What Happened to 1/3 and 28%?
A few years ago, I started to get smart about real estate in hope and anticipation that soon my number would be called amongst the wide-eyed and dreamy, hoping to be amongst the homeowner population. I read about property taxes, inspections, finding a neighborhood with good schools, blah blah blah. What I learned about mortgages was very enlightening, but there were two numbers, which I had already heard about, that were once again reinforced: 1/3 and 28%.
1/3: The magic maximum number for housing expenses (mortgage, property tax, insurance, homeowners assn, etc.). And this is the AFTER-tax, take-home pay.
28%: This is BEFORE tax—but I was forewarned that in applying for a mortgage, lenders would never give out a loan that would eat up more than 28% of one’s gross monthly income.
Let’s apply this to Marin, where according to my earners and spenders blog, they had the highest dual earner income at $107,856. Applying the 28% rule, the max monthly mortgage payment a lender would give for this dual earner household would be $2,517. This translates to a 6.75%, 30-year fixed mortgage of ~$389,000. With the median home price in Marin ~$1,107,500 (the average of the Sept and Oct 07 median home prices of $985,000 and $1,050,000), the average dual Marin earner would need to have a down payment of ~$718,500 to buy that Marin house. Where does anyone have that kind of down payment?
Ok—so maybe Marin, with all its filthy rich residents and a gazillion high-end homes skews the numbers and isn’t the best example. So, let’s look at the state of California, where the median household income (not dual earner) was $53,629. The 28% rules says that banks should limit the mortgage amount to $193,000—or under the same assumptions above, $1251 a month. With the median home price in CA at $513,970 (avg of Sept and Oct 07 median prices), that would equate to a $320,970 down payment… still pretty hefty.
Doing these quick calculations, my take on this is that these two magic numbers have gone out the door in the lending world the last few years. The subprime mess is clearly an illustration of these guidelines going by the wayside.
So, what are the new rules of thumb? How do you judge what your limits should be? Have we realized that father does always know best?
