An Affordable Residence

So, you have decided that you want to purchase a house, but you are not sure how much you can afford to pay for one!

Well, there are several methods that are used to determine what price house people can afford.  The problem is that most of these methods do not take into consideration such factors as the following:

• Differing levels of mortgage interest rates, which affect the amount of the required monthly payment

• Housing-related expenses, which can vary significantly, even for houses in the same price range

• Differences in spending not related to housing, which can also vary significantly, even for families with the same level of income

There is, however, at least one method that does take into consideration each of the factors mentioned above. The following illustration shows how this method works:

*Housing and related expenses include mortgage payments, property taxes on the house, insurance on the house and its contents, utility bills (electricity, gas, water and sewer, etc.), and house maintenance and repairs.  In some cases, there may also be garbage collection fees and/or homeowners’ association fees.

As you can see, this method requires you to know how much you need for saving, spending, and your other financial obligations.  You will have this information if you already have a budget.  Otherwise, you will need to take the time necessary to look through your checkbook and other records to determine the appropriate amounts.

If you decide that the amount that is available for housing and related expenses is not enough to purchase a house that will be adequate for your needs, wants or desires, there are a number of alternatives for you to consider.

1.  Reduce your discretionary spending in other categories and apply the resulting savings to housing and related expenses.

2.  Add another income to increase the rate of your saving for the down payment. However, it is somewhat risky to depend on a second income to make the regular monthly payments, because there are a number of unpredictable circumstances that can result in the loss of that second income.

3.  Convert some of your assets into cash. For example, you might be able to sell one of your cars, your boat, your extra furniture, or some of your other assets that will add several thousand dollars to the amount of the down payment you can make.

4.  Rent a modest residence for a period of time and save the difference between the amount of that rent and the estimated amount that you would have spent for the more expensive housing that you otherwise would have chosen.

5.  Rent with an option to purchase.  You will be able to enjoy living in the house while you are saving money to make the necessary down payment.

6.  Spend less money for a lot. Purchasing a smaller lot, or a lot located in a somewhat less developed area, will enable you to either reduce your total cost or have more money to pay for the house itself.

7.  Purchase a smaller house than you otherwise would prefer. After several years, you should be able to sell the house and use the equity to make a down payment on a larger house.  Meanwhile, your expenses for property taxes, homeowner’s insurance, utilities, and maintenance, as well as the mortgage payments, should be significantly lower.

8.  Purchase a relatively inexpensive older house that is in reasonably good condition, so you can live in a larger house than you could otherwise afford.

9.  Purchase a house that needs significant updating and/or repairs, provided that the costs of updating and repairs wo not eliminate most of the savings from the lower purchase price.

10. Consider a condominium or a town house.  They usually are less expensive than free-standing houses in the same locality.  However, be aware that the market for such homes tends to be more volatile than the market for free-standing houses.

11. Rent to someone else part of the residence you purchase.  The rental income will offset a portion of your housing and related expenses.

12. Consider purchasing a home through the assistance of HUD (the U. S. Department of Housing and Urban Development).   Many HUD homes require a down payment of only 3% and some as little as $100.  HUD will pay the real estate broker’s commission, up to 6% of the sales price and may pay the closing costs charged by the mortgage company.

13. Check on the various types of mortgages that are available.

• Longer-term mortgages have lower monthly payments, but carry somewhat higher interest rates than mortgages with shorter durations.

• Adjustable-rate mortgages (ARMs) usually have lower initial monthly payments than fixed-rate mortgages.  This type of mortgage is best suited for people who plan to sell their house before the interest rate on the mortgage is adjusted upward. However, if interest rates rise considerably before the mortgage is paid off, there could be serious problems for the mortgagee.

The Wall Street Journal (2-8-07) provides the following perspective with regard to the risk associated with ARMs:

[Some homeowners] who would like to refinance into a new loan   . . . can’t.

 In some cases, that is because their loan carries a prepayment penalty, which would force them to come up with thousands of dollars if they refinance in the first few years.  Such penalties are common with so-called option adjustable-rate mortgages, which typically carry a low teaser rate that rises sharply after an introductory period.

 Other borrowers [get caught] by a changing housing market – one in which home prices have flattened and lenders . . . tighten their standards    . . . . The challenges are greatest for homeowners whose credit has declined since they took out their last loan and for those who have little if any equity.

• Graduated payment mortgages have lower monthly payments than the usual fixed-rate mortgages, but the payments start to rise gradually at a predetermined rate before leveling off after several years at a level somewhat higher than those on conventional fixed-rate mortgages.

14.  Check if the seller of the house you want to purchase will make you a loan for the amount you need above the amount a regular mortgage lender will provide. However, if you are seriously considering this option, proceed with caution.  Ask someone who is knowledgeable about this type of loan to explain to you what the risks are.  Keep in mind the following statements from an article in the Wall Street Journal (8-5-81):

The biggest concern [with a loan from the seller] involves the short-term nature of seller loans.  [When] the notes come due . . .  where [are] people . . .  going to get the money to pay them off?

[S]ome buyers may not qualify for mortgages.  They may have to pay very high rates at finances companies, or they may not be able to get the money at all. . . . [I]f they can’t get the money, the seller (who lent them the money) will foreclose, and they’ve made [several] years of payments for nothing.