I’ve never been one to play by the rules, which in my opinion, are made to be broken. In fact, I hate when people talk about rules of thumb as if they apply to everyone in every situation. But the fact is rules of thumb give people a starting point for doing further research; the problem is when there is no follow-up research and the rule is taken as the “be-all, end-all” for financial decision-making.
Here are the first five rules and some thoughts of my own.
1. For return on investment, the best home renovation is to upgrade an old bathroom. Kitchens come in second. If the only reason for renovating a house is to increase the possible sale price, the best way is to go with renovations that research shows return more than the cost to renovate. Adding extensions and pools, for example, cost more than the value added when it comes time to sell.
However, if you get pleasure from renovations and are considering the work as an expense to offset that pleasure, you won’t be expecting to make up the cost of renovation when selling.
2. It’s worth refinancing your mortgage when you can cut your interest rate by at least one point. You have to consider the expenses in refinancing, not just the principal and interest on the mortgages. This rule of thumb assumes that your refinancing expenses won’t exceed one percentage point.
The corollary of what Money Magazine says is that the lower monthly payments will benefit someone not planning to stay in the house for long more than someone planning to stay.
3. Spend no more than 2 1/2 times your income on a home. For a down payment, it’s best to come up with at least 20%. Do you think someone living in New Jersey and getting paid a salary of $40,000 — supposedly “middle class” — can find a suitable home in the area for $100,000? The only option for that amount of money? This is what she would be able to find in downtown Trenton, NJ.
4. Your total housing payments should not exceed 28% of your gross income. Total debt payments should come in under 36%. Using the calculator provided on the Money Magazine page for this rule, that house linked above, with a $20,000 down payment, a 6.25% interest rate, $3,000 in yearly taxes, and $1,000 in homeowners’ insurance add up to a $826 monthly payment.
That’s already 25% of the $40,000 hypothetical salary. On top of that, you’ll need to add maintenance costs, which in downtown Trenton are sure to be high if you want to live in a functioning building.
5. Never hire a roofer, driveway paver or chimney sweep who is going door to door. This is a general rule that could apply to any service, not just the three listed. Find help through referrals only. The only way this is a rule “to get rich by” is because it reduces the chance someone will take your money and not provide the service. It’s good advice, but I’m not sure it belongs in this particular list.
Some good investment rules to grow rich by are coming up next.
Published or updated October 19, 2006.