|Gary Foreman is a former Certified Financial Planner (CFP) who currently writes
about family finances and edits
The Dollar Stretcher website
http://www.stretcher.com. You'll find hundreds of FREE
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Considering the cost of homes these days, what is a reasonable
percentage of a person's salary that should be used for a mortgage
payment? And does this percentage include everything needed to run
that home (utilities, water, phone, etc.)?
Good question! And with the current
median selling price of a house being over $185,000 it's an
important question, too.
In recent years, people say that you
can't buy too much house. Common thinking is to buy as much house as
you can squeeze into today's budget. Expected increases in housing
prices and your salary will make the deal fit better next year than
it does today.
Yes, both housing prices and wages
should go up over the long term. For instance, the Consumer Price
Index shows that housing prices have increased about 43% over the
last 10 years.
Unfortunately, the mortgage is due
over the short term. Neighborhood housing prices can drop for a year
or two. And not everyone gets a raise each year. In fact, some
people lose their jobs. So you can get into a lot of trouble before
the long term increases bail you out.
OK, so if bigger isn't always better,
how expensive a house can Margie afford? Let's start with what
people actually do spend. The U.S. Statistical Abstract shows that
of all the money we spend, about 33% goes to housing. That would
include shelter, maintenance, heating and cooling.
So should she plan on spending 33%?
Probably not. Margie will need to consider her family situation.
Looking for a new house because you're about to have a baby?
Groceries, medical, college savings, daycare could all require a
higher percentage of your money than before.
And past financial decisions will
also affect what Margie can reasonably afford. Alimony and child
support are common issues. In fact, Tierney Foster, a long-time
Realtor with Remax in Bradenton, FL won't give a client advice on
affordability. She refers them to the lender who will consider their
debt ratio and other factors that will affect the calculation.
Interest on any debt that you owe
will lower the amount that you can safely spend on housing. In real
rough terms (depending on your interest rates), for every $8,000 you
have in credit card debt you have $100 less to spend on housing each
month. And that works out to a house that costs $16,000 less.
Remember that you can only spend 100%
of your after-tax income without getting into trouble. And you
really should be saving a portion of that for things like college
education and retirement. If you spend 40% on a house, and another
30% on food and transportation, you won't have enough money to cover
Another problem that Margie will run
into is that housing expenses aren't easily adjusted. If you buy a
house that's too expensive there's not much you can do reduce the
mortgage payment by 10%.
And, if housing consumes too much of
your money, it's hard to make it up in other areas. You'll never
make up $200 each month by reducing your spending on entertainment!
An over-expensive house often puts a family budget in serious
Which brings us back to the question
of how much house can Margie afford. There are some broad guidelines
that she can use. In most cases if she's planning on spending less
than 30% of her after-tax income on housing she should be alright.
On the high side, if she's approaching 40% she'll need to be very
She might want to check out
calculators on the internet. Bankrate.com has a good one.
They provide financial information and aren't affiliated with anyone
in the industry so their advice is neutral. She might also want to
check with a mortgage banker or broker and ask their advice on what
would be affordable.
There is one trick that Margie can
use that might prove helpful. She can pretend that she already owns
the house that she wants to buy. Estimate how much the new home
would cost. Then set aside the difference between that amount and
what they're currently spending on housing for a few months. In
other words, pretend that she's already paying for the house. She'll
pretty quickly find out whether they can comfortably handle the
increase. If she finds that she's scrambling while playing pretend,
she can expect to be in real trouble if she buys the house.
We hope that Margie finds a home that
she can love and afford at the same time.