What Can You Afford to Buy?
Adam Wilson

Our current economic crisis is due, in part, to individuals purchasing homes that they couldn’t afford. Some blame should be placed on predatory lending practices; however individuals should be able to determine what they can safely afford. Consider the following information when determining how much you can afford.

Many lenders compare the cost of a mortgage payment against your monthly before tax (gross) income to determine the qualification of a borrower. Most lenders don’t want to see more than 35% of your income dedicated to mortgage payment. For example, if your gross income is $6000 your lender will not allow expected monthly housing expenses to exceed $2100.

GROSS INCOME x .35 = MAXIMUM MONTHLY HOUSING EXPENSES

This one size fits all approach doesn’t address the many variables that potential homeowners face. You might consider adjusting the formula to more accurately fit your needs. Perhaps 30% or 25% are more your style. Now let’s consider what items are included in monthly housing expenses.

The mortgage, or loan you take out to buy a home, will represent the bulk of your spending. Mortgage loans are typically repaid over a 15 or 30 year time span. In addition to principle and interest, you will be required to pay property taxes and insurance. So calculation of your total payment looks like this:

PRINCIPLE+INTEREST+TAXES+INSURANCE = TOTAL PAYMENT

You can save literally thousands of dollars over the lifetime of your home loan if you do some shopping. The primary variable of concern is interest rate. Currently interest rates are screaming! As of this writing the average 30 year fixed rate is around 5.5%. Using the table below you can calculate the mortgage payment based on the amount you want to borrow, and the loan’s interest rate. Simply find the interest rate applicable and multiply the loan amount in thousands of dollars by the number listed next to the interest rate. For example if you are going to borrow $200,000 to finance the purchase of your first house at an interest rate of 4 1/4% you would multiply 200 by 4.92 for an estimated payment of $984. Remember this table is useful for estimates only.

Taxation on your property is unavoidable. Utah is ranked 34th in the nation in terms of the property tax burden placed on its citizens. The median tax is $1130 or roughly .68% of the properties value. When estimating the property tax, multiply the price of the home by .68%. For example, if your home price is $200,000 multiply by .0068% for an estimated tax of 1360. If you divide this by 12 you can estimate the amount of tax you will be paying monthly. Remember, this is an estimate only.

HOME PRICE x .0068 = ESTIMATED ANNUAL PROPERTY TAX

Insurance is the last part of the monthly payment formula. In order to secure financing for a home it must be insured. When you purchase home owners insurance you should buy the most comprehensive coverage that you can and take the highest deductible that you can afford to help minimize cost. Your homeowners insurance is going to cover the cost of rebuilding, lawsuit protection, and personal property protection. Consider contacting the following companies for quotes on insurance:

AMICA: AMICA customers give the company high reviews although their premiums are on the high side. (www.amica.com)
GEICO: You have probably seen the talking lizard commercials. (www.geico.com)
SAFECO: SAFECO insurance is generally less expensive although customer service is not the best. (www.safeco.com)

Once all of these figures have been calculated you can determine an estimated payment. This is not, of course, the beginning and end of your housing expenses. As a homeowner you must plan on maintenance and repairs. Plan on spending about 1% of the purchase price of your home each year on maintenance. With some types of housing, such as condominiums, your monthly HOA fees cover maintenance.

So lets consider a hypothetical scenario to tie all of these concepts together. First, lets say your gross monthly income is $3800. Remember that your monthly payment shouldn’t exceed 35%. In this example our payment should be around $1330 after principle, interest, insurance, and taxes. Next take a look at average interest rates on home loans. This information is readily available on the internet. Lets say the average interest rate on a 30 year fixed rate is 5 1/2 %. Armed with these numbers we start shopping. While searching for homes in your favorite neighborhood you spot a good looking house listed at $250,000. Using the chart above you multiply 250 by 5.68 for a total of $1420. It looks like $250,000 is a little bit too expensive. You can recalculate using a lower price to determine what you can afford.
Remember that you might feel pressure from lenders, realtors, family members, or even from yourself to borrow more money than you can comfortably manage. Use the ideas presented in this article to determine what the most prudent choice for your situation.