Buying a home - rule of thumb -

I agree with the basic sentiment of irrational real estate spending, but the rules of thumb don't really work across income and tax levels. And, people think of real estate too much in terms of affordability of monthly payments, rather than the absolute price, and the ability to absorb a loss on that leveraged investment. My parents' rule of thub was that the house price should be less than twice annual income.

i love that rules of thumb passed from generation to generation that don't take into account changes in taxes (oldish people paid 1/3 of current FICA taxes for ex), nor existence of student debt (a none issue for those that were young a generation ago), nor the fact that wages didn't catch up with inflation...

those 3 forces alone should justify re working those "rules", otherwise, following them might not be realistic either. might be a scary result... the fact that instead of 30% of gross income to housing one might actually need to limit to 20%. if they increase payroll taxes, then the limit will have to be reduce to 15% .... what's next?

like one of the biggest clowns said (barney frank), the american dream now is a house, not necessarily home-ownership (meaning, the american dream is now not being homeless).

many are just buying a call option on future appreciation. the premium is the possible hit on their FICO and the tiny downpayment (PITI in a monthly basis too though).

I had always heard 3x annual salary for a house and max of 9 months for a car. I think it was in an Andrew Tobias investing book at some point.
Thus, when the mortgage broker told me two years ago that I could easily up my budget and go higher than 4x on my mortgage, I sort of suspected something wasn't quite right.

Very true that this is just a rule of thumb. The less you make, the more that goes to just basics like food, and the more you make, the more that goes right to taxes. Obviously interest rates also skew the idea.

admin,

This is the first time I've read your post and you give great advice.

and when this man was born in the late 30s, the average family spent about 30% of their disposable income on food and clothing, vs. about 14% now. and of course spending on healthcare and education has gone up. why should housing expenditures as a % of income remain stable? not to mention the fact that in other developed countries the numbers are much different than our own.

should i tell my wife that we are spending too little on food - no more Fairway, only Eli's? and too much on school - screw saving for college - if it costs more than a few percent of our income, our kids can't go?

things change, the world is not static.

Printer: agree.

Families also have different priorities. My parents' biggest priorities (spending) when I was growing up were: 1) private school for their kids 2) helping their large extended family out.

Our priorities are not quite the same - spending on private school & helping our extended family out are way down there.

lol printer, spending in technology and "media and entertainment" will suffer the most... parents would tell their spoiled kids "your grandpa didn't have a mobile phone till he was 85! lol

The biggest problem with these rules in Manhattan is finance. What are people with a $150k base a bonus between $0 and $800k supposed to spend? These rules of thumb are not so far fetched. Banks used to say 28% of gross monthly income in a housing payment. For bonuses they might look at a trailed two are three year average. The problem really came in 2006 and 2007 looking at the trailing two years of bonuses and then finding out in 2008 that the banks were failing, consolidating and everything 'normal' about 2004-2007 might be an illusion...including the value of the apartment on which the bank accepted an 80% or greater LTV.

if they increase payroll taxes, then the limit will have to be reduce to 15% .... what's next?

removing the deduction for mortgage rate interest. can't imagine this would get through both houses. but if it does, big affect on home ownership, no?

gosh, if I only I had written a book about this.

My rule was that you could carry a loan balance in the range of 2-2.5X HHI if you were rich (because counterintuitively, the more wealth people have, the lower they think their housing costs should be) or had kids/high costs with kids and that you could carry a loan balance in the range of 2.5x-3x HHI if you were less well off/childless (or at least private-school-less).

At various times in my life, I've actually carried 5x HHI, but the above rule, which is a little more conservative, seems to work for just about everyone.

ali r.
The book: http://tinyurl.com/2ag28z

"The biggest problem with these rules in Manhattan is finance. What are people with a $150k base a bonus between $0 and $800k supposed to spend? "

$450K max, if they want to buy.

If they can't get enough apartment for their needs at $450K, they have to R E N T.

No one said BUYING real estate in Manhattan was a birthright.

the finance kids should bank those bonuses for a rainy day...rainy month...rainy year... or decade.....

That sounds good, but if you are ten years into your career and you still have a VP level salary of $150-175k, you can't structure a Manhattan family lifestyle around that. And if your average total income has been $500k for three or four years, the bank will lend you $2mm. I am not saying its right, but it is what drove Manhattan real estate.

To say someone who has made $500k on average for four or five years should buy a $450k apartment is pretty stupid (then again, its Matt). That said, maybe they should wait until they save $450k, take a $450k mortgage and buy something for $900k. Again, they probably did not do that...because the brokers, banks and their own ego had them buying a $1.5-2.0mm apartment. I don't think this very represenative finance person needed to limit themselves to a $3,500 housing payment...but nor should they have gone to $10,000 pre-tax as many of them did.

I strongly recommend to buy as much house as you can finance and make sure you keep your own downpayment as small as possible. If it does not work out, you will have had at least a lot of fun and not given up too much of your own hard earning dolares. Also make sure you don't build up ANY reserves for bad days - they will come but won't cost you a penny.

"My parents' rule of thub was that the house price should be less than twice annual income."

And where the heck in Manhattan can you buy that will meet this rule?

rhino -- but when one is a vp -- they should use a chunk of what they have banked and keep the nut small....

Right...but how small is small enough? How many VPs are now unemployed? And is the moral of the story that $1.5mm-$2.0mm family apartments should have never cost that much at all? In other words, people should have never been willing to pay that much for them, based on their income and/or the rental price of the equivalent apartment...Which is admittedly tough to find because rentals are generally less nice. With 20-20 hindsight, someone like this making $500k all-in should have been buying at the conservative $900k to $1mm level and putting 50% down. In fact, they were buying at $1.5mm-2.0mm and putting 20% down because it became the market and the banks made it easy. Much of my bearish view is that the banks and common sense will drive those prices back to $900k from $1.8mm in a couple years... Because appreciation will no longer be taken for granted...neither will bonuses....neither will banks be as easy.

"I strongly recommend to buy as much house as you can finance and make sure you keep your own downpayment as small as possible. If it does not work out, you will have had at least a lot of fun and not given up too much of your own hard earning dolares. Also make sure you don't build up ANY reserves for bad days - they will come but won't cost you a penny."

the last could be solved by buying only in places that are non-recourse

"the finance kids should bank those bonuses for a rainy day...rainy month...rainy year... or decade....."

100% agree. if you want a call option in RE appreciation, buy those calls on a discount brokerage. much smaller transaction costs and liquidity is not an issue.

If the banks didn't lend on a bonus, they wouldn't have bought on a bonus...And real estate in NYC would have topped out much lower. Also, finance is the only industry where base can be less than 25% of your comp or less routinely. The only way they'll ever have the discipline to buy on base alone is if the banks force it. If the banks had never lent on bonus, all those 2000-2002 hires would have taken many more years to bank what they'd have needed to afford big apartments. Banks will be much more conservative now. Most bulls in my view do not understand this is the primary story of Manhattan 2004-1H2008. Lots of mid level bankers making $500k (only $150k bases) and buying $1.5mm places or more. Its over. And most of the buyers now are likely the savers of that era who can meet the new (or back to normal) underwriting standards.

"And where the heck in Manhattan can you buy that will meet this rule?"

Is this a reason to ignore the rule, or is it a reason not to buy in Manhattan unless you make enough money to meet the rule? Was paying 5x annual income for a place with 20% down what people should have been doing...or was it part of the problem? Do you see a problem with any of what went on Alpo?