I was checking my credit on CreditKarma as I do weekly, and just for fun I was poking around the site to see what else it offers. One of the tools is a Calculator for “how much can you afford on a home?”. Since my wife and I bought a new house last year (and sold the old one), the numbers were fresh in my head. On a lark, I decided to see how much their calculator thought I could afford. It took four pieces of data:
[ul]
[li]monthly before tax income (I rounded down)[/li][li]monthly debt payments (zero for us, no student loans/medical debt/car loans for us)[/li][li]down payment (just used what we used to get 20% on our house)[/li][li]interest rate (I used the value we actually on our 15 year note, although the calculator was for a 30 year note)[/li][/ul]
My wife and I are pretty conservative spenders, so I figured we’d get a number maybe 150% of what we actually ended up paying. Imagine my surprise when the number came back at 320% of what we paid.
:eek:
If you want to know the actual numbers (no accusations of humblebragging, which is why they’re in a spoiler box):
My wife and I make about $200k a year between the two of us, so I used $16k/month as our monthly income, even thought that’s a little low. We had $80k for a down payment and got a rate of 3.125% last year. The house we actually bought was $375,000. The calculator thought we could afford $1.2MM :eek: indeed
Growing up I had heard that the rule of thumb for whether you could afford a house was to get a house that was three times your annual before-tax income (conversely, a car should only be one-third of your before tax income). I figured with the housing crisis those numbers would have gotten a bit smaller to accomodate the risk involved, but apparently not.
I’m actually quite happy with the house we got - it’s bigger than we need, actually. And we’re going to pay off the note before we’re 40 and be debt free a quarter century before retirement, barring unforeseen circumstances. I’d much rather be debt free early and have money to sock away/spend on really nice vacations than be dragging a mortgage around for 30 years (the interest deduction is not a worthwhile reason to keep a mortgage around, IMHO).
But apparently I’m a minority, and people spend six times their annual income on a house. Who knew?
Most people now base “how much house” on the monthly payments. I think 20% of your salary is the rule of thumb. So if you make 200k, 20% means 40k in payments a year would be fine. At 3.125% interest, 1,280k would be the result for an interest-only loan. So, yeah, looks like 20% is roughly what they used.
Mind you, I think they’re nuts too. My advice to people: never spend more than half what the bank says you can afford.
They showed the expected monthly payment, which was 37.5% of monthly pretax, but I imagine they were not using a interest-only loan. You’re probably right, they just have a rule-of-thumb percentage that is way high.
Unfortunately there is no option for term of mortgage. They assume everyone is going to get a 30 year note, because why not! More house for a lower payment! Just ignore the interest building up!
My wife and I also just bought a house. We’re fortunate to both have high incomes, and we’re also relatively conservative spenders. The loan guy was ready to qualify us for about four or five times what we wanted to spend. We got a very nice place in a great school district. For a lot less than 1.5 megabucks. Looking at the monthly payments for the loan we qualified for, we could have met them, as long as we didn’t want to save for retirement or kids’ college. Or really buy much of anything else.
When I was buying houses, most calculators would tell me I could afford 2-3x what I felt comfortable spending. I think any ‘what can you afford’ calculator works on ‘what’s the absolute highest payment we can say you can afford with a straight face’, not on a reasonable basis. IMO you’re much better off figuring out what interest rate you’ll probably get, decide on a max monthly payment, and calculate how much house you can afford from there.
I had the same surprise when I was looking for loans. They were willing to give me three times the amount I needed to buy a house that I believed to be in my reasonable price range. And that was using my income alone, without my wife’s considered at all.
For some cities, you would not be able to afford the average house. The average selling price of a single-detached home in Metro Vancouver (excluding Surrey) was $1.83 million in January 2016. It’s gone up since then. Substantially.
For what you paid for your home, you could afford an 800 square foot 2 bedroom strata apartment in an older building. People in Vancouver are getting outrageous, stupid mortgages to buy a single family house.
When I was prequalified through my credit union last year, they gave me a number approaching $300k. I live alone, and I make decent money, but there was no chance in hell I was paying that much for a place.
My absolute upper limit was $150k (which was slightly over twice my salary, but at a point where I felt comfortable) and I ended up paying $95k for my condo, which is in a part of Atlanta where it should sell fairly quickly once I get to that point, especially once I do some of the upgrades.
When we were house shopping in the bubble years we were offered threes times our combined income for a mortgage, we thought that was nuts. Fast forward to 2014 when we wanted to buy a condo, we had more than enough in the bank to pay cash, we only want to borrow 50k, we have credit scores in the 820 range, and our income was substantially higher than the last time we shopped. It was such a painful and ridiculous process we finally told them to cram it and paid cash. We met every criteria at the higher levels but they still dicked us around every day “we need a letter explaining this $116 dollar cash deposit from April” I cashed in the change jar! They seemed pissed that we didn’t want to borrow more and kept trying to move the numbers up.
When we bought our last house we went for a preapproval to have in hand while we were shopping around. The bank approved 2x what we asked for (and ended up needing) based on my husband’s income alone.
When we redid our mortgage a few weeks ago I was chatting with our banker about it and she explained that their lending standards are required to include only the house payments, defined amounts for heating and electricity based on the square footage of the house and any existing debt.
No food, transportation, entertainment - nothing else is considered. She explained that the banker should be going over that with the client so they can make the best decisions for themselves, but that many took short cuts.
We were lucky in that we learned the lesson early in our lives and in a relatively controlled manner.
We bought our first house from a builder and went for the absolute max they would approve us for. In the 18 months it took to complete the house, we both received promotions and raises and STILL we felt like we were poor for the first couple of years there. Luckily it was fairly early in our careers and we managed a couple job change/ salary increase moments that brought us back to a reasonable lifestyle but the bank would quite willingly have let us buy our way into house poor.
When you’re only plugging those 4 numbers in, what you’re going to get is the absolute highest price you can pay based on those numbers. Because the calculator doesn’t know if you are 30 years old and need to save money for 2 kids’ college educations and your own retirement or if you are 62 years old and have $500K in the bank in addition to your $200K income derived from pensions and Social Security benefits*. It can’t possibly tell if you are the sort of person who likes to travel and have little luxuries like cable TV or if you are the sort who wants the nicest house you can afford and is happy to staycation every year to make that happen.
And it’s great that you got as much house as you needed/wanted while paying way less than the calculator said you can afford but it doesn’t always work that way. When we bought our house , it cost 3 times our annual income and over the past 29 years, I’ve often wished we paid more. Because I would have been happier with a bigger lot than 20x100 and with larger rooms (it’s under 1200 sq ft) and even though it would have been difficult for the first couple of years, our income went up dramatically after that.
and that’s not crazy. I checked and if I retire at 62, my pension/SS income will be roughly 98K. If I were married to a coworker, it would be 196K combined.
I live in the Bay Area, and around here the 3X income rule would mean that only high execs at tech companies can buy anything. I’m with Doreen. 20 years ago we paid 3.5X my salary for a bigger house than we strictly needed, but I’m glad that we did since its price relative to smaller houses has accelerated. It’s now worth about 8X what I make, and my income has gone up a good bit.
If you think your income has upside potential, then it is good to stretch, since your costs are fixed so the percentage of income paid for your house decreases. But not stretch to near the breaking point, of course.
That’s us! Well, we paid substantially less than $1.83 million, but for a relatively ordinary house in a relatively ordinary suburb, we owe way more than we can afford. We pretty much took out the maximum mortgage we could qualify for.
On the other hand, what we pay in the mortgage every month is less than our old rent on a two-bedroom apartment. Factor in the property taxes, and it’s a couple hundred dollars more per month for a much better quality of life, + equity instead of nothing at all.
I bought my house at the bottom of the market when all of the mortgage companies were really cranking down on their limits. I applied for the amount that I needed and was approved with no issues. During a finalizing paperwork conversation, I asked my mortgage guy what I would’ve been approved for and the number he said was about 2.5x what I requested. I told him that he had NO BUSINESS loaning me that kind of money, I had a horse habit." His response was “we don’t factor in anything but income, debt and credit history.” All I could think was that with my salary, I should’ve had a MUCH larger down payment if I could afford that much larger payment. The money was clearly going somewhere else…
Couldn’t you have just bought your current house, then sold and moved up into a nicer/larger house once you had the income to afford that larger house? Why stay 29 years in one place if you don’t like it and can afford better?