Continuing last week's offering on our perilous journey into homeownership, I thought I would discuss how we made the decision about how much house we could afford.

We are a naturally fiscally conservative people, we McSudermans.  As I think I mentioned before, we wish to pay off our house in ten years.  However, we are not a cash-rich people, particularly not after paying for the massive party we decided to stage in June.  So we set some parameters on the home purchase:

1)  At least 10% down  We were aiming for 20%, but set an absolute floor of 10%.  This seemed pretty safe in DC, where house prices have been pretty stable.  Any lower than that, and we figured we'd run a serious risk of being forced out of the house by some exigency, and having to show up at the closing with cash to cover closing costs and the broker's fee.  Our credit union offers 10% down loans to members without personal mortgage insurance, so in a pinch, we figured we were willing to go that low.

2)  Lots of room for repairs in the budget  I figure that it's safer to overestimate this sort of thing than to find out--surprise!--that you don't have the money for the new roof you need.  Our house has had some updates, and the engineer says it's in good shape, but it's still over 100 years old.  We figured we needed a payment that would let us budget at least 1% of the home's value for annual repairs:  roofs, boilers, plumbing, and whatever else it is that you homeowners do with your spare time and money.

3)  A payment calculated only on salary  Both of us do freelance, but neither of us is willing to count on it.  If we have extra . . . well, I'll just get my new kitchen all that much faster.

4)  PITI of no more than 25% of take-home  PITI stands for Principal, Interest, Taxes and Insurance.  For those of you who have not yet bought a home, that's the payment that you send to the bank every month--the mortgage payment, plus taxes and homeowner's insurance, which they hold in escrow for you.  We wanted to keep it on the low end of what most people pay, for lots of reasons:

  • We want to be able to make a substantial extra payment each month
  • We want room in our budget for a full 15-20% savings rate
  • We want to insure against income loss; if something happens to one of us, the other person should be able to cover the mortgage
  • We can always spend surplus cash; we cannot spend surplus house without selling the whole damn thing, or taking out a home equity line that puts us at risk of losing the whole damn thing.

5) Reasonable relationship of house to income  A mortgage of 2.5 times annual income was the absolute cap, and we wanted to stay well below that, for the reasons I've already enumerated.

6)  Fixed rate mortgage  We thought hard about an ARM.  It's quite possible that it would have been a better fit for us, since we plan to be pretty aggressive about paying it down; with a seven year ARM, by the time it reset, we might have a substantially lower payment.

On the other hand, the rates offered by our credit unions on longer-term ARMs were not that much better than on conventional mortgages, and interest rates don't have much place to go but up.  We opted to pay a little extra for the insurance.

7)  The house had to work, financially, without the tax deduction  Given that we do freelance, we already itemize, so we're glad to take the home-interest deduction.  But we were not interested in a "stretch" that was only really feasible with a big tax deduction; we wanted a payment that was the same as, or less than, the rent we were already paying.

Once we'd hashed all this out, I called the credit union to apply for a loan.

Peter was sitting in the living room while I paced up and down (I pace while I talk on the phone) feeding name, age, income, Social Security numbers, work history and so forth to the nice lady in Florida who took the application.

At the end, she sucked in her breath and said, "Well, based on this, we couldn't loan you more than [figure equal to approximately 5 times the stated income]." I am ashamed to admit that I reacted with an indelicate expletive.  Peter looked up anxiously.

"Won't we be able to buy the house?"  he said. 

"We can buy the house," I told him.  "In fact, I think we can buy two."

It's frightening to know that the above calculations, which don't seem too stringent, are far, far tighter than those used by our relatively sober credit union.  We McSudermans may be a fiscally conservative people, but we Americans clearly still aren't.