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How much house can you really afford?

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Is buying a new home an investment, a savings vehicle or a lifestyle choice during a time when prices are rising?

Homes in many parts of the country are getting less affordable than ever. According to a recent report by Interest.com, a finance website, in 17 of the 25 largest cities in the country, a median-income household can’t afford a median-priced home. That’s up from 11 of the 25 just last year. The difference is a product of two factors: the uneven economic recovery that has boosted home prices almost 16 percent while median household income has risen only 3 percent, and an increase in average interest rates, from 3.52 percent to 4.44 percent for a 30-year fixed-rate mortgage.

After the 2008 crash, many of us have been cured fortunately of any aspiration to be “house poor.” There’s a big difference between getting approved for a mortgage of a certain amount, and actually being able to afford that amount month to month. As a general rule of thumb, many financial advisers say, a home’s purchase price should be anywhere between three to five times annual household income. Or, as it’s commonly expressed, the total monthly payment should be 31 percent of gross monthly income. However, this is likely the biggest purchase of your life, so don’t stop there to figure out how much house you can afford. This decision takes some deep financial thinking — far more than just plugging numbers into the many calculators available online.

Here are some points to help decide how much house you can really afford.

• Consider your future career and life plans. Affordability is a ratio of purchase price to income. Unfortunately, Americans are experiencing record-breaking volatility in their income. Remember you are signing to pay down a mortgage every month for the next 10 to 30 years, or else incur the transaction costs of a resale at best (or, at worst, be forced to sell at a loss into a down market). So you have to try to do a 10- to 30-year forecast of life choices and prospects, just like a company making earnings forecasts. What are the chances that one member of the household might lose his or her job? Does one of you want to take time off from paid work to care for a child or relative? What if job opportunities beckon in another city?

On the positive side, buying a home means that your housing costs will be stable. You won’t have to deal with constantly rising rents. Statistically, annual earnings peak around age 40 to 50. If you are on the upward slope to middle age, and you buy a home that is affordable for you now, it is likely to become increasingly affordable for you the longer you stay in it.

Consider debts and obligations. Credit card debts, car loans and student loans, child support, and credit rating affect how good a mortgage you can qualify for. The overall “back-end” debt-to-income ratio, defined as mortgage payment plus all recurring monthly debt, divided by gross income, should be less than 43 percent.

Consider total costs. Operating costs, including fuel, utilities, maintenance, property taxes and insurance, were estimated in 2012 by the National Association of Home Builders at 4.24 percent of a home’s total value per year, less for newer homes. These expenses may be the most daunting financial aspect because they are unpredictable.

Anya Kamenetz may be contacted at diyubook@gmail.com.


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