There it sits, like a big, inviting slice of cake at the all-you-can-eat-buffet: The heaping helping of mortgage that a lender says you're qualified to borrow. Should you put it on your plate?
Maybe. Then again ...
The Internet and folk wisdom abound in "rules of thumb" about determining your housing budget. A casual surfing of financial-advice sites, for example, turns up all manner of estimates of how much house one can afford, ranging from 2.5 to 5 times one's annual salary.
And that, of course, isn't necessarily the same thing as how much debt one should assume, a concern that apparently has its own infinite supply of rules of thumb.
Financial planners say, yes, it can be enlightening to plug your personal figures into the online calculators that ostensibly gauge how much you can afford -- just don't believe everything you read.
For one thing, such calculators vary wildly in the number of factors taken into account to come up with "affordability." Among the literally dozens of such devices that turn up on an Internet search, some omit such pesky line items as the cost of homeowners' association dues, homeowners insurance or even property taxes.
Nonetheless, those rules of thumb persist. Mortgage financier Freddie Mac, for example, suggests that a mortgage payment be no more than 25 percent of your monthly income.
"I wish people were at 25," said Lynette Briggs, a housing counselor for the DuPage Homeownership Center in Wheaton.
She said locally variable factors -- particularly property taxes and homeowners insurance -- can throw such guidelines out the window. "In DuPage County, where the median home price in September was $348,000, [the typical proportions of debt are] in the neighborhood of 30 to 40 percent."
But the interesting thing about rules of thumb is that if you look long enough, you'll find one that fits -- or comes close. For example, the Web site for financial services provider Credit Suisse suggests allotting one-third of one's income to housing. Sherry Smith, a counselor for Neighborhood Housing Services of Chicago, says her non-profit group suggests a limit of 40 percent.
"We don't use rules of thumb; we use real circumstances for real people," said Shawn Parker, a financial adviser for Ameriprise Financial in Schaumburg. "What might be appropriate for one person, might be a disaster for another."
But you've got to start somewhere. Mortgage lenders for many years have used a couple of benchmarks to determine how much they'll lend, though industry standards have made them anything but hard-and-fast. Those benchmarks are called "front-end ratios" and "back-end ratios."
The former consists of the total housing payment - loan principal, interest, taxes and insurance/homeowners' fees (or PITI) -- divided by gross monthly income. This tells the lender how much of your income you should be able to devote to housing, and the standard has historically been 28 percent.
Back-end ratios carry more weight. In this calculation, the lender combines PITI with monthly debts (such as credit cards, car payments, student loans, etc.) and divides that sum by gross monthly income. The traditional industry standard on this ratio suggests you should be able to put 36 percent of your income toward housing.
Those ratios bring us back, generally, into the 30 to 40 percent rule-of-thumb territory.
But the problem with relying on the ratios is that the lending industry has changed the rules.
No concrete standards
"There are no standards anymore," said Jack M. Guttentag, professor emeritus of finance at the Wharton School of Business at the University of Pennsylvania and author of a syndicated column called the Mortgage Professor. "It used to be that 28 and 36 were fairly well enshrined, through the standards of Fannie Mae and Freddie Mac," which set guidelines for mortgages that they will buy from banks and other lenders.
Which is just right?
Determining how much house -- and loan -- you can afford defies formulas
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