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November 26, 2009 07:48 AM

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Purchase power: Know your true max

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REThink Real Estate

November 26, 2009 07:48 AM

By Tara-Nicholle Nelson
Inman News

Q: My wife and I were approved to buy a home up to $400,000, but we knew that we couldn't actually afford the monthly payment on that much. So, we started out looking at homes in the $200,000 range. Over the months, we realized that we would have to offer quite a bit more than the asking price to get in.

And so many of the properties we were seeing were in really bad shape -- so bad that we couldn't afford to fix them up if we did get them. So we decided to look in the $250,000 range, but even after offering $30,000-$40,000 over asking, we still weren't getting anything.

Now we're looking up in the low $300,000s -- we're starting to see fewer offers on the properties and better places, but I'm concerned by this trend and I fear that we're in danger of overextending ourselves. How should we proceed?

A: When I was a kid, there was a series of animated commercials for Crest toothpaste in which the city of Toothopolis was attacked by these massive, muscular invaders whose sole mission was to drill cavities into teeth. The name of this tribe? The Cavity Creeps. I believe that you might be running into their cousin: the "Price Creep."

Mindset Management

Unlike The Cavity Creeps, Price Creep has some redeeming qualities. Many times, buyers start the house-hunting process with unrealistic expectations, especially given the hit home values have taken recently. Many first-time buyers or folks who have been out of the market for any significant period of time read the headlines that prices were down and assumed they could get a mansion for a song.

For those who were laboring under this misconception, Price Creep can be useful, even necessary. You need to have some mental flexibility and, ideally, room in the budget to creep your mental maximum price upwards to the point where you're at least operating within the same reality as the rest of the players in the market, or you'll make lowball offers, continually experience rejection, and burn yourself and your agent out -- all without getting a home.

Educated, reality-based Price Creep is the opposite of fantasy-land, ignorant rigidity, and that might be why you were willing to move your price range upward initially.

However, Price Creep Gone Wild is a potentially dangerous animal. I've seen it time and time again -- buyers trying to beat out all the other offers, creeping up by $5,000 or $10,000 every 15 minutes because, well, it adds only $50 or $75 to their monthly payment. And that's true, but those reasonable and incremental Price Creeps, multiplied by four or five, can hike up your monthly mortgage payment from a place where you have to give up a night out a month to a place where you have to give up food altogether -- and that's not a good look, as the kids say.

Need-to-Knows

So the name of the game is getting clear and concrete: on your personal finances and what they can bear, on your priorities, and on your vision for your life in your new home -- and what lifestyle or property must-haves, compromises and sacrifices you're willing to make to keep Price Creep under control.

I want you to move from where you are now (nervous that you'll overextend yourselves) to a place of confidence about what your absolute max is. I want you to be so confident that even if you saw your quintessential dream house, you would have no regrets if you made your best offer and failed to get it, because you know exactly what your best offer is.

To get there, you need to get crystal clear on your personal finances. If you haven't already, write out a list of your current income and expenses. Talk with your accountant or tax preparer to get an estimate of how much your monthly net income will increase when you change the taxes withheld from your paycheck to account for your mortgage interest deduction.

Then, tweak your list to exclude your current rent, and to include all of the miscellaneous costs of ownership (outside of your mortgage payment), like maintenance and utilities that you're not paying now.

This is a truth-telling exercise. You'll have to be honest with yourself about how much you're currently spending on discretionary expenses like dining out, leisure shopping and traveling -- put it all on the list. Ideally, work from your last month's bank statements to get the most accurate picture.

Then, prioritize and make some value judgments as to which discretionary expenses you can reduce once you buy your home, based on what you two feel is worth giving up in exchange for homeownership. Be honest here, too. Some folks will tell you not to buy lattes or to downscale your international travel habit to road trips in the tri-state area.

My suggestion is that you stay true to what you know about yourself and what level of spending-habit change is actually feasible. And remember that your life is supposed to get an upgrade from buying a home.

So while almost every homeowner needs to scale back from the unfettered spending of their days as a renter, do not assume that you're going to go from mimosa brunches every Sunday to total self-imposed poverty the day after you sign your closing papers. Avoid setting yourself up for failure.

After you reduce those expenses on this spending plan you're creating, you should have a much clearer picture of how much you can afford -- max -- to spend on your home.

Go back to your mortgage professional and ask them to work backward from that monthly dollar amount, keeping in mind how much cash you have to put toward downpayment and closing costs, and tell you what purchase price corresponds with your monthly max.

Make sure he or she includes principal, interest, property taxes, homeowners insurance, mortgage insurance, and homeowners association dues, if applicable.

Follow these action steps, and you should be so clear on your max that you'll be much more likely to stick with it -- period. You've gotten all the benefit possible out of the Price Creep, now put the creep back in its place!

Tara-Nicholle Nelson is author of "The Savvy Woman's Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.

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Copyright 2009 Tara-Nicholle Nelson

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