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February 2, 2013, Bedford, NY
by Jonathan Winter
Ten years ago, if you were to ask a real estate agent “how much house can I afford,” the response would come back, “The question is not how much house can you afford, but rather how much house can you afford and still make the minimum payments on your credit card!” Using this methodology, you’d plug in your down-payment and interest rate assumptions into a standard mortgage calculator, it would spit out your payment and you’d continually increase the principal amount until the mortgage calculator would spit out a number that you could barely afford. The you knew you reached utopia.
This cavalier comment was common in the go-go-real estate days of the past. With real estate prices going up 20 percent a year, and mortgage companies willing to lend you 100 percent of your home’s purchase price, PLUS CLOSING COSTS, buying a house looked like free money. The strategy was simple, buy your house, wait a year, take out a home equity loan for vacations, giant screen televisions or whatever your interests. Wait another year and then do it again. The problem was that the question, “how much home can I afford” was answered with “how much money do you want to invest?”
101MoneyTalk’s answer to: “How Much House Can You Afford?”
First let’s frame the issue properly. Your house is not an ATM, a visa card or a supplement to your personal income. If you’re lucky, in your lifetime, your house will be paid off and increase in value. If you’re lucky. If you’re looking at your home like a stock, bond or mutual fund, you’re violating the one inviolable rule of investing. Never, ever invest more than you can afford to lose.
If you believe this, then the answer to “How Much House Can I Afford” takes on an entirely new meaning. It depends on three primary considerations.
– Quality of life in the home
– Quality of life outside of the home
– Quality of life upon selling the home
Quality of Life in the Home
For many people the home is a sanctuary. Children are raised there; couples grow old together there; and family memories are created there. If you believe this, then the home should be a place that is conducive to all of this and more. Do you need 7000 square feet, probably not, but if you believe that the home is the center of the family, then is should be a very special place, and this costs money.
Quality of Life Outside of the Home
Let’s looks at this the other way. If you believe that life is about experiences then this means that you believe that your funds are better suited toward the things that life has to offer: summer camp for the kids, trips, outdoor family activities, etc. Many life experiences are free, but some are not. If you are an extreme adventurer, for example, and you want to climb Everest, you’re look at $50,000 +/- for a guided expedition, plus the price of the flight. Who would have thought the great outdoors could be soooo expensive!
You Can Have Anything You Want, Just Not Everything You Want.
My mother used to tell me, Jonathan, you can have anything you want, just not everything that you want. So your decision about your home is as follows, do you view is as the sanctuary, the place where everything happens? If so, then you may want to opt for more versus less. Conversely, do you view it as a place to sleep, cook meals, have a chat and then storm off to your next great adventure? Then perhaps you spend less. There is a third and final consideration.
Quality of Life Upon Selling Your Home
No discussion about “how much home can I afford” would be complete without discussing the likelihood that you will receive a sizeable payout upon the sale of your home when you sell it, years from now, when the family has grown and it’s time to slow down.
The first two topics are easy. You either like to sit by the mantel at home or sit by the mantel at the ski chalet. The former means that you put more money into the home the latter means you put more money into life experiences. This last one is tricky. . .
The premise to this article is that you can’t rely on your home to go up in value to fund your life. This is sensible, because betting that the house will be a growing asset is, well, betting the farm, so to speak, on your retirement. I think it’s fair to assume however that when your house is fully paid, it should have significant value. What it will be 30 years from now is anyone’s guess, but one thing is certain, it will be worth a lot.
With this in mind then, most seniors sell their homes and move into retirement condos, pocketing the difference to live life. The total amount is unknown, but with a fully paid mortgage it most certainly will be more than zero . . .
Now that I’ve laid the ground work, let me give you the answer to the question, “how much house can I afford,” that you were originally looking for. The heuristic is quite simple.
Following the guidelines of most banks, the mortgage payment would be between 28 and 33% of your monthly income. For a person making $72,000 a year, this would mean a month income of $6,000 a month which would mean a payment between $1680 and $1980 per month, depending on how aggressive you want to be.
The actual payment is a function of interest rates and amount financed. Try our mortgage calculator on the right to test different assumptions.