Lately, everyone seems to want to know whether I think this is the bottom and do I think this is a good time to buy a house? The short answer is that home affordability depends on a person’s financial situation.
We have just gone through an economic cycle where the home affordability model was determined by how much house one could buy for the lowest monthly payment. As we can see, there are significant problems with this economic model. I would argue that a better economic model for home affordability is either (1) how much secured debt can you pay off prior to retirement or (2) is the price-rent ratio on the home appropriate given the investment of funds.
A good rule of thumb is that a person can payoff 2-2.5 times their gross household income in secured debt over the course of their working life and go on vacation and have a child or two. Therefore, if a family’s average gross household income is $100,000, they should not have a home loan which exceeds $250,000. This is assuming a 30 year fixed loan. If a borrower has less than 30 years remaining work time, the amount should be reduced accordingly. If the home loan is kept to 2-2.5 time gross household income, there will be adequate income for retirement savings which will be needed to eat when we can no longer work. Anything more than 2-2.5 will cause the finances to be out of balance and risk inadequate savings for retirement.
Another way to look at this economic model is to see the value of the investment in relation to rent paid for a similarly situated property. If you could rent the house you need for $2,500 per month, your yearly rental expense is $30,000. If you currently have debt against the same house of $600,000, then the price to rent ratio is 20. What this means is that you would have to rent that same house for 20 years before you would have 1 dime in profit assuming you were paying principal. Since the likelihood that you are going to live in the same house for 20 years is not great and you are not paying principal equal to rent, it probably is not a good investment. That is the reason that we would like to see the price to rent ratio less than 10, if possible. If the price to rent ratio is 10 or less, you should be able to afford a 30 year fixed mortgage on the property with 20% down payment and still save the first 10% of income for retirement.
In conclusion, this is probably not the bottom based upon what people can really “buy” in a home and price-rent ratio are just starting to make sense in parts of Contra Costa County. There is still a huge “speculator” part of the market in Contra Costa County as indicated by the amount of debt against real property given the average household income in Contra Costa County. But there will always be speculators; I just don’t encourage you to be one of them. It is better to watch them on TV.
If you are having financial problems, seek legal counsel. You did not make this real estate meltdown. There are serious personal liability and tax consequence of a short sale and foreclosure. Make sure you understand your legal rights prior to undertaking either a short sale or allowing your property to be foreclosed. Do not lose sleep and your sanity worrying about financial problems. Help is available to you just like it was to the Bank, Investment Companies and the Insurance Companies.
WE ARE A DEBT RELIEF AGENCY. WE HELP PEOPLE FILE BANKRUPTCY RELIEF UNDER THE BANKRUPTCY CODE. THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON IN MAKING ANY DECISION REGARDING A VOLUNTARY DEFAULT, SHORT SALE, FORECLOSURE OR BANKRUPTCY. THIS INFORMATION IS NOT A SUBSTITUTE FOR OBTAINING TAX & LEGAL ADVICE REGARDING AN INDIVIDUAL SITUATION.
© 2011 Joan Grimes