How Much House Can I Afford?

Home ownership is definitely something that’s in my long-term plan, but I haven’t quite figured out where it fits in. One important aspect of determine when I will buy a house, is determining how much house I can afford. I obviously don’t just want to buy a house for the sake of buying a house, so I won’t be buying until what I can afford aligns with what I want.

The eventual approval for a mortgage is a complicated process, but there are some simple calculations that can be performed to get an idea about how much house you can afford. For example, the FHA publishes its loan requirements on its website. Zillow also offers a quick-and-easy calculation of how much house you can afford. But before you rush off to run the calculation, let’s look at these ratios a bit more.

Mortgage Payment to Income Ratio
Under this qualification ratio, the total mortgage payment (including principal, interest, taxes, insurance, amd PMI) is compared to your gross income as a ratio. This is sometimes referred to as a front-end ratio. The FHA states that it requires a minimum front-end ratio of 31%. You might see 28% mentioned as a common ratio required by private lenders (often expressed as 28/36 debt-to-income — the 36 applies to the next ratio).

To calculate this, you multiply your monthly gross income by the required percentage. For example, if you have a gross income of $8,333 (100,000/12), your mortgage payment should not exceed $2,333 (under a 28% ratio).

Total Debt to Income Ratio
This is where your other debt comes into play. This ratio compares your total monthly payment toward servicing debt with your income. Total debt adds auto loan, student loan, and credit card payments. For U.S conforming loans, the maximum ratio is typically 36%. By taking the difference between the two ratios (8%), you can see that your other debt servicing payments can be up to $666 per month.

Calculating Your Affordable Mortgage
Now that you know what type of payment you can afford, you’ll need to convert this into the amount of house you can afford (or qualify for). If we use today’s rates of 3.5% on a 30-year fixed mortgage, you’d owe about $45 per month for each $10,000 borrowed. You’d have to adjust for any PMI required.

Using the above example:
$2,333/45 = 51.84
51.84 x $10,000 = $518,400

So based on this example income and ratios (which mirror mine), I’d be able to qualify for approximately $500,000 worth of house. And then I’d add any down payment made on top of that.

By comparison, if interest rates are at 6%, then you’d use a ratio of approximately $60 per $10,000 borrowed, which would yield a total mortgage of $388,833.

As you can see, just by being able to take advantage of lower interest rates, I’d be able to purchase more than $100,000 more house for the same monthly payment. I know these aren’t the correct terms to think of as far as home purchases go since the higher 6% loan could potentially be refinanced later, but it’s hard to ignore the huge impact that today’s lower interest rates play.

Personal Balance Sheet – March 2013

March was a busy month. I sold a portion of my online business (nothing related to this website), which means I’ll be getting a chunk of money in April that will definitely help me reach my goals for the year. The stock market did well during March, which also helped my bottom line even though our expenses have been running a bit high with the wedding and other purchases.

We’ve managed to make great progress toward our goals this year. To be on track with a goal we need to be at least 25% done with the goal at this point and we’re there for the goals that we care about. The travel goal is really incidental to our Wedding fund since it covers our honeymoon and we already paid $4.5k of our honeymoon expenses (and we expect about $1-1.5k more, but we can just cash-flow this at the time so it’s by far the least important savings goal.

Personal Balance Sheet March 2013

My weight is basically back to where I started at for the year. However, during March, I shattered my workout goal, working out a total of FIFTEEN TIMES! That’s an average of every-other day! I can definitely feel the progress I’m making with increased muscle, but that didn’t help me reach my weight goals.

With a lot of things happening in March, I managed to write about the trends in two major markets, so make sure you check those out if you haven’t. Check out 2013 real estate trends and predictions, as well as my thoughts on the stock market reaching new highs.

Is 2013 the Year to Buy a House?

If you’re currently renting then it’s probably a question you’ve asked yourself. Is 2013 the year to buy a house? Purchasing a home is probably the biggest financial decision you’ll ever make, so it’s important to look at the facts in order to keep the emotions surrounding potential home ownership in check.

Housing Market 2013Firstly, interest rates have been low, and continue to remain low relative to historical rates. Your mortgage rate will determine the size of your monthly interest payments, which makes up the bulk of your mortgage payment for the first five years. The lower your interest rate, the lower your monthly payment. In 2012, the average 30-year fixed mortgage rate was 3.88%. Rates are expected to continue to be below 4% during the first half of 2013, and possible ease a bit higher by the end of the year. Now, nobody knows what will happen, but consensus seems to be that mortgage rates will remain reasonable throughout 2013.

So if mortgages rates are currently low and expected to remain low in 2013, it looks like one of the two factors is indicating it’s a great time to purchase a home. Now, let’s look at the other half of the equation: home prices. January 2013 marked the 15th consecutive month of home value gains, according to Zillow. January also showed the largest year-over-year gain since July 2006. Home values rose nationwide, with cities like Phoenix, San Francisco, San Jose, Las Vegas and Sacramento experiencing double-digit gains over the prior year.

I’m hearing word of bidding wars and houses selling for more than their asking price. The main reason for the uptick appears to be housing supply, with the National Association of Realtors reporting an average of 4.8 months supply of existing homes for sale in Q4 2012. In 2010 this had been 10 months, and we’d expect this to be something around 6 or 7 months.

Unfortunately, the supply constraint is being fueled by banks slowing down the foreclosure process and delaying the sale of foreclosed properties. This isn’t anything new, and is certainly in the best interest or banks and current homeowners. Homes that banks currently own on their balance sheets is typically referred to as shadow inventory. According to CoreLogic, the shadow inventory as of October 2012 was at 2.3 million homes, down 12.3% since October 2011. If banks were to try to sell these homes all at once, supply far outreach demand for homes and prices would plummet. By delaying selling, banks are able to artificially deflate the supply of homes, and inflate prices.

Even though home prices are being inflated by banks, there are a number of other indicators that point to strong housing prices in the future. Year-over-year, constructions starts are up, existing home sales are up, and the rate of delinquency and foreclosures has improved. The Trulia housing barometer for January 2013 estimates the housing market to be 50% back to normal, up from 31% of normal in January 2012. These are all good signs for future home prices and point that we may well be beyond the housing bottom of this current cycle. However, with the existing shadow inventory, home starts, and underwater mortgages, I wouldn’t expect home prices to skyrocket.

With low interest rates and stabilized (and slightly improving) home prices, 2013 may be the perfect time to purchase a home. Now comes the most important part of the equation, which is your own financial position. You’ll have to determine what type of home you want and where, and then determine how much home you can afford and how much home you need or actually want to pay for. Sometimes, what you can afford and what you need or very different. Just because you can afford something doesn’t mean you need to buy it. You’ll also need to evaluate whether it makes sense for you to rent vs. buying a home. When I looked at an example in my neighborhood, I saw that it only made sense for me to buy if I was going to stay in the home for 19 years. Yikes!

(Image: Flickr)