When I bought my first home, I was quite overwhelmed by the financial uncertainty of owning my home. It seemed a risky proposition to indenture myself to a mortgage loan worth more than a year's gross paycheck. What if I lost my job? What if I had an accident? What if all the appliances broke at the same time? What if a hurricane struck or a tree fell on the house? It seemed safer to rent than to buy. Years later, when I became a real estate sales person, my clients mirrored similar worries. But, I believe with some financial planning, prospective and new home buyers can in fact plan and hedge effectively against the what ifs that come with home ownership.
Renting is not necessarily safer
I believe the first step for me was to realize that renting was not necessarily a safer choice. For example, if I lost my job, I could be evicted from my rental apartment probably faster than a mortgage bank could foreclose on my home. If appliances or carpet was damaged, the landlord could say it was my negligence, and I could owe money or lose my security deposit. If I had money saved towards a downpayment on a home invested in the stock market that crashed (which did happen in my case), I could potentially face a larger financial loss as a renter rather than a home owner.
Hedging mortgage loan amount with a life insurance policy
Say my mortgage amount was $300,000. If I died after purchasing the house, my next of kin would be left holding the lien. This was quite daunting until I realized I could effectively and inexpensively hedge this risk by purchasing an insurance policy with the same amount as the mortgage loan. A quick internet search for "mortgage insurance death, disability, unemployment" yielded results for mortgage protection insurance -- MPI (which is not the same as private mortgage insurance, or PMI). However, I learned that like most guaranteed acceptance insurance policies, the cost of MPI is high, and the benefit ironically reduces over time due to the loan's amortization.
A much easier and cheaper way to hedge the mortgage loan risk against death was to buy a term life insurance policy for the same term as the mortgage (say 30 years), and the same value as the initial loan. This would ensure that in case of death, the proceeds can be used by the beneficiaries (the MPI pays the lender directly) for repaying the debt, or any other purpose. For a young, healthy person, the cost was as often advertised, pennies a day. Sure, a term life policy had a high likelihood of expiring worthless, but for the sole purpose of hedging the mortgage, it is a great product.
Disability covered free of cost
My employer's benefits included free coverage of short term disability, which allowed me to earn a paycheck if I could not work for medical reasons. Moreover, long term disability (one year or more) is covered by Social Security.
Government programs help unemployed homeowners
After the bursting of the housing bubble, programs such as Home Affordable Modification Program (HAMP) have been introduced by the Treasury Department and Housing and Urban Development (HUD) to help homeowners who have lost their jobs. For example, under the Home Affordable Unemployment Program (UP), some homeowners may be able to reduce their mortgage payment to 31% of their income, or even suspend them for 12 months or more.
Extended warranties and service contracts for appliances are available
Ironically, I learned about warranties and service contracts when my gas water heater broke the same time I was giving birth to my son. These days, some homes are sold with warranties paid for by the sellers or builders. In my case, my local utility company has fairly inexpensive warranty contracts for heating, cooling, and kitchen appliances. For example, the cost of insuring a water heater is $2.55 per month and a high-end refrigerator is $11 per month, which in my experience is cheaper than the extended warranties offered by appliance manufacturers.
Home insurance and property insurance covers a wide range of perils
When getting a mortgage, home insurance, and in some cases flood or earthquake insurance is mandatory. Except flood insurance rates, which have seen 20-25% hikes post Hurricane Sandy, property insurance in my area is fairly inexpensive and covers a wide range of perils such as fire, smoke, hurricanes, vandalism or theft.
Can all the financial risks associated with home buying and home ownership be completely done away with? Perhaps not, and for those I maintain emergency funds. But I believe financial planning can prepare for many of these "what ifs" in home ownership and help mitigate their losses.
Disclaimer: This article is for information only and not a solicitation to purchase any financial products or real estate services. Author is a former finance professional and real estate agent currently licensed in the state of New Jersey.
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