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.
Labels: Debt, Mortgages, Suze Orman
