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May 13, 2010

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Hi FMF, my question on all calculations like these, is do you use your gross or net wages? I'm looking to buy in hte next couple of years and it makes a great difference in the price range I should keep in mind. Thanks.

Jenn --

He uses gross wages for his calculations.

"For those people I'd suggest waiting to buy and saving up enough downpayment so your mortgage is under control when you do buy."

Those mortgage to income ratios simply don't work in any part of the country where people actually want to live (i.e., non flyover areas). I'm sure they work just fine in rural Michigan, with 25% unemployment and an Applebee's.

Pop, We live in a rather high cost of living area (without a high income to match) and our ratio is only slightly higher than what is recommended here. We are currently throwing extra money on the principle each month, which should pull our ratio into balance within a year or two. Other than our high mortgage balance, we live well below our means and manage to save about 25% of our income. It can be done, you just have to make it a priority.

If I'm a 30yo making $80K/yr ($6,667/mo), what lender is going to give me a loan with a monthly payment of $3,333? At current rates, that would be a loan for about $440,000 (15yr fixed) or about $620,000 (30yr fixed). My calculations are only considering principal & interest (i.e., no taxes and insurance). A home affordability calculator on web comes up with $328,000 and $1,400/mo (30yr fixed). Am I misunderstanding his ratios?

What I dont understand about the mortgage to income ratio is if it costs 1200 to rent a house or apartment vs. 1200 in mortgage/taxes/insurance - why is it better to rent than buy just because the initial mortgage may be higer than 2 years?

I'm looking at closing on a house in the next few weeks, and my ratio is about 2.5*, but we have a realistic plan in place to pay it off w/in 6 or 7 years. The ratio would quickly fall within the "acceptable" amount - so why not have the 25 or 30 year old ratio a little higher? In my case, with my husband working form home, a dog, and a kid, and hopefully another kid soon - what we would pay for renting something of a similar size is much more expensive than what we end up paying with the mortgage.

I wonder if there is any type of adjustment for interest rates as well. Considering you can get a 5% 30 year fixed rate right now - do the ratios change based on what the interest rate is? the same price house is much more expensive when you have a 7% rate.

*Actually - if you count my expected bonus check, which i never do for the sake of budgeting, we are very close to the 2.0.

Pop --

Actually, they work in most non-expensive markets (NY, LA, Chicago, Boston, etc.).

I've lived in Nashville, Pittsburgh, Cincinnati, and Grand Rapids and those numbers work. Maybe you consider all these "flyover areas", but millions of people don't.

We are 27, 5 years out of college, and our current MIR is 0.90875 (woot) and our Education Ration is 0 (double woot).

Our low mortgage is a huge factor in our early retirement goal. We got really lucky on having no educational debt (his parents paid and my parents covered about $16,000...my part-time jobs and scholarships covered the rest).

Jeff,

Double your income for the calculation. So you should have a mortgage of NO MORE than $160,000 (with your current $80,000 a year income). Notice I (nor FMF) said you shouldn't buy a house of no more than $160,000...

So if you want a $220,000 house. You should have a down payment of $80,000 and a mortgage of $160,000 (2.0 X Current Income) to meet the criteria of this ratio.

I'm 49 and my mortgage/income is 0.4. And that mortgage will be paid off in 3 years -- whoo hoo!

Of course, I live in a smaller city in a flyover state.

It is true there isn't much to recommend it except the low low cost of living (unless you like the cold cold winters!)

Unemployment is only around 8% in my county, though, and my city is growing in size as people move here for the jobs. I just wish someone would open a decent restaurant!

Also Jeff I would like to mention that the housing affordability calculator you are using was may more aggressive (more debt) than the ratios discussed in this post. I would personally not take on a loan of $328,000 with an $80,000 a year income...

BTW that would put your ratio at 4.1 (much higher than the suggested ratio of 2.0 for your age as described in the post).

I have a house with a $110,000 mortgage and a 6 figure income. However a few months ago I was making $45,000 a year - so at that time my ratio was 2.4... Now my ratio is less than 1.

A house is not an investment -- I think buying what you can afford is the underlying principle of the ratios in the post.

MC --

Don't you have an Applebee's or Bob Evans?

I read the post a bit too quickly. I originally thought he was suggesting spending half (the inverse of 2.0) of my income on my mortgage. BTW, we'd have to set the wayback machine back a few years for me to hit 30; this was merely an example. If a 30yo lived in my area s/he wouldn't be able to get much for $40K down and a $160k mortgage.

"It can be done, you just have to make it a priority."

Sorry, I should have been more clear: the ratios don't work if you don't want to live in a dump.

"A house is not an investment -- I think buying what you can afford is the underlying principle of the ratios in the post."

A house (i.e. the land) is like anything else, it all comes down to supply and demand. In small towns that have lost manufacturing jobs, a house cannot be considered an investment.

"the ratios don't work if you don't want to live in a dump"

Nice try. Our house is only six years old with hardwood floors, in a great neighborhood and one of the top school districts in the state.

We do have an Applebee's.......also an Olive Garden. So maybe not so bad?

Our house is far from being a dump, fortunately, and I just added a brand new gourmet kitchen. So I cook and entertain at home instead of going out!

I don't live in a McMansion but I don't want to. I think these were hit hardest in the housing bust. Who in there right mind buy a 750K house when a 250K house will do. I live in the most econmically depressed area in the nation DETROIT. My house after living in it for ten years is now what I paid for it. No biggie seeinig that I will have it paid for in 5 more years and I am 47. When that is done ALL the money will go for saving for retirement over and above 401k,roth,403b.

My ratio is .75. Include my wifes income .25

My house that has a $110,000 mortgage on it ($128,000 value) is located in Columbia, SC. This is the state capital and is a decent city to work and play in (college town). The houses is 1400 sft. and is only 2 years old (highly efficient with a power bill of $130 a month).

I just wanted to point out that you can get a nice affordable house in a great city for a good price. You just have to shop around (like anything else). Any by shop around I do mean you have to look outside of your current surroundings (town, city, state) for possibilities.


I actually now live in Charlotte, North Carolina (renting out the house in Columbia, South Carolina) and the housing costs are much higher here. I am not considering a purchase here at all (until prices drop - if they even do). Otherwise I plan on renting and doing my research before purchasing another house (cash this time) somewhere else in the country.

MIR is 0, bought our first place in cash. Highly recommended, as you can also negotiated a better deal.

Mike

On the MIR, this almost always doesn't work for quality walkable urban neighborhoods in cities in metro areas with thriving job markets, which is where I live and where I will always want to live.

I am 35 and my MIR is 2.67. I am 6 years out of grad school and my SLIR is about at the .45 for the 5 year out measurement.

So I should theoretically move to somewhere cheaper and save money, right? Not necessarily. Salarywise, my field pays maybe 70% of my current salary in smaller towns and cities, at best.

Loanwise, my student loans were refinanced at the perfect time and are fixed rate at 2.125% for the next 20 years. That's almost like free money.

Lifestyle-wise, I don't have an Applebee's, but within a 15-minute walk I do have a slew of local farm-to-table restaurants to eat at, a killer public bus system which keeps our transportation costs very, very low, (wife only drove 4000 miles all last year) and public schools that have high schools with better SAT averages than most colleges. While I know these community amenities sound like expensive frills to some, we definitely feel we are getting value for what we pay in our considerable property taxes and our mortgage.

The condo I bought in 2006 and sold in 2009 appreciated 5% per year over those three years and we sold at a profit of $12k after transaction costs. Buying the condo allowed us to garner enough equity to buy into a house in the same neighborhood. Without the appreciation of the condo, it would have been impossible. Here, homes ARE an investment. How many people who sold CONDOs last year can say the same?

In our case, I am early enough in my career that my salary will grow into the mortgage comfortably as we pay it down. At the same time, property appreciation has been so strong over so long a period here, that once you get a foothold on the first rung, it is easier to climb the ladder up to better properties by getting local appreciation to help you along with savings and salary growth.

So what does this all mean? Ratios aren't everything, and lifestyle matters more to some folks. I try to keep a healthy balance, and have a goal of $500 debt prepayment per month above my regular mortgage/car/stuloan payments. I agree with FMF and like trying to pay college debt off in ten years. My rates are so low, though, that I'm much better off paying down the mortgage. I save more interest and build equity faster that way.

It would be interesting if someone thought about how to tune these ratios for different cost-of-living locales...

I think the mortgage-to-income ratio is grossly unrealistic for a market like Vancouver. Even if you suggest that people save up longer for a down payment, they could be saving up for a very long time.

Consider that a (very modest) one bedroom apartment can easily run you $300,000. Based on a median (single person) income of about $40,000, this implies that the person should not have a mortgage of more than $80,000. If this is the case, they need to save up a $220,000 down payment before buying?

Even at a savings rate of 20% (of gross income), this person is only saving $8,000 a year. A $220k down payment would take nearly 30 years! So they can finally get ready to take on a mortgage in their fifties?

MIR - 0 (thanks to my wife for support & my earlier company for stock options)
EDAER - 0 (thanks to my dad for financing my degree - even if i had taken a loan, the ratio would have been ~.5)

MC --

Good for you! Cooking in a nice, new kitchen IS better than eating out!!! ;-)

These ratios are meant to be low...the point is that if you follow the guidelines, your finances will be very manageable and there will be plenty of 'working' money in the budget to build capital.

Too bad I didn't read much about PF in my 20's (or even in my thirties), but better later (I am 39) than never!

"Nice try. Our house is only six years old with hardwood floors, in a great neighborhood and one of the top school districts in the state."

Which state is that?

Washington, Pop.

Pop, our 1750 sq. ft. house in a suburb of Houston, TX was built in 2004, has 3 bedrooms, is in terrific condition, and is in a great school district (Klein is rated really well). We are also 5-10 minutes away from almost anything a person could need (food, entertainment, hardware stores, Sam's Club, a park, hobbies, etc). My husband is 15 minutes from his job and I'm 30 from mine.

Our MIR is 0.9. We're 27 now and our house was a foreclosure that cost $114,000 and we put 20% down in 2007.

These ratios can work in non-dumpy places.

Holly is spot on. The whole point of the ratios is to guide you in a direction that leads to build wealth.

Michael Kwan,

The ratios are indeed grossly unrealistic for Vancouver. I will tell you what the solution is. RENT! I am currently renting in Charlotte, NC because it doesn't make sense to buy in this area. It is the fiscally responsible thing to do in that situation. I know that is also unrealistic thought... Right? Because we all know that houses always appreciate in value. It is impossible that someone would buy a condo in Vancouver for $300,000 and then a couple years later that very same condo is only worth $150,000. That is IMPOSSIBLE!

Why take the risk? Don't speculate. Rent when it makes sense for your individual finances (again that is what the ratios are trying to accomplish)...

Have a great day everyone!

Even though I want to buy a house/apartment, I'm resigned to renting because even if I can afford the mortgage, the maintenance on a co-op or condo here is more than what most of the country pays for their mortgage. So even when you pay off the mortgage, you're still shelling out (with taxes and maintenance) 1,000 plus a month, realistically closer to 1500 per month. And that is for a 1 bedroom and a den, not even two bedrooms!

Thanks FMF! Now here's to hoping my income grows by leaps and bounds in two years =)

Hahaha (that's meant to be a bitter laugh). The idea of a mortgage twice my income to buy a property here in London is crazy. Try 6x.

Your solution makes sense though, in that it's what I've actually done (save/invest a massive capital portfolio).

Thing is when you've done that, you feel rather less inclined to gamble it on what's still (here in the UK) an overvalued looking house market!

Having a MIR of 2 in the DC area, where I live is HIGHLY unrealistic. My husband and I bought a small home (2 br, 1 ba, no garage, basement or yard) 2 years ago. If we had followed this ratio, that would mean we could've spent just $260k ($60k down payment plus $200k mortgage). Just try finding ANYTHING other than a tiny studio for that amount. We have no debt and a mortgage payment of $1520 (plus $370 condo fee). We contribute fully to our Roth IRAs AND 403(b)/401(k) AND have savings and other investments AND travel internationally AND can afford to buy most anything we want (not that we want for much; we're pretty simple folk). There's no reason to limit the amount you spend on your home - the place where you eat, sleep, entertain, raise your family - to just 2x your income. It's the most important place in your life!

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