Housing Reserves: What’s A Good Margin Of Safety?
I think I’m still bruised.
I spend a lot of time on real estate chat boards, answering people’s questions. It’s usually a good experience for me; it lets me listen to what customers are thinking about the market, gives me a chance to practice my sales pitch, and, often, helps connect me to actual clients.
The Story: Do You Need More Than $600,000?
So when I advised one potential high-income buyer with no savings to consider buying after he’d saved $600,000, I was surprised to find that the internet community thought I wasn’t being conservative enough. The buyer was a freelancer who had made a six-figure income every one of the past three years, but hadn’t saved any of it. (He pointed to the high cost of having two kids in private school). He was now in a position where he had contracts set up to earn nearly two million dollars over the next two years, and wanted to buy a home so he wouldn’t run through his money.
Delegating To Savings v. Down Payment
I suggested saving $600,000 total, and putting $500,000 of that as a down payment on a place that cost just under a million. That would give him monthly housing costs of about $3,500 a month. I also suggested leaving $100,000 in cash equivalents, so that if some catastrophe happened, he had a year’s worth of housing expenses in the bank, plus time to get out and sell the place if he needed to. As for the $100,000 left over – the technical term is “post-closing reserve.” By current mortgage standards, the $100,000 is okay on a million-dollar purchase. That would pass muster at any big bank.
Was It Really “Imprudence”?
However, I was roundly criticized for my, how did one person put it? “imprudence.” That made me think that maybe reserves – the emergency funds you want to have in place before you buy – would be a good topic for discussion. Do you have enough reserves? Here are some things to think about:
- Number of months’ expenses. LearnVest suggests keeping from six to nine months worth of expenses in your emergency fund. Suze Orman, who has a new book out called “The Money Class,” suggests that you keep eight months’ worth of living expenses in reserves. This number will vary per person, since you’ll have to weigh how easy it is for you to cut your expenses in a pinch, and whether you have a partner who is working. If you’re buying a property, I would certainly suggest, as I did above, having a year’s worth of housing costs set aside, plus a little on top.
- Family structure. How strong is your family network? Someone who has a rich uncle who would help in a pinch is not in the same situation as someone who can’t borrow from their relatives. It works the other way too: How likely are you to have to help your parents out in case they face, say, an unexpected medical crisis?
- Ease of re-employment. Those hit hardest in this recession have been people stuck in towns where the jobs went away, who couldn’t sell their houses and move to places where new jobs were. If you lost your job, how long would it take you to find another one? Would you have to move cities to do it?
- Amount of down payment. Current lending standards ask for twelve months’ worth of reserves (that’s housing costs, not total living expenses) if you put 20% down on a home. If you put more money in, then mortgage lenders will allow a lower reserve, closer to six months’ worth of payments.
- Illiquid reserves. Do you have retirement funds you could crack into if you absolutely had to? If that’s the case, you can probably safely keep a little less on hand in terms of cash. Remember, you don’t want to let your need for a rainy-day fund prevent you from saving for retirement, especially if your company is matching your 401(k) contributions.
- Extra space. No one wants to take in “boarders” like it’s the Great Depression, but could you take a roommate if you absolutely had to? All other things being equal, it’s less risky to buy a property with space for a roommate than a property you just barely fit into.
LearnVest wants to hear from you: Have you bought property in the last five years? If so, what was your “reserve” fund? Do you think now that that was an adequate amount?