Lots of good comments on my previous post on how much to spend on housing. As a follow-up, let’s run some numbers for fun. To make things easier, let me refer to what I call mortgage calculator heaven at DinkyTown.
How Big A Mortgage Can I Get?
Let’s start with the Mortgage Qualifier calculator and use the ‘Total Monthly Payment’ option. I’ll assume an annual gross income of $100,000, but let’s also say I go nuts and pay 41% of it towards housing: $3,417/month. With no cash on hand, a 6.25% APR 30-year fixed mortgage, no other debt payments, and the defaults for everything else, it says I can get a loan for $432,378. Here’s how the monthly payment breaks down:
Note that since I had nothing for a down payment, it made me pay private mortgage insurance (PMI). What makes me depressed:
1. $3,400 a month is more than three times what we currently pay for rent, living in the Pacific Northwest. We could rent a mansion here for that much.
2. $430,000 is a lot of money. But it still won’t buy much more than a decent 2 bedroom condo in the San Francisco Bay Area!! And most likely with one parking space. That interest rate deduction better be as good as people say…
Lender Ratio Question?
I’m still a little confused by the lender ratios, maybe somebody can help me. According to the Required Income calculator:
Maximum monthly payment (PITI) is calculated by taking the lower of these two calculations:
1. Monthly Income X 28% = monthly PITI
2. Monthly Income X 36% – Other loan payments = monthly PITI
This seems to be the official way to use the lender ratios, but why? Shouldn’t it be the greater of these two calculations? If you have no other debt obligations, shouldn’t they allow you to pay more towards housing? Or are they afraid you can’t handle it.
And are these ratios set in stone, or more of a guidance-type of thing? I’m guessing that a good mortgage broker should work with you on this.
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Johnathan:
1- Dabt/Income ratio is one of many areas the bank consider when they review your loan application. There are many other factors that they must consider during the underwriting process. In the end, they have to have some objective means to determine whether you pose any significant risks of defaulting and foreclosure. Evidently, other than credit score, spending patterns, PITI ratio is the most accurate way to predict your chance of failure.
2- If you can’t get a decent 2 bed house in the bay area, get a condo, or move somewhere you can. The idea is that you start something small, keep the value up. In few years, when your current property gained enough equity, sell it and use that profit to move up to a bigger or better house. In California, there are a lot of first time home buyer assistance programs are available that offer you all kinds of helps ranging from down payment assistance to low interest loans with no PMI requried to income tax certificates. Many of these programs, unlike common preception, aren’t necessarily just targeting the poor. Young couples with medium or slightly higher than medium income can qualify easily. For instance, the maximum CaFHA loan house price cap for SF county is nearly $620,000. That’s much more than your $420,000 estimate. Moreover, you can probably combine these programs to maximize your affordability. On top of that, I see real estate is one area the BoM&D (Bank of Mom and Dad) really helps. They are allowed to give you cash gift for downpayment up to $15,000 per year per person and you don’t even have to claim those as income (check tax expert on this).
You can ignore the lender ratios; the lenders do so themselves all the time! We had no trouble finding lenders who would give us a loan that would cost us 40-60% of our gross monthly income in PITI.
And if you have absolutely zero other debt, they’ll probably let you bump your front-end ratio as high as your back-end. Just make sure you’ve paid off any 0% balance transfer deals before you apply because they still count as debt.
Regarding the interest rate deduction, remember that you no longer can get standard deduction, so whatever interest rate deduction you get subtract the standard deduction from that, Sometimes the difference is so small, it makes no sense why people make a big deal on the Interest rate deduction.
I hate to sound like the disgruntled blogger over here, but seriously, you might consider moving to a cheaper area. I live in the Maryland area, and I have a co-worker who moved to Ohio a month ago. He basically swapped houses in terms of value, but the one in Ohio is a freakin mansion by comparison! He sold his house here for around $400k, and he says the place he bought in Ohio would run in Maryland for around 1.5 million.
Its supply vs demand. If you want to live in a popular area, be very prepared for your dollar to not go very far. The ability to re-locate is the only tool we have to fight that trend.
“Cost of living” adjustments obviously don’t account for housing adjustments. I’m originally from LA, and while there people might get paid 10% higher than in Maryland, the cost of housing is at least 50% more… Weigh the ol’ scales and see if the extra housing cost is worth the area, in your personal frame of reference.
My wife and I just purchased a house 2 months ago so we learned all about this first hand. What we heard is that for anyone with a high credit score (720 and up) the 28/36 ratio isn’t even looked at anymore. All the places started at a 29/41 ratio and a few said that they would go up to 50% debt to income.
This company said they would consider how stable they considered your job to be, expected salary growth, past loan history, etc. – basically taking into account future raises for you, which is exactly what a buyer is told not to do.
We did manage to find a place that suited us and was within the 28/36 ration (because I wanted to adhere to that). Both our lender and real estate agent couldn’t believe that we could qualify for so much more and chose not to go for it. Bigger commisions/fees for them down the drain?
And, yes, we found that it is the greater of those two numbers – if we had no other debt, the one lender would have giving us a loan with monthly payment up to 50% of our before tax income. And we looked at our monthly budget and figured that we might have enough to eat, maybe not, and said no thank you.
if considering condo, then where is the condo/ association fee? they are another $50-400 added to your monthly housing payments, and include master insurance, landscape, exterior maintenance, garbage, sometimes may include water, heat, &/or hotwater.)
Hey Jonathan,
I run a mortgage brokerage here on the East Coast, and I can tell you for fact that ratios are not set in stone on A paper loans. In fact, if your credit score is high enough, I have seen a person with a back-end ration (housing + all monthly liabilities) as high as 62% get an approval from an automated underwriting system. In fact, almost all of the sub-prime lenders will go to 50% back-end ratios, and they will do this on a 2 year interest only ARM (Adjustable Rate Mortgage.) It is no wonder that foreclosures are rising so rapidly throughout the country 🙁
I have heard different variations of this. I have heard the ones you mentioned countless times. I think they all typically work out to the same thing. The lender I talk to, told me this: Take your gross income and multiply it by 45%. That 45% has to cover all your potential housing expenses (mortgage, homeowners insurance, HOA fees, real estate taxes,etc.) and all your other debt payments.
In the boom times of housing, I don’t think any of this matters, you can probably find a mortgage lender who will do anything for you. That is the scary part. Heck, I just read about the 50 year mortgage. When will it end? 🙂
Why not rent? If you can rent a nice house, and invest the surplus money you have as a result, aren’t you ahead in the long run?
I’ve owned and I’ve rented my homes, and I generally prefer renting, if I have a good landlord. It’s lower cost, and it frees up money for investing.
People will tell you you’re “throwing away money each month” if you rent. What they don’t talk about is the higher risk homeowners expose themselves to with a large, highly leveraged, undiversified (undiversified!) asset, and massive interest costs.
Renters have less responsibility (someone else fixes my roof, furnace, plumbing, etc…), more cashflow and can choose their investments tailored to their risk tolerance instead of their choice of neighbourhood.
With regard to the two debt equations, it’s definately just for guidance. The two equations essentially mean you can spend 28% of your monthly income on PITI, but your PITI plus other monthly debts (car, student loans, min credit cards) should not exceed 36%. So no more than 28% on home or less than 28% if your debt payments on other things exceeds 6% of your gross monthly income.
people want the excitements of the big cities, the close distance from the coast, AND they ALSO want cheap house prices????
people who want a bigger house should move to suburbs or smaller cities. know what? 400k can probably get you a 5-bedroom, 4.5-bath, 3500ft house somewhere else
Yep, I’m perfectly aware we could move lots of places and live in a McMansion (or two). We are just trying to be next to all our family, who all of a sudden live in a neighborhood of million dollar houses.
Am I complaining? Yeah, I am. It’s not going to be easy. But it’s gonna happen! …sooner or later 🙂
Jonathon,
I am someone in kind of a similar situation. I moved here in the SF/Bay Area a couple of years ago for a job I got after college. Ive been living with family but I am trying to find affordable housing of my own preferrably close to them. The only problem is that they live in neighborhoods where the median price is atleast $800k. I am a first time buyer and plan on using my savings from the past couple of years + BoM&D (although I really prefer not to use them). But it seems like that is the only way I may be able to afford a home here. Another option I have considered is to buy with someone close, but this would be a hassle if one of us had to move. I have seriously thought about moving as the opportunity cost(for jobs)/weather/whatever else people here think is the best thing about SF/Bay Area is NOT WORTH the living cost.
Jonathan,
I found it a paradox that you spend all this time be frugal and yet you are considering plunging 400k into a tiny place and paying so much for interest? at 400k and 6%, you are probably paying 24k a year just in interest payments, that’s like throwing away a branding new car a year!
I would love to live in S.F. too(my brother lives there), but I have saved so much money by living in Austin,TX(a great place btw). with the money you saved in interest payments, you can fly to S.F. as often as you would like and still come out ahead.
Pay more for location coz it will someday pay you back (provided it is *reasonable* and you CAN afford it)
In real estate, the only important thing is:
1) location
2) Location
3) Location
4) Where the condo is located 😉
I just moved from Missouri to Chicago!!
2 bedroom rental in MO: $475
2 bedroom rental in Chicago: $1100
Ouch…!!
And now we laugh when we think about the times when we were in Missouri and kept thinking a zillion times whether we should buy a house we saw on the market for $70,000 or not!!
$70,000 gets you a parking lot here and maybe if you are lucky, a garden shed.
Source: The Dallas Morning News, 07/19/06
Mark Dotzour, chief economist at the Texas A&M Real Estate Center, is celebrating his 10th year on the job.
Here are two of his opinions on the real estate market:
On housing appreciation: ?The average rate of annual appreciation nationwide is still running at 12 1/2 percent. It?s unbelievable that the Fed has been tightening for over two years and home prices are still going up by that much. That tells me that there is intense demand in the United States to buy a home, in part driven by the basic need for shelter, but also by investors? lack of trust in Wall Street. That is part of the Fed?s dilemma few talk about ? the need to create an alternative investment, something else for people to invest in besides real estate.?
Why investors worldwide are buying U.S. real estate: ?The big theme that?s affected everything has been a global oversupply of capital, which was largely engineered by the Fed and the Bank of Japan. And even though the global economy is pretty solid, most of the growth is occurring in countries where investors aren?t as comfortable putting their money. Think about it ? if India was a state in the U.S., all of the developers in the nation would be fighting each other for a piece of land. If for no other reason than lack of opportunities, many investors ? American and international alike ? have stayed focused on the U.S. market. As a result, America has been hit with a tsunami of investment capital from all over the globe.?
The U.S. has always been and will continue to be a safe haven for international investors. The weak dollar makes investment in the U.S. that much more attractive. However, I don’t think that’s directly contributing to the housing market, except in international cities like NYC and Miami, or on the West Coast, where Asian investors are prominent. That said, the preponderance of global capital, does, however, provide more liquidity to credit markets, which translates to cheap capital for lending.
I do believe the demand for housing is unusually strong, driven by any number of well-documented factors. The bottom-line is that housing has come to be recognized as an “investment” opportunity by the masses. There is some good and some bad in that. The good is that r.e. and housing have an importnant place in the average person’s asset allocation. The bad is that the expectation of out-sized returns and amateur speculation has been distorting the market. A correction is underway and long overdue. Hopefully, it won’t be too painful. Ultimately, if you are buying for the long-run, as you should be, near-term price flucuations shouldn’t matter a whole lot to you. And there is no ignoring the intangible feel-good qualities of home ownership. If there is one thing people want to have control over, it is their living situation.
Despite the age old mantra of “renting is for suckers” or “Buy a house and get rich” or “with rent you’re throwing money away”, I think that in high priced markets, you HAVE to give serious consideration to staying renters.
1) Housing is hot right now, as a smart investor why buy into a market when it’s hot, buy when it’s cold and ABOUT to become hot.
2) I live in the Seattle area in nearly the highest priced Suburb in the metro area. I pay around $1k/month for a 1,300 Sq. Ft apartment. Condos nearby with less space (say 900-1200 Sq. Ft) Sell for a minimum of $350k and many are upwards of $500k. In that situation, my non-deductible interest expense is significantly higher than my rent.
So in an area like mine, you throw money away on interest on a condo vs. renting a comparable apartment.
Homes in an area I’d really like to live in go for $600k (at minimum) to well over $1M. You’re looking at non-deductible interest payments (at the low end) of over $2k in many cases. Yes, houses in that same area rent for
A few years ago my uncle told me to never borrow more than 3 times your total gross income. Basically if you make 100k, then you should never borrow more than 300k. I’ve never heard anybody else say anything of this nature before, but it’s what I’ve been using as a fast rule of thumb. I always try to get a 15 year mortgage.
Also not all lenders give you a rate based on your credit score. My credit union does not determine your rate by your credit score. If you are approved the rate depends on how much you put down. I love my credit union also as they don’t require PMI if you put down at least 3% instead of the normal 20%, free biweekly payments if you’d like to do biweekly and their escrow actually makes intrest.