When people think about saving for their first home, the focus is always on the down payment. While a sizeable down payment is a worthwhile goal, by itself it isn’t a great indicator of home ownership readiness. There are two related metrics you should be tracking when deciding if you can afford to buy a home: emergency fund size and the rate at which you can refill your emergency fund.
An emergency fund is a liquid asset that acts as a safety net for unexpected expenses in life. Your emergency fund should be easy to access on short notice and free of fluctuations in value. In other words, a dip in the stock market should not translate to a dip in your fund size. Standard advice suggests an emergency fund size of 3-6 months of living expenses. There are lots of good articles and tools to help calculate the size of your emergency fund.
While preparing to buy a home, your emergency fund should be at least 6 months of expenses. Also, your definition of an average “month of expenses” must be recalculated based on what your budget will look like after your home purchase. This is an important point and worth repeating. Your emergency fund size will change over time, especially after significant events like a home purchase. You must recalculate regularly and adjust your savings as necessary.
Once you’ve calculated your sizeable down payment and fully updated emergency fund, now’s the time to force yourself to do a hard numbers gut-check. Start asking questions like “What if I have to replace a major appliance in the first 6 months?” or “What happens if I get laid off and am unemployed for 5 months?” You’re probably tempted to say “my emergency fund will cover it” and consider it resolved.
Unfortunately that isn’t going to cut it. While having an emergency fund is absolutely key to surviving tough situations financially intact, the recovery is not complete until you’re finishing refilling your emergency fund. Forecast the effects of any large drain on your emergency fund in terms of “How long will it take to refill?” or more importantly “Can I refill my emergency fund before the next emergency happens?” If you spend $5,000 on some unexpected repair and you can put $200/month towards your emergency fund, it is going to take 2 years to get back to normal. How confident are you that you won’t have another unexpected large expense in the next two years. Double the size of the repair and throw in some temporary unemployment and you’ll start to see how easily things can get out of control.
As you try to model these hypotheticals and estimate how much you’ll be able to save after an emergency, stay open to the idea that you might need to redefine what price home you consider affordable. It may be the case that now is not the right time for you to buy or you need to drastically lower your maximum purchase price.
Owning a home is guaranteed to be stressful at times for many reasons, but if you are honest with yourself about what you can handle financially, you can avoid adding money to that list of reasons.