What if I told you that all you need to do to own a million dollar home in the future is a $9,750 down payment?
I can only begin to imagine the scrutiny this article will draw, so let me first explain a few things. Yes, I am well aware that different markets produce different price points and annualized appreciation. Yes, I am aware that interest rates will change over time. Yes, I am aware that there could be another housing crash. Yes, I am aware that a meteor could hit the planet and ruin this 15-year plan that I am explaining. This article cannot possibly encompass every scenario for every person in every market, but it can paint a picture of the ability to climb your way into home ownership. The biggest problem people tend to have is a lack of an action plan that they will execute. They see an expensive home and think, Ill never be able to afford that. And so they dont do anything. The worse thing in life is to do nothing. Dont have paralysis by analysis; read this article and take the baby steps that will lead you to success.
- 5% annual market appreciation
- 4% interest rate
- 43% debt/income ratio
- No other debt
- 6% loss at each sale (commissions, escrow, and closing costs)
- Market: Santa Barbara, CA
My hometown of Santa Barbara, CA is consistently on the list of the most expensive places to live -- our median home price is about $1,200,000. To make my point that home ownership is a possibility for anyone, Ill use numbers from this incredibly expensive market.
Step 1) Buy $325,000 Condo
The most affordable thing to buy here in Santa Barbara, especially for first time buyers, is a 2bed/1bath condo for about $325,000. Using a new Fannie Mae loan that only requires 3% down payment, you can buy this condo for only $9,750 down payment. The mortgage (including mortgage insurance (PMI), property taxes, and HOA fees) will be +/- $2,700/mo. This payment amount requires a combined income of +/- $75,000/year.
Step 2) Sell Condo, Buy $525,000 Home
After 5 years, sell your condo for +/- $415,000. This will leave you with +/- $105,000 for a down payment on a $525,000 purchase. This home will be small and probably a fixer, but that is ok! Your mortgage will be +/- $2,700/month which means your combined income can remain at +/- $75,000/year. The reason the payments do not go up with a larger loan amount is because you are buying a house (no monthly HOA fees) and have 20% down payment (no mortgage insurance).
Step 3) Sell Home, Buy $750,000 Home
After another 5 years, sell your home for +/- $670,000. This will leave you with +/- $250,000 for a down payment on a $750,000 purchase. Your mortgage will be +/- $3,125/month which means your combined income will have to be +/- $87,000/year.
Step 4) Sell Home, Buy $1,000,000 Home
After another 5 years, sell your home for +/- $960,000. This will leave you with +/- $450,000 for a down payment on a $1,000,000 purchase. Your mortgage will be +/- 3,400/month which means your combined income will have to be +/- $95,000/year.
Are These Numbers Correct? Yes!
You may think that these numbers are drastic and unrealistic. How can I end up with a $450,000 down payment in just 15 years? The answer is a combination of principle reduction and appreciation.
- Principle reduction: A portion of your monthly payments goes towards paying off your loan. Wouldn't you rather pay monthly towards equity in your home rather than rent?
- Appreciation: Real estate as an investment is incredible because you have the ability to leverage your money in powerful ways. When the market increases a certain percentage, you benefit from the increase of the homes total worth, not just how much you have invested as a down payment. That is how an initial investment of only $9,750 turned into a $450,000 down payment after only 15 years.
Notice, The Salary Barely Increased
Youll notice that salary did not have to drastically increase during this process; it went from $75,000 to $95,000 per year (which is not crazy for a combined household income). The reason is because your down payment percentage continues to increase; the first purchase is 3% down while the last is 45% down.
Side Note: Home Ownership Offers Great Tax Benefits
Mortgage interest is a tax deduction, so in addition to making money as the market appreciates you also save a lot of money each year on taxes! Check with your accountant for specific details.
Listen, I understand that this is a very simplistic overview of investing in real estate. However, the overall method is tried and true and if it works in a market as expensive as Santa Barbara, it can work anywhere!