Careful borrowing
Matt asked:
I need help figuring out how much of my income should be devoted to owning a home. As a 1st time prospective homebuyer I don't want to over extend my family's finances at all. Some people say 33% of your gross income and others say 33% of your Take-Home income... What should I be limiting my housing expense at? Ball park we make $105k combined with zero debt of any kind except for 2 more year on a car loan which we owe $6,000. Any advice would be greatly appreciated!
For the total novices:
There are two ratios that lenders look at
1. First there is a ratio of your income compared to your housing cost (principal, interest, property tax and home hazard insurance.)
2. The second ratio is your income compared to your housing expense plus all your other ongoing debt (rotating balances on your credit cards, car loans, student loans, mortgages on other homes, home equity loans…)
Back to Matt’s question:
In regard to your car loan: If you can qualify for a loan with 33 percent of your gross pay for your housing expense, you should be able to handle the next two years with a car loan also. The key is to keep your housing costs where you can handle them.
That said, 33 percent of your gross income is the standard that is tried and true. People who hold to that limit tend to avoid problems. The mess occurred when that limit was ignored by masses of lenders and borrowers.
Something else to consider: If you are a two-earner household, figure an average income that allows for maternity leave through your child-bearing years. If you are going to have children, your income will drop just when you need it.
While I’m telling you to be careful: I advise you to limit your down payment so that you still have 3 months of living expense still in the bank after closing.
I bet I just talked a few of you out of buying. So be it.
Comment
Permalink
Email
don't go above 28% of your gross pay for your monthly PITI. Remember it's only shelter, forget about making any money out your house by levering up. The days of housing being an extension of a person's "worth" are long gone...
My personal bias is that lenders' tried and true standard is probably too generous. If I were spending 33% of my income on housing, I would feel like my ability to save were too constrained. My advice to anyone buying a house would be for principal, income, taxes, insurance, and condo fees if applicable to not exceed 28% of gross income. I'm sure others will disagree, and it depends somewhat on personal circumstances, but I think it's important to recognize that the 33% limit is based on what is likely to avoid trouble in terms of keeping up with mortgage payments, but may be at odds with other financial goals.
We will not buy until our monthly payment is 25% or less...I'll add my vote to the "it's just shelter" argument.
My husband and I are currently paying rent equal to about 14% of our gross income. This is a very comfortable amount for us. In the past we paid up to up to 25% of our gross income on rent or mortgages. That felt like too much, after taking out taxes, health insurance premiums and a small amount of student loan payments. And owning a home was even more expensive when factoring in maintenance, renovations, property taxes, etc. So I'm in the "it's just shelter" camp. Will not buy again until it becomes cheaper than renting.
I sometimes wonder if the the 28% rule itself is too high. My guess (without any particular facts to back it up) is that this figure was formulated at a time when people could still reasonably expect to receive an employer-funded pension for retirement. Since that is no longer the case, and since we are supposed to be saving 20% of our gross income for retirement, doesn't 28% seem a bit high?
(28% for housing + 20% for retirement + 30% for taxes = only 22% for all of the other expenses in life)
Rona hit on the risks of counting on 2 incomes. Search for 2 income trap (the Mother Jones article is a pretty good summary of the general idea). The quick take away is that you're actually at a higher risk of having an outside event derail your earning ability if you're counting on both incomes.
Don't count on two incomes. Don't. Don't. Don't. We bought our first house (in Cumberland, RI) because we got it at a price that allowed for one income. If one of our jobs went south, we were still in great shape. My income was the icing on the cake. It payed down our other debt and then started paying off the mortgage. When we sold last year, we didn't get as much as we'd hoped, but because we owed so little on the house, we walked away with a nice chunk of money for a house in Virginia.
I'll third the two two-incomes argument, especially regarding if you plan on having children. Unless you are one of the fortunate-few who gets free childcare via family members, plan on paying MINIMUM $1600/mo for childcare.
You might also consider the H+T affordability index. It says that the cost of housing and transportation should be no more than 45% of your income. Not sure if that is net or gross. With low car costs (include maintenance and gas), you may be able to buy more house. In my case, I bought close into the city and bike/T/zipcar wherever we need, so I'm well under the 45% limit.
There is what you can afford (what the bank tells you), and what you can afford (what your budget tells you). Sit down and figure what your net. Look at what you spend. Be realistic on a budget (don't cut out Starbucks if you know you can't stick to that). Then figure out what happens when you add in childcare for 1 then 2 kids and increase your other spend 10%. Start this again and see what happens if one of you isn't working. This is what you can afford. Next, forget 3 months in the bank, you need 6 - 9 months net income if one of you out of work.
If your really need a guide post - PITI should be no more than 30% of your net.
Think realistically. If you know you are bad with money, would you spend far more than you do right now on a 30 year debt obligation? Commit wisely and know what you can afford based on your own budget, not what a bank tells you can afford. I'm sure someone who can afford a mortgage on a 1.5 million dollar property is living more comfortably than someone who qualified at the maximum on their 200K property.
An appropriate amount to borrow is easy to determine.
A) one weeks pay should cover your housing costs
or
B) don't borrow more than 3 times your average annual income, excluding bonuses.
or
C) 28% of gross monthly pay is a reasonable maximum amount to spend on housing, but keeping it under 25% is much more confortable for most people.
As soon as you start thinking about percentages you are putting yourself on the track to make a bad decision. Everybody is different. What is your cushion? If you have none or it is small, I'd rethink buying. If you find yourself in a pinch, will you be able to rent out your house or will you go belly up? If the answer is you'll go belly up then why not rent? How important is having a nice place to you? Are you willing to make sacrifices in other areas for a nice place? How much money do you need/want for the rest of things in your life? If you have kids, will that effect your income?
I'm surprised nobody else has mentioned the obvious: NOW IS A TERRIBLE TIME TO BUY A HOUSE UNLESS YOU ABSOLUTELY MUST!
The best advice for anybody who is starting out right now (and who is in a financial position that necessitates asking for advice on affordability) will be better off renting for a couple years and saving their money. Home prices are headed MUCH lower.
Look at the big picture. You have nothing to gain if you buy now. But you have a lot to lose. In a couple years when prices have come down, the situation will likely be very different. My advice is to wait.
I completely disagree with Lance.
It is a great time to buy a home right now(if you can afford one).
This blogger might want to review your comment before posting it.
Recent Posts
browse this blog
by categoryINside Boston.com