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Welcome to NerdWallet’s SmartMoney podcast, where we answer your real-world money questions.
This week, we’re talking to Chris Browning of the Popcorn Finance podcast, who wants to buy his first house. Chris wonders how to pull it off in Southern California, where home prices are high and options for first-time buyers seem limited.
Becoming a first-time home buyer is particularly tough in expensive places such as Southern California, where the median home price is over $500,000. In most other parts of the country, you can pay a lot less, get a lot more house or both. But not everyone can move away, or wants to.
Every home search should start by getting a realistic estimate of what you can afford. You don’t need to have a 20% down payment — most first-time home buyers put down far less, often as low as 3% (or 0% if they’ve been in the military and can qualify for a VA loan). Many areas, including Southern California, have programs to help first-time home buyers come up with the cash for a down payment.
Smaller down payments mean you have to pay private mortgage insurance, but it’s generally better to get into a home and start building equity than to put off a purchase waiting to amass a larger down payment. It’s possible to wait too long and have home prices rise so much that you can no longer afford to buy.
You do, however, need to have enough money saved to cover not just the down payment but also closing costs and at least two months’ worth of mortgage payments.
Also, don’t buy if you’re not sure you’re going to stay in the area. The costs of buying and selling a home are significant and it takes a few years’ worth of appreciation to offset those.
Make sure you can stay put. You typically need to live in a house for three to four years, maybe even more, just to break even.
You don't need a huge down payment. You'll need to pay mortgage insurance, but you'll also get into a new home sooner and start building equity.
But you do need to save up more than just your down payment. Expect to pay closing costs and have a cash reserve big enough to cover a couple of mortgage payments after closing.
More about first-time home buying on NerdWallet:
Sean Pyles: Welcome to the NerdWallet SmartMoney podcast, where we answer your money questions and help you feel a little bit smarter about what you do with your money. I'm your host, Sean Pyles.
Liz Weston: And I'm your other host, Liz Weston. As always be sure to send us your money questions. Call or text us at 901-730-6373. That's 901-730-NERD. Or email us at [email protected]
Sean: This is typically the part of the show where we would get to the listener's money question, but we're doing things a little bit differently over the next few episodes, where we're going to be trying out a few new segments. We'll still be answering your money questions, so don't worry about that.
Liz: In this episode, we're having a conversation with Chris Browning from the Popcorn Finance podcast about how to buy a home in an expensive market. But first, it's time for our new segment, This Week in Your Money, where we talk about what's happening in the personal finance world right now and how it might affect you.
Sean: Yeah, and this week, we're gonna be talking about how Americans are using their emergency funds right now. The long and the short of it is that 30% of Americans have tapped their emergency funds in response to the coronavirus pandemic. That's according to a NerdWallet survey conducted online by The Harris Poll from April 8-10.
Liz: And what it found basically, besides three in 10 Americans tapping their emergency funds, is that nearly 1 in 5, or 18%, didn't have an emergency fund to begin with.
Sean: Which brings me to something I want to talk about, which is that now is the perfect time, the best time really, to start saving if you can. It's interesting because, while a lot of people have had their incomes impacted in one way or another by the coronavirus — 1 in 6 Americans is out of work according to recent numbers — we also are in some areas spending less. We're not going out to the sports games. We're not going out to the theater as much, and that can translate to an opportunity to save right now.
Liz: Yeah. We've noticed something different in our household, though, because we're ordering in a lot of things — dinner for one, groceries. I have some hobbies that I've been gearing up for. It can be really easy to spend money online. But in general, yeah, there's a lot of areas. Travel was a huge part of our budget, and that's obviously gone. So there are opportunities, if you can, to put some money aside. And I really think it's a good idea right now. We don't know what's next. That's the thing about this pandemic is that there's so much uncertainty. And if you have the opportunity to cut a few expenses, now's a really good time to do that.
Sean: Yeah, exactly. But also at the same time, this is what emergency funds are for. So if you did lose your job or your car broke down, this is what you would want to use that money for. Something that you want to consider is, OK, now is when I want to save, but also now is when I might need to tap this fund. Liz, I'm wondering, in general, do you have any parameters for when someone might want to decide, OK, here's when I'm using my emergency fund versus here's when I'm pulling out the credit card?
Liz: Yeah, that's a really good question to ask yourself, and there are some rubrics that I use in the situation. A lot of people, they save up a certain amount, and then they think they have to preserve it. It’s like they'll pull out their credit card instead of using their fund. And that doesn't always make sense. So here's the general thing. First you want to — if you're thinking about using your emergency fund — first, you want to cut every possible expense. That's why we talk about the 50/30/20 budget. You identify what are the must-haves, what are the wants, and what is, you know, what you need to be using to pay down debt or to save. The first thing you do is you look for expenses to cut, and then you look at those extra debt payments you've been making. And you basically halt those. And in fact, you look at debt in general. If you can make the minimum payments right now or even get forbearance, that's a super good idea. The idea you want to keep in your head is you want to maximize the amount of cash that you have on hand and have access to so if that means getting forbearance, if that means asking for lower payments from some of your lenders, that's probably a really good idea right now. Once you've done all that, and you still need the money, then that's when you start tapping your emergency fund.
There's one other sidebar to this whole discussion, which is, if you were struggling before the pandemic, there's a pretty high chance that you might wind up in bankruptcy court. And if that's the case, you really want to be strategic about how you're saving and spending money. You really don't want to be making those extra debt payments on debt that you could be discharging in bankruptcy. And I also want to talk, always, about — you do not want to take money from your retirement accounts to pay debt. It's a bad idea in general, especially bad idea now.
Sean: But if you're going to save, maybe you would want to put that money into a retirement account, which wouldn't be able to be tapped if you're filing for bankruptcy.
Liz: We've discussed this in a couple different places on the site, which is if you are headed for bankruptcy court, any money you have in savings could be taken by your creditors. So if you are trying to save up money to file for bankruptcy, for example, one of the places you can put it is into a Roth IRA. Now with a Roth, any money that you put in, you can take out at any time. It's tax-free, it's penalty-free, but the money is safe from creditors while it's in the Roth. So that's something to consider.
Sean: I want to circle back to your mention of debt payments and potentially putting off debt payments. There are all sorts of offers being put out from various creditors. Obviously, federal student loans are on pause through September. Now is a chance to gather as much liquidity as you can and put it into savings because, as you mentioned, we don't know what's happening. And yet no one thinks that they're going to be filing for bankruptcy at the end of the summer, but chances are, there's gonna be a pretty big spike. So do what can you do right now to drum up some cash so that you can cover whatever unexpected expense may come up, and you can roll with the punches a little bit easier?
Liz: The idea to keep in mind is financial flexibility, and hoarding cash, but not hoarding it to the point where you're not spending your emergency fund when you need to. There's, as we've said, a balance to be struck here, and it's kind of different for each person.
Sean: Mm hmm. Well, with that, let's move on to our conversation with Chris.
Liz: All right, sounds great. We recorded this episode before all the "safer at home" shelter in place orders came down, which put the real estate market on hold. But as areas start to reopen, more people will be able to restart their efforts to buy a home, and that includes Chris.
Sean: Just make sure you're wearing a mask and probably some gloves when you're touring a house.
Liz: Good idea. Yes.
Sean: Let's get to our conversation. To help answer Chris’ questions, we brought in Holden Lewis, our resident home-buying Nerd. Chris, Holden, welcome to the show. So happy to have you guys on.
Holden Lewis: Greetings from South Florida, where the houses are a lot cheaper than where you are, but the incomes are a lot lower, too.
Chris Browning: Yeah, it is crazy-expensive out here. That really makes me think of my very first question, which is, is it even worth it? Is it even a smart decision to buy a house in a market where it is just so overpriced right now?
Holden: Well, I kind of question whether it is, frankly. When I hear people who want to buy a home in California, in LA or San Francisco especially, I feel like telling them just move to Texas. I know that there's a lot of ties keeping people in California, but sometimes I wonder, well, if you're not in the movie business or the tech business, why not go to Texas, or Idaho or Colorado or...?
Sean: I think the hard part with that is that a lot of jobs are in California or other expensive markets, and a lot of folks don't have the luxury that you and I have, Holden, of being able to work remotely full time. So people need to stay in these expensive markets, but they don't want to be renting forever. And that's a really difficult conundrum to work through. Chris, it sounds like that's kind of where you are. I'm wondering what it is that's making you want to buy a house in California?
Chris: You know, I really go back and forth on the idea because it is a lot of money. It would definitely increase our expenses a huge amount, but at the same time, rent is constantly rising as well out here in California. So I'm kind of thinking ahead and saying, “Well, at some point, will rent become too expensive for us to viably still continue this route? And maybe we should start looking at our options if we are going to consider buying.”
Sean: Right. So do you have a general budget that you're working with right now, or are you still scoping it out?
Chris: So, as of right now, we've looked around, and probably the highest we would consider is somewhere around $500,000, which still suddenly seems like a ton of money. It seems like a lot to actually commit to because that will put us a little bit more than what we're paying in rent right now. But the problem is the issue with coming up with a down payment. And that was going to be another one of my questions for Holden was, is the whole concept of making sure you put down 20% to avoid PMI and all the other things, is that still the best practice that you would recommend to people?
Holden: When we're talking about first-time home buyers, especially in the expensive, most expensive housing markets, a 20% down payment has been an unreasonable expectation for a long time. You know you have options like the VA loan, you can buy a home with 0% down. That's a wonderful program for people who qualify for it. People who are in active-duty military or retired and a few others. But there's also first-time home buyer programs that let you get in at 3% down. You can get an FHA loan at three and a half percent down, and that's especially good if your credit score is below 720. The way I look at mortgage insurance is that it's the price that you pay for buying now when you want to own a home, rather than waiting to save that down payment and meanwhile home prices keep rising.
Chris: Mmm. Yeah, because that is one of our concerns is the longer we wait, the housing seems to just continue to keep growing in the process of us waiting.
Holden: That's right. I mean, with mortgage insurance, let's say you pay $500 a month for mortgage insurance, which would be quite a lot, but in a really high-price market that might be the case. Well, are home prices rising faster than $500 a month? They probably are. And so, it just kind of makes financial sense. OK, well if you're spending that amount every month, but your appreciation is rising faster than that PMI payment, it's probably worth it.
Chris: Hmm. That makes sense. I mean that's definitely a better way of looking at it than the way I'm looking at it now, which is PMI is a lot of money. So, I appreciate that.
Holden: Yeah. Right. I mean, people look at it as a necessary evil, and I think of it as more like an expensive good. It is allowing you to buy that house now, and it's really valuable to buy a house when you're, say, in your early 30s instead of having to wait until your late 30s.
Chris: No, that makes sense because it's such a scary prospect of committing to something that I think every little thing that makes it a little more expensive kind of scares me away at times.
Sean: Yeah, especially because you're putting a lot of money into a down payment, but then you also need to have some reserves still for when emergencies pop up, as they inevitably will. And all of that takes a really long time to save. Do you and your wife have a timeline for when you want to buy a house?
Chris: We were thinking probably not within the next 12 months, just because we were very focused on building up an emergency fund and kind of taking care of any other things we had as priorities in the near future, and then begin the process of saving up for a down payment, not knowing how much in the end we would have to set aside to buy a home.
Holden: Such a great idea to save up that emergency fund because, frankly, that is going to be required. When you think about the costs of buying a home, people realize that there are closing costs that you have to pay to buy title insurance, and get the home inspected, and to pay the lenders fees. But there's also saving up the reserves, which is money you have in the bank that the lender is going to require you to have so you can actually take care of emergencies that pop up, like a water heater breaking.
Chris: Right now, what would be the typical amount they would expect you to have set aside for those types of emergencies?
Holden: It really depends upon your situation. I mean the way I look at it is with total closing costs and building up reserves there, they're expecting you to save up between 2% and 5% of the home’s price just to pay those closing costs, and to have a few thousand dollars of reserves left after you close.
Sean: So thinking about these numbers here, Chris, if your budget is around $500,000 and you want to put down maybe 3%, then you'll also need another 3% in savings. It seems like just to be safe, you'd probably want to have around $50,000, or 10%, saved so you can make the down payment and then also have your cash reserves as well. Does that seem about right to you, Holden?
Holden: Yes. That does seem about right. Or you could move to Iowa and put down like 30% or 40% down on a house with that kind of money.
Sean: Yeah. I will say, California has a very particular draw, and once you get drawn in, it's hard to pull yourself out of there. So I get it. But there's also a reason why I moved to Oregon and didn't try to buy a house in California. It's just too expensive. It's a really tricky balance. I'm wondering what kinds of compromises you might be willing to make in terms of maybe getting a fixer-upper, or maybe moving a little bit out into a more suburban area. What are you thinking in terms of the changes you'll make and what you want so that you can buy a house in your timeline?
Chris: You know, I think that's what makes it so difficult is that for years, even though we've been renting this whole time, I had an over-an-hour one-way commute to work, and it was miserable. I hated it every day. It was two hours a day I was just sitting in a car. And so the thing is where I work, and where most of the work is, it's concentrated in really expensive areas. And the issue always is, am I willing to move to somewhere that's going to be a definite hour-long commute and I'm like locked into that for years and years, versus maybe being willing to go for a cheaper home that is a fixer-upper, which is harder and harder to find these days out here. But that was actually one of my questions as well was, is the process of finding a fixer-upper — especially in an expensive market — and then going through the work of repairing it and getting up to a place where you'd be happy with it, is that still a good idea in this kind of a market?
Holden: I think it is a good idea if that's the best way to buy a home where you want to buy it and avoiding gigantic commute times. You've got to be careful. One of the main things you've got to do is get a thorough estimate of the costs of fixing up a home from a general contractor. Know exactly what work you'll want and need to have done. Know how much it'll cost, what the possible overruns might be, and you can make a good decision only after you have those numbers, you know? And you also just kind of have to think about the disruption. I think of it in terms of if you're going to still be living in the home while work is going on, how much would you pay to avoid those hassles? And just kind of think of that as an added expense, you know? But I think overall, fixer-uppers are going to become more and more popular because houses are just so expensive.
Sean: Chris, are you considering any sort of tiny house situation or more like a trailer? I know that there are some in the Southern California area. There are neighborhoods have really nice trailers, and it's not the three-bedroom family home that you typically expect, but they can make it really efficient use of the space and they will tend to be less expensive than a traditional home. Is that anything that you're considering or willing to compromise on as well?
Chris: Sean, I actually love tiny homes. I have a slight obsession with them, and my wife and I have looked at them. One of the reasons we were like, “Maybe we should move out of state” was because we stayed at a tiny home resort in Wyoming, actually, a couple months ago. We're definitely open to the ideas, I guess it's just finding the right place. We haven't seen too much in our local vicinity, but we would definitely be open to that if we find the right place.
Sean: Right. Well you guys, I think that might be all we have time for. Chris, do you have any final questions that Holden might be able to answer for you?
Chris: Oh, I would say the one final question I had was that a lot of times people say that when you get into a home, you need to stay there for a certain amount of time for it to be a worthwhile investment. What would you recommend for someone, especially a first-time home buyer? If you're going to finally decide to go in and buy a home, what would be the minimum amount of time you need to commit to staying there to make it a sound purchase?
Holden: Just remember that you're shelling out a lot in closing costs when you buy, and then real estate commissions when you sell. So you want to get a certain period of ownership to make it worth it. I would say generally that's three or four years at the minimum. Maybe even more than that.
Chris: I was always wondering what that point was, where it's like, “OK, now you should maybe consider looking for something else.”
Holden: Right? I mean, I owned my first house for just two years. But first of all, it made a pretty good capital gain. I mean it was in Toledo, Ohio, so the house is cheap. So like a capital gain of like $10-$15,000 seemed like a whole lot. I moved just after two years to take a better job in Florida. So, that kind of thing happens. It's unforeseen and you roll with it. Even if you maybe lose some money on the home sale, if you're moving to get a better job, then it's probably worth it.
Chris: Well, thank you, Holden. I really appreciate all the help. You've answered a lot of my questions here.
Holden: Oh, great. Great. Well, it's my pleasure.
Liz: Now let's get to our takeaway tips. First tip: Make sure you can stay put. Given the costs of buying and selling, you typically need to live in a house for three to four years, maybe even more, just to break even.
Sean: Next up, you don't need a huge down payment. Most first-time home buyers put down 5% or less. Yeah, you'll need to pay mortgage insurance, but you'll also get into a new home sooner and start building equity.
Liz: And finally, you do need more than just the down payment. Expect to pay closing costs and have a cash reserve big enough to cover a couple of mortgage payments after closing.
Sean: And that is all we have for this episode. You can call or text your money questions to 901-730-6373, that's 901-730-NERD. And you can also email us at [email protected]com. Also, visit nerdwallet.com/podcast for more info on this episode.
Liz: And here's our brief disclaimer, thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances. And with that said, until next time, turn to the Nerds.