House Affordability - Question on standard advice

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4fitness
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House Affordability - Question on standard advice

Post by 4fitness » Fri Aug 31, 2018 7:06 pm

Hi all,

My question is in regards to advice I see about home affordability. A number of sites have advice that you can afford a house at 2, 3, or even up to 4 times gross income. Is that number referring to the mortgage alone (after down payment) or total price (mortgage plus down payment)?

Obviously there are a lot of other factors, but I see this advice fairly often and just want to make sure I’m interpreting it correctly.

Thanks

mbasherp
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Re: House Affordability - Question on standard advice

Post by mbasherp » Fri Aug 31, 2018 7:10 pm

I’m sure there will be variety among responses, but we used 2x gross income as a cap for total purchase price.

JoeNJ28
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Re: House Affordability - Question on standard advice

Post by JoeNJ28 » Fri Aug 31, 2018 7:12 pm

We did 2x our income, total price of the house didn’t account for a downpayment.

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snackdog
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Re: House Affordability - Question on standard advice

Post by snackdog » Fri Aug 31, 2018 7:13 pm

PITI should be 36% of gross income, roughly.

delamer
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Re: House Affordability - Question on standard advice

Post by delamer » Fri Aug 31, 2018 8:11 pm

I thought it was a total price of 3X income, assuming a 20% downpayment.

Whether that is good advice is, of course, another question.

runner540
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Re: House Affordability - Question on standard advice

Post by runner540 » Fri Aug 31, 2018 8:16 pm

The rules of thumb are just that: not really applicable for individual situations, which vary with property tax rates (1% vs 3% makes a big difference in annual costs), income stability, down payment size, etc.

According to Fannie and Freddie, it's fine to spend 50% of income on your mortgage...

Do you have a specific actionable question?

mortfree
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Re: House Affordability - Question on standard advice

Post by mortfree » Fri Aug 31, 2018 8:21 pm

Depending on the site it would probably mean whatever math equation gives you the highest Home price/loan.

My recent purchase I put 50% down and the house is just under 4x my gross income.

But the math that really mattered was based on my net income after maxing 401k and if I had enough to comfortably afford the PITI. That is, I relied on my budget calculations and not another website or financial person.

Dottie57
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Re: House Affordability - Question on standard advice

Post by Dottie57 » Fri Aug 31, 2018 8:25 pm

The higher the interest rate , the lower the amount to borrow. When I bought, the interest rate was 10%. The amount was 2.5 times income.

student
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Re: House Affordability - Question on standard advice

Post by student » Fri Aug 31, 2018 8:29 pm

I did about 2.5 times my salary over 15 years ago.

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4fitness
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Re: House Affordability - Question on standard advice

Post by 4fitness » Fri Aug 31, 2018 8:33 pm

Hi all,

Thanks for the responses so far. We are starting to look at homes and I just wanted to get a general consensus on advice I see commonly listed. I've messed around with the house affordability calculators online and they all say we can afford much more than we are willing to spend.

We are in a fairly HCOL area around DC so the 2-2.5x gross is a bit tougher to hit. If that is after 20% down payment we would be in the range for the houses we are seeing in our online searches.

Thanks

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Socrates
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depends on where you live

Post by Socrates » Fri Aug 31, 2018 9:14 pm

IMHO....HCOL areas the ratios will be much different (e.g. Ca.).
“Don't waste your time looking back. You're not going that way.” ― Ragnar Lothbrok.

KlangFool
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Re: House Affordability - Question on standard advice

Post by KlangFool » Fri Aug 31, 2018 9:17 pm

4fitness wrote:
Fri Aug 31, 2018 8:33 pm
Hi all,

Thanks for the responses so far. We are starting to look at homes and I just wanted to get a general consensus on advice I see commonly listed. I've messed around with the house affordability calculators online and they all say we can afford much more than we are willing to spend.

We are in a fairly HCOL area around DC so the 2-2.5x gross is a bit tougher to hit. If that is after 20% down payment we would be in the range for the houses we are seeing in our online searches.

Thanks
4fitness,

1) Is it cheaper to rent? If yes, why would you buy?

2) Do you have kids? Do you plan to have kids? Until and unless you have kids going to school, why would you buy? What if the school system went bad before your kid starting school? Then, you are forced to sell and move.

3) How high is HCOL? My neighborhood in Northern Virginia is around $200 per square feet.

KlangFool

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4fitness
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Re: House Affordability - Question on standard advice

Post by 4fitness » Fri Aug 31, 2018 9:43 pm

Hi Klangfool. Thanks for weighing in.

1) Is it cheaper to rent? If yes, why would you buy?

I've done the NYTimes calculator and buying comes out ahead for similar houses.

2) Do you have kids? Do you plan to have kids? Until and unless you have kids going to school, why would you buy? What if the school system went bad before your kid starting school? Then, you are forced to sell and move.

Yes to kids. Our goal is to be in the house when elementary school begins. We have some time.

3) How high is HCOL? My neighborhood in Northern Virginia is around $200 per square feet.

We are in MD. Just ballpark, I'd say it is about 10% cheaper than your number or about $180 per square foot.

I originally posted my question related to the 2-4x gross income I always see thrown around just to see what actual numbers that worked out to. As I have seen from responses here, it looks like folks calculate this in various ways and nothing set in stone.

4fitness

KlangFool
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Re: House Affordability - Question on standard advice

Post by KlangFool » Fri Aug 31, 2018 9:58 pm

4fitness wrote:
Fri Aug 31, 2018 9:43 pm
Hi Klangfool. Thanks for weighing in.

1) Is it cheaper to rent? If yes, why would you buy?

I've done the NYTimes calculator and buying comes out ahead for similar houses.

2) Do you have kids? Do you plan to have kids? Until and unless you have kids going to school, why would you buy? What if the school system went bad before your kid starting school? Then, you are forced to sell and move.

Yes to kids. Our goal is to be in the house when elementary school begins. We have some time.

3) How high is HCOL? My neighborhood in Northern Virginia is around $200 per square feet.

We are in MD. Just ballpark, I'd say it is about 10% cheaper than your number or about $180 per square foot.

I originally posted my question related to the 2-4x gross income I always see thrown around just to see what actual numbers that worked out to. As I have seen from responses here, it looks like folks calculate this in various ways and nothing set in stone.

4fitness
4fitness,

<<I've done the NYTimes calculator and buying comes out ahead for similar houses.>>

The calculator is only as good as your input. For example, what was your house appreciation assumption? I got a great deal when I bought my current house a few years ago. The PITI with 20% downpayment and 30 years 3.49% was around $1,800. The rent for the same townhouse was around $2,300. So, I could buy the house assuming 0% appreciation.

KlangFool

Cycle
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Re: House Affordability - Question on standard advice

Post by Cycle » Fri Aug 31, 2018 10:54 pm

4x income seems ludicrous to me, we paid less than 1/3rd income for our unit. I could maybe entertain up to 1x income in our area.

We live in a lcol city tho, I'm not sure we could buy a dumpster in CA for 1x income.
Never look back unless you are planning to go that way

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Nate79
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Re: House Affordability - Question on standard advice

Post by Nate79 » Fri Aug 31, 2018 11:36 pm

Stretching to buy a home in LCOL or HCOL is the same, it's stupid. Just because someone loves in HCOL doesn't mean they get a pass on math. If you can't afford to buy you should rent.

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Re: House Affordability - Question on standard advice

Post by IowaFarmBoy » Sat Sep 01, 2018 5:57 am

I'm not sure I can explain this clearly but I'll give it a try....

For years I've heard numbers like 2.5-3 times income should be the cap on purchase price, at least here in the midwest. As I've watched our kids move off to HCOL areas, that ratio doesn't work very well. One thought I have had is that in the HCOL areas, it seems like their salaries are 30-50% higher than here in a LCOL area. My impression is that most of the difference in COL is due to housing- basics like food, clothing, utilities, life insurance, etc. are somewhat higher but not nearly as relatively high as the cost of housing. So let's say someone would be making $100k in a LCOL area and $130k in a HCOL. While some of this increase will go to the increased cost of the basics and taxes, most of this additional income could be applied to increased housing costs. This could really help them stretch beyond the standard ratios.

That said, DD and family in Hoboken currently own at about 2x income but their 800 sq ft 2 BR condo is crowded with 2 kids. They will probably upgrade in the near future and getting into something more spacious could easily push them up toward 3x if they stay close to the city. They will have some good equity to apply so that will help ease the pain. So maybe the ratios aren't so far off after all.

FireProof
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Re: House Affordability - Question on standard advice

Post by FireProof » Sat Sep 01, 2018 6:33 am

Depends on the other options. We were willing to spend 7x income, because the mortgage payments were still considerably cheaper than rent.

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Re: House Affordability - Question on standard advice

Post by Sandi_k » Sat Sep 01, 2018 2:16 pm

Cycle wrote:
Fri Aug 31, 2018 10:54 pm
4x income seems ludicrous to me, we paid less than 1/3rd income for our unit. I could maybe entertain up to 1x income in our area.

We live in a lcol city tho, I'm not sure we could buy a dumpster in CA for 1x income.
You can't.

:D

Hulk
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Re: House Affordability - Question on standard advice

Post by Hulk » Mon Sep 03, 2018 8:26 pm

We kept our mortgage (not purchase price) at 2x our income. Still save 20% for retirement and have money to do the things we want to do, which is the whole point of the question right.

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CyclingDuo
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Re: House Affordability - Question on standard advice

Post by CyclingDuo » Tue Sep 04, 2018 4:28 am

4fitness wrote:
Fri Aug 31, 2018 7:06 pm
Hi all,

My question is in regards to advice I see about home affordability. A number of sites have advice that you can afford a house at 2, 3, or even up to 4 times gross income. Is that number referring to the mortgage alone (after down payment) or total price (mortgage plus down payment)?

Obviously there are a lot of other factors, but I see this advice fairly often and just want to make sure I’m interpreting it correctly.
I ran the calculations to see what a house 4 X our gross income would be with a 20% downpayment, and PITI. It would be 28.38% of our gross income, so not out of line. At 3 X our gross income with a 20% downpayment, PITI would be 21.42% or our gross income. That's better. At 2 X our gross income with a 20% downpayment, PITI would be 14.47% or our gross income. That would free up the household budget in a nice way to boost savings and enjoy life day to day. All of those would work, but which one (2X, 3X, or 4X) would free up your household budget the best to provide a nice balance of quality home and the ability to save/invest, pay all of your expenses, take vacations, and enjoy life?

Lenders consider the front-end debt to income ratio using PITI. They will also consider the back-end debt to income ratio of all the other debt you owe combined with the PITI.

Several ways to run the calculation, but the mortgage payment (how much you can afford) is the critical number. If your monthly PITI X 50 equals your annual salary, then you have 24% of your gross income going to your mortgage. That's the same figure they use in New York City to rent an apartment. The renter must qualify with the equation of annual salary being at least 50 X the monthly rent. Not a bad rule to keep everyone solvent.

Many calculations suggest keeping your PITI at 28%-33% or below of gross income. The lower the percentage, the better in terms of creating a household budget that will allow you to save, invest, and pay for your expenses (needs, wants, variables). Example: After our downpayment when we bought our house 15 years ago, PITI began at 24% of our gross income. Today, due to increasing household income over the years, the percentage for our PITI is only 10% of gross income. That has naturally allowed for a higher percentage of our income going to savings.

Avoid being house rich and cash poor!

Calculate how much of a down payment you’ll need to keep your payments to less than 25% of your monthly income. At this percentage, you’ll still be able to pay your bills, save for retirement, go on family trips and, overall, just enjoy life.
https://www.marriagekidsandmoney.com/5- ... rs-market/

We would agree with that author's premise. However, we understand that in HCOL areas things are much different. :dollar
"Everywhere is within walking distance if you have the time." ~ Steven Wright

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Re: House Affordability - Question on standard advice

Post by Kow » Tue Sep 04, 2018 5:36 am

I generally find the ratio of income to house spend over simplistic. It all comes down to your individual situation and how you spend your money.

First figure out your net monthly income. For example maybe it's $5k
Then figure out your monthly spend on everything you need. Maybe that's $2k. Build a buffer.
Next figure out how much you want to save monthly to hit your goals both for long term and short term need. Maybe that's $1k
Now you are left with $2k a month to spend on a house for mortgage plus taxes.

Everyone's cost of housing and goals/savings are different. If you are actually buying a house do the math very specifically for your situation.

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Re: House Affordability - Question on standard advice

Post by DarthSage » Tue Sep 04, 2018 6:31 am

We did things a different way. We applied for a mortgage, the bank said they wold loan us X. We then used X/2 as maximum mortgage amount. I realize there's no scientific basis for this, but when we bought our first house, we were 23/24 and newly married. WE couldn't believe the bank would loan us so much--seemed foolish, even in our naive state of mind.

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Re: House Affordability - Question on standard advice

Post by Jags4186 » Tue Sep 04, 2018 7:18 am

Just work backward from your income and that will determine your budget.

Say you have $10,000/mo income.

$10,000
-Monthly savings
-Monthly non-housing expenses
-Incremental home expenses (say increased utilities, maintenance, etc. overestimate if you're coming from an apartment)
-Foreseeable near term expenses (daycare, tuition, new car, etc.)

Let's say after all of that you are left with $2000. This is what you can afford to pay towards PITI. Now look at some houses you're interested in on Zillow or Trulia, whatever. Input your downpayment and see if you can keep the monthly payment with taxes & insurance in that $2000 range. If you're nowhere in the range of $2000 then you need to recalibrate what you're looking at or save a larger downpayment.

It's easier to do this off of net income, but it works regardless of whether it's gross or net. If it's gross, just make sure you subtract out your taxes and all your pretax deductions. If it's after tax just subtract out your non-payroll savings and continue on. You should arrive at the same number.

Advice about multiples of income is meaningless due to differences in tax rates and quality of home stock. In some parts of the country $500,000 comes with $2500 property taxes and is a mansion. In that case, you may be able to easily afford that house but do you really need it? People say they need 3000+ square feet but who is responsible for cleaning all that? In other parts of the country $500,000 house is a smaller midcentury home that needs updating and comes with $15,000 property taxes. Are you prepared for the endless maintenance and do you want to tackle updating? And when you do that updating the taxes will go up even higher. In other parts of the country $500,000 buys you nothing and you have no choice but to rent.

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Re: House Affordability - Question on standard advice

Post by MrBeaver » Tue Sep 04, 2018 8:02 am

What about this?

To buy a house as a wise financial decision, it must pass three criteria:
  1. Cheaper than renting (NYT calculator, for instance)
  2. 12 * PITI + 1-2% of Home value < (gross income - retirement savings) * 45%. This guards against total housing outlays putting too much strain on the rest of the cash flow budget. The 45% factor could be adjusted for cost of living delta between housing and other expenses. The 1-2% number is for maintenance and upgrades.
  3. Home value < 150% * (total portfolio - total debt [aka net worth without home equity]). This ensures one’s portfolio is sufficient size that the house and debt are not reducing future expected returns needed for long term goals by too much.
In reality, many will fudge on these or other criteria because of non-financial desires (location, stability, schools, etc.). That is fine, but it’s useful to know when that is happening.

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Re: House Affordability - Question on standard advice

Post by Admiral » Tue Sep 04, 2018 9:45 am

I would not use any number or multiple of gross income to determine what amount of house you can afford, as gross is meaningless. 20-35% could go to taxes, and you should be maxing your retirement accounts.

I would work backwards. At the minimum, look at your net (take home) after the above items are subtracted out. Using that number, I would suggest PITI should be no more than 30% of your net. Don't forget, utils etc also cost money. Then there are repairs. So, that may mean you need to put a lot down to achieve that low percentage. But figuring out the payment first should help you determine how much you can reasonably afford without being house poor.

People who spend 40, 50, 60 % of their net income on housing are crazy IMO, but of course in many places (CA, NYC) this is common.

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Re: House Affordability - Question on standard advice

Post by Nate79 » Tue Sep 04, 2018 9:51 am

MrBeaver wrote:
Tue Sep 04, 2018 8:02 am
What about this?

To buy a house as a wise financial decision, it must pass three criteria:
  1. Cheaper than renting (NYT calculator, for instance)
  2. 12 * PITI + 1-2% of Home value < (gross income - retirement savings) * 45%. This guards against total housing outlays putting too much strain on the rest of the cash flow budget. The 45% factor could be adjusted for cost of living delta between housing and other expenses. The 1-2% number is for maintenance and upgrades.
  3. Home value < 150% * (total portfolio - total debt [aka net worth without home equity]). This ensures one’s portfolio is sufficient size that the house and debt are not reducing future expected returns needed for long term goals by too much.
In reality, many will fudge on these or other criteria because of non-financial desires (location, stability, schools, etc.). That is fine, but it’s useful to know when that is happening.
I do not agree with #3. If you have #1 and #2 which basically means that it is cheaper to buy than rent and is affordable within your income flow then how can #3 make sense? So if you fail #3 you should instead rent which means you will actually have less money to invest (because of #1)?

P in the PITI is actually an asset and not lost. Owning a home stabilizes your long term housing cost and once paid for will provide much less housing cost than renting. It relates in no way to portfolio value if costs between buying vs renting are the same.

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Re: House Affordability - Question on standard advice

Post by cherijoh » Tue Sep 04, 2018 11:35 am

snackdog wrote:
Fri Aug 31, 2018 7:13 pm
PITI should be 36% of gross income, roughly.
PITI should be no more than 36% of gross income. It is perfectly ok and desirable to spend less than that!

cherijoh
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Re: House Affordability - Question on standard advice

Post by cherijoh » Tue Sep 04, 2018 11:54 am

4fitness wrote:
Fri Aug 31, 2018 8:33 pm
Hi all,

Thanks for the responses so far. We are starting to look at homes and I just wanted to get a general consensus on advice I see commonly listed. I've messed around with the house affordability calculators online and they all say we can afford much more than we are willing to spend.

We are in a fairly HCOL area around DC so the 2-2.5x gross is a bit tougher to hit. If that is after 20% down payment we would be in the range for the houses we are seeing in our online searches.

Thanks
Rules of thumb around X times your income are basically useless. For one thing it ignores your down payment and for another it ignores your mortgage interest rate! As interest rates increase, the PITI will also increase - making a house costing the specified multiple of salary totally unaffordable.

If you want to know how much you can actually afford, figure out what the PITI would be on a house costing $X dollars with a down payment of $Y. Then compare that to your current budget (making adjustments for your current housing, utility, and commuting expenses) and figure out if it would work and what sacrifices you would need to make.

cherijoh
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Re: House Affordability - Question on standard advice

Post by cherijoh » Tue Sep 04, 2018 11:57 am

DarthSage wrote:
Tue Sep 04, 2018 6:31 am
We did things a different way. We applied for a mortgage, the bank said they wold loan us X. We then used X/2 as maximum mortgage amount. I realize there's no scientific basis for this, but when we bought our first house, we were 23/24 and newly married. WE couldn't believe the bank would loan us so much--seemed foolish, even in our naive state of mind.
Clearly, you weren't as naïve as the average home buyer! :wink:

cherijoh
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Re: House Affordability - Question on standard advice

Post by cherijoh » Tue Sep 04, 2018 12:07 pm

4fitness wrote:
Fri Aug 31, 2018 9:43 pm
Hi Klangfool. Thanks for weighing in.

1) Is it cheaper to rent? If yes, why would you buy?

I've done the NYTimes calculator and buying comes out ahead for similar houses. <-- People often want to buy more house than they currently rent. Are you using your actual rent or the rent for a comparable house that you are looking to buy? If it is the latter, the signal will heavily favor buying unless there are odd circumstances like people forced to rent out their house because they can't sell it (e.g., after the housing bubble in some locations). In other words, the landlord is expecting to make a profit on renting out their house.

2) Do you have kids? Do you plan to have kids? Until and unless you have kids going to school, why would you buy? What if the school system went bad before your kid starting school? Then, you are forced to sell and move.

Yes to kids. Our goal is to be in the house when elementary school begins. We have some time.

3) How high is HCOL? My neighborhood in Northern Virginia is around $200 per square feet.

We are in MD. Just ballpark, I'd say it is about 10% cheaper than your number or about $180 per square foot.

I originally posted my question related to the 2-4x gross income I always see thrown around just to see what actual numbers that worked out to. As I have seen from responses here, it looks like folks calculate this in various ways and nothing set in stone.

4fitness

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Re: House Affordability - Question on standard advice

Post by bloom2708 » Tue Sep 04, 2018 12:20 pm

Don't forget that owning a home will bring new/exciting/unheard of ways to take your money.

New or used, I don't think it matters much.

Use a 2 or 3x multiple to start your analysis and budgeting. You can't nail it exactly, but you can get ideas of insurance, property taxes, repairs/maintenance, upgrades, additional HOA type fees and utility bills.

I love owning a home, but it is expensive. Something is always breaking or out dated or just not the way you want it. Landscaping, mowing, snow removal, weather incidents, wind. We have loved our previous houses and put a lot of money into them. I would say we likely will come out ahead by buying, but it is not a free lunch. Much work and responsibility.

I also do not think the NY Times calculator is updated for the 2018 tax changes. Although it could be by now. Not meaning to scare you off, but Principle, Interest, Insurance and Taxes are above the water in your iceberg home purchase. :wink:
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Re: House Affordability - Question on standard advice

Post by MrBeaver » Tue Sep 04, 2018 12:25 pm

Nate79 wrote:
Tue Sep 04, 2018 9:51 am
MrBeaver wrote:
Tue Sep 04, 2018 8:02 am
What about this?

To buy a house as a wise financial decision, it must pass three criteria
...
  • Home value < 150% * (total portfolio - total debt [aka net worth without home equity]). This ensures one’s portfolio is sufficient size that the house and debt are not reducing future expected returns needed for long term goals by too much.
I do not agree with #3. If you have #1 and #2 which basically means that it is cheaper to buy than rent and is affordable within your income flow then how can #3 make sense? So if you fail #3 you should instead rent which means you will actually have less money to invest (because of #1)?

P in the PITI is actually an asset and not lost. Owning a home stabilizes your long term housing cost and once paid for will provide much less housing cost than renting. It relates in no way to portfolio value if costs between buying vs renting are the same.
I guess for me, if my housing asset approaches the value of my investment assets, then I’m not allocating my capital in a way that will grow efficiently because I’m tying a lot of my net worth up in an asset that rises marginally above inflation. In your example (cheaper to buy than rent and I can afford the PITI and maintenance, but fails #3), I’d rather buy a smaller home so my investments can grow efficiently. If that is not feasible or available, then I’d look at increasing my income and/or moving to a different city.

I guess #3 is just my way of ensuring I’m not buying a lot more house than I need even if I can afford the monthly payment so that I stay on track for long-term goals. Granted, this strategy would likely keep me from living in HCOL areas.

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Re: House Affordability - Question on standard advice

Post by barnaclebob » Tue Sep 04, 2018 12:29 pm

House value was just over 4x our income but the mortgage was less than 2x income and for a 20 year note the PITI is just about exactly 33% of our take home pay after tax withholding and 401k contributions.

randomguy
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Re: House Affordability - Question on standard advice

Post by randomguy » Tue Sep 04, 2018 7:50 pm

4fitness wrote:
Fri Aug 31, 2018 7:06 pm
Hi all,

My question is in regards to advice I see about home affordability. A number of sites have advice that you can afford a house at 2, 3, or even up to 4 times gross income. Is that number referring to the mortgage alone (after down payment) or total price (mortgage plus down payment)?

Obviously there are a lot of other factors, but I see this advice fairly often and just want to make sure I’m interpreting it correctly.

Thanks
You can afford what your paying in rent and any savings you want to put into a house instead of a bank account. Every other rule is making assumptions that may or may not apply to you. Think about it. Is a person with 2x of their salary in student loans able to take out as much for a house as a person with 0x? What about the person who likes to driver 50k cars versus the person who likes 25k? What about the person who likes 15k/year vacations versus the 5k person? And the 2-4x rules are even stupider when you realize they are saying that 1k and 2k payments are equally affordable (i.e. one person gets a 3% mortgage, the other a 7% on).

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Re: depends on where you live

Post by stocknoob4111 » Wed Sep 05, 2018 12:09 am

Socrates28 wrote:
Fri Aug 31, 2018 9:14 pm
IMHO....HCOL areas the ratios will be much different (e.g. Ca.).
wrong, it shouldn't be different... in HCOL the same affordability metrics apply. Affordability is just what it is and math suddenly does not stop being applicable just because one lives in a HCOL. Trust me, I have a high income and still can't buy at 3X income but then I just don't buy. I would rather build up a strong investment portfolio instead of being house poor.

https://www.youtube.com/watch?v=MjzM5WpWk4E

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