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How much house can you afford?

There are few purchases more costly or more emotional than buying a home. Here's how to do the math to see what you can really afford.

By Stacy Johnson Aug 15, 2012 12:19PM

This post comes from Stacy Johnson at partner site Money Talks News.

 

Money Talks News on MSN MoneyIf you're thinking now's the time to pull the trigger on a home purchase, I agree. In fact, I just went in with a friend of mine and bought another house. You'll be hearing more about that in future posts.

 

But just because you can buy a house doesn't mean you should. Consider this email I recently received from a reader named Chris:

My question is: Do you think a house that's $110,000 with yearly taxes in the $4,200 range is too much for a person making $34,000 a year? I currently have $10,000 saved for closing costs and hopefully some down payment.

The email continues below. But here's a video I made to help answer the question. 

The rest of the email says: 

My parents told me that's a normal tax range here in Buffalo, N.Y. I am going back to school toward a degree in accounting, so I'll hopefully make more after school is over. (I'm going back to school free on the GI Bill.)
Should I keep saving until I have a more sizable down payment? Or buy the amazingly priced 1,900-square-foot home or one of the others like it in my area?
How to figure out how much home to buy

Image: House with coins (© Digital Vision/Getty Images)As I said above, in my opinion it's time to buy houses (hence my recent post "Housing has bottomed -- time to buy.") But no matter how good the deal or strong the desire, buying anything you can't afford is traveling down the road to ruin.

 

Let's start with one of a plethora of online calculators available to answer this question. I used this one from MSN Money

 

Here are the questions it asked, along with the answers I provided for Chris.

 

Income and expenses:

  • Annual income -- $34,000.
  • Monthly child support -- $0.
  • Monthly car loan -- $0.
  • Monthly credit card payments -- $0.
  • Monthly association fees -- $0.
  • Other monthly obligations -- $0.

Mortgage assumptions:

  • Annual interest rate -- 4%.
  • Mortgage term -- 30 years.
  • Down payment -- $5,000 (I assumed he'd use half his available savings for the down payment, half for closing costs).
  • Annual property taxes -- $4,200.
  • Annual insurance -- $500 (I pulled this number out of the air).

Result:

  • The maximum house Chris can afford is $89,134.

As you can see, the $110,000 house Chris has his eye on is a bit out of reach. And that's in the best-case scenario, since I assumed he has no other debts or monthly obligations.

 

This occurred because most lenders cap the maximum you spend on a mortgage payment (including taxes and insurance) at 28% of your gross monthly income. Chris' income is about $2,800 monthly, and 28% of that is about $790, which would allow Chris to support a mortgage of about $84,000. Add his $5,000 down payment, and you end up with $89,000.

 

What should Chris do?

Here are several options Chris could consider:

 

Get a partner.

I bought my first house in 1978 at the age of 22. It was a four-bedroom, two-bath home with a pool. The cost was $85,500 and my income was -- believe it or not -- $12,000 a year. How did I do it? I went in on the house with a friend. Together, we were able to come up with the down payment, and because the seller owned it free and clear, the seller carried the mortgage, so we didn't have to qualify for a loan. After we moved in, we rented the remaining bedrooms to other friends to make ends meet.

 

I'm still using a version of that technique today. As I said at the start of this article, I just bought a house with a friend. This one was more expensive, neither of us will live in it, and we paid cash. But the principle is the same: Bringing in a partner requires half the money and results in half the risk.

 

The potential nightmare of choosing the wrong person for any financial partnership should be obvious and therefore approached with extreme caution. (My rule of thumb: Never partner with anyone with less money than you.) But at least it's something to consider.

 

Buy a cheaper house.

If Chris can buy a 1,900-square-foot house for $110,000, he can surely find something livable for less. He doesn't say whether he needs that much space -- we don't know if he has a family, for example -- but that's a lot of house for one person.

 

One of the dumbest things Americans do is buy the biggest, fanciest things they can possibly afford. And nowhere is this mistake more evident than in home shopping. When you work with a real-estate agent, the first thing many do is what I did with Chris above -- use a formula to determine the most expensive house possible. They then proceed to show you houses at that upper limit, and often above it.

 

The result? You let vanity replace common sense, buy more house than you need, leave no margin for error, and end up furnishing, heating, cooling, maintaining and paying taxes on rooms you don't use. Dumb.

Granted, because of the leverage offered by real estate, there's an argument to be made for buying as much property as you can, especially if your goal is to maximize returns. But if you're buying simply because you want your piece of the American dream, determine what you need (as opposed to want) and spend as little as possible to get it. There's no reason to create unnecessary risk by overleveraging.

 

Wait.

Although many experts think the housing market has bottomed, virtually none are expecting an immediate recovery. In other words, there's no rush. Houses will probably still be affordable next year, or even when Chris graduates with his accounting degree. It's something to think about, especially considering that houses require time, and he'll soon be working and going to school.

 

Bottom line? My advice to Chris is to somehow share the cost, set his sights a bit lower price-wise or wait till he has more money and more time.

 

More from Money Talks News and MSN Money:



38Comments
Aug 16, 2012 7:46AM
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If you have to ask someone  how much can YOU afford, you probably should not be purchasing a house until you educate yourself ALOT more regarding the costs of homeownership and the financing process.

Aug 16, 2012 11:10AM
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Why allow posting for an article if most of it is spam.  If you can't control your site, don't have one.
Aug 16, 2012 9:20AM
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Is part of the reason housing is so expensive because so many large homes were built for indulgent home buyers during the housing boom?  Is there enough inventory out there for smaller, more affordable homes?  I'm amazed at the number of people who think it's so great to own a large home.
Aug 16, 2012 12:26AM
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Hey MSN were is all coverage of the 7 banks that were being busted today for the libor scandal!

Maybe if we knew how much they over inflated the interest rates we would really know what homes are worth!!!  PRINT SOME REAL NEWS MSN!!!

Aug 15, 2012 9:26PM
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When owning is cheaper than renting, then is the time to buy.  Forget the formulas.
Disclosure:  I am a real estate broker.
Aug 16, 2012 6:32AM
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It's simple.  All banks should require 10 - 20% down.  Debt to income ratio should be no more than 38%.  That means that your monthly payments will be 38% or less than your monthly income before taxes.  This is what the smaller banks do, where I live in Michigan.  This is part of the reason that the large financial institutions got themselves in trouble.  Asking for no money down and gave loans to everyone.  Partly the fault of the federal government, Fannie, and Freddie.
Aug 16, 2012 6:14AM
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We have friends who purchased a newer place in nw Nevada last year. $419 a month including tax & insurance. You need good credit and proof of income for two years. That is less than the cost of a one bedroom apartment over 30 years ago. Their place is up $10,000 already. Knock -Knock, Who's there, Opportunity. Nobody wanted that gold in the late nineties at less than $400 an ounce. knock - knock. In 2008 the stock market was never going to recover when it hit around 6900 - knock - knock. These interest rates on 30 year home loans are amazing today-knock - knock. Its a no guts no glory world in money.
Aug 16, 2012 12:47AM
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Chris

 Don't even think about wasting your money on a house. Use your GI bill and your savings and go, go go for an in demand degree. Move back in with your folks if you can or split an apartment... Then after you get your degree your pay should double going forward in a few years and then you can easily save up the 30k to buy the house in a few more years and then use your GI bill here too. This should take several years but it is the solid path... Housing prices will continue to drop as the standard of living is dropping and those with jobs can't afford the houses and the good jobs are looking for houses in China and India,  the houses are stil 20% too expensive relative to our internationally job reduced standard of living, even after droppping 30% since 2006/7.

Aug 15, 2012 10:45PM
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Housing is just way to over inflated still.
Aug 16, 2012 10:32AM
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If you can get the financing at 4% fixed for 30 years, go for it.   Current interest rates are not going to hold and consider what a 7% rate, for example, would do to your monthly payment.
Aug 16, 2012 8:22AM
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Remember to put in an odds adjustment. The possibilities of you have your current job in ten years and the possibility of a better job 50 miles away. Also, increase your base and include transport between your location and your job.

Aug 16, 2012 1:37PM
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 Before deciding to buy, check local utility companies for gas, electricity, water and garbage

monthly charges for a specific address.   In MI, gas usage in winter weather is costly; if you purchase an older home lacking energy saving appliances and insulation, your electricity and

gas could approach $1,000 monthly.  In TX or  AZ, cooling costs a fortune. Tall ceilings, poorly

constructed windows and doors push monthly bills to $400 even in a condo. Dripping pipes

are too costly to ignore. Trash is often competitive, so always consult a few vendors for any

utility or service before buying. After you know a specific addresses normal usage, compare

it to other locations across town, then to national averages for best insight. 

 

Familiarity with vendors and taking time to get specific address particulars takes time.

Allow time for housing search - prepare several years in advance to assure you GET

IMPORTANT details compared and grasped prior to placing bids. 

 

 

Aug 16, 2012 3:53AM
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Houses are selling for about half their insurance replacement costs where I live. The shadow inventories are starting to disappear in our area. You can get a great deal in some good living places. Newer 5 star enegy places. Maybe 3% down or less & closing costs. Even house taxes have gone down here. House payments of $600 a month or lower including taxes & insurance won't last forever. Gold at less than $400 an once in the late nineties did not last forever. The give away stock prices in 2008 did not last forever. I posted on Your Money my house payment was just over $500 a month including taxes and insurance on a newer 5 star energy house. Another poster said no where in the USA is that possible. Now rents are double or more here. To each their own.
Aug 16, 2012 12:25PM
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The cost of owning a house is more than the cost of the house.  Property taxes are really high because government officials squandered the extra tax money during the boom. Now, they don't want to lower the tax rate when it is a bust.  With increasing taxes, new taxes, increasing utilities, increasing cost of living, and new forms of taxes and fees.  The cost of owning a home is actually more, event though the cost of the home (bottomed out) is only a little less than during the boom.  Those dame tricky business and finance majors and government official.  Although during the boom, homes increased 200% - 300% in value, my income didn't increase at all and homes only adjusted 25% - 50%.  How does this make sense.  Hmmm something doesn't feel or sound right.  How can I continue on this path?
Aug 16, 2012 7:33AM
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If your un-mortgaged house, valued in real market terms, yields an opportunity value in excess of the invest-able cash represented by that value, then owning makes good sense (be sure to factor in expenses and taxes). For example, 100,000 in the bank yields currently a top end of one point two four percent (TIAA online account), or $103 per month, less income tax. in your bracket. Renting a house worth 100,000 might reasonably cost $600-700 per month (location dependent) per 100,000 value. Thus owning is roughly six times more valuable than renting within this price range. Of course, we are all highly deserving movie stars needing marble counter-tops and gold plated fixtures even though we can't come up with a minimum down payment, but this is apart from the need to keep our fannies out of the rain. 
Aug 16, 2012 5:09AM
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The above article leaves a bit up in the air. Is the 34K income gross as it appears to be? If so his take home is considerably less. Forget that for a minute. He is going to school using veterans benefits. Obviously he is a verteran. He can obtain a VA loan, currently (8/16/2012) 3.5%, with nothing down, no PMI, and a 41% debt/ gross income ratio.

 

If you don't use the VA, you will have to pay mortgage insurance called PMI. It is .3% for USDA plus 2% of the loan value added to the mortgage amount and 1.25% for FHA mortgages unless you put down 20%.  

 

If he is frugal he can afford a new rather than old house. Old houses are extremely expemsive to run on an operationg basis. Everyting has a useful life. Old houses have often used much of that up. New houses use fewer utilities often a a half to a third as much. In Houston I looked at new homes recently. The best homes that I found also had the best deals. Total closing costs were $500 plus insurance - $500 a year from GEICO on a $132,900 house. Property taxes vary all over the place even within a few miles. Those at houses that I looked at varied from 2.07 to 3.4 percent of adjusted assessed valuation. Buffalo is a dead/dying city. I would not recommend buying a house or living there.

 

My net retirement income is $29.4K - net of income taxes and medical insurance. I qualify for a new house $133K mortagage with an 813 credit score in Houston, Texas. I have about $600 a month left in my budget even with that house loan, but I am frugal and do not have a working persons expenses to deal with. My advice is to sit down and make a real budget, based on what you really spend. You can afford the same loan that I looked at and pay the extra costs associated with working, if and only if you live frugally - AKA no cable TV, cell phone, etc.  By the way every loan that I looked at had 29% and 41% ratios - house costs and house with other loan costs respectively.  

 

34K gives you about $822 a month for the mortgage, property taxes and insurance at a 29% ratio versus $793 using the 28% ratio . $110K at 3.5% VA is $494 a month - Outrageous property taxes are $350 - House insurance $42 - net $886ish. If you property taxes are more reasonable (20% less) the house is easily doable. Unfortunately, Buffalo is one of those places that have next to no local industry to pay local taxes. SO - property taxes are HIGH. New York also has a state income tax.  

Aug 16, 2012 1:57PM
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About the kitchen:  It's safe to assume we want good looking, efficient, shiny kitchens

with super appliances, granite counters (or comparable), easily maintained surfaces

and corresponding baths in our next home.  Unless you're a contractor, that list reaches

$50,000 very fast and early. DO YOU NEED THAT MUCH KITCHEN? So much bath?

Now? Later? Perhaps never?

 

Since reaching seniority and divorce, my cooking and entertaining budget,  style and

project frequency has drastically changed.  How much kitchen and of what quality and

ease do you require to make grilled cheese, spoon yogurt, boil spaghetti, toss lettuce

and microwave pot pies? Is a hundred-thousand dollar kitchen really that necessary

today given our mobile life style and vast selection of restaurant cuisines available?

If you only go 'all-out' a few times a year (Christmas, Thanksgiving perhaps a summer party)

rethink the cost you're really paying to produce  that event. Perhaps it's unnecessary. 

Clean, healthy and visibly tolerable might serve better.  And don't forget to add costs for gutter spouts, fireplaces, security alarms, shudders, down garbage disposals, extra-extra soft

water dispensers or a thousand-and-one shower heads....    

 

Aug 16, 2012 1:37PM
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Screw the banks build your own small cheap house yourself No mortgage ! 
Aug 16, 2012 8:21AM
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Remember to put in an odds adjustment. The possibilities of you have your current job in ten years and the possibility of a better job 50 miles away. Also, increase your base and include transport between your location and your job.

Aug 16, 2012 10:13AM
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The question should be how much is the house really worth!!!!!  You may have good credit , but what good is that if the house is over valued by $100,000 or more. Don't be suckered into buying a house that is the money pit. Don't trust house inspectors or evaluators or realtors!!!! They look at how much the house is being sold for and will give you a report that states the house is worth that amount.  LOOK AT THE TAX ASSESSMENT and what the house is appraised at.   If the house is being sold at thousands more then what it is appraised at then offer what the house is appraised at. A buyer needs to cautious and smart. If a house does not have what you want  like a garage or descent backyard don't buy it. Its better to rent then live in something you end up hating.  Over 10% of homeowners live in houses that are an average of $100,000 more then what are worth.  That is owe $100,000 more on mortgage then worth!!!! I just can't believe how deceptive and dishonest realtors , banks and house inspectors are, they prey and take advantage of innocent young house buyers. It really needs to stop!!!!   
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