There is a great article today from Reuters, titled “Home prices rise in January, best yearly increase since 2006: S&P“.
I find it interesting that people cry because the price of housing is going up, but do not understand what this means. Some people are stating that they cannot buy a house. There are several things that one must consider about this.
One thing to note is, we are now selling houses at about 1993 prices. The current price of the average house sold is $152,000. The prices will have to increase about another 75% to reach pre-bubble home prices of November 2003. (http://www.statisticbrain.com/home-sales-average-price/)
Let’s look at what is needed to purchase a house. Let’s use some stats that are available:
The average gross income is $63,685 (http://www.bls.gov/news.release/cesan.nr0.htm) with the average spending of $49,705 in total expenses, that included $16,803 on housing. Their housing is 26% of their income, and if my calculations are correct, that means the average American family spends 77% of it’s income! If the average American pays 27% in Federal and State Income taxes (http://www.nowandfutures.com/taxes.html), that means the average American pays (77% + 27%) 104% of it’s GROSS INCOME!
THAT might put a damper on the ability to buy a house!
Let’s take out that $16,803 mortgage and drop their expenses down to a manageable $32,902 and look at what the average American will need to make it happen.
Well, you do need a down payment of at least 3%. Based on the $152,000 house price, that would be $4,560. It would be better if you had 5%, so let’s up that to $7,600.
Next, let’s assume (I know that is a bad thing to do, but it will work here), that you have a FICO of 740 (see “https://www.lendingtree.com/mortgage/credit-score-needed-article” about the effects of FICO on your mortgage qualifying). BTW, if you have under a 620 FICO, don’t even bother considering getting a mortgage. Work on increasing your score to over a 740.
Now … the “Front-end Ratio”. It is defined on bankrate.com as:
Front-end ratio: The housing expense, or front-end, ratio shows how much of your gross (pretax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28 percent of your gross monthly income. To calculate your housing expense ratio, multiply your annual salary by 0.28, then divide by 12 (months). The answer is your maximum housing expense ratio.
So, that would be $63,685*0.28 = $17,831.80. Then $17,831.80/12 = $1,485.98 as your maximum payment (remember that is PITI). Take out $65.92 for Insurance (http://www.census.gov/compendia/statab/2012/tables/12s1224.pdf) and $300 for taxes (assuming $3,600/yr in property tax), that would leave you a mortgage (P&I) of $1,120.06. If you have an interest rate of 4%, on a 30 year fixed, that would put you at a house worth $234,609. An interest rate of 5% would be $208,647. With the average house sold in February at $152,000, it would seem that everything is GREAT!
Uh-oh, the second ratio … The Debt-to-Income:
Back-end ratio: The total debt-to-income, or back-end, ratio, shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36 percent of your gross income. To calculate your debt-to-income ratio (DIR), multiply your annual salary by 0.36, then divide by 12 (months). The answer is your maximum allowable debt-to-income ratio.
Let’s calculate what that number would be for the average American ($63,685*.36/12) = $1,910.55. This is the amount of income that is taken up by debt obligations, monthly.
So, if your mortgage is $1,485.98 and your DIR amount is $1,910.55, then that means that all other debt, Student Loans, Credit Cards, Auto Loan, etc can only be $424.52.
If you look at the index from the Federal Reserve Board (http://www.federalreserve.gov/releases/housedebt/), you will notice that the average American’s DIR is at 13.6% of their disposable income (FOR). Let’s look to see what that number really calculates out to. We know that the average Gross Income is $63,685 and the average taxes is 27%. That would make the average Net Income = $63,685. ($63,685*.27) = $46,490. 13.6% of the Net Income would then make the average debt calculated at $6,322.65, or 10% of the Gross Income. Total monthly average would be $526.89! That appears very low compared to the numbers above.
The main issue with the qualification is where renters have historically paid more for housing and have, typically higher debt service. They, on average have a DIR 10 points higher than their homeowner counterparts.
So, what does this mean?
If you want to purchase a house, then you must take steps to make that possible. You WILL need a down payment and you MUST fit within the guidelines.
Take your own home affordability pulse by looking at the following:
What is your Gross Income? If it is below the National Average, then you will have to purchase a home that is below the national average! If necessary, do whatever it necessary to increase your income … get a second job, start a small business (can reduce your tax bite and increase your income), start working like you really want a raise and then ask for one.
What is your FICO score? Check online for free credit reports that do not impact your FICO. Look it over. Are there items on that report that are inaccurate? If so, correct the mistakes. If you have less than a 740, then look to see what you can do to increase your score legitimately. Do not fall for those quick-fix scams that abound on the web. This will take some time. If you are working on increasing your income level, then this is a great time to also work on this area. (Update … I have found a legitimate credit repair company called “Credit Nerds” (www.creditnerds.com). They can help you repair or boost your credit scores. Check them out.)
How is your Debt Load? Look online for methods to reduce your debt load. Pay off your consumer debt and think, seriously, about the impact of that debt on your ability to qualify for the home of your dreams. Every time you go to a store and have the urge to buy that big screen TV, that quad, or some other toy, really consider how that debt impacts your ability to purchase a house. This is the biggest area that keeps people from buying a house!
Reduce your monthly expenses. Do you REALLY need those sports packages on cable? Drop anything that you do not really need. It may surprise you how much you spend on stuff that you NEVER use! This may be one of the hardest things for you to do. We are conditioned to SPEND! Do not go out to dinner, takeout food, movies, bar, or anything else that is preventing you from getting where YOU SAY you want to go!
Take those savings and use the extra money to accelerate the pay down of your debt. Once you have reduced your expenses and debt load, then SAVE, SAVE, SAVE. Get rid of those things that are cluttering up your life. Sell off the stuff that is sitting around and not getting you “there”.
Anyone (within reason) can afford a house, if they are willing to do what is necessary to do so.