I write this post primarily to satisfy my own curiosity. What am I curious about? Just how much difference Dave Ramsey’s home buying recommendations would make to those who bought their homes at the height of the housing balloon, just before it burst. What Are Dave’s Principles? 1. Do all of the following before buying a house: Get out of debt . This includes all debt: credit card , student loan and car debt . I repeat: ALL DEBT. Build an emergency fund. Dave recommends three to six month of expenses set aside for emergencies…a family with two stable incomes might get by with three months, whereas a family with one bread winner, especially in a precarious job situation, would need more. Save for a good down payment . Dave, who is famous for saying that he loves the 100% down plan, recommends 20%, but I have also heard him give a thumbs up to only 10% down. 2. Determine how much home you can afford. Once that debt is gone, the emergency fund is in place and the down payment saved, but BEFORE shopping for a house, Dave recommends qualifying yourself (never allowing the lender to do it for you) for how much home you can afford to purchase. The formula is pretty simple: your payment on a 15 year fixed rate loan shouldn’t be more than 25% of your take home pay. Example: John and Jane, who are debt free with a $15,000 emergency fund, are now saving for a down payment. Their take home pay is $4,000 per month. What is their price range? Assuming 5% APR and $1,000 payment for 15 years, they could justify payments on a $126,000 loan. However, being staunch Dave Ramsey advocates, they agree to buy no more than a $150,000 house, which after a 20% down payment ($30,000), would leave them a mortgage of $120,000. But would Dave’s advice have held up when the housing bubble burst? What if, two years after John and Jane purchased their house, it plunged in value by 50% — to $75,000 – and stayed there? By continuing to make the same payments, our unhappy couple would remain under water for 53 months … a disheartening scenario. However, if they HAD to sell and needed to use their emergency fund to get their heads above water, they could make it in 27 months. If, by virtue of being debt free, John and Jane could apply another $500/month to their payments, they could breathe in 15 months. I realize these are disturbing numbers, but a buyer in the very same house who has no down payment, no emergency fund and a 30 year mortgage will not get his head above water for 218 months … 18 years! With no emergency fund and ongoing debt, this owner has few options. Conclusions I am not necessarily recommending that home owners deeply under water should pump every asset they own into their homes. However, if they HAVE to sell when the market is at rock bottom, they might not have any other choices. My conclusion is that the buyers who follow Dave Ramsey’s home buying advice will have more options to cope with a devastating drop in home value than those who don’t. The possibility of achieving break-even equity in as little as 15 months, while gloomy, is doable. Being stuck for 18 years with very few options is downright depressing. One more thing: Dave Ramsey has always preached that there are no guarantees that your home will go up in value. Because none of us know the future, his home buying advice remains solid, in good times and bad. Readers: Do you follow Dave Ramsey’s home buying advice? Has your house plunged in value? How are you coping? Meet us in the comments! Image by Sir Armstrong / Shutterstock Related Articles: 5 Things To Do Before Buying A House Real Estate and Mortgages – FPU Review # 12 Could We…Should We Pay Off Our Home Early? The Cost of Delaying Your Financial Plan Dave Ramsey’s 7 Baby Steps Defined Dave Ramsey’s $1,000 Starter Emergency Fund: Why It’s So Important Renting Versus Buying A Home Joe Plemon, a retired engineer, financial counselor and blogger, lives in Southern Illinois with Janice, his wife of 40 years. Joe likes online Scrabble, St Louis Cardinal baseball, blues music, power naps, high school football, short term mission trips and Sunday family dinners. You can read more from Joe at Personal Finance by the Book . The articles on this site are for entertainment purposes and should not be taken as financial advice. Please contact a financial professional for specific advice regarding your situation. Also, many of the CPF articles help us pay the bills by using affiliate relationships with Amazon, Google, eBay and others. Find out more here .
How Would Dave Ramsey’s Home Buying Advice Work When the Bubble Bursts?