According to the MacArthur Foundation’s How Housing Matters Survey, 52 percent of U.S. households had to make sacrifices in order to manage their rent or mortgage for the past three years. Housing affordability is the culprit. The problem is housing affordability. While home prices have risen by around 20 percent in the last two years, wages have not risen. The slow recovery of the economy, particularly for young people, has made it harder for them to save money for a downpayment or to afford a mortgage.
Housing is a serious investment. This includes getting a second job, not saving enough for retirement, cutting back health care, cutting down on healthy food, and taking out credit card debt.
A growing number of people are skeptical about buying a home. The survey found that 43 percent of respondents believe owning a house is not a wise long-term investment. More than half of those surveyed feel that buying a house is less attractive.
For those who have a long-term perspective, one of the biggest concerns is the dim future for home prices. The historically low mortgage rates have been trending upwards, which is bad news for future home values. Currently, home ownership rates are at 64.8 percent. This is the lowest level since 1995’s second quarter.
Housing affordability ratios
A substantial loan is required and you are responsible for the maintenance of your home. You may need to adjust your lifestyle if you have been renting.
The amount of house you are able to buy will depend on your income and the amount you have for a downpayment. Banks, realtors, and mortgage lenders will run your numbers to determine the cost of the house and the amount of mortgage you can afford. They usually base their estimates on the ratios at the front and back ends. Here’s how it works:
Front-end ratio (or housing expense): This is how much of your monthly gross income (pretax) would go towards the mortgage payment. Your monthly mortgage payment should not exceed 28 per cent of your gross monthly income. This includes principal, interest and real estate taxes. Divide your annual salary by 0.28 to calculate your housing expense ratio. Your maximum monthly housing expense ratio is the result.
Back-end ratio: This is the ratio of total debt to income. It shows how much of your gross monthly income you would use to pay for all your debt obligations. These include mortgages, car loans, child support, alimony, credit cards bills, student loans, and condo fees. Your total monthly debt obligation should not exceed 36% of your gross income. Divide your annual salary by 0.36 to calculate your debt-to income ratio. Your maximum monthly debt-to income ratio is the result.
Before you purchase, consider the cost of maintenance and repairs. My rule of thumb is that your total housing expenses should not exceed 25% of your gross income. The common sense will tell you that with 25 percent of your gross earnings going towards housing expenses and 25 percent going toward income taxes (federal state and Social Security), you have only 50 percent to live on to save for retirement and other expenses.
