How Much Home Payment Can You Handle?
- Wednesday, May 12, 2004
According to the National Association of Realtors, there is an old rule of thumb that says most home buyers can afford a house that costs about 2 to 21/2 times their annual gross income. (This is total earnings before taxes and other withholdings are deducted.) But, as the NAR so correctly points out, this is only a rough rule of thumb.
People's situations vary. Job stability in some areas of the country is not what it is in other areas. Your present debt load may be more, or less, than the average. How about your other financial planning? How long is it to retirement? What arrangements are you making for the kids to go to college? Do you have your financial house in order? These are all considerations that will have an impact on what you can comfortably afford to spend on a house -- and, more specifically, your monthly payment.
RealEstate.com reports another rule of thumb saying that lenders feel comfortable with people spending between 28%and 33% of their gross monthly income on housing.
But don't forget, lenders are in the business of loaning money. If they don't make loans -- they go out of business. And, the bigger the loans they make, the better. Although a good lender will not make a loan that doesn't fit what his models say you can repay -- he may not be overly concerned about how tough it will be for you to make those payments. Ultimately, it is your job to decide what is affordable for you. How much can you pay back every single month for the next 15 or 30 years -- without sacrificing your emotional and spiritual peace?
As I present the No Debt No Sweat! Christian Money Management Seminar at churches and in other venues around the country, I teach people how to determine what their "True Income" really is. As I urge people to avoid too much debt I use this phrase when referring to the money that a family brings home after all taxes and withholdings have been factored out. This is also reasonably predictable income that is not dependent on unreliable bonuses, wishful thinking, and the like.
I like to encourage young, first-time homebuyers to work from this "true" income amount. Then, if at all possible, my advice is to keep total housing costs including your monthly payment (which typically includes principal, interest, taxes, and insurance), plus maintenance and upkeep, at no more than 25% to 33 % of that amount. I realize that this is less than some commercial lenders may allow, but my job isn't to make loans. My job is to encourage you to buy no more than you can afford-without adding undue stress to your life.
15-Year Vs 30-Year Mortgages
Americans love to defer pain. Pleasure and gratification have become the mantra of our culture. But, sometimes it's a question of deciding how best to cut off the dog's tail: Is it better just to whack it all off at once, or 1-inch at a time? Although our squeamish side might prefer the inch-by-inch approach, the poor dog would probably rather get it all over with at once.
When it comes to mortgages, there is a similar question to be answered: Would you rather have more pain for a short period of time; or would you prefer a low-level, nagging, on-going, dull pain for a much longer period? That is the difference between 15- and 30-year mortgages. The benefit of the 30-year plan is that the monthly payments will be somewhat less than in a 15-year payout. But that also means monthly payments for 15 more years -- that's 180 more checks to the mortgage company! Also, you need to know, that often the interest rate on a 30-year mortgage is higher than it would be on the same house with a 15-year mortgage.
For instance: Suppose you decide to borrow $150,000 on a home with 30-year mortgage at seven-and-a-half percent. (At present rates are somewhat lower, but seven-and-a-half percent is well within historic norms.) Your monthly payment (principal and interest only) would be about $1,049. But, if you bought that same home on a 15-year mortgage at seven-and-a-half percent, your monthly payments would only go up to $1,391 -- or, $342 more per month.
But here's the real story: By the end of the 30-year mortgage you would have made total principal and interest payments of $377,640. If, instead, you had financed the home over 15-years, the total payout would have been $250,380. That's a savings of $127,260 in interest costs!
And, as I mentioned a few sentences ago, frequently the rates on 15-year mortgages are around a quarter percent to a half percent lower than for comparable 30-year mortgages. So, if you chose the 15-year loan, it would be reasonable to look for a rate of around seven to seven-and-a-quarter instead of seven-and-a-half. Based on that, with a 15-year mortgage at seven-and-a-quarter, your monthly payment (principal and interest) would be around $1369-or, only $320 more per month. And, your savings over the life of the loan would increase to about $131,220!
Adjustable Rate Mortgages: The Path of Least Resistance
An adjustable rate mortgage, often referred to as an ARM, is a home loan with an interest rate and monthly payments that are subject to change. Sometimes the payment starts low with a "teaser" rate. This rate, though, is designed to go up or down depending on what interest rates do. Usually the loan rate is tied to some external interest rate index(s). Mercifully, there is usually a maximum interest rate cap.
My advice for someone convinced to roll the dice with one of these loans is twofold: Be sure never to sign anything until you understand all the details of the loan document; and second, make sure you can pay the highest possible rate if you have to.
But, think about it, if you can't afford those higher payments today -- what makes you think you'll be able to in a couple of years? Yeah, I know, your salary will increase and you may hit it big on a quiz show --but, don't bet on it. Just when you think you'll be able to easily absorb those higher monthly payments that's when Murphy's Law kicks in --an elderly parent will need financial aid, or you'll be downsized at work, or the stork will knock at the door with that sweet, little, unexpected bundle of joy.
Maybe instead of calling these ARM's, it would be kinder to admit the obvious and name them ARM & LEG loans -- since that's what they can cost! Personally, I'm not enough of a riverboat gambler to appreciate this offering from our friends in the lending business. My advice regarding adjustable rate mortgages is clear, terse, and concise: DON'T
Steve Diggs presents the No Debt No Sweat! Christian Money Management Seminar at churches and other venues nationwide. Visit Steve on the Web at www.stevediggs.com or call 615-834-3063. The author of several books, today Steve serves as a minister for the Antioch Church of Christ in Nashville. For 25 years he was President of the Franklin Group, Inc. Steve and Bonnie have four children whom they have home schooled. The family lives in Brentwood, Tennessee.
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