Sunday, April 16, 2006

Suze Orman: What House Payment Can You Afford?



I happened to watch a bit of CNBC's Suze Orman Show last night. As is her custom lately, Suze focused her entire show on a specific topic. Last night's topic? First-time homeowners.

Because Google regularly brings me visitors who are searching for house-payment guidelines (i.e., "What house payment can I afford?"), I thought it a good idea to use this post to spell out Suze's guidelines as she related them on the show, and in her latest book. (See below, if you're one of the 4 people in the U.S. who are unfamiliar with her work.)

I've covered David Bach's house-payment guidelines elsewhere (they're staggeringly misguided, in my opinion). And I've mentioned my fondness for Dave Ramsey's "25 Percent" house payment rule a time or two. So it's only fair that I dole out a little IYM screen time to Queen Suze.

(You can quit calling my cell phone now, Suze. Like I told you, I'd get around to you when I had time. Sheesh.)

Here you go, Dear Reader. Grab a notebook and pencil and some hip waders, because this will get a bit muddy.

If you're wondering how big a house payment you can really afford (which will almost certainly not match what your lender tells you), then Suze Orman makes this suggestion:

Suppose you can afford whatever you're paying in rent now. Is that what you can target for a house payment? Suze answers with an unequivocal NO.

Say your current monthly rent is $1,000. Suze suggests that, in order to get your aspirations more aligned with reality, you take that rental amount and add 45 percent to it. This is a the figure for what a home with a $1,000 mortgage payment (principal and interest) is actually going to cost you on a monthly basis. In this case, obviously, the math would give you a calculation of $1,450.

What Suze is saying, in her special glittery roundabout way, is that if you can't afford housing expenses of $1,450 per month, then you can't afford a basic principal-and-interest house payment of $1,000. Time to ratchet down your housing budget ... and expectations.

Suze reasons that that extra 45 percent will encompass your property insurance, property taxes, private mortgage insurance (if applicable), and monthly maintenance costs. Judging from what she says in her
Money Book for the Young, Fabulous, & Broke
, this will also cover any extra expenditures you'll have for utilities and such in your new home.

Real estate agents, rich friends, and maybe even your parents are going to try to talk you into stretching to buy a bigger house than you can afford right now. Their well-intentioned philosophy is that your income will grow in the coming years, and so the mortgage payments will become easier to handle. Un-uh. That's just way too much pressure. ... Go for a house that leaves you room to breathe. If in five years your career has taken off and you can afford a bigger place, then that's the right time to buy it — not now, when you can't really afford it.


And I'm thankful that Suze makes this absolutely vital point, because not many people pay attention to it:

Knowing how much lenders will let you borrow is simply not the same as knowing how much you can afford. You need to make sure that you can truly afford the total costs of owning a home.


And this, regarding that famous mortgage-interest tax deduction we all know and love:

I don't want you to base how much house you can afford on the size of the mortgage interest deduction you will receive. If the only way you can afford the house is with the tax break, then I think you are cutting it really close. You should view that tax break as a nice bonus, but not a necessity.


Now Practice Making Those Payments

Once you think you know what you can afford — using the ((Principal + Interest) + 45 Percent) calculation — Suze instructs that you ought to practice squeezing that expense into your budget.

Consider the $1,000 rent payment we used above. For the next three to five months, you would make your normal rent payment and set aside another $450 in a savings account somewhere. How does this affect your budget? Can you pull it off easily, or does strangle your cash flow and leave you clutching for your credit cards within a few weeks?

If the latter, then you're back to the drawing board. Lower your housing budget and expectations, and try again.

If you can handle the extra expense easily, then you're ready to begin looking for homes in earnest. And you can use those extra few months of "practice" savings to pad your down payment. Or pay for some of your closing costs.

I Plugged In My Numbers And ...

Not being quite satisfied with Suze's formula, I applied it to my own situation. I wanted to see how accurate it would really be.

The answer? It's pretty close.

Our 15-year, fixed-rate mortgage payment (P&I) is a nudge over $500. Add 45 percent to that, and I end up with roughly $738. Would this $738 cover my total housing costs?

Add property taxes and home insurance to my mortgage payment (P&I), and we're pretty near $650. With Suze's formula, that leaves us just $88 to cover PMI (if it were applicable; we don't have it) and utilities (over and above what we'd already be paying if had been renting) and home maintenance each month.

Given, say, maintenance costs of 10 percent of our P&I per month ($50, in this case) and theoretical PMI of ~$40, we'd be tacking on another $90. Which is pretty close to the $88 that Suze's formula left us to work with.

Suze's "45 percent allowance," though, since it's based on principal and interest, would be lower if our mortgage were of the 30-year variety rather than the 15-year. The problem with this is that no matter the mortgage term, the property taxes remain the same, as do the necessary monthly maintenance dollars. The PMI would be marginally higher, I believe, due to the longer loan term. So I'm thinking that in the some cases, Suze's allowance could be a bit optimistic.

Anyhow, there you have it. Yet another Financial Guru's take on "what it takes" to afford home ownership.

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— Posted by Michael @ 6:50 PM








11 Comments:
 

Not only is this a great article...I like how you tailored it to your Google visitors. That's smart!

 

Thanks, Tim, for the kind comment. Got to feed the Google monster, you know.

 

This post is great, and timely for me as I've been wondering if I bought TOO LITTLE house. Our payments, including principle, int, insurance, and taxes, are only about 15% of our monthly gross. I've been wondering if we should have been willing to cut corners in other areas in order to buy a house that might have appreciated faster. But at the time, job situation was different, and two years later it's still a little shaky, so I guess we made the right decision. If I lose my job and the payments become suddenly 25% of our monthly gross or an even bigger percentage, I'll sure be glad I shot so low to begin with!

Congrats on the 15 year loan. I didn't quite have enough chutzpah. Our loan is a 20 year fixed, but by God it'll be paid off in 15.

 

Ok, Michael, you piqued my curiousity and I had to run our numbers. We have a 30-year 5/1 arm at 3.99%--we have been diligently paying extra w/ the goal of being mortgage-free by the end of 2008 (and before the mortgage would adjust to 5.99%). Here are our figures by MONTH: Mortgage $670 (plus my discretionary principal payment); RET $435; HO $50; maint. $175. I'm including several items in this maintenance figure: garage door repair; furnace/a/c service; painting supplies; flowers & fertilizer; batteries; propane refills; etc. Basically, anything that we incur that relates to the homestead. So for us, Suze's 45% figure doesn't hold up. Obviously, our payment is low, so that's part of the issue, as you pointed out. However, for those who live in higher RET-areas, the percentage would be a difficult benchmark to hit.

Note to Claire: don't rue over not having "more house". Save,save, and pay down that mortgage! I'm a believer in principal paydown, but not for a fee (unlike Bach's biweekly mantra--you'll save more interest than you'll spend in fees so do it!) You can pay extra principal ON YOUR OWN and it's FREE! I do agree w/Bach's Automatic Millionaire premise to make it automatic. Just set up a recurring principal payment every payday, at the end of the month--whatever's attainable--and JUST DO IT! Your mortgage balance will melt away! Good luck!

 

This was a great post. My guys is looking into buying a house and I fancy myself his financial muse so I will pass on this post. Thanks!

 

The problem is that you can't count on always earning the same salary. My mortgage payment was fine for my income at the time I bought the house. When I lost the job in 2002, I had a terrible time trying to make payments. Still do as I've never been able to find a job that payed that well. When I bought the house, I was the sole wage earner. I felt that we could both work and make payments if the worst happened. That was true. We didn't count on a continuing increase in property taxes. House payment is $600 but taxes are another $200 every month. The house is up for sale. We're moving back to where we used to live, buying property with an owner contract and simple interest. And I've yet to be able to use the mortgage deduction as it's never as much as the standard deduction

 

I like Suze's rule of thumb it works well in most cases. But in high COLA it doesn't. When rents are running $1800 anyway and a mortgage is $2200, no biggie, your going to spend, spend, spend on rent or mortgage.

You have to have an EF for job loss and realize what you'll do if you need to take a paycut. Another issue is the fact that buying a home isn't cheap, thus why people say to "stretch". But too much stretch will put you on the fast lane to BK.

Our first place we bought it was 50% of our gross, but gee we made $40k/year gross in San Diego. Our mortgage was less than our rent at the time, go figure. With refinancing we came out ahead. Now we make more, have more home but the rent/buy is still in the equation. Rent was ridiculous so we bought.

 

I can't decided whether or not I'm onboard with everything Suze says, but this is definitely a good point. I try to catch an episode or 2 and she does have some good advice for saving, but just because she's a professional doesn't mean she knows all. Each situation has it's own circumstances, but nicely written!

 

Wow, amazingly helpful piece of advice. Good job to you and Suze!

Anonymous Anonymous
, at 3:49 PM, October 30, 2008  
 

Two people that have never failed me...Suze, and Joel Osteen! I love the way Suze gets you to focus on the "whole" picture. Thinking "down the road" is so important for everyone now. To be able to enjoy that "homeowner" feeling has got to be incredible. I'd hate to lose it due to unseen events that I didn't factor in. This was very helpful, Thanks again

 

Please help, Suze. I will be 52 in 2 weeks and trying to make some very immportant decisions so I can retire comfortably. Divorced 3 years ago and was left with a huge mortgage-$2113. Bought the new home in '05. Pay 5 3/4 % and owe about $304,000. The house is valued at about $450,000.
I make about $80,000 a year, have approximately $172,000 in ladder CDs, a Roth that I contribute $500 a month and a 403b in place where I save an addt'l $100 a month. I own a 2nd home outright. It is valued at about $210,000.
My question is...w/ 25 more years to pay off my mortgage, is it best for me to keep the house, pay down the principle with my savings & invest the money saved in my Roth OR should I get from under this new house, invest the extra $2000 and call it a day!? The other house is old and not in the best area--just okay. The current home is in a nicer area that will appreciate at a greater pace.
I have 2 adult children whose interests I want to protect in the event of my death-son,24; daughter,29. Please advise.

Linda, DE

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