By Doug Katz – 06/20/2022
It is no secret that the housing and mortgage markets are changing and not for the better. As expected, there has been a deluge of articles of new programs and other ways to juice your purchasing power to still be able to buy a home. I am deliberately leaving out the term “afford” because it afford is a tricky word in this case and it is why everyone considering buying a home need to have a personal budget.
First lets attack that afford question. When a bank looks at what you can afford, they objectively look at your financial picture and determine your debt service ratio. Generally, 43% is considered an allowable ratio, but it can go much higher if certain automated systems allow it and/or other certain programs like FHA or VA where ratios can exceed 50%. This is a huge number for a housing expense but when you add to this the fact that is is your GROSS income, it gets really scary. This means that you are being evaluated before taxes and most other deductions so the actual impact on your cash flow is much greater. The lender is defining that number as the measure of your affordability and many a buyer has been hit with their own payment shock when they begin to make the payments and/or if they get hit with an even higher payment when real estate taxes increase (they always do, by the way), insurance increases or later if they are in an adjustable rate mortgage and it moves to the indexed rate.
A personal budget acts as a safety tether. It introduces into the decision process a realistic reflection of what you can pay a month and not only survive but live your preferred lifestyle. It takes into account your goals for things like retirement and savings or needs like college for a child as well. It puts you where you should be, in the driver’s seat for driving the transaction. It can also appropriately take into account expected income growth or other expected sources of income. Too many homebuyers get caught up in the excitement and emotion, especially during crazy markets, and make decisions that can adversely impact them later. Either way, it ensures that the home purchase is a wholistic one.
You are likely wondering why there is such a profound dissonance between what is allowable and what is prudent. As I mentioned earlier, there are times when a buyer knows that the high number is temporary as with situations of likely higher pay in the coming months or years or when someone’s documented pay is less than actual and their ratios are actually better than the lender is using, i.e. self employed or occupations with a lot of cash compensation. The systems, however, do not differentiate. They cannot due to fair lending requirements that were strengthened after the 2008 crash to minimize potential discrimination and inequities. In short, the lender is objective and the borrower owns their finances. Many lenders do require counseling for new homebuyers or those with high debt service ratios to help prospective buyer more broadly evaluate the decision, which helps, but you would be astounded at how many of my past clients and prospects actively work to avoid this counseling or reduce the inconvenience of needing to attend.
This is why I am so adamant in advising my clients that they need to have their own budget. The lender, as you now know, cannot decline a loan if the person is dangerously pushing their debt ratio to an unsustainable but allowable level. It actually violates fair lending to decline a loan that fits guidelines regardless of my personal opinion on how much it impacts the client. Let me reference that again so it is completely clear. If a deal meets guidelines and does not have any type of legal red flags, the lender will approve them loan. They have to per fair lending. I can let them know and I do, but the decision is theirs. That is why that decision needs to be grounded in actual cash flow, monthly costs, inflation, decreased income or job loss and potential increases in costs of living like taxes and insurance. This is especially so if the non-housing parts of your financial picture are changing like during marriage, divorce or retirement because more than one variable is changing which makes it an even more complex but immensely more important point to know, understand and make decisions based on the projected new normal. Remember, you are buying something very expensive and the onus is on you to make a prudent, well analyzed and sound decision when buying a home.