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7 Step Housing Budget – Part 2

Written by : Scott Snider, Mellen Money Management September 26, 2018

Welcome back for Creating a Housing Budget series – Part 2!

Last week, we learned how to create a plan to help shape our housing budget and this week we will put those steps in motion.

To help summarize the key points from last week, I created a DIY housing budget guide. Outlined below are the 7 steps you can follow to get a very good approximation of what you can afford to pay. However, for those who want an easier and quicker way to do it online, you can skip the 7 steps and corresponding example by using the following affordability calculator. Either method will help you “buy what you can afford.”

7 Step Housing Budget Guide

  1. Calculate Maximum Housing Payment

    • Cap it at 28% of gross income.
    • Total debt-to-income (DTI) ratio to never exceed 36%.
    • If DTI is above 36%, the housing payment needs to be lower than the 28% rule of thumb number so that all debt payments are equal to or less than 36%.
  2. Convert Housing Payment to a Lump Sum Mortgage Estimate

    • Quick way to calculate – for every $100,000 borrowed at 4.5% on a 30-year mortgage, your payment will go up by approximately $500 per month.
    • Your monthly payment will also adjust $30 per month for every 0.25% change in interest rate on each $100,000 borrowed over 30 years.
  3. Estimate Property Taxes and Insurance

    • Annual Property Taxes (Saint Johns County) = 1.088% of Purchase Price
    • Insurance Estimate = $35/month for every $100,000 in Home Value
  4. Convert Housing Payment to a Mortgage Estimate by Factoring in Property Taxes and Insurance

    • Subtract monthly cost of property taxes and insurance from housing payment in Step 1.
    • Convert the reduced monthly payment to an adjusted target price by using the $500/month for every $100,000 borrowed rule of thumb.
  5. Calculate Down Payment and Closing Costs

    • Down Payment = [Savings Account + Proceeds from Sale of Home] – [3 Months Living Expenses + Closing Costs]
    • A shortcut way to estimate closing costs is to multiply 2.5% by the price of the home.
    • Commission and variable incomes should keep 6 months of living expenses.
  6. Add Back the Down Payment to the Mortgage Amount to Arrive at an Estimated Target Price

    • Target Price = Mortgage Estimate + Down Payment
    • Almost there…other costs like PMI, HOA, and CDD fees are not yet included
  7. Research Properties to Fill the Cost Gaps and Adjust Housing Budget Accordingly

    • Search for properties through your realtor or sites like ZIllow to gather actual data
    • Make adjustments to your budget based on the other costs not yet captured, such as PMI, association fees, and community development dues.
    • PMI = [0.75% x Borrowed Amount] / 12
    • Association and community development dues vary by neighborhood.

Now that you have a 7 step process, how do you actually implement all of these budgeting tips? The best way for all of this to stick is to learn from a real life example and show you how to run the calculus.

Real Life Example

Example: John and Suzie Jones are married with 2 kids and are looking for homes in the Ponte Vedra area. They are first-time homebuyers. The Jones’ have $75,000 in savings and make a $130,000 combined salary. Unfortunately, in her younger years Suzie switched majors at a private out-of-state college and was on the 6 year plan, therefore she has a sizable student loan payment of $1,200. Total monthly expenses, including all debts and rent, currently run them at approximately $7,000. Interest rates on 30-year mortgages are 4.5%. Given their lack of experience, the Jones’ are not sure what they can afford and need help figuring out their budget.

Step 1 – Take 28% of gross income to calculate the maximum payment, and make sure all debt payments are less than 36% of gross income.

  • Housing Payment @ 28% = ($130,000 x 28%) / 12 = $3,033
  • Debt-to-Income (DTI) @ 36% = ($130,000 x 36%) / 12 = $3,900
  • Projected Debt Payments = $3,033 Housing + $1,200 Student Loan = $4,233
  • Projected DTI = $4,233 / ($130,000 / 12) = 39% → over the recommended level of 36%
  • Reduce Monthly Housing Payment = $3,900 Debt Limit – $1,200 Student Loan = $2,700
  • Recommended Monthly Housing Payment = $2,700

Step 2 – Convert the maximum monthly payment into an initial estimated purchase price using the “$500/month for every $100,000 borrowed” rule of thumb.

  • $2,700 / $500 = 5.4 (multiplier) → 5.4 x $100,000 = $540,000 max target price
  • Property taxes and insurance have yet to be included so the target purchase price will get reduced even further.

Step 3 – Calculate property taxes and insurance.

  • Property taxes = 1.088% x $540,000 = $5,875.20 → Monthly = $490
  • Insurance = $35 x 5.4 = $189
  • Total Taxes and Insurance Payment = $679

Step 4 – Reduce the maximum payment by taxes and insurance, then convert the payments to a lump sum mortgage estimate.

  • Mortgage Payment Estimate = Max Housing Payment – [Property Taxes + Insurance]
  • Mortgage Payment Estimate = $2,700 – $679 = $2,021
  • Mortgage Affordability Conversion = Mortgage Payment Est / $500 = multiplier x $100,00
  • Mortgage Affordability Conversion = $2,021 / $500 = 4.04 → 4.04 x $100,000 = $404,000

Step 5 – Estimate the down payment and closing costs.

  • Initial Down Payment Estimate = $75,000 savings – (3 x $7,000) = $54,000
  • Closing Costs = 2.5% x $404,000 = $10,100
  • Proceeds Available for Down Payment = $54,000 – $10,100 = $43,900
  • This is a little over 10% of the purchase price, which means there will be PMI

Step 6 – Add back the down payment to the borrowed amount to arrive at an estimated target price.

  • Borrowing Target = $404,000
  • Down Payment = $44,000 (rounded up)
  • Target Price = $404,000 + $44,000 = $448,000

Step 7 – Research properties and account for other costs like PMI, association fees, and community development dues – adjust housing budget accordingly.

  • PMI = [0.50% x $404,000] / 12 = $168 per month
  • Check listings for HOA and CDD fees → $150 per month
  • Total other fees = $318 per month
  • Adjustments to housing budget at a 4.5% interest rate for 30 years
    • Mortgage payment target = $2,021 – $318 = $1,703
    • Mortgage amount target = $1,703 / $500 = 3.41 x $100,000 = $341,000
    • Purchase price target = $341,000 + $44,000 (down pmt) = $385,000

For a lot of readers, crunching the numbers is enough to make your head spin. Which is okay. Developing a well-thought out housing budget doesn’t come naturally. It is why I recommend leveraging the expertise of a realtor and a financial planner, so that you have a team of professionals to help you get it right. Both experts can help you keep more money in your pocket. A great realtor will ensure you negotiate a fair purchase price and don’t overpay for something. Then, once you find “the house,” have a financial planner confirm your decision by reviewing the long-term financial impact.

Life is a lot easier when you understand the financial responsibility that comes with homeownership.

If anything else, the biggest take away to remember when shopping for a house is to, “only pay what you can afford.” Buying a home is one of the biggest purchases you will ever make. Therefore, it is in your best interests to have a very targeted price and remain disciplined during the shopping phase. Doing so can make all the difference in landing your dream home actually becoming a reality.


About Scott Snider and his company’s services….

Scott is the founder of Mellen Money Management, a fee-only, independent financial planning firm locally based in Jacksonville, Florida. In a nutshell, Scott helps clients plan for the financial impact of major life events, so that they are prepared for life’s biggest moments. Such an approach has helped his clients live a more fulfilling life. Mellen Money Management’s financial services include investment management and comprehensive financial planning. While their specialty is all things collegethey help families pay less for college and young professionals tackle their student loans. It is their mission to end the student debt crisis one client at a time. To do so they believe the cost of college cannot be solved in a vacuum and that financial trade-offs, like saving for retirement, must be prioritized in a way that one goal doesn’t come at the expense of the other.

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