As so often is the case, inspiration for this post comes from personal experience. I’m in the market to purchase a home for my son and I, something he can stay in long after I’m gone. I’m shocked, to say the least, at what mortgage companies are willing to offer prospective buyers; it’s easy to see how people can become “house poor”. In the buyers’ defense, “dream homes” are expensive and from what I’ve been hearing many purchasers are looking for “move-in ready” – which further drives up the price.
Why am I concerned? Because we’ve had a very flush economy for the last (9) years, and I’m afraid people have short memories. Recessions, or US Business Cycle Contractions as defined by the National Bureau of Economic Research, happen; they are not freak events – although I cannot predict when the next one will occur I feel absolutely 100% confident we will see another one in the not too distant future.
When it does occur, and people are down-sized or retire early, will they be able to afford the home they’ve bought? This isn’t a mortgage company’s problem, nor should it be. The mortgage company is evaluating a buyer to determine how much the buyer can afford to pay the company each month for the loan they give. It’s not their business to figure out your living expenses; and although they will consider your debt to income they do not project future car or other major purchases.
Here’s a breakdown I think anyone can use. Most experts agree we should be saving 20% of our income for the future. This leaves 80%. If you spend 30% of your income on mortgage payments (let’s include taxes and insurance), and if you don’t consider income tax; this leaves you 50% to spend on a car payment, groceries, cable tv, eating out – you get the picture. So let’s put some numbers to this.
The following calculation is not a perfect representation, it’s meant to provide a rough overview. The median US household income is $57,617 (source US Census Bureau). For simplicity we’ll assume they are married filing joint returns, so in the 22% tax bracket (source Tax Foundation). We’ll also assume they are saving the recommended 20% into a Roth 401(k). So after taxes and Roth contributions their estimated net income is $35,953, or $1,382.80 if paid biweekly (26 pay periods). This is what is available to pay a mortgage, buy groceries, etc.
Some will use the first month’s paycheck to cover their mortgage, and their second month’s paycheck for everything else – which works out to be about 29% of their gross income. This is as high as I would want to see it. Unfortunately, many families are NOT saving 20%, and still using an entire paycheck to pay the mortgage – for my fellow nerds approximately 36% of gross income. This leaves very little wiggle room if something negative (translation life) happens.
This is the drawn out version of why I recommend people rely on no more than 30% of their current (not promised or estimated future) income when accepting a mortgage. If you want more house, use a bigger down payment. The mortgage company will almost certainly approve you for more than this, but YOU DON’T HAVE TO TAKE IT. You are the master of your financial destiny, don’t let yourself get caught up in the emotion of buying a home. Yes, this is a major decision, and yes this will have a significant impact on your family’s quality of life – but it’s not the ONLY influence. Give yourself enough financial breathing room to enjoy life (without going into further debt).