Saturday, January 5, 2008

How Much House Can I Afford?

Fannie Mae provides future home buyers a calculator to help them estimates how much house they can afford to purchase. I took the calculator for a test drive. Here are my entries:

I then click on Calculate and voila!...

…and what the hell? Either this calculator is broken or I just found the reason for the current housing market crisis.

According to this calculator, and assuming a 6% interest rate, I can afford to purchase a $335,000 house which after down payment and closing costs would leave me nearly $4,000 in the red?? Why is this calculator telling me to bring $84,000 to the closing when I told the calculator I only have $80,000? Not to mention that my total debt-to-income ratio would rise to 50% (new monthly payment $2,450 + current debt payment $800 divided by monthly gross income $6,500).

According to this Yahoo How-to guide the standard requirements for conventional mortgages as established by Fannie Mae are the 28% and 36% debt-to-income ratios. Monthly mortgage payments, interests, property taxes and insurance cannot exceed 28% of the buyer’s monthly gross income. This is called the front-end ratio. Total monthly debt payments (housing, credit card payments, car payments, etc) cannot exceed 36% of the buyer’s monthly gross income. This is called the back-end ratio. I was not able to find any confirmation of those debt-to-income ratios on Fannie Mae’s website.

For a second opinion, I turned to the Yahoo calculator How Much Home can I Afford? I plugged in the same information and here are the results:

Now this makes a lot more sense. According to this calculator, the maximum house I can afford is around $281,000 (assuming a 6% interest rate). I am currently capped by the 36% debt-to-income ratio (my total monthly debt payments). I would have to either reduce my debt payment obligations or increase my gross income in order to afford more house.

I am contemplating buying a cosmetic fixer upper, preferably a real estate owned one, in a desirable neighborhood where home prices are typically in the $350k-$400k range. I am staking the market for the right opportunity to show up.

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