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During the first four months of 1996, personal bankruptcy filings increased 27 percent, the largest four-month increase in history. Williams says financial problems usually stem from a combination of increased expectations, decreased income and easy credit.
Lending agencies for many years have used the rule that housing expenditures for mortgage, taxes and insurance can range from 25 percent to 28 percent of gross income. However, Williams says there are additional expenses that should be included in the true cost of housing. Her research suggests that things like repairs, yard maintenance, gas and electricity -- in addition to mortgage, taxes and insurance -- should all add up to the total amount budgeted for housing.
Williams says a 60-40 breakdown of housing costs better reflects housing affordability. She says 60 percent of the money earmarked for housing can go toward principal and interest. The remaining 40 percent is spent for taxes, insurance, upkeep and utilities.
Following is an example of the process for determining an affordable mortgage loan, excluding down payment and closing costs. It should be calculated using the total money available for housing expenses or 25 percent of gross income. For a couple with a monthly gross income of $4,000:
| This is 25 percent of monthly gross income. | $1,000 |
| Multiply that by 60 percent. | .60 |
| This is the amount of an affordable monthly mortgage payment. | $600 |
| Divide that number by the monthly installment cost per $1,000 borrowed (see graph at end of story.) The figure is based on the interest rate and duration of the loan. For example, a 30-year loan at 8 percent interest would cost $7.34 per $1,000. Continuing with the example above, divide $600 by 7.34. | $81.74 |
| Now multiply that figure by 1,000 to come up with the amount of loan that the couple could afford -- excluding down payment and closing costs. | $81,740 |
"Usually the resulting figure is less than people want," Williams says. "Although it may be less than most people's dream home, this more realistic estimate could prevent financial problems down the road. I tell people that if they want more house, they need to arrange for a larger down payment or reduce the nonmortgage costs of housing in order to purchase a more expensive home."
That's easier said than done. Williams says a new home brings with it the costs of landscaping, window treatments, furnishings and more. An older home usually means higher maintenance costs. "It's much like buying a car -- you're usually better off buying one that's just a few years old," she says. "That way you don't have the expense of a new one or the upkeep of an old one."
Some people purchase homes in rural areas because housing prices are generally cheaper. "The problem there is the savings usually translate into higher transportation costs," Williams says.
If the hypothetical couple in the earlier example went to a lender, they might qualify for a mortgage of $125,000, assuming that mortgage, taxes and insurance accounted for 28 percent of their gross income. With the same length of loan and interest rate, their monthly principal and interest payments would be about $920.
Williams speculates that lending institutions loan money with the idea that homeowners will let other bills slide and try to make their mortgage payments even during tough financial times, rather than risk losing their homes.
Despite her formula, Williams says, "As a rule, you should never substitute this or that 'rule' when thinking about your unique situation in obtaining a home." Because housing is most people's biggest investment, she says it requires much thought and planning. "Housing decisions infer tradeoffs based on people's priorities, skills and opportunities," she says.
Monthly installment per $1,000 borrowed
| Interest rate | 7.00 | 7.25 | 7.50 | 7.75 | 8.00 | 8.25 | 8.50 | 8.75 |
| Years | ||||||||
| 15 | 8.99 | 9.13 | 9.28 | 9.42 | 9.56 | 9.71 | 9.85 | 10.00 |
| 30 | 6.66 | 6.83 | 7.00 | 7.17 | 7.34 | 7.52 | 7.69 | 7.87 |
Source: Flora Williams, (765) 494-8297; e-mail, floraw@purdue.edu
Writer: Beth Forbes, (765) 494-9723; e-mail, beth_forbes@purdue.edu
Purdue News Service: (765) 494-2096; e-mail, purduenews@purdue.edu
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