How-to Monday: Affordable mortgages
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The mortgage mess hanging over the country offers many useful (if painful) lessons. First on the list: Don't borrow more than you can really afford to pay back.
Closely related to that is Lesson #2: Don't blindly rely on industry professionals to tell you what that amount is. Get down and dirty with the math yourself.
Here's a look at the debt-to-income levels you'll need to qualify for a loan nowadays, and some thoughts about how to get beyond that to true affordability.
Lenders look at a measurement they call your debt-to-income ratio. In plainer English, that means they'll be comparing your monthly before-tax income to your proposed mortgage payment (principal, interest, insurance and taxes) PLUS any other installment or revolving debt (car loans, boat loans, student loans, personal loans, credit-card minimum payments, etc.). Thanks to Ryan W. James, senior mortgage banker with First Horizon Home Loans, for that plainer English definition.
James, who's based in Timonium, said lenders will in most cases allow a debt-to-income ratio of up to 50 percent. If you make $5,000 a month ($60,000 a year), your monthly debt can't top $2,500.
"If you had a $400 car payment and a $200 student loan and a $60 minimum payment on your credit cards, we know your maximum mortgage payment is only going to be about $1,840," James said.
(U.S. News & World Report has a debt-to-income calculator HERE, if you'd like to take one for a spin.)
In the go-go housing boom days, it wasn't too hard to push beyond that 50 percent limit, James said. Good credit? Sure, go ahead. But he says it's much tougher now.
Though credit availability has tightened a lot in the last year, with loan products disappearing everywhere you look and lenders requiring better credit scores, today's debt-to-income limits are still high by historical standards. The traditional rule of thumb was 36 percent, says Christopher Cruise, a mortgage trainer in Silver Spring and a board member of the National Association of Responsible Loan Officers.
Both Cruise and James recommend you think carefully about how much mortgage debt you'll be comfortable taking on.
James says he does a budget analysis with clients that gets beyond the ratios to the nitty gritty. What's your take-home pay after taxes, retirement plan contributions and the like? How much are you spending a month in addition to debt payments -- the cost of meals, entertainment, gas, utilities, etc.? How much do you want to be able to save once everything, including your mortgage, is paid up each month?
Cruise says that Baltimore-Washington housing prices, even with recent declines, remain high enough that buyers may feel forced to choose between the house they want and the lifestyle they're used to. His advice: Look in less-expensive neighborhoods you might not have considered, cut back on your non-mortgage spending or keep renting while you whip your finances into shape.
"Have some willpower, for God's sake," Cruise said. "Buying a home now and getting foreclosed on in a year or two is not ideal."
Comments
I think you meant to write "monthly debt service" and not just "monthly debt".
And letting a lender tell you how much of your income you can risk for debt service is just as bad as letting them do the math themselves. Borrowing what they'll let you borrow is what stated this entire sub-prime mess in the first place.
Posted by: Peter Lorenzi | March 17, 2008 2:17 PM
Right -- what you owe per month, not the grand total you owe.
But I'm certainly not telling people to let lenders define for them what an acceptable debt-to-income ratio is. I'm saying there's often a difference between what's allowable and what's really affordable. Didn't that point come through?
Posted by: Jamie Smith Hopkins | March 17, 2008 2:25 PM
Hi Jamie,
I'm an Real Estate Investor and many times when I deal with banks I run into debt-to-income issues with banks. I also work a full-time job which thoroughly covers my expenses but sometimes I don't think the bank factors in my rental income (80%)when determing whether or not I qualify for a loan. My FICO score is in the low to upper 700's. Thanks to Mr. James and the link for breaking this calculation down for people like me. Now I can compare my calculations with the banks.
Posted by: mo | March 17, 2008 4:36 PM
Mo, mortgage issues are generally more complex when you're borrowing for an investment property. You might reach out to other real estate investors in your area to see what's typical -- I'd guess that the rules range quite a bit from institution to institution.
Posted by: Jamie Smith Hopkins | March 17, 2008 4:58 PM
Jamie,
The basic message and piece is fine but all borrowers need to be VERY careful as to who they listen to and what "ratios" they adopt.
You had James tell you us will be tough to borrow over the "industry" standard 50% today. I'm saying that a year ago, that same industry advisors would tell you and allow you to go over the limit. You need to know your limit, not theirs, and you can't exceed it, even if they let you.
What you must include is basically a worst case scenario, i.e., assume the ARM rate will increase to the max; assume the home will not appreciate, perhaps even depreciate; assume you may have to sell the house sooner and not when you expected.
Posted by: Peter Lorenzi | March 17, 2008 9:02 PM
I can't disagree, Peter, because this was precisely my point.
Posted by: Jamie Smith Hopkins | March 18, 2008 7:29 AM
People should also think beyond making "just" the required monthly payments on their mortgages. The interest rate on my savings account keeps decreasing as the Fed cuts rates....but my mortgage interest rate is still about 6.75%. Paying down your mortgage principle as fast as possible is one way to make the most of your money.
Posted by: Lili Velez | March 18, 2008 9:55 AM
Good point, Lili. And it's certainly easier to do that if your monthly mortgage isn't a huge chunk of your paycheck to begin with.
Posted by: Jamie Smith Hopkins | March 18, 2008 9:57 AM