Ooops! She broke the 25% Rule ….

keeping up with the jonesI wrote a post some time ago about how I broke (nay, smashed!) the 20% Rule (you know, the one that tells you what % of your net worth you should have ‘invested’ – read: tied up – in your own home) when I bought my latest house – considering that we paid $4 mill., are about to renovate for at least $1 mill., and still own another $2 mill. house that we haven’t been able to sell due to the crash, I’d say that we need some major corrective action … which, I outlined in this post.

The next housing problem that I wrote about, doesn’t affect me (as we paid cash for our houses) but, was how to deal with the now-all-too-common situation where you are ‘upside down’ on your mortgage.

Now, thanks to Alexandria who commented on that post with a question, we can now assess the third major housing-related financial problem: what to do when you break the 25% Rule (the one that lets you know how much of your income to spend on rent/mortgage payments)?

Panic is always a good first option …

… before we do that, let’s hear Alexandria’s ‘problem’:

Ok… after reading the above I want some options on my situation. Married, three school aged kids. Currently own a home with a high mortgage that is worth just about $50K more then we owe. Not the home of our dreams. We are not in foreclosure. I am self emplyed and my husband is a Police Officer. We can make our monthly mortgage but it eats up about 60% of our monthly income. We have no savings, a mininal 401 plan, no large other debt. We are both in our mid thrities. We can rent a much nicer home in our area for about $1k less then our mortgage a month. If you were us, would you sell and rent or keep the house?

OK indeed!

My first piece of financial advice would be to dump the copper and marry some rich bloke (I’ve seen your photo) who looks like me … but, marriage proposals aside, I can’t offer you any better advice than that, because I am NOT you …

… that’s why I struggle to answer specific “what would you do if …” questions on this blog, because I rarely have enough information to know how to deal with YOUR Life’s most difficult financial decisions.

BUT, it’s not all doom-and-gloom, because I can use wonderful readers’ questions, such as this one, to inspire some general points: just don’t construe it as direct personal advice, even though I may liberally intersperse “you” and “should” in my posts to make them more readable.

Disclaimer out of the way 🙂

Even though I can’t really give you the answer that you can ‘take to the bank’, I can ask why you would consider keeping a home that you don’t like, when you can sell it and rent a nicer one and save/invest an extra $12k a year?

Better yet, what would it do for you financially (balanced against family ‘needs’ … not keeping up with the Jones’ … hence, the image at the top of this post) if you sold this place and used the freed up equity as a deposit against a smaller/cheaper place that fits closer to the 25% income Rule, and then used the money saved on mortgage payments (100% of it!) to finally start to build your financial future?

Remember, given that this is effectively your first home (i.e. you have not built up any housing equity yet) the answer – for you – maybe somewhere between the two …

Nice house v fewer financial headaches … what a trade-off to have to make 🙂

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4 thoughts on “Ooops! She broke the 25% Rule ….

  1. hi! i accidentally stumble upon your blog. i think it is wonderful that you write about your personal financial journey.

    anyway sir, i have a question. how do people like me age 24, working like any other employee in the creative field go about building our millions? i have always been interested in real estate business and becoming a landlord, though at my age and with my income (with the economy included) i don’t know how to start. i want to start working on it as soon as i can. some tell me save and save and save, though i doubt it will work. i will be an old man before i build my first building if i just save save and save. i hope you have a wonderful experience to share about this. 🙂

    thank you and have a nice day! 🙂

  2. >We can make our monthly mortgage but it eats up about 60% of >our monthly income
    >We have no savings, a mininal 401 plan, no large other debt.


    That 60% of income make the mortgage pretty risky – if you or your husband lost your job could you continue paying that large of a mortgage payment? Even if that didn’t happen with no savings, what happens if there is major expense- a new roof, AC, or furnace?

    If you aren’t comfortable with that risk I see a couple of options:

    #1 Refinance your loan- rates are still pretty low 5.27% for 30 year fixed, but this won’t solve the problem unless your current loan rate is much higher. You would also need good credit and there are closing costs. Finally, it won’t make your house any nicer…

    #2 Sell and rent – It sounds like the rental market in your area has some great deals right now. Also, that $1000/month could be a real key to building wealth.

    #3 Sell and buy another house. You could sell your house and buy a less expensive house.

    #4 Rent a while then buy – sell your house, rent for a while then look into buying if you don’t like renting. Since you have a place to live and no pressure you could make a really low offer and wait and see… could be a great way to buy a real bargain.

    The real question is how much can you get for your current house? Estimates are one thing, real offers are another!

    -Rick Francis

  3. I agree with Rick. 60% of (after tax?) income going in mortgage payments does not leave much room for problems.

    I’d also suggest running a comparison of all the numbers (sell and buy smaller v sell and rent). It’s useful to distinguish between cash flow and expense. Of the mortgage payments, part will be interest (expense) and part will be principal (savings). In effect, part of the $12K in savings from renting is already being saved by way of reducing the principle amount of the mortgage). All the other costs need to be factored in as well – as home owners typically face more expenses than renters, this will increase the savings gained by renting but the transction costs of selling and buying (and moving) can be pretty steep.

    Depending on the area you live in and your longer term plans, you may also want to take a view on the future direction of the real estate market. If prices improve while you are renting, it may end being more difficult/expensive to get back into the market.

    Assuming that the real estate market in the area is at depressed levels and I had the ability to lock in long term financing at relatively low rates, I would want to own property both as an investment and as a hedge against future increases in the cost of accomodation.

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