Despite an increase in interest rates, housing prices are still very high. Existing homeowners do not want to sell because they have mortgages that were set in a low-rate environment, so if they move their monthly cost will go up for the same sized house. The result is there are not very many houses for sale in comparison with demand. Sales of newly built homes have been increasing, but it takes time to build, plus inflation has meant it costs more to build a new house than it used to. Meanwhile, apartment rents have been subject to inflation as well. Yikes! We don’t expect interest rates to reverse any time soon, so the situation may go on for some time.
How do you have a place to live and still make ends meet?
It is hard! We wish we had a magic wand. The good news is that our advice should be able to help you, if you apply it consistently over a long period of time.
If you are struggling with credit card debt, spend more than 30% of your income on housing, and have little in the way of savings, you are not alone! Don’t despair, there are positive steps you can take to solve the problem. We suggest you establish a budget as soon as possible. A plan that you stick to can get you out of debt into equity.
To get started, take a look at your monthly expenses. Looking for savings on your biggest expenses will naturally have the biggest impact. For most people, their biggest expense is housing. The rule of thumb is to spend 20-35% of your budget on housing. However, if you live in a big city, or if you are working in your first job, where you are gaining valuable experience, but not getting paid very much, that may be a difficult target. Nevertheless, see if there is a way to reduce your housing cost from the present level: consider moving, consider having a roommate, and above all, don’t rent more space than you actually need. We are even fans of multi-generational living, provided you get along with your family. It may be cheaper to pay a relative to live in their house than to have a separate apartment.
If you have credit card debt that you don’t pay off completely at the end of every month, with interest rates at present historically high levels of about 20%, please keep in mind that you are paying more than the stated price for everything you buy. Try to pay more than the minimum payment each month so that you eliminate interest as an expense. Every dollar that you pay above the minimum will reduce your interest expense next month. Paying interest on credit card debt is a waste of your hard-earned money.
Are you thinking about buying a house?
Conventional wisdom says that a house is a good investment. Indeed, it can be, so we are in favor of owning your home, if you do it prudently. When you can take the cash that you presently spend on rent and use it to pay a mortgage and maintenance costs on a house that you own, you can expect to be better off if the house appreciates over time. This is especially true given that mortgage interest is often tax deductible. However, there are a few cautionary points we want to make related to the housing market.
First, it is dangerous to assume that housing prices always go up. California is presently experiencing a downturn in housing prices, with May prices down 6% compared to a year ago. During the credit crisis in 2008, average U.S. home prices declined by 20%. By 2010, 23% of all U.S. residential mortgages were under water. That means the price of the house was less than the outstanding mortgage. For the most part, people who did not have to sell their houses were not hurt because prices rebounded and now those houses are worth a lot more than when they were purchased. However, a person who lost his job, could not pay the mortgage, and had to sell the house, likely lost money.
The key caution is that when you buy a house, you need to make sure you can weather the storm if you lose your job or have some other financial emergency. Also, you need to make sure that you have enough money to pay for maintenance, otherwise the house will deteriorate and lose value. Therefore, we recommend that you make sure you have plenty of money set aside for emergency costs.
Banks are almost always willing to lend you more than we would advise you to accept, so we strongly recommend not buying the largest house you can afford according to the bank. Of course, it is always better to buy a small house in a good area than a large one in a problem area. Real estate is always about location.
You don’t have any consumer debt and you own a house, what is next?
Congratulations on your financial health. Make sure that your extra money is working for you, not sitting idly in cash. We do not give investment advice. However, we will point out that interest rates are up if you are a borrower, but they are up too if you are an investor. Funds that might be needed in the next year can go into short-term investments that are presently yielding 4-5%. Long-term funds that won’t be needed for a few years can go into a diversified portfolio of stocks. While bonds may also be a reasonable choice for medium term investment, with inflation at 5% or so, it is hard to get a real return in bonds that keeps up with inflation. Especially if you are many years from retirement, we tend to prefer a high-quality diversified stock portfolio.
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