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Some of this Dave Ramsey advice is worth following, but homeowners should avoid one rule.
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If you want to buy a home, you need to make sure you’re financially prepared. And, of course, you must also make smart choices about what mortgage loan you end up with. To help ensure you don’t regret your property purchase, finance expert Dave Ramsey has outlined three rules you need to follow.
He’s right on two of them, but not the third. Here’s why.
1. Make a down payment of at least 5%
First and foremost, Ramsey says you should not move forward with buying a home unless you can put some money down for it.
“Here’s the bottom line: If you can’t afford to put any money down on a home mortgage, you’re not in a financial position to become a homeowner.”
Having no down payment is risky because you won’t be able to sell your house for enough to pay off the mortgage and closing costs for a long time — even if property values stay the same. If property values fall, you could end up owing much more than the home is worth.
Ramsey ideally recommends a larger down payment of 20% to avoid having to pay for private mortgage insurance (a policy that protects lenders against loss), but said “a 5–10% down payment will work, especially if you’re a first-time home buyer, but be prepared for the PMI payments.”
This is good advice and you should follow this rule, aiming to put down as much as you can to get the most affordable loan.
2. Take out a 15-year mortgage
Ramsey’s next rule relates to the type of mortgage he recommends.
“No matter how much you’re putting down, go for a fixed-rate 15-year mortgage,” the Ramsey Solutions blog reads. Ramsey believes this is a better option because it allows you to become debt-free sooner.
This is the rule you should break. A 15-year mortgage comes with monthly payments that are much higher than on the more popular 30-year loan. There is a huge opportunity cost to making these high payments.
You’ll need a larger emergency fund to make sure you can afford the payments if things go wrong. Additionally, you won’t be able to invest all that extra money you’re putting toward your mortgage, and you’ll be accepting a much lower return on the money you’re using to pay down your loan if you opt for a 15-year loan. You’d be much better off investing and potentially earning around a 10% average annual return with a safe investment in an S&P 500 index fund, rather than the paltry return on investment (ROI) that comes with saved interest.
Instead of listening to Ramsey on this, consider getting a 30-year loan. If you decide you have extra cash and want to pay it off within 15 years, you can, but you won’t be tied into a huge payment you can’t escape.
3. Keep your payments to 25% of your income
Finally, Ramsey suggests keeping your housing costs to no more than 25% of your income. This is good advice because you don’t want to end up house poor. If you take on too large a mortgage, you could regret it when doing other things with your money becomes impossible.
If you’re looking to buy a home the right way, make sure you follow two of these three rules. Save up a good size down payment, be sure your housing costs aren’t too high, and get a 30-year loan that has the best interest rate you can find. This is the best recipe for success in home buying, and it maximizes the chances your purchase will pay off for you in the end.
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