How much home? Home Value - net worth ratio

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How much home? Home Value - net worth ratio

Postby Btc » Wed May 22, 2013 10:34 pm

I've been looking all over for some advice, all I can find is how much home you can afford, everything i found refers to debt / income ratios. I am more interested how much home others buy in ratio to their net worth. If you have a net worth of let's say $1.0mm, 25% in real estate, 30% in stocks, 25% in 401k, 20% cash and other investments. How much home would you be comfortable buying? Lets assume you are in your mid 30ies, and based on your income, you could get approved for a mortgage equal to 1.5x your current net worth. You have been offered 10y Arm , 2.75%, interest only, 100% financing (401k and stocks are with same bank, and combined value is more than 35% of proposed loan value) how much home would you be comfortable buying?

The idea Is to increase leverage to hedge against inflation and buy a nice home for the family at the same time.
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Re: How much home? Home Value - net worth ratio

Postby letsgobobby » Thu May 23, 2013 12:02 am

Buy the home you need, but payments matter more than price in this case since interest rates are so low and so relevant to affordability.
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Re: How much home? Home Value - net worth ratio

Postby DieselEngineer » Thu May 23, 2013 4:18 am

Payments matter as you approach the high end of what you an afford. Just because you can afford the payment doesn't mean you have to spend that much.
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Re: How much home? Home Value - net worth ratio

Postby Valuethinker » Thu May 23, 2013 5:05 am

A long term fixed rate mortgage is an inflation hedge.

A variable rate mortgage is *not* because interest rates tend to catch up to inflation eventually.

It is generally not worth considering house value/ total assets as a ratio-- a house is a consumption decision. And your equity portfolio is too volatile-- mine has gone from twice my worth of house to 60% the worth of my house (equities dropped, house prices rose, we moved).

What you want is to buy a house that you are comfortable living with long term (given 5% agents fees plus other costs, moving frequently is a mug's game). that is a baseline cost of living. I favour repayment mortgages because there is an element of forced savings there. You want to know that at 55 or 60 you are free and clear. If you then need that capital to fund retirement or lifestyle change then you can trade down.

The issue about moving frequently is important. In the US as I understand it agents still charge 5-6%? In addition there is a 'bid offer spread' on houses that you don't see: you seldom get the 'market' price for a house, you get a slight discount representing whatever the buyer negotiates. And then when you buy, you have the same problem (ie you sell at the bid price, and buy at the offer/ask price, and there is probably typically a 3-4% gap between the two). Add it all up, you can lose 10% every time you move house. Huge transactions costs.

Investment comes on top of that.

Re cash you need enough to cover a prolongued period of unemployment. Say 12 months at least (depends entirely on profession, how far you can reduce ordinary expenses etc.). After that you invest.

Generally I favour 'investing' in paying down your mortgage rather than investing in bonds, given the relative after tax returns of the 2 activities, and given paying down your mortgage is as safe as investing in US T Bonds. However there is a case for the alternative depending on making full use of tax deferred account allowances etc. But bonds are paying such low yields right now that repaying mortgage is a pretty good idea (the alternative would be to invest in inflation indexed bonds-- but the expected real yields are generally negative).
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Re: How much home? Home Value - net worth ratio

Postby YttriumNitrate » Thu May 23, 2013 6:08 am

Btc wrote:401k and stocks are with same bank, and combined value is more than 35% of proposed loan value) how much home would you be comfortable buying?


Why do you have your stocks held in a bank? Based on the one or two bank sales pitches I've listened to, the expense ratio on the investment products they sell is terrible.
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Re: How much home? Home Value - net worth ratio

Postby johnep » Thu May 23, 2013 6:24 am

I would never consider an ARM, especially one that is interest only. Get a fixed rate mortgage for the shortest number of years that you can comfortably afford. The offer from your bank sounds a lot like the mortgages that got us in trouble in 2008.
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Re: How much home? Home Value - net worth ratio

Postby bungalow10 » Thu May 23, 2013 6:44 am

Btc wrote:You have been offered 10y Arm , 2.75%, interest only, 100% financing (401k and stocks are with same bank, and combined value is more than 35% of proposed loan value) how much home would you be comfortable buying?


That mortgage makes it sound like you can't afford to buy a home at all.

How much down payment do you have? Can you afford a home that suits your needs on a 15-year-fix or 30-year-fixed mortgage? If not, then you need to keep saving.

FWIW - we are 33 and 34 with three kids and our home is 1:1 with our annual income and 1:2 home value to retirement and 1:3 home value to net worth (ie our net worth is 3x the value of our home).
Last edited by bungalow10 on Thu May 23, 2013 9:35 am, edited 2 times in total.
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Re: How much home? Home Value - net worth ratio

Postby Bacchus01 » Thu May 23, 2013 8:30 am

johnep wrote:I would never consider an ARM, especially one that is interest only. Get a fixed rate mortgage for the shortest number of years that you can comfortably afford. The offer from your bank sounds a lot like the mortgages that got us in trouble in 2008.


I have had both an ARM and an interest-only in the past.

It depends on your goals and time horizon. In the case of the interest only, I was only going to be in the house for probably 2 years and my company relocation policy provided a COLA adjustment that paid 3% of the interest in the first year, 2% second year, 1% third year. And, we had a back-end agreement that if I lost money on the sale, they would reimburse me. This is a very extenuating circumstances, but I took an interest-only loan at the time for 4%. My company paid 75% of my payment. I lived in a $700K house for far less than rent would have been in the area and sold it for exactly what I paid for it 1 year later. Would I do that again? Probably not. But never say never.

As for the ARM. Do the math. If you expect to live in the house for only a certain period of time, it can be a real money saver. I've had 4 ARMs over the last 9 years. At the current rate, I'm paying 2.125% interest one year in on a 5/1 that we refinanced into. I did the math. Even if it resets to the full max amount in year 6, I still break even on interest costs out to about year 9-10. The likelihood that we'll have 12 years in our house (2 before the refi, 10 after) is slim to none. And, if it gets out there and I don't like the interest, I'll just pay it off or pay it way down.

Thus, again, never say never. It really depends on your situation.
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Re: How much home? Home Value - net worth ratio

Postby feh » Thu May 23, 2013 4:27 pm

Buy the house you need, not the house you can afford.
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Re: How much home? Home Value - net worth ratio

Postby Btc » Thu May 23, 2013 6:11 pm

bungalow10 wrote:
Btc wrote:You have been offered 10y Arm , 2.75%, interest only, 100% financing (401k and stocks are with same bank, and combined value is more than 35% of proposed loan value) how much home would you be comfortable buying?


That mortgage makes it sound like you can't afford to buy a home at all.

How much down payment do you have? Can you afford a home that suits your needs on a 15-year-fix or 30-year-fixed mortgage? If not, then you need to keep saving.

FWIW - we are 33 and 34 with three kids and our home is 1:1 with our annual income and 1:2 home value to retirement and 1:3 home value to net worth (ie our net worth is 3x the value of our home).


After reading your comments and seeing your ratios I feel like I need to clarify. If you are 33/34 and assuming you make combined 200k, u live in 200k home, your retirement is 400k and you have a total net worth of 600k. So you choose not to have a mortgage to take advantage of tax deductions, interest and property tax?

I chose to have a mortgage for tax reasons and use my cash for other investments. I think that average Americans often buy homes that often exceed their net worths. Someone that makes 80k year at age 30 could probably get a 200k mortgage, but based on this persons age, salary, his net worth may not be 50k.... If he feels confident that he will be making more money soon and the house at 200k is a opportunity, why should he not try to take advantage of low interest rates? In this example the person would be buying a home 4x-5x his net worth.

Anyway, going back to the original scenario, the person with a net worth of 1mm, 25% in 401k, could liquidate real estate, cash in stocks and bonds and buy a 750k home cash... Wouldnt be very smart not having any emergency fund etc... Losing out on yields by bonds and stocks. Etc.... he could cash in some investments to come up with a down payment of 150k and finance 600k. If he qualifies, he could also do 100% financing.....That house purchase would be 75% of the persons net worth.... What if his income qualifies him to get a 100% financing for a mortgage for 900k, 1mm, 1.1mm or even 1.2mm.
Question is' what would you be comfortable with?


I feel like I need to clarify
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Re: How much home? Home Value - net worth ratio

Postby bungalow10 » Thu May 23, 2013 6:34 pm

Btc wrote: So you choose not to have a mortgage to take advantage of tax deductions, interest and property tax?


We do have a mortgage, it's 15-year-fixed at 2.375%.

I don't, however, have it for tax purposes. What's the point of paying $1 in interest to get 33 cents back at tax time? That's ridiculous.

Btc wrote:Anyway, going back to the original scenario, the person with a net worth of 1mm, 25% in 401k, could liquidate real estate, cash in stocks and bonds and buy a 750k home cash


No, your original scenario was buying a home for 1.5x net worth and financing 100% of it with an IO mortgage. Why would you need a 1.5mm house? Can you really afford to finance 100% of it if you have to take an IO mortgage to do so?
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Re: How much home? Home Value - net worth ratio

Postby travellight » Thu May 23, 2013 9:22 pm

A home that is 1.5x my net worth would cost about 80% of my monthly income in payments. I don't think you can do it by home value to net worth ratio.

I would buy the amount of house that translates to house payment being no more than 30% of my monthly income, as is standard.
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Re: How much home? Home Value - net worth ratio

Postby YttriumNitrate » Fri May 24, 2013 10:32 am

Most people here will give you the advice that you should buy the least expensive property that will suit your needs for the next 5-10 years, and that’s good advice.

However, as a 30-something person who has more non-income producing real estate than needed, I understand your perspective. In my particular case, there were two transactions and it might be useful for you to think in the same way.

First, I bought the least expensive house that would suit my needs using a 30 year fixed mortgage. It was a lot less than what I could have qualified for, and I actually could have paid cash for it if I was willing to sell off a chunk of stock. FYI: The house was bought in the summer of 2009, so I’m pretty happy with the decision to get a loan.

About a year later I bought a tract of land nearby as play real estate. I don’t “need” that land, but I get a lot of enjoyment out it (mmm….venison) and have no plans of selling it. I’m guessing you would enjoy a bigger/nicer house and would probably end up not wanting to sell it as well. And, just like a more expensive house there are extra taxes on the property as well as maintenance costs.

When looking for land in my area, I only felt comfortable buying something that was less than 25% of my non-retirement net worth. With 100% financing on a 10 year ARM you’ve jacked up the risk substantially. Applying my experiences (and risk tolerance) to your case, I would be looking at houses that are no more than 10% of your net worth more expensive than the least expensive house that will suit your needs. In other words, going back to your scenario of the person with a 750k non-retirement net worth, if a 400k house would suit their needs then getting a 475k 100% financing 10 year ARM would seem reasonable to me.
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Re: How much home? Home Value - net worth ratio

Postby Batousai » Fri May 24, 2013 10:56 am

feh wrote:Buy the house you need, not the house you can afford.

Pretty much. I suspect most people who could afford a 400K house would be much happier with a 200K house and the extra disposable income for the difference.
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Re: How much home? Home Value - net worth ratio

Postby Honobob » Fri May 24, 2013 11:49 am

Batousai wrote:
feh wrote:Buy the house you need, not the house you can afford.

Pretty much. I suspect most people who could afford a 400K house would be much happier with a 200K house and the extra disposable income for the difference.

Only property in SF between $190-200,000. It's some Senior living property. http://www.realtor.com/realestateandhom ... 3555?row=1

Now we're lining large!
http://www.realtor.com/realestateandhom ... 3694?row=1
It's slowly dawned on me that we won the real estate lottery!
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Re: How much home? Home Value - net worth ratio

Postby vital15 » Fri May 24, 2013 12:00 pm

I agree with previous posters that the home value/net worth ratio doesn't make sense. Depends too much on your age and stage in retirement saving.

It is all well and good that people suggest buying a house that is 1x your income, but in some areas that is simply impossible. In my planning I typically think about a mortgage payment under 30% of monthly income.
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Re: How much home? Home Value - net worth ratio

Postby Batousai » Fri May 24, 2013 12:40 pm

Living in any of the extreme cost of real estate markets is a choice, if you choose to live there, then that's part of your choice. Not all choices are wise financially. ;)
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Re: How much home? Home Value - net worth ratio

Postby spotty_dog » Fri May 24, 2013 1:01 pm

When we bought our home, its value was probably at least 4x our other assets, and the mortgage sent our net worth slightly negative. Four years later, the house (which has lost about 10% of its value in the interim) is about 1/3 of our assets and about 1/2 of our net worth.

I think the calculation is a little nutty.

We bought the house with a 30-year fixed at 95% LTV. We refinanced after 3 years to a 15-year fixed at 80% LTV. The payments on the latter are about 15% of our household gross income. Still, the payments are about the largest line item expense in our budget, and the maintenance on the place isn't always easy to cover.

IMO a nice conservative rule of thumb is to put 20% down and have a 15 year mortgage whose payments are under 25% of net income. I don't really see where net worth comes into it except that the less interest you pay and the more income you have left after the payment, the more you can grow your net worth.
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Re: How much home? Home Value - net worth ratio

Postby Nukeboilermaker » Fri May 24, 2013 3:07 pm

spotty_dog wrote:IMO a nice conservative rule of thumb is to put 20% down and have a 15 year mortgage whose payments are under 25% of net income. I don't really see where net worth comes into it except that the less interest you pay and the more income you have left after the payment, the more you can grow your net worth.


I grossed just over 140k last year and took home ~80k, with the 25% net rule I should only spend 20k/yr on housing does this include taxes and insurance in this figure (especially on a 15yr mortgage)? Living in Illinois where real estate taxes are fairly high (I pay 3,200 for a house that is $145-150k value). We are looking to trade up in our home soon and are looking to get a mortgage in the 240-300k range and taxes will range from 6-12k (depending where you buy). That right there means that one should only spend 8-14k/yr on P.I.T.I. meaning someone who makes 140k/yr should only mortgage a 150k at MOST to make the numbers work.

I hope to put 20% down but I am doubtful I will save enough in time since I am wanting to move ASAP before some major home re-investment (windows, roof, tree trimming) may arise in the next 3-5 years. I don't plan on making this move until I receive an offer for a promotion which would come with a nice signing bonus (~20k... 10k post taxes). I would also likely sell my ESPP which would bring in 20k, and hopefully I will receive at least a 10k check when I sell my current home. Would we be living beyond our means to spend 30-40% of our net on housing (w/30yr mortgage)? We have no other debt... I'd be curious on what others think!

P.S. the 30-40% would include taxes, interest, and insurance. I max out my 401k, 10% to ESPP, and make sure to contribute 5k/yr each to IRA's (wife and I) we are 26 going on 27.

Cheers,
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Re: How much home? Home Value - net worth ratio

Postby spotty_dog » Fri May 24, 2013 4:22 pm

It's just one example of a very conservative rule of thumb. I got the idea from the book, Financially Stupid People are Everywhere (don't be one of them). That author's gist is to live WAY within your means and build financial independence. If you're spending 30-40% of your paycheck just to keep a roof over your head, and another couple of percent of the home's value each year on maintaining it, then you're locked to your job and your house. In your 20s, maybe that is totally fine by you -- you don't see any reason to want to be free of your job or out of your house, I get that. My husband is cresting the middle of his 30s in a high-stress job and looking for an exit; sometimes we feel like we have too much house even following the rule of thumb.
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