Today’s housing market is a difficult one for buyers, whether one is looking to buy a first home, or to upgrade. Prices for new and existing homes are at record levels and continue to climb, with demand continuing to significantly outpace supply. Nationwide, houses are staying on the market an average of six days (even less in some markets), and buyers are regularly having to win bidding wars against cash offers well above asking price to get a home under contract.
The hot housing market is due to a variety of factors. For one, the inventory of existing homes hitting the market is low, and there’s not enough new construction to pick up the slack. In addition, a large group of the over 62 million millennials out there are reaching the prime age for home purchasing and are eager to buy. Last, mortgage rates remain near record lows, which is boosting consumers’ buying power and letting them bid up prices.
For all of the reasons above, the consensus amongst housing experts is that if prospective buyers are able to be patient, they’re probably better off waiting for more inventory and less competition than they are buying today.
That said, buyers often can’t wait for ideal buying conditions (or don’t want to). Once the decision has been made to buy, the next question, especially with today’s sky-high real estate prices, is “How much house can I afford?” This is a highly personalized question ultimately determined by a combination of your current financial situation (household income, monthly debts, savings) coupled with your long-term investment and lifestyle goals.
While some buyers have the luxury of paying cash to purchase their home, most buyers will need to utilize a mortgage. There are a few different methods commonly used to determine an affordable payment amount:
- The 28% Rule: You should spend 28% or less of your monthly gross income on your mortgage payment (principal, interest, taxes, and insurance).
- The 35% / 45% Model: Your total monthly debt, including your mortgage payment, shouldn’t be more than 35% of your pre-tax income, or 45% more than your after-tax income.
- The 25% Post-Tax Model: Your total monthly debt should be 25% or less of your after-tax income.
Generally, lender requirements are in-line with the first two methods—most require that you spend less than 28% of your pre-tax income on housing and 36% on total debt payments. However, for many buyers the more conservative 25% Post-Tax Model (or less) will be the more prudent option. For those with large lifestyle expenses, such as young families, putting a smaller percentage of income towards a home to have more disposable income to fund education, activities, vacations, and retirement savings may be preferred. For those who aren’t supporting kids and/or have significant incomes, financing 28% of gross income might not be a problem. The above models are simply starting points that address the upper limits of responsible financing. Ultimately, the percentage of income one can afford to finance is a personalized function based on one’s current finances and long-term goals, and a question that can be addressed through comprehensive financial planning with your financial advisor.
Together, we can work to keep you on-track towards your financial goals. Request a consultation with me to learn more.
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