I was perusing the CNN Money website, and I came across a link for “How much house can you afford?” so obviously I clicked on it. It asked for three inputs: 1) annual income, 2) down payment, and 3) monthly debt. So of course I tossed in some quick numbers resembling my scenario and it popped out a house value of over $500k! Let me repeat that, 27 year old me can “afford” a home of over $500k! I almost spit out my water when I saw that number pop up. And remember, I’m an accountant so none of those three numbers were anything special.
Of course someone in our online personal finance community would never make a life changing decision like determining how much house they could afford by using some calculator online that only takes into consideration three inputs, but then it got me thinking. Who are the people that would use this calculator? Unfortunately, those are the people without any financial background or interest in personal finance. They don’t research how to open up an IRA, just contribute enough to their 401k to get the employer match, have a car payment, and pay the minimum on their student loans.
So I decided to run an experiment with this calculator to see how appropriate it is. Our lucky participant is Sally from New York (upstate, not the city). She is a 25 year old nurse earning $65,000 a year at a hospital in NY state. She has lived at home for a couple years and saved up a $20,000 down payment for a home. The only debt she has is some student loans from nursing school at $275 a month (she purchased her used car in cash), and she knows that credit cards are not meant for reckless spending so doesn’t carry any balances on them. Interest rates are at an all time low so her friends and family members have convinced her to purchase a home as it will be a great investment.
So as you can see, Sally’s scenario isn’t too bad. She definitely would have a leg up on most people utilizing this online calculator. So let’s input her information into the calculator and see how much home she can afford. Lucky Sally! She can afford a home valued at $302k!!!
From there I went to the payroll processor ADP to utilize their online Salary Paycheck Calculator to see how much Sally would take home from her job to see if she could really afford this $302k house. Here are the assumptions I used:
Salary – $65,000 annually
State income tax jurisdiction – New York
Exemptions – 2 federal exemptions as Sally is single and has only one job
Deductions – Only deduction I used for Sally was a 10% pre-tax 401k contribution. Sally once read an article that said contributing just enough to receive the employer match was not enough and to aim for 10%.
Her monthly take home pay with those assumptions would be $3,557.
Now let’s look at her expenses. The CNN Money calculator came up with a monthly mortgage payment of $1,675. This payment calculator assumes a 30 year loan at 3.84%, annual property taxes of 1% of the home’s value, and annual home owners insurance of 0.4% of the home’s value. Since Sally only had a $20k down payment, she’s going to need to pay private mortgage insurance (PMI). Using goodmortgage.com I calculated a monthly PMI payment of $169. See below for her total guestimated budget (before you tear up the budget, I put it together off the top of my head just using experience and from what I have been told by homeowners over the years in the northeast).
As you can see, per the budget to the left, at the end of the month Sally only has a $63 surplus. You might have noticed I have not included health insurance since this can vary greatly from person to person. Also, $350 a month to heat and cool a home in the Northeast may be a little bit of a stretch depending on the age of the home. For instance I once rented a bedroom in a 3-bedroom house in New England and it easily cost over $400 a month for electric and heating (annualized) for the whole home.
The $100 a month budgeted for home maintenance isn’t going to get her very far if she needs a new roof or furnace, especially since she drained her emergency fund for the down payment. And she will definitely have to take out a car loan to purchase her next car unless she can earn more, pay down her mortgage enough to rid herself of the PMI, or cut down her budget.
So as you can see, the people these calculators are meant to help are exactly the wrong people who should be using them. With only $63 left over at the end of the month, Sally is really going to reconsider her “investment” especially since since she’s living paycheck to paycheck now and has to cut back on her more expensive hobbies.
Do you think the Sally can actually afford a $302k house? Is the CNN Money calculator dangerous for uneducated users?