One of the cardinal rules of personal finance is to avoid lifestyle creep. That means that as your income increases your cost of living should not. So if you make $60,000/year and at your annual review you’re awarded a 5% raise, conventional wisdom states that instead of upgrading your lifestyle with that extra $250/month (i.e. more clothes, nicer car, better apartment, etc.) you should keep living as you were and divert the extra money to savings and investments. It’s good advice and is the easiest way to widen the gap between earnings and spending. So what did I do when I left my $70,000/year job for a $120,000 base salary plus bonus? Obviously, I chucked the deuces to my $900/month studio apartment and bought a $2400/month condo.
Was it the most prudent financial decision I’ve made? Probably not. I decided to buy on a whim without so much as saving a dime for the purpose of a down payment. However, even though my decision making was rash, it turns out that the decision itself was not a bad one. In part one of this “Homeownership Series” I used three different methods to compare the cost and ROI of buying my unit versus renting it and in all but one scenario I came out ahead by owning. Even when I compared renting a less expensive one bedroom apartment, albeit with all of the amenities I currently have (e.g. parking, in-unit washer dryer, etc.) by year two buying my 2 bedroom/2 bathroom condo was in fact cheaper.
In my case the key to buying being a better option than renting was being able to lower my out of pocket costs year over year. So even without months of prior planning
What I Got Right
I bought less than I can afford
The standard rule for lenders is that monthly housing payments (principal, interest, taxes, and insurance) should be no more than 28% of gross (i.e. pre-tax) monthly income. Typically this means approval to buy a home 3-4X gross salary, assuming a 20% down payment and moderate longterm debt. So if you make $100,000 a year a typical bank will approve financing a home up to $400,000, which is what I was approved for. I purchased at $359,000 and had a $2157 monthly payment, which was less than 22% of my monthly gross. With monthly assessments my spend went up to 24%, still giving me breathing room in my budget.
On a visit to my bank to discuss getting a mortgage to buy an investment property the banker took a look at my accounts and suggested that I could save money by refinancing. After running the numbers the monthly savings were enough to justify the $1990 closing costs. Refinancing lowered my rate from 4.25% to 3.5%, required an appraisal which lowered my loan to value from 87.5% to 82.6% thus cutting my monthly PMI premium in half, and reduced my monthly payment by $228. Not only will refinancing save tens of thousands over the life of my loan it also brought down the annual cost of ownership.
Oh and pro tip on PMI. It’s determined in 5% increments, meaning that there is no difference in the PMI you’d pay putting 10% down versus 11% or 12%. The key to reducing the premium is getting below the next threshold. I went from 11% equity to 17% equity which is what triggered the price drop.
I improved my property
My eternal disdain for carpeting led me to invest in home improvements before I even moved my furniture in. I spent about $4000 to have hardwood floors installed in both bedrooms. This helped increase the value of my condo in comparison with similar units.
I picked the right type of unit
When I first made the decision to buy I considered a variety of bedroom and bathroom combinations. 1/1, 2/1, 2/1.5. I quickly honed in on the magical combination of two bedrooms and two bathrooms. These units tend to have the best resale value due to their appeal to buyers and renters of numerous demographics. Singles, DINKs, small families, roommates…two bedrooms and two bathrooms work well for all of the above living arrangements.
I made income from my condo
“You should rent your place on AirBnB.” My asshole brotha from another motha who usually has nothing worthwhile to say actually made himself useful when he texted that message a few months after I’d moved in. Since then I have made over $7000 in tax-free income by renting out my entire place whenever I go out of town. It’s good money and the only work I have to do is clean up before the guests arrive.
How I Got Lucky
Timing and Location
I started shopping for a condo spring of 2015. Since then there has been an avalanche of real estate development throughout Chicago, McDonald’s announced it was moving its headquarters from the suburbs into the city, and housing prices have risen by more than 15% in some neighborhoods. It just so happens that I inadvertently picked a neighborhood that was starting to heat up. When I first started looking I didn’t have a specific location in mind. I knew that I wanted to be close to the lake, within a ten minute walk of a train that could take me to the office, and near grocery stores, restaurants, a drug store, dry cleaner, etc. I wanted to have the same setup I’d enjoyed when I lived in the South Loop. Although I had been living in Chicago for almost three years by that point in time I still didn’t have much of a grasp on the city’s layout and where certain neighborhoods were in relation to each other. I probably toured fifty listings in ten different neighborhoods before finding my place. I did give up living close to the lake but I quickly got over it. I hadn’t even heard of my current neighborhood prior to buying here. It turned out that it’s sandwiched in between two very popular neighborhoods that people are getting priced out of and it is a short commute to the offices of several major companies. These factors and the local amenities have brought a spike in demand which has led to…
Appreciation that outpaces inflation
The reason why real estate is considered a good longterm buy is because it tends to appreciate at the rate of inflation. Standard inflation is typically pegged at 2% annually so every year the value of your home should steadily increase. This is also the reason why a personal residence is not considered an investment, because the ROI is small and can be wiped away by the cost of maintenance, improvements, utilities, and taxes. In my first year of owning the condo, it appreciated 4.5% after improvements. In year two my value jumped by another 8.4%. Thus far the appreciation has been good, but not so good that prices are based more on speculation than actual value. Gaining $55,000 in equity strictly from appreciation has not only been great for my net worth, it also allowed me to drop PMI premiums in two years without additional principal payments. Which brings me to another fortuitous decision I made…
Putting less than 20% down
Now I know that down payments elicit very strong opinions. There are many who say that if you cannot afford a 20% down payment then you cannot afford to buy. Others are much more lax on this standard and argue it is risky to tie up a large amount of cash in a house. Hell, there are some who are fine with putting nothing down at all. First, I could have put 20% down. However, it would have taken the majority of my capital and I would have had to push back closing. My first inclination was to make it work anyways in order to steer clear of PMI. I had a strong aversion to PMI ever since I purchased my first house in 2004 and was told it should be avoided because it did not add to equity nor was it tax deductible. Back then I was able to put 5% down, but also get a home equity loan for the remaining 15%.
Alas the lending voodoo of yesteryear is no longer allowed today so my options were 20% down or PMI. Math and past experience made the decision for me. First, prior to moving to Chicago I had a history of moving every two years on average. Between October 2009 and November 2010 I had lived in three different states. Although I was happy in Chicago, I knew that I could not commit to staying put. I could not justify tying up an additional $40,000 just to avoid paying $100/month for a home I may only live in for two to five years. Additionally, after seeing my first house lose 32% of its value during the last recession I was nervous about being burnt by depreciation. I decided to put 11% down, suck it up, and pay PMI.
Without any appreciation and making just my regular payments it would have taken me five years and three months to build 20% equity and get the PMI removed. However, thanks to generous appreciation I ditched the premiums in two years without having to spend any extra money. By checking RedFin regularly for recent sales prices in my neighborhood I made an educated guess that paying for another appraisal one year after my refinance would yield good results.
Other offers fell through
The moment I toured my condo I knew that it was the one. Even the carpet in the bedrooms couldn’t keep me from making an offer. However, it was not the first place I’d put in a bid. In hindsight I would have overpaid for one place and overextended myself for another. I am beyond grateful that my previous offers either fell through or were outbid.
Mistakes…I Made a Few
By no means did I do everything right when reentering the world of home ownership. Jumping into buying with no prior planning is a recipe for doing at least a few things wrong.
Not saving for a down payment
I know you’re probably wondering how I managed to buy a house without saving for it. I did have a few thousand dollars in the bank at the time, but that was my designated emergency fund and it definitely did not hold three to six months of living expenses, let alone enough for even 5% down. The money for the downpayment and closing costs came partially from the repayment of a loan I’d made and mostly from raiding my 401K (again). Although I was able to take out some of the money without penalty (since it was more than five years since I had sold my house I was once again considered a first time home buyer), buying my condo decimated my retirement savings at the time. Was it worth it?
I love my place, the neighborhood is booming, and Silver Betty has her own room (well really she shares it with three other vehicles). Even with all that I probably would not make the same decision now. I’m behind on my retirement savings and a big reason is because I dug into them early. I could have paid for everything with little to no withdrawals from my 401K if I had asked for a longer escrow and waited until I received my signing bonus to close.
I didn’t negotiate the price
I paid asking price for my condo. I also did not request any seller funds toward closing. The desire to be done home shopping plus my obsession with the property made me a bit too eager. I later saw that two of my neighbors who had moved into the building a couple of months before I did had paid $5K-$10K less than I did for pretty much the exact same unit. While not a big deal in the grand scheme of things I do sometimes kick myself for not at least trying to save a few dollars.
I didn’t know enough about the HOA
One of the must-haves on my shopping list was a monthly HOA assessment under $400. When I saw $232 on the listing, a property that I loved became my condo in my head. Finding out that the association had very healthy reserves only made me more sure that this was the place for me. It wasn’t until I’d lived here for a month that I learned that only seven of the eight units were paying assessments. One owner was not only in foreclosure, but had also stopped paying his dues years ago, declared bankruptcy, and relieved his unit of all its appliances and fixture (that includes the kitchen cabinets, bathtubs, toilets, etc). Not only were the remaining seven owners (which now included me) making up the difference from the missing payments, the association could not rent out the vacant unit since it was uninhabitable and we did not have the funds to renovate.
Thankfully, the situation worked itself out. The bank was finally able to finish foreclosure proceedings when the previous owner came out of bankruptcy. The unit was sold, the past due assessments were paid in full, and eventually the place was flipped and sold to an owner who pays his HOA dues on time. However, the situation did hit my pockets in the form of HOA increases and higher payments for necessary special assessments. Which brings me to…
One of the most often touted advantages of homeownership is the insulation against rising rent. If you get a fixed interest rate the monthly principal and interest payment remains the same for the life of the loan. However principal and interest do not a monthly housing payment make. There are also property taxes, insurance, and for many of us HOA fees. While I knew that property taxes could fluctuate, it never occurred to me that my HOA would. Well in the first 18 months of living here my dues have changed twice. First they went up $80/month then they went down $45 a year later.
I also learned that if you belong to an HOA special assessments are unavoidable. Eventually the building’s roof will need replacing, the brick will need to be sealed, something will need to be tuck pointed and you’re going to have to pay your share of the expense. I was so excited about a small building with low assessments and strong reserves that I did not bother to ask what work needed to be done or when the last special occurred. Six months after moving in I was hit with a $3700 masonry bill.
Ultimately, shopping for and buying a place is just the beginning. Homeownership is an ongoing adventure with its own set of rules, pitfalls, mistakes, and payoffs. Stay tuned for part three of this series where I’ll break down how I’ve managed the unique costs of owning versus renting. Until then hit the comments and let me know your home buying wins, fails, and “holy shit I got lucky” moments.