Housing affordability boils down to knowing your budget


By ,
Ask a Lender
November 15, 2016 | Updated September 14, 2017


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Key Points

Advice for first-time homebuyers

  • Know what you can afford.
  • Understand that affordable housing is not the same as being able to afford a house.
  • Get prequalified to help determine how much house you can afford.
  • Accept that just because you are qualified for a certain loan amount doesn't mean you should spend that much.

 

For first-time homebuyers, the thought of spending five, six or seven figures on one purchase is daunting. In many instances, it will be the single biggest purchase they make.

The thought of not being able to afford that purchase down the line, and having a house foreclosed upon, can be terrifying.

So it is vitally important that, when considering such a purchase, homebuyers are aware of what they can afford.

Affordable vs. Affordability

According to the 2015 "How Housing Matters" study from the MacArthur Foundation, housing affordability is not only a major cause of concern for most Americans, but it has also changed the way most Americans live. Fifty-five percent of respondents said, within the past three years, they had made at least one sacrifice so they could pay their mortgage or rent. For many, that meant working more hours or an extra job, or taking on credit card debt.

Many municipalities have made affordable housing a priority, with the U.S. Department of Housing and Urban Development saying that families shouldn't pay more than 30 percent of their income to rent or mortgages.

But affordable housing isn't the only issue, particularly for homebuyers, and some economists don't tout that 30 percent number as gospel.

In a 2006 paper, and in several studies since, University of Massachusetts at Boston Professor Michael Stone has written about this issue, highlighting the difference between affordable housing and housing affordability.

"Affordability is not a characteristic of housing — it is a relationship between housing and people," Stone wrote. "For some people, all housing is affordable, no matter how expensive it is; for others, no housing is affordable unless it is free."

Stone is one of many people who tout the virtues of "residual income" affordability, which means determining if a family can still pay for all of its needs — not just its debts — after paying for housing. For example, a family's residual income would be different if they have children and pets than if it is a couple living alone.

For many families with high incomes, spending 30 percent on housing would still leave plenty of money left over for other needs and expenses. For some with low incomes, however, spending 30 percent on housing may not leave enough money to pay for other needs. Each scenario is different, and requires potential homebuyers to take a long, honest look at their finances.

What lenders want

When it comes to funding a mortgage, many lenders will still use some of the tried-and-true ratio and percentage rules.

"Most mortgage lenders want to see the housing expense — the principal and interest, taxes, insurance, mortgage insurance and [homeowners' association fees] — be no more than 31 percent of your total monthly gross income," says Alisa Glutz, a licensed mortgage professional with Cherry Creek Mortgage Co.

When you add that housing expense to the minimum payments for credit cards, cars and other debts on a credit report, Glutz says, that total should be no more than 43 percent of total gross income.

Several websites feature "mortgage calculators" that claim to show prospective buyers how much house they can afford and what that monthly mortgage payment would be. These often take into account the borrowers' annual income, the downpayment amount they can afford, the projected interest rate and what other debts the borrower has. Some of these calculators, however, don't show the other expenses that go into monthly mortgage payments, such as property taxes, home insurance and mortgage insurance.

"Make sure you read the fine print on what the payment includes and what criteria is required for a person to qualify for the projected payment," Glutz says.

The easiest way to find out how much of a loan you can qualify for is to speak with a broker or lender. Going through a preapproval or prequalification process will give you a better idea of how much house you can afford.

It is also important to remember that, although you may qualify for a certain amount, that doesn't mean you need to spend that much on a house. But by taking into account your potential loan amount, your current financial situation and how secure you feel about your financial future, you can get a better vision for the price range that is right for you.

"Part of the reason you want to have this conversation early on is, you may be someone who qualifies for a higher loan and a higher price range, but that may not be in your comfort level," says Jason Bloom, a branch manager with Guild Mortgage. "You want to be sure … the financing [meets] not just your financial needs, but also your comfort zones when you factor in your other financial obligations."


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