Ms
Warren and Ms Warren Tyagi in The Two Income Trap wisely
advise families to prepare for emergencies ahead of time. I am thinking of
copying the chapter “The Financial Fire Drill” and giving it to my clients
before they start house hunting. They pose three questions:
1. Can your family survive for six
months without one of the incomes you rely on?
2. Can you downshift the fixed expenses?
3. What is your emergency back-up plan?
Rent
or mortgage is usually the family’s biggest fixed cost. Since mortgage is
almost invariably higher than rent here, would-be home buyers need to think
about their fixed costs and how to prepare to pay them. Therefore holding the
mortgage payment to something you can handle is key.
I
would like to get specific about how to think about your mortgage payment.
The
“front” ratio for a loan is your real estate monthly payment in relation to
your gross adjusted income. A prudent limit is no more than 28 percent of your
income that can be used for your housing expense. I advise my clients not to
fudge it beyond that level.
Let’s
keep it simple:
If
a couple earns $100,000 gross adjusted income, their mortgage payment is capped
at $28,000 a year, or $2,333 a month. That’s the whole payment: principal,
interest, tax and insurance. Most of the
time, my would-be clients are clueless about the weight of property taxes. They
can borrow $350,000 for less than $2000 in principal and interest. Fine.
Property insurance is likely to be under $200 a month. Great. But taxes in that
price range can get as high as $600 a month. Especially in the suburbs where
there is more land on the parcel.
OK,
scale back. Since a cheaper house will have lower property tax, on average, at
$100,000 gross adjusted income, the prudent loan amount comes in at about
$280,000, assuming a $500 a month tax bill. Where taxes are lower, say $300 a
month, that figure goes up to about
$315,000.
In
this market, that doesn’t buy a family home in a toney suburb. If both members
of the couple are working full time to earn that $100,000, can you have a
back-up plan that would work? Unlikely.
Depending
on two incomes at maximum mortgage level is a bad idea.
When
mortgages were calculated on a single income -- in those Father Knows
Best days -- couples could overcome a set-back by sending Mom to
work. I think the mortgage rules should be scaled accordingly, with a lower
ratio if two incomes are being counted (maybe 20-25 percent.) Even if the rules
aren’t changed, I try to convince my clients to scale themselves back so they
have fixed costs that they can handle.
I
feel like a lone wolf crying in the wilderness about this. At least The Two Income Trap authors take it seriously.
Reprinted
from BREN, March
2010.
3 comments:
Rona, how do you get those numbers?
At 3.5%, on a 30-year mortgage, a $300k loan requires a $1350 monthly payment. Our taxes are under $4k/year, call it $350/month. Insurance is pretty cheap -- less than $100/month. (Much less.)
You can buy a SFH for ~$350 on a $1800 nut. The $2800/month you cite would be enough for a $500k house, with room to spare.
Remember that this couple is borrowing $350,000, so they are buying $350,000 plus 10% ($385,000) or 20% ($420,000.) Roughly $1,350 principal and interest (PI), plus insurance (I agree that could be as low as $100 a month, but could be as high as $200 a month.) Taxes in the $350-425,000 price range goes over $500 a month in Acton, Bedford, Medford, Natick, Sudbury and Wayland. Some over $550 a month in Acton, Natick, Sudbury and Wayland. (source: MLS for sale today.) That brings the buyer to $1350 + $150+ $550 = $2050. Add water and maintenance and the buyer is too tight, in my opinion. I am pretty conservative about what I recommend my clients spend on housing.
The takeaway I was aiming at is that buyers must keep an eye on the taxes. Land carries a high tax charge. I don’t expect to see property tax go down in my lifetime, do you?
More figures: Borrowing $280,000 the PI is $1,257. Borrowing $315,000, the PI is $1,415.
If I didn't answer your question, ask it again a different way.
Okay, so with the revised numbers we're looking at a $300k loan on a $375k property, at a PI cost of $1350. Insurance really shouldn't be more than $100/month (mine is under $75/month) on a property in that range, unless you are in a flood zone. Tax rates do vary dramatically by town, could easily be as low as $400 or as high as $600 on the same property. But we basically agree, PITI on that comes to ~$2000, fully 10% below the guidelines which intentionally do NOT include utilities or maintenance.
Whether or not that is comfortably supportable on a $100k income depends on the other financial obligations. No kids? No debt? Ought to be no problem. This is roughly the cost/income ratio that we hit when we were buying, though with higher interest rates we were looking at higher mortgage payments vs. lower taxes and insurance.
Whether or not you can safely continue those payments depends on job security, financial reserves, and (once again) the other financial obligations in your life. If you have $50k in liquid savings and at least one job that is unlikely to evaporate in a downturn, then you can sustain a loss of the other job for several years. Our neighbors managed that trick.
Is actually riskier if the $100k income derives from a single job. Lose that job, lose your benefits, and suddenly you are getting by on public assistance.
Many factors in assessing somebody's financial situation, but with the present low rates it isn't at all unreasonable for somebody with $100k income to be looking at a $375k property.
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