How much house can I afford? The right question should be

How much house can I afford? The right question should be -

how much house do I need? That is correct, most of you often need much smaller home than the one you would afford, according to all Housing Affordability Calculators you can find on Internet. Actually the very "how much house can I afford" question should be made illegal. The thinking along those lines combined with a mistaken notion that everyone deserves the right to own a house is what got us in the current mess. All the calculators now assume general guidelines, allowing total debt to income ratio of no more than 36%, and total house payment to income ratio between 28% and 33%, and take into account in one form or another, your down payment, available cash, mortgage term, interest rates, property taxes, insurance, association fees, PMI and points. That is all fine from technical point of view, but in the today's reality there are three potential problems with this thinking.

First, you can only judge how much house can you afford based on your situation today. What happens in few months or a year, no one knows. Too many borrowers bought and are buying the most expensive homes they can qualify for, snapping what they think are the greatest bargains. And those bargains won't look cheap as the home values will keep falling, but go ahead, try to argue. Often slight decrease in income means financial trouble. And many homeowners have qualified under adjustable, rate mortgages with low rates. Once those mortgages reset with higher rates, they are getting squeezed by higher payments and often taxes, and what seems affordable today may become quite unaffordable very soon.

Second, the parameters were relaxed in the past and will be relaxed in the future. Not in a near, but in several years. I saw those debt to income ratios at 55% just 2 years ago, and we all know of course what has happened, but I can guarantee we will see them again. Memories will fade and we can afford attitude will prevail. If you are telling me that we are not going to have more relaxed requirements and guidelines in a future, you just wait and see.

Third, buying the more expensive house means you are assuming bigger risk with value going down much further than that of a cheaper home. If you can afford a $300,000 home today which may only be worth $200,000 in few years, isn't it better to buy one for $250,000 that tomorrow will be worth the same $200,000? Better yet not to buy at all and wait for the bottom. And don't tell me that a $250,000 home will also loose $100,000, because it won't. That is not how it currently works.

Speaking of the real estate bottom, don't buy much into idea that it is coming soon. I have seen predictions of the end of 2009, third quarter of 2010 or first half of 2011. I am thinking more in terms of 2013 or 2014. Yes call me crazy, I think that is what is coming. The real estate boom started around 1994 or so, and went all the way into the first half of 2006. That is good 12 years. So the correction will go for at least 6 years in my opinion, and we are now just into third year. The problem is aggravated by complete collapse and insolvency of our financial institutions plus ruined credit ratings of tens of millions of past and current homeowners. Many first time buyers have their own problems derived from school loans, car repossessions or late credit card bills. So worry about distinguishing between how much house can you or I afford and how much do you or I really need. I would get the least expensive house I can live in.

Wed Feb 25, 2009 01:02PM by Tony | More in Mortgage | Comments (0)

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