Thursday, April 9, 2009

The MORTGAGE Factor: Getting back to the basics


QUICK FACT #1:
What our parents told us was true

At the height of the housing boom, many borrowers had to stretch to afford a house. In some cases agreeing to spend half their monthly earnings on their home and getting into the mortgage with 100% financing. We all know how that turned out. Now, reducing monthly payments to 31 percent is the goal that many financial advisors say is optimal and the amount that is being targeted in the new housing plan to help people who are in mortgage “trouble”. But is that a reasonable goal? And where did that number come from? Its roots may go back more than a century to company towns, where employers would collect a week’s wages for a month’s rent. In the 1920s, as homeownership became an option for more middle-class families, lenders adopted a similar standard: spend a quarter of a month’s income on housing. Though the number has inched up through the years, that general rule of thumb has stuck. I remember my dad advising me early in my college years that my housing costs could not exceed 25% of my pay….thanks dad, I should have listened to you!

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QUICK FACT #2:
The 28/36 Rule

Financial planners agree that a figure around 30 percent is not a bad place to start. That usually leaves enough to pay for life’s many other costs. Given that the current economic crisis has turned a lot of financial assumptions on their head, it is probably wise to rethink how much of your income should go toward servicing the large debt that is truly homeownership. Here is where the old standard known as the “28/36 rule” comes in to play. Using that rule, households should spend no more than 28 percent of their gross income on housing costs — including mortgage payments, property taxes and insurance — and less than 36 percent on all debt. The total includes obligations like car payments, student loans, credit cards and medical debt.

QUICK FACT #3:
Now is the right time to revisit some of the lessons our parents and grandparents learned long ago.

HOW MUCH CAN I AFFORD? Your housing budget depends on your situation and priorities. One exercise I remember from school involves simple math and planning. Write down all of your expenses. Break them down into expenses that are fixed (utilities, groceries, auto expenses, insurance, etc.) and variable (everything else). Now, look at the variable costs…what am I willing to give up that could be reallocated toward housing?

DO THE MATH Before you start hitting open houses, sketch out a rough budget based on the 28 percent rule of thumb, using a simple mortgage calculator.

DOWN PAYMENT Currently, many consumers have no choice but to make a sizable down payment. If you do not, or cannot, it will cost you dearly in the form of a higher interest rate or fees. FHA is a great option and many times offers lower interest rates and lower down payment options for homes under $271,000.

TAXES Consider the tax savings associated with buying a home, but do not use it as an excuse to buy more than you can afford. Property taxes and mortgage interest are generally tax-deductible, but only if you itemize your deductions. Itemizing makes sense when your individual deductions exceed the standard deduction, which is $11,400 for married people filing jointly in 2009.

RESERVES Ideally, homeowners should have six months of net pay in the bank. But if you halve that figure and save three months of your take-home pay that generally translates into eight months of payments. That does not account for food and other necessities, but it does provide some cushion.

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