Being a public financial figure makes me like a priest. People come up to me and make a financial confessions all the time. This happened recently and the situation was so interesting I did a whole segment covering the topic on my radio show this week. Listen to this clip from The Pete the Planner® Radio Show courtesy of 93 WIBC.
My friend’s confession was this: They are attacking debt in order to free up room in their budget to buy a new house. Okay, so it’s not groundbreaking or even that shocking. Paying off debt is a good thing! Saving for a new home purchase is a good thing! But, further explanation sheds light on a common problem. My friends are attacking their debt in order to free up more cash per month that will be used exclusively for their new home’s mortgage and utilities. Why is this a problem? Because committing too much income to one budget category, especially over a long period of time, can create a great number of risks.
Joe and Sally currently pay $1,000 a month toward debt, and their housing expense is at 25% of their budget. If they aggressively pay more toward their debt for the next six months their debt will be paid off and that will free up $1,000 a month. They would like to upgrade to a larger home which would increase their housing budget to 33% of their income. They justify this decision by putting the “new” $1,000 into their housing budget. This seems strategic and practical, but it will make life difficult down the road, if anything else in their situation changes.
This example shows that just because you can do something, doesn’t mean you should. While the math works out for Joe and Sally it is setting a bad precedent for the future. Their past is also an indicator. If Joe and Sally were already in debt up to a $1,000 a month, that shows they have made either made bad decisions in the past, or lacked the emergency fund to deal with a financial emergency . A few months of debt free living doesn’t automatically justify a new purchase. Shifting money that was used to pay off debt to help pay for new debt isn’t the ideal decision.
Another problem? Basing how much you spend on a house by what the bank will lend you. A mortgage lender will often lend up to 30-40% of your gross income. That is significantly more than my Ideal Budget (which is based off of take-home pay) recommends.
I want you to pay off debt. And freeing up money that was used to pay off debt is great for your financial life. Don’t get in to big a hurry to recommit newly freed-up money toward new debts.
Most importantly, I want you to avoid a situation where you have no room for error. Want a fun life? Under-house yourself.
Peter Dunn a.k.a. Pete the Planner® is an award-winning financial mind and a former comedian. He’s a USA TODAY columnist, author of ten books, and is the host of the popular radio show and podcast, The Pete the Planner Show. Pete is considered one of the foremost experts on financial wellness in the world, but he’s just as likely to talk your ear off about bass fishing.