The goal of home ownership is an important one. However, what good is owning a home if the homeowner can’t afford the payment in the long run?
We will be addressing three issues with regard to affordability–
1. Can you afford the payment (budgeting)?
2. What about the tax ramifications that would affect affordability (equivalency)?
3. Can you afford the payment in the long run?
A lender will typically qualify you for a mortgage based upon your ratio of debt to income. For example, a 50.0% ratio would mean that you are qualified based upon having total debt payments (including the mortgage) that are one-half as much as your total gross monthly income. As a borrower who is responsible for the monthly payment every month, it is not likely that you will assess affordability based upon a ratio. You are more likely to run a budget.
A simple budget would take your monthly income and subtract out your monthly expenses–
•Income and Social Security taxes
•Monthly debts such as car payments and credit cards
•Monthly living expenses such as the health insurance, food, entertainment.
•Monthly housing expenses
The last category, monthly housing expenses, would include the mortgage payment but also other expenses such as utilities, maintenance and association dues. It should be noted that some of these expenses would be incurred for those who are renting.
In a reasonable budget, you would subtract out all of these expenses from your gross monthly income and have at least some money left over for emergencies and savings. If we look back upon the issue of qualification, it is the residual method of qualification utilized mainly for VA loans that best utilizes a budgetary approach.
Here is the way a sample budget may look (all numbers being fictitious):
$6,000 Monthly Income
$1,500 Federal Taxes
$ 400 State Taxes
$ 400 Social Security/Medicare
$ 400 Health Insurance and medical
$ 800 Car Loan, Insurance, Gas
$ 400 Food
$ 300 Other Living Expenses
$1,500 Mortgage (PITI)
$ 400 Maintenance and Utilities
(-100)
This may not look like a great budget–but we have not looked at it from a tax standpoint. If the person were renting, they would have no leeway for emergencies or any money going into savings. They may qualify for the loan because their debt ratio is under 40%–
$1500 Mortgage + $600 Car Loan
Divided by $6,000 Income
Equals–35% Debt Ratio
Yet, a negative $100 per month before emergencies and savings is not acceptable.
However, we have not taken into account the tax deductibility of the mortgage vs. rent. In this case, we will assume that the person is in a 30% tax bracket inclusive of Federal and State taxes. This means that every extra dollar they earn, they will pay 30.0% of it back in taxes. This does not include Social Security and Medicare taxes which are not tax-deductible.
Reducing the payment by 30% would be a savings of $450 per month and that would mean that the budget is “positive” by $350.
$1500 x .30% equals $450
Whether this amount is enough of a cushion for the borrower on a monthly basis is another question. The question of comfort as well will be addressed in the next segment–as well as the issues of receiving the tax reduction on a monthly basis instead of at the end of the year and looking towards the future. All very relevant questions with regard to the suitability of owning a home.
