What can you afford?
HERE'S HOW TO FIND OUT
By Sue McAllister
Mercury News

Before they bought their two-bedroom condo in San Jose, Morghan Ready and her husband, Matt, had a ``lengthy chat,'' as Morghan put it, about how much they could afford to spend each month on their mortgage, property taxes and insurance.

They'd already found a condo they liked, then talked to a mortgage lender who gave them an idea of what they could afford using a variety of different types of loans. They opted for one that allowed them to afford the highest price tag. They completed all the application paperwork, and discovered their monthly expenses would be about $150 more than they had aimed to spend. Nonetheless, they took the plunge, becoming first-time homeowners at age 25.

The couple followed what mortgage brokers say is a typical pattern for first-time buyers: They had a vague idea of what they could afford but didn't know until after they started house-hunting exactly what they'd be paying each month to get the home they wanted.

What first-time buyers should do, said mortgage broker Renee Morgan of Princeton Capital, is go directly from that informal ``pre-qualification'' phone conversation with a lender to an in-person ``pre-approval'' session, in which the lender will examine borrowers' income documents, bank statements and credit report. The borrowers fill out a loan application and learn the maximum price they can afford. A lot of first-time buyers max out their purchasing power to get into their first home, Morgan said. But even first-timers need to make sure they have some reserves for emergencies.

The trouble is, it's tough to find an easy, point-and-click way for most prospective homeowners to figure out exactly what they can afford. Affordability is a complex calculation that involves analyzing buyers' income, outstanding debt, the cash they have available for down payment and closing costs, and the loan types suitable for them, along with prevailing interest rates.

``The average person has not figured it out themselves,'' before coming to her for mortgage help, said loan broker Morgan. To determine which loans borrowers qualify for, Morgan needs details about their gross income, the minimum monthly payments required on their other debts, how much down payment they can make, and what buyers' goals are in owning the home.

Some buyers want to get the biggest mortgage they can qualify for, Morgan said, while others are more conservative. She recommends that first-time buyers also visit an accountant or financial planner who can help them determine whether they can take on home ownership expenses without sacrificing other financial or personal goals.

``People come to me sometimes and they want to be in the $600,000 price range but their numbers are showing they are in the $500,000 price range. So then we get creative -- maybe there's a parent who can help you'' with gift funds for a bigger down payment, for example.

It used to be a rule of thumb that borrowers with moderate debt loads could afford to buy a home equal in value to about three times their gross income. But Morgan says that rule doesn't necessarily hold any more, as 100-percent-financing loans and special loan programs for first-time buyers have allowed buyers to stretch their price limits.

To get started on figuring out what price house they can afford, experts say buyers should:

• Determine how much cash they have available for a down payment and mortgage closing costs.

• Consider how much of their income will be used for other monthly debt payments.

To obtain the best interest rates, Morgan said, a borrower's housing debt -- mortgage principal, interest, taxes and insurance -- and other debt -- such as minimum payments on credit cards, student loans and car loans -- should not exceed 45 percent of the borrower's monthly household gross income.

• Clean up any credit problems, if necessary.

• Get familiar with where their cash is being spent, then alter patterns as necessary to save for homeownership costs.

``Very few people know where the money goes,'' said Curt Weil, a certified financial planner with the Lasecke Weil Wealth Advisory Group in Palo Alto. He said writing down every dollar spent for a few weeks is a painstaking but effective way for prospective home buyers to see where their cash is flowing. ``Knowing that, we can start to point out where money is going that it maybe doesn't need to go.''

Once they've got their financial particulars at hand, Weil said, tinkering with online mortgage calculators can be a good way for buyers to start gauging how much they can afford. He recommends the one at the Nolo Press Web site (www.nolo.com), as well as Nolo's articles about qualifying for a mortgage. (To find the calculator, go to http://tinyurl.com/s4m75.)

Nolo's book ``How to Buy a House in California'' also includes a chapter on calculating how much house you can afford, which involves creating a ``family financial statement'' detailing all a buyer's income and expenses, assets and liabilities.

Many financial Web sites have such calculators, but some allow users to play with the variables more than others, and some do a better job of explaining their results than others.

The Mortgage Professor's site (www.mtgprofessor.com) has numerous articles about qualifying for a mortgage, a ``housing affordability calculator,'' and even a reply to the question ``Why do different affordability calculators provide markedly different answers to the question of how much you can afford to pay?'' (Answer: Some oversimplify the variables involved.)

Speaking of which, the whole process of trying to figure out how much home they can afford has way too many variables for most home buyers to tackle alone, said Bella Berlly, a certified financial planner with GoalPath Financial in Los Altos who specializes in mathematical ``modeling'' of clients' financial situations.

To be thorough, Berlly said, would-be home buyers need to consider things like whether a career change or children will be in their future. If so, what will those changes cost? If one spouse in a couple stops working for some time -- to start a business or take care of children, for example -- how will that affect the ability to repay debts?

``It's just really difficult for people to be objective when it comes to working out how much they can afford for fairly high expense items,'' Berlly said. ``They're a little too optimistic.''

Berlly says clients frequently come to her already knowing which neighborhood they hope to live in and want her to help them determine whether they can really afford it.

``You can always trade up in the future as you get increases in salary, as your savings increase more and more. But it's really terrible when you get into a situation and you realize after you've committed to it that you're in over your head,'' she said.

Morghan and Matt Ready, who purchased their condo in February, have been spending weekends fixing the place up before moving in. The couple's monthly housing-related expenses are about triple what they were when they were renting. But that's OK, said Morghan, who works as an assistant to an agent at Keller Williams Realty. They'd been living in a ``dumpy old two-bedroom apartment'' in order to save money for homeownership. They had scrimped.

``We were on a strict budget,'' Ready said. ``We didn't turn the heater on as much, we tried to find activities to entertain ourselves that didn't cost anything. . . . It affected every aspect of everything that we did.''

She and her husband got a first- and second-mortgage combination to cover the approximately $500,000 cost of their condo. Most of the money they saved went to closing costs, refurbishing the home, and to their ``just in case'' reserve fund.

``I think a lot of first-time home buyers are having to do some creative financing, because who can afford to get their foot in the door with a regular 30-year fixed mortgage?'' Morghan Ready said. ``You kind of just scrape up every last penny you've got, and go for it.''
Contact Sue McAllister at smcallister@mercurynews.com or (408) 920-5833.

 

© 2006 MercuryNews.com and wire service sources. All Rights Reserved.