How much house can you afford?

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!!!

number1

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).

number2As 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?

28 thoughts on “How much house can you afford?

  1. Lifestyle Accountant

    Hell nah, don’t do it Sally!! Nice analysis FF. It appears that the calculator is allowing about a 30% mortgage payment based on gross salary. I think 30% is a mainstream housing number and definitely not for those interested in financial independence. When I first purchased my house (before I discovered FI) my housing cost was more than the 30% mark because that’s what I thought was normal at the time, but I’ve since learned that it’s an outrageous amount to spend on housing. You bring up a great point…just because a calculator says you can afford a certain loan amount doesn’t mean anything, you need to realistically look at your own budget and see if it fits within your goals and lifestyle.
    Lifestyle Accountant recently posted…March 2015 Credit Card App Spree: 2 Cards, 120K Bonus Points & Over $1,300 in ValueMy Profile

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    1. Fervent Finance Post author

      Yeah there should be an asterisk next to “afford”. Or they should replace afford with “how much you’ll get a mortgage approved for”. I mean I could probably “afford” a brand new ZR1 Corvette, but at the expense of my savings and retirement, and stomach 🙂 It’s just sad that the people who use those calculators are the ones who do not know any better. Thanks for stopping by LA!

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  2. Debtless in Texas

    She can afford it…

    She just won’t be able to afford to do anything else like oh I don’t know, saving for retirement. I hope people know enough to use these calculators for entertainment purposes only, as that really is all they are good for.

    That and lenders seem to have their stuff locked down. Even when we were searching, they were super strict about where our finances came from, how much we made, assets, debts, etc. and hopefully they would look at her application and say DENIED!
    Debtless in Texas recently posted…What is a 529 Plan?My Profile

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    1. Fervent Finance Post author

      What’s scary though is when I type into Google search “how much home can I afford?” the 5th link is this CNN calculator. So when people are first starting off and don’t know where to look, this will be one of the first tools they see. They don’t realize that they will have to cut back on basically everything if they were to buy a home for the max value the calculator spits out. I too hope she would get denied for her sake Brian, but that probably wouldn’t happen!

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  3. Anne - Money Propeller

    Hahahaha. The last time I played this game, the calculator told me that my spouse and I could get a $900k something mortgage. (Just the part they’ll lend to me, I’m not talking about a down payment in that number!) Ridiculous!! There’s no way I want to be paying more in mortgage payments than most people make in a year. Plus, our incomes are high, but not sky high.
    Too bad most people shop at the top of their budgets, and on TV I constantly see people being pressured into spending more. “To get what you want in your neighbourhood, you have to spend way more.” seems to be the only thing one dude knows how to say.
    Anne – Money Propeller recently posted…How to Spend an Obscene Amount on Groceries – Tips from an ExpertMy Profile

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    1. Fervent Finance Post author

      The Rent-A-Center ads are the worst! Convincing low income households to rent large flat screen TVs with monthly payments. I guess “save for retirement” doesn’t sell like flat screen TVs 🙂

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  4. Finance things in Life

    Hah, poor Sally I really hope she wouldn’t bring a print sceen of the calculator result to a bank asking for a loan of that size.

    I don’t understand how CNN can keep a calculator like that. It just gives a bunch of false hopes, or lead people down a very expensive road.

    Reply
    1. Fervent Finance Post author

      What is scary is from what I hear, banks are loosening up their mortgage lending. 3% down mortgages are coming back and I wouldn’t be surprised at all if a bank would approve her for that mortgage. And I agree, you would think CNN would be wary of the consequences of that calculator, but I’m sure down at the bottom in real small print it rids them of any liabilities.

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  5. Abigail @ipickuppennies

    Yeah, these scenarios are what get people in trouble. Just because you can technically afford something (minus health care, car repairs, etc) doesn’t mean you should buy it.

    I can technically afford a couture piece of clothing, but it would set back my ability to save toward our various goals.
    Abigail @ipickuppennies recently posted…Wedding by Amazon Prime?My Profile

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    1. Fervent Finance Post author

      Hi Abigail Not going to lie, I had to Google couture clothing 🙂 But I agree, many things are actually “affordable” at the expense of what I deem more important items such as investing, emergency fund, retirement, etc.

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    1. Fervent Finance Post author

      I don’t think anyone with some level of personal finance knowledge would trust these. But then again, look at all the people who bought homes with zero percent down, or finance cars over 7 years, or carry credit card balances, or listen to their “financial advisers” who have them put their money in all sorts of fee-ridden investment products.

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  6. Hannah

    I’m in my mid-twenties and a lot of my peers are buying houses assuming that they are going to continue to get fat raises through the rest of their twenties and thirties (so they are buying at the top end of their qualifying bracket). To me, that is nuts because it absolutely guarantees that they need to be a dual income family for the next 30 years (at the same time that they generally want to start raising a family).

    It’s pretty awesome marketing that real estate agents have gotten people to ask how much house can I afford as opposed to, how much house do I want, or how little can I pay to meet my housing needs.

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    1. Fervent Finance Post author

      In all honesty many of my friends and peers have gotten healthy raises ever since graduation. The problem is the thinking starts “I’ll save most of my raise next year” but when the raise comes, your old car seems older, and your home begins to feel small. Lifestyle inflation is a terrible disease. I’m glad I have been fending it off! Thanks for stopping by.

      Reply
  7. The Money Mine

    These numbers are as dangerous as the “minimum due” on the credit card statements. While they are technically correct, it isn’t in anyone’s interest (except the bank) to follow them.
    I’ve been looking at this lately: does it actually make sense to borrow for a 30-year period? Wouldn’t a 10-year mortgage be more representative of what one can afford?
    The Money Mine recently posted…Liebster Award!My Profile

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    1. Fervent Finance Post author

      I’d have to agree with you Money Mine. Personally, I would only purchase a principal residence if I could afford the mortgage if it was a 15-year term. But then I would still take out the 30 year loan for a couple of reasons. 1) You could still pay-down the mortgage as if it was a 15 year term, but if certain cash needs arose you could always drop back down to the minimum payments, if needed. 2) With interest rates so low, I wouldn’t mind creating a little interest rate arbitrage and socking a lot of the money away in other investment vehicles (i.e. real estate, index funds, etc.). But that’s just me, and definitely isn’t as “cool” as taking out the biggest mortgage possible for the house with the four car garage and in-ground pool 🙂

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  8. Vawt

    It is a scary thought that even after the mortgage crisis that this could still happen to middle class families. I hope they are checking the numbers and seeing that these calculators or the number that the bank approves them for are a starting point, not the answer.
    Vawt recently posted…Liebster AwardMy Profile

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    1. Fervent Finance Post author

      Yeah we can only hope that people are using this just as a ballpark for the MAX they can “afford”. But sadly that probably isn’t the case. Creating a budget before purchasing a home is essential, so you know where all your cash outflow is going and make sure you are still reaching your savings and other goals. Thanks for stopping by Vawt!

      Reply
  9. Steve Adcock

    I couldn’t resist – I had to try out that calculator and put our own numbers in. And wow.

    Says I can afford a $1.1m home – even with $0.00 down.

    And maybe I can afford it, but only if my idea of retirement is finally calling it quits well into my 60s. Phew, that sure isn’t my idea of retirement.

    How about a $150k townhouse that we pay off in 3 or 4 years and live mortgage free until we find the house of our dreams? Ah yes, much, much better. 🙂
    Steve Adcock recently posted…The 3 most critical steps towards early retirementMy Profile

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    1. Fervent Finance Post author

      Haha, only $1.1m??? You’re definitely not keeping up with the Joneses with a home in the low seven figures 🙂

      Your story reminds me a lot of the Corvette you bought. The Corvette can go 0-60 fairly quickly, just like you did with your savings and financial independence plan.

      Reply
    1. Fervent Finance Post author

      And on top of that mortgage payment you’d probably love your new electric, heating, and real estate tax bills. And a house that size would take quite the time to clean and maintain! Glad you didn’t fall for the calculator 🙂

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  10. LaTisha

    This is exactly the type of analysis I was explaining to a friend. She can “afford” a home according to the income based calculator but once you look at her normal budget and savings, the story changes. It would really help if lenders used net income or disposable income to calculate how much to lend instead of gross income.
    LaTisha recently posted…VIDEO: 401k Rollover Process with Betterment-ReviewMy Profile

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    1. Fervent Finance Post author

      Yeah I think educating people that what the bank is willing to lend you or what an online calculator says you can afford, most likely isn’t the case. Unless you have no savings goals and don’t spend any money 🙂 But I agree the term “afford” is used very loosely.

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  11. Jacob

    I’d have to agree that generic calculators can be dangerous for the average person. The recommendations provided are probably feasible, but the individual would be saddled by the PITI, completely void of cash flow, and unable to properly save for retirement.

    But most people don’t understand that, and if they can swing the monthly payments, they can “afford” it…
    Jacob recently posted…How to Start a Successful Blog and Make MoneyMy Profile

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    1. Fervent Finance Post author

      Couldn’t agree with you more Jacob. “Afford” means different things to different people. Some people define it as, if I have cash from my paycheck to pay for it, then I can afford it. But for me, if that means I’m not meeting my savings or debt pay down goals, then to me I CANNOT afford it.

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  12. a woman

    yes, I did it. My fist mortgage=30% + the other depth=20% so totally was > 50%. I was young, 25 years old, I knew in 2-3 years I will finish the smaller depth and to be with 30% mortgage. I had no tv, no car, 1 salary for emergency fund, less budget for clothes and lunch out (I am sewing and cooking) and took a temporary second job for furniture. I eat season vegetables and do jogging to keep a good healthy status (and I had retirement plan + medical assurance covered by my job, indeed is a small package but is free….).

    I finished to pay the mortgage in 8 years instead 30. I am ready to another mortgage (first aprt. is rented and I will sell it only if I will loose my job). No, this time I will not book for 30 years, but maximum 20 years. I don’t want a mortgage at 60 years old. I am searching now a house with a small garden to plant something after my job. I will still live without tv, car, and a minimum retirement plan: I have the first house for this, with his value I can live around 10 years well balanced.

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