Know Your Range, What You Can Afford

Before you actually buy a home, it’s imperative that you understand what you are getting into and how much you can afford, writes Phyllis Furman of the New York Daily News. The paper’s business columnist cites the case of Alison Papalia, a 35-year-old marketing director at Time Inc., who has been preparing for the process by paying mortgage and maintenance for several months — on paper.

As Papalia hunts for the perfect one-bedroom in Manhattan, she is setting aside the amount of money she’d be shelling out on a monthly basis if she owned a home.

“Here it is the holiday season and I’m not touching that money,” Papalia said. “We’re ratcheting back our lifestyles.”

Will you be able to get your dream home? Don’t even bother looking at your local real estate listings or visit an open house before playing the numbers game. Understanding how much you can realistically afford will help you avoid the emotional letdown of becoming smitten with a property that’s priced beyond your means. Or, the worst case scenario of losing your house later because you overextended yourself.

“People look at what they will have to pay in mortgage and taxes and they think they will be okay. [But] They are not factoring in that utility costs have doubled since last year because of the gas crisis,” said Valerie Adelman, a New York financial planner.

Doing your research before buying a home is hardly a new concept, but the issue has become even more important because of rising mortgage rates and utility costs, both of which are adding burdens to homeowners. So, when all is said and done, how much can you really afford? We’ll give you a few formulas to keep in mind.

1. To arrive at a ballpark price for your home, multiply your salary by four. Therefore, if you earn a salary $62,500 a year, look for homes in and around the $250,000 range. Conservative buyers and most financial planners recommend spending no more than 28 percent of your gross monthly income on monthly housing expenses of principal, interest, taxes and insurance (PITI). Under this calculation of, you earn $100,000 a year, no more than $2,333 each month should go toward housing costs.
2. If you add in other monthly debts - student loans, credit cards, car payments - to your housing costs, your debt-to-income ratio should not exceed 36 percent of your income.

Of course, a lot of banks will be willing to lend you far more, as evidenced in recent years. Mario Cavallaro, a consumer real estate account executive at Bank of America, says that his company encourages a DTI ratio of 38 percent, but will go as high as 45 percent in certain cases if the buyer has good credit and attends an approved home buyer education course. This can lead to disaster, as lenders are not concerned about the other expenses that come with homeownership. Buyers have to be.

“There’s a difference between what a lender will give you and what you can afford for a comfortable lifestyle. People forget about other costs like fixing the roof, fertilizing trees, snow removal and gardening,” Alderman said.

Then there are closing costs. Aside from the money set aside for a down payment, you will have to pay these additional expenses to get the deal done. The average in New York City is between $10,000 and $12,000, which is on the high end of the real estate spectrum. Even average one- and two-bedroom apartments frequently hit $400,000, thus causing closing costs to rise along with the price. Here in South Florida, you are looking at prices of $200,000-$250,000, and therefore closing fees in the neighborhood of $6,000 or $7,000 — generally, they will amount to about 3 percent of the sale price.

Either way, you are not looking at a small chunk of change. You will also want to set aside between three and six months’ worth of payments, in the event of unforeseen circumstances such as the loss of a job. The last thing you want is to default on your Florida home loan because you did not plan ahead.

CRUNCHING THE NUMBERS

When ready to purchase a home, a buyer will typically need to make a down payment of 20 percent of the purchase price with the remainder financed through a mortgage. If you can only put down 10 percent of the purchase price, your lender will subsequently require you to buy mortgage insurance, an additional expense that you need to consider. Assuming you can hit the 20 percent threshold, here is what you can expect:

• A $400,000 house requires an $80,000 downpayment and a loan for $320,000. For a 30-year mortgage at a 6.5 percent interest rate, a monthly payment would be $2,022.62.
• That is before local taxes or homeowner’s insurance, which could easily add another $500 to $1,000 a month depending on the cost of your policy and the local tax rate in the town of your residence.

Under current law, property taxes and mortgage interest are tax deductible. Assuming that the mortgage amount is primarily interest in the early years of the loan, a $3,000 monthly mortgage payment would save approximately $1,000 a month in taxes for someone in about a 30 percent overall federal & state tax bracket. The after-tax cost of those payments would then be closer to $2,000 a month. But be cautious about using after-tax amounts since tax laws are subject to change. Also, as your Florida home loan gets closer to maturity, more of the payments will be on the principal of the mortgage, which you cannot write off.