Saturday, July 12, 2008

How much house can you afford

In the last half dozen years all of the tradition methods and ratios that were commonly used by lenders (and buyers) to calculate affordability were thrown out the window. A few years of this has everyone thinking a $500k house is a cheap house. It's NOT!

Lets take a look using traditional ratios how much home you can afford. The old quick and dirty method was 2.5 times your yearly income. If you make $100k per year, you can afford a $250k home. Easy, peasy. Now this does not take into consideration interest rates, other debts you might have etc. So the lenders used the 28/36 ratio. Basically 28% of your income for payment, taxes, PMI and insurance. The 36% adds in your other debts like credit cards, student loans and car payments. In the good ole days if you could not make those ratios you rented or found a cheaper house.

Using the quick and easy method of 2.5 times your income you need to make the following to afford the median priced home.

In Corona last month the median priced home was $385k. You need to make $154k per year

In Riverside the median priced home was $284k. You need to make $113k per year.

In Moreno Valley the median priced home was $218k. You need to make $87K per year.

Now taking that Corona home and figuring a 10% down payment and using the 28% ratio lets see what your monthly and yearly needs to be.

Corona at $385k. 10% down ($38.5K plus your closing costs) leaves you $346k to finance. Assuming perfect credit you can get a loan at 6.5% giving a payment of about $2187/mo add in $200 PMI (you put down less than 20%), add in taxes of $450/mo (most newer homes are 1.6% to 1.8%) and another $100/mo for insurance gets you to a grand total of $2937/mo. Using the 28% ratio that means you need to be making $10,489 per month (or $125,871 per year).

Now you can clearly see that using traditional ratios home prices are still FAR too high in most areas for the average or even above average family. Maybe I'm out of touch with how much people make these days. I just don't think there are that many families out there making $125k per year. And who are they planning on selling all those $700k homes to? How many families are making $250k per year. Not many I think.

That's the beauty of numbers. Maybe it's the engineer in me but laying out the numbers sure makes it crystal clear. The prices still have some distance to fall.


Tyrone said...

Amen, brother.

Oldtimer said...

While I agree with your sentiment (prices were too high and still need to come down some), the median price/median income analysis can be tricky.

Remember that in SoCal, a huge portion of the population rents. In LA County only about 50% of households own their own homes. I don't know the stats for the IE, but I'd guess that probably around 60% own their homes.

While some high earners choose to rent, most own their homes, while those that can't afford homes are forced to rent. So when you are looking at the median home price in the IE, if the ownership rate is 60%, then the median home price would actually correlate with 70th percentile of household earners. The top 60% rent, and halfway down is 70%. In LA it would the 75th percentile.

Sellin @ Da Drop said...

You have to consider many households now are 2 income earners. So the case might be 2 people each bring in 60k. But who am I kidding, its the IE. mostly historically and still, blue collar workers. I doubt many wives hold jobs that bring in an extra 60k.

Careful housebuyer! said...

This is a very good argument! My wife and I moved here from Hawaii 3 years ago and off course where looking for houses to buy. Prices blew me away and we make 155000/year, both professionals.
We cannot afford a house in my book with these home prices! Something called positive cashflow is out the window with that high of a mortgage.
Is it worth it, to live in a "track home" paying 500000+ for it! You people thinking that must be out of your mind! Needless to say, I am still looking. People in the IE are up to their eyeballs in depth but the sad part is that they just ignore it! This housing slump is not a slump, it's back to normal. We will be in this "normal"
housing mode for a very long time no matter what any realturd is saying. Most of them don't understand basic economy 101!

golfer_X said...

oldtimer, I'm not trying to make any correlations between median income and median home. I agree, the median income earner is not going to be able to afford the median income house in most of the IE. Those families will be stuck renting or buying low end homes. That's just the facts of the area we live in. But when the median home in Corona requires $125k that prices out a lot of families making far more than the median income. I'm not sure what percentage of families make $125k or more but I'd guess it's not that many (10% to 15% maybe). I would think families earning that much probably think they can buy something more than a "median" home. I'd be those families are thinking they are pretty well off and that they can live in higher end area.

I'm just trying to shed a little light on what it takes to buy a house (and not go broke). Judging from the multitude of emails I get there is a large gap between what people think they can afford and what they can actually afford.

Oldtimer said...

It seems like Corona should have one of the higher household incomes in the IE because of its proximity to the OC and LA job markets.

I haven't seen a household income distribution for the IE, but I don't think $125K is all that extraordinary or rare. Something like 75% of households have two incomes. If you pair up just about any two government jobs you easily get $125K, no? Prison guard/court clerk, teacher/cop, DWP/fireman, etc. Heck, the way they pay cops in OC and LA, you pair two up and you have a household income well over $200K. And government jobs have never been the highest paying careers.

Maybe I'm out of touch, but $125K today is equal to about $70K in 1987 dollars, when I first joined the workforce. And back then, finding a way to a $70K household income didn't seem all that daunting if you were willing to double up.

Martin Burtin said...

According to Wikipedia: "The median income for a household in the city was $88,615, Males had a median income of $51,752 versus $36,884 for females. The per capita income for the city was $47,001. About 6.0% of families and 1.3% of the population were below the poverty line, including 10.1% of those under age 18 and 7.3% of those age 65 or over."

golfer_X said...

The last income chart I saw for Corona had about 25% of the families earning over $100k per year. Two people with good jobs can easily break $100k. But there just aren't that many families with two good incomes. It's much more common to find one high wage earner and one low or medium wage earner. At $100k per year you cannot comfortably buy that median priced home without a huge down payment.

Another good question is who is going to buy all those $700k to 1M homes that are on the market in the IE? The obvious answer is no one. But assuming there were buyers those people would have to be pulling down close to $200k per year. How many of those are floating around the IE?

Empire Realty said...

Having read all the comentary I agree with most sides. As a Realturd and Investor myself I agree that prices will continue to relax for some time. With the secondary mortgage market changes and mortgage insurance failures of this recent market madness future home value growth will be mutted.

Face it, the availability of funding went crazy, many of the home buyers went right along with them. Time to get our sanity back.

Take care!

Oldtimer said...

"Another good question is who is going to buy all those $700k to 1M homes that are on the market in the IE?"

I have no earthly idea. If you can swing a $1MM house, you can find some very nice alternatives in civilized parts of LA and OC.

I toured one development in South Corona where the floorplans ranged from 3,800 sf to 4,900 sf.

golfer_X said...

"I toured one development in South Corona where the floorplans ranged from 3,800 sf to 4,900 sf."

Hell, that was pretty much EVERY developement. They didn't build very many average sized homes in the last 5 years.