Professor's House

House Poor Life Rich – How Much House Can you Afford?

Starting to look at buying a house, aren’t you? I knew it. Well, as a long-time real estate broker, former real estate rehabber, investor, homeowner, and a man who made a lot of money and lost a lot as well, I have two sentiments for you of equal importance: Congratulations! And Look Out!

Congratulations!

Just the decision to buy a personal residence or investment property is a life change. You start seeing things differently. Through the eyes of an owner you frankly tend to care more. A sound in the attic or a wheeze in your air conditioner might be more disturbing than before, but when you work through your added responsibility and interest in the condition of your home you arrive at a beaming pride for things well cared for and a safe, aesthetic neighborhood as well. You become the fabric of American society. And I mean that.

And, if you’ve bought well, you have started a vehicle to increasing financial stature, net worth, social prestige, and eventual retirement. That’s if you’ve bought well. And they say you make money in real estate when you buy, not when you sell. This of course means buy low, sell high, but it actually means more than that. The ability to afford your payments has now been highlighted with a big, hot, bright spotlight, and underlined in black and blue!

Look Out!

People got into their unwieldy mortgages and have now suffered a long list of consequences for several reasons. Homebuyers believed that if they qualified for a loan in the bank’s eyes they must be able to afford the house. During the boom many were excited by being told they could afford higher mortgages as long as they had lower interest rates.

One problem was the adjustable-rate mortgage. You might start with a rate you can afford but in a year, two, three, or four that rate could increase many-fold. A good friend lost his house after his payment jumped, after a year, from about $1,200 to over $3,000. He was qualified for the $1,200, not the $3,000. He went through an extremely painful, scary and confusing three years, including a threat to his marriage. It was a pride-swallowing period of reinvention just to get his feet back on the ground and to be able to look himself and his family and friends in the eyes again.

In his case it was simple – there was just no way they would be able to keep the house. In other cases, though, it’s not so simple. Others have been able to hold on longer but still feel the squeeze. Adjustable rates were all the rage for a while there, but what about the buyer who has a payment grow to where it may be extremely uncomfortable, but they can and do make it every month? This segment is largely ignored. They hold on because of their own ethical sense, because they don’t want to move, and because of threats to their credit, which can effect employment, as well.

For this family, what is the opportunity cost of keeping their home? What education do they miss, what ski trips, water parks, and other valuable family times do they miss because of maintaining their loan commitment?

What about lost precious time? Perhaps they work longer hours or extra hours to make ends meet. They are to be commended and empathized with. Where the former example suffered obvious social, financial and personal consequences, this latter example endures a large opportunity loss.

And what about those folks who have a payment they can afford but who now suffer negative equity? Their payment might be very manageable but their value has decreased. For these people the worst may be that they are locked into the home, and would be unlikely to sell if they needed to, but not the worst case scenario.

All of this can be avoided if you buy well. Buying well means determining how well the home meets your probable current and future needs and desires, predicting what the market is likely to do and how this may affect your value in the number of years you plan to own the house, and determining how much house you can afford each month.

The last item there is the one that got us into a lot of trouble, as mentioned, because people trusted the government! Now, this isn’t a manifesto or a rally cry in any way against government, but only a wake-up call to not depending on anything but your own intelligence to make major decisions and commitments that affect your life and the lives of others.

Government Formulas

Everyone assumes there is great intelligence behind government criteria, and there may be, but that should at best suggest a starting place for your decision process on committing to monthly payments and debt.

The Federal Housing Administration is a government body that insures home loans that meet certain criteria in order to encourage home ownership by giving banks confidence to make loans. FHA guidelines state that your total housing payment, otherwise known as PITI for principal, interest, taxes and insurance, should be equal to or less than 31% of your family’s gross monthly income before taxes.

Let’s say this is a perfect criterion, and in fantasyland guarantees a buyer will be able to afford his payments. What if you lose your job? What if you incur medical expanses? What if you have other goals that take money? What if you have a baby and expenses go up?

And what if it’s not a perfect criterion? How much should you trust it? It takes an act of Congress, by the way, to change FHA criteria, so it may not be the most fluid parameter to make financial decisions by.

Trust them? Don’t. Vested interests have influenced what we spend on housing and have not yet earned back our trust when it comes to dishing out advice. Too many real estate agents and mortgage brokers convinced too many buyers to buy bigger houses or to buy investment properties not well-thought through just to make more moolah in the form of a sales commission.

That said, that was yesterday. If a person is in the business today, after all the hoopla of the bubble burst, well, in my opinion they are more likely to be more committed to real estate as a profession rather than just as a fast-cash plan, as it used to be.

So place ye trust in big brother alone at ye own peril, and something about Karl Marx and a ten-foot pole.

Aaaaah, That’s Better!

Your proper yardstick for what payment you should look for is already sort of known to you. It will be your own comfort level, what you can easily conceive of spending on housing, after knowing what you really make, and weighing into the equation your other life-priorities such as speed of saving, family trips, education and so on.

This is a pretty cool process. You’ll discover something about your own values in the doing, and perhaps be a more aware person for it. And the great news is you’re not alone. The Golden Age of Conspicuous Consumption got us big houses, fancy cars, and expensive restaurants along with high divorce rates, time away from family, and a prolifically medicated population. But that frantic spending is hopefully gone like an uncomfortable national puberty!

And while we’re still paying for the hangover, the new generation has learned from that and places bigger value on simple pleasures like time, flexibility, and serenity. If this means a smaller house, one where you can afford to fix the air conditioner if it blows, so be it.

Keeping up with the Joneses has been a frantic hot-dog eating contest. Even when full, it was no good for us! Opt for the frugal picnic in the park instead.

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