ever pay the loan off, you will still get to pay these expenses directly, so your house payment never really ends. These costs are, however, usually much lower than the average cost of rent. Ultimately, a homeowner will spend less on housing costs than a long term renter.
Equity and Its Advantages
As you pay off your loan, you build up equity in your house. Generally, building equity is a good thing. As your home increases in value, which it usually does, Great Recession aside, you will build up even more equity without paying any additional money. This equity can be used for a variety of financial benefits.
A reverse mortgage is one of the most common means of using a home’s equity. This is a type of loan that turns that equity back into cash usable for almost any purpose. Remember that home loans are cheap money, so a reverse mortgage is often a much better choice than relying on credit cards or other high-interest types of borrowing. It can even be used when the house is entirely paid off. It is important to get as much info on reverse mortgages as possible to ensure it is a financially responsible decision for you.
Strategic Repayment Plans
Many people today fear debt, especially mortgage debt. When done right, however, a person can make a loan work for them and end up much better for it. There is definitely a right and a wrong way to approach a home loan. Paying it off as quickly as possible and sinking every last dollar of savings into it, is not the best choice.
When a home loan is approached with an investment attitude, it can be made to work like a financial asset instead of a liability. A borrower who makes only a modest down payment and aims for a longer loan term will be able to invest extra money in other things. Those investments will make money, so when life happens, the person will have a safety net. A house by itself, isn’t much of a safety net, even if it’s entirely paid off. As with most investments, it’s better to diversify.
The bottom line for home ownership and the loans that come with it is that doing it right can bring great financial advantages and doing it wrong can end in disaster. A home purchase should always be considered carefully and strategically. The decision is certainly a financial one and should be part of a greater financial plan.