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July 2008 |
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How Much House Can You Afford?With America's personal debt, bankruptcies and the price of real estate at recent historical highs, perhaps a lesson in housing affordability is in order. We could simply pass along some rules of thumb, such as: Never let your housing payment exceed one third of your income. But we think readers of Debt Matters can think for themselves. So, as is our style, we are providing some questions to consider before closing on that next piece of property. What's the "real" price of the home? Most people shop for a home with three numbers in mind: The sales price, the interest rates and the payment they can reasonably come up with each month. But there are a couple other numbers to keep in mind. The first we'll call "the cushion," which is the amount of money you'll have left over for emergencies, maintenance and other investments each month after your housing payment. Everybody needs to factor in a cushion because without it, even if everything goes right, you'll have all your wealth invested in your home. If that happens, the real price of the home also includes the "opportunity cost" of you not being able to diversify your wealth. Another number to consider is the age of the home. A home that's 30 years old requires more of a cushion than a brand new home. It's much more likely you'll be facing a major repair such as a roof or new plumbing, which could cost tens of thousands of dollars in the near future. Buyers of older homes need to factor in added cushion. Another thing to consider is insurance. If insurance costs have gotten pricey in the area you are considering, the type of house you buy can affect the "real price" of the home. Generally, apartments and town homes are cheaper to insure than single-family homes. Is that price going to stay fixed? Once you determine the real cost of the home, another key component of affordability is the likely fluctuation of that cost. Insurance increases are always possible and repairs are hard to predict, but many homebuyers in recent years have bought adjustable-rate mortgages, which mean the interest rate can climb (or drop) after you're tied to a mortgage. To make matters worse, people often buy ARMs to bring the interest rate low enough to make the house seem affordable. And if that's the case, these folks probably have little "cushion" to fall back on if the interest rate rises. Is your income going to stay fixed? One of the inherent risks of buying a home is that usually the buyer is signing up for 30 years of sizable payments, which means you are betting you can maintain the necessary income for 30 years. If not you risk, selling the home in a pinch or foreclosure. However, this is a reasonable risk because generally our incomes increase during our careers and with a fixed interest rate, your housing payment can, in effect, decrease in real dollars. But, when gauging affordability, it's important to not to turn this reasonable risk into a silly one. For example, if you had an unexpectedly good year financially, don't base your mortgage payment on repeating that every year. Also, if two spouses work, they should consider what happens if one of them loses a job. Or if they have children, will one spouse want to take an unpaid leave to be with the child? Buying a home should be one of the most rewarding investments we make because it gives us more than just a stake in the real estate market. It gives us, well, a place to call home. So, if you are buying such an investment, take the necessary precautions to keep the investment a safe and pleasurable one. |
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