The Hidden Risk of Buying a Home Like You Buy a Car

by Kevin on March 16, 2012

Buying a home is fraught with financial dangers. But there’s one hidden cost you probably haven’t thought of that will keep your finances from really progressing for decades. Do you know what it is?

Any purchase that involves thousands of dollars should be seen as a big deal. When you are dealing with five or six-figure purchases, negotiation and a deep understanding of the cost is critical. When you agree to buy a vehicle you’re likely agreeing to own a (depreciating) asset for several years — ideally 10+. Likewise with a home; you want to hold it for a long time lest you never make a dent in the principal.

So what’s the hidden mistake you probably won’t catch?

How the Average Person Looks at a Car Purchase

I thought we were talking about buying a home? We are. Stick with me.

When the average American goes to buy a car they do some research about what type of car they want, but not as much on the costs or where to buy the vehicle. If dealerships were as bad as everyone makes them out to be, they would go out of business. But the average person doesn’t want to deal with the hassle of tracking a used car down with used car financing. We’re all about easy, fast, quick, give it to me now.

What does the average car advertisement look like?

The problem most people have with buying a car — and you’ll notice this in the car company’s advertisements — is the monthly payment.

There’s no talk of the total purchase price of the car. That’s down in the fine print you never have time to read.

There might be a mention of the interest rate, but it is usually a promotional rate that only those with the best credit will receive.

There’s no up front discussion about the number of months you will need to have that monthly payment. If it is mentioned it is, again, down in the fine print.

The car loan trap

That’s because the dealerships want you to focus on one thing: the monthly payment. As long as the monthly payment fits into your budget (forever!) you will be able to drive their vehicle. And when it starts to run down — or when you’ve paid off the loan — they’ll gladly let you trade it back in at a horrible loss and buy a new shiny vehicle on another loan.

It’s a trap that keeps you focused on the monthly payment rather than the total cost of the vehicle plus the interest you pay.

Purchasing a Home with a Car Buyer’s Mentality

Maybe you can see where I’m going with this.

The problem with buying a home is most people focus on how much of a monthly payment they can afford. There is some good in this because, obviously, you need to know what your budget can withstand. But when the only focus is on how much it will cost you for the loan, you miss a big problem: how much it will cost you in total.

We do take home price into consideration as we go home shopping. But I’d bet 9 out of 10 people shopping for homes base their price on what monthly payment than can afford at today’s current interest rates.

I talked about this in How a 30-Year Fixed Mortgage Holds You Back Financially. The difference between a 30-year fixed and a 15-year fixed mortgage in today’s market with a principal balance of $160,000 is $70,000.

“But the 30-year fixed mortgage payment is so much more affordable!”

Is it?

Or should you be basing how affordable it is by the amount of interest you will pay or how long you will be indebted to the bank?

I’m not saying 30-year mortgages are all bad. However, there is a serious problem created in any purchase when the focus becomes the cost of the payment rather than the cost of the purchase. The payment may seem affordable now, but once you run the math you may decide that holding off on the purchase or not purchasing at all is the best decision.

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