How big of a mortgage can I realistically afford?

Question

I'm 25, and I'm in the process of closing on a $260,000 mortgage for a very nice condo in downtown Salt Lake City. My salary is $80,000 right now, which I feel is pretty solid, but I'm starting to get cold feet as I am a first-time homeowner and the amount of interest just seems devastating to me.

My question is, are my fears warranted, or am I just being paranoid? Reading a few finance articles, I have heard that most people can afford anywhere from 3-5 times their gross salary on a mortgage. Clearly, I am within that range, but there are also property taxes, HOA fees ($150 per month), and utilities to take into consideration. Another consideration is that I do not have much cash saved for a down-payment. I had a substantial sum, but family troubles combined with paying off my student loans ate up most of my savings.

Some other nuggets of information to aid in any advice/calculations:

• I've rented for the past 4 years; my current rent is $600 per month.
• The condo is a 2-bedroom and I do have a roommate in mind. His monthly budget is $700 per month.
• For the down-payment, I am considering taking a loan on my 401k. I can take up to 50% of the total balance with no penalties. The balance right now is around $25,000. Of course, if I do take a loan, that's another monthly bill I will have to pay.
• I have $6,000 in liquid cash, and the condo association has agreed to pay $7,500 towards closing costs.
• The interest rate I am looking at is 4.625%.

Am I in a reasonable position, or am I setting myself up for being "house-poor?"

SIX MONTHS LATER:

I appreciated all the good advice, and I figured I would give you an update and let you know how it all turned out.

Basically, I ended up pulling the trigger. Researching the economy in Salt Lake City made me feel quite optimistic and I was pretty much in love with the location, so I went ahead with it and even took out $12,000 from my 401k for the down-payment (coincidentally, the stock market plunged immediately afterward). Interest rates dropped to 4.375%. In addition, my roommate and I worked out a deal where he would pay 4 months rent upfront, so I was able to get $2,400 more to put into initial home-related expenses.

After a fairly drawn-out closing process, I finally moved in at the end of August. The property appraised for nearly $280,000, and is projected to increase to $300,000 over the next five years! The place is beautiful and such a step up from the dingy apartments I've been renting; I couldn't be happier with the decision. Here's some pictures to give you a feel for it.

Answer 1

You're biting off a lot.

Let's say you can swing 5% for a down payment: $13k. A 30-year loan on $247k at the rate you quote gives you a payment of $1,270 per month.

This does not include taxes, insurance, or private mortgage insurance (which you'll pay because you have a down payment less than 20%). The PMI will run you about $150-$200 per month, I think, until your loan-to-value ratio falls below 80%.

Plus your HOA fee, utilities, your 401(k) loan payment, etc., you're pushing $2k/month.

You have a roommate in mind, and that will help, but the roommate can go, and you still own the property. Then you get the whole payment all to yourself.

If I had the option, I'd rent a little longer. Save up for a decent down payment, and shop around for someone who is desperate to sell.

Answer 2

Let's start with income $80K. $6,667/mo. The 28/36 rule suggests you can pay up to $1867 for the mortgage payment, and $2400/mo total debt load. Payment on the full $260K is $1337, well within the numbers. The 401(k) loan for $12,500 will cost about $126/mo (I used 4% for 10 years, the limit for the loan to buy a house) but that will also take the mortgage number down a bit. The condo fee is low, and the numbers leave my only concern with the down payment. Have you talked to the bank? Most loans charge PMI if more than 80% loan to value (LTV).

An important point here - the 28/36 rule allows for 8% (or more ) to be "other than house debt" so in this case a $533 student loan payment wouldn't have impacted the ability to borrow. When looking for a mortgage, you really want to be free of most debt, but not to the point where you have no down payment.

PMI can be expensive when viewed that it's an expense to carry the top 15% or so of the mortgage. Try to avoid it, the idea of a split mortgage, 80% + 15% makes sense, even if the 15% portion is at a higher rate. Let us know what the bank is offering.

I like the idea of the roommate, if $700 is reasonable it makes the numbers even better. Does the roommate have access to a lump sum of money? $700*24 is $16,800. Tell him you'll discount the 2yrs rent to $15000 if he gives you it in advance. This is 10% which is a great return with rates so low. To you it's an extra 5% down.

By the way, the ratio of mortgage to income isn't fixed. Of the 28%, let's knock off 4% for tax/insurance, so a $100K earner will have $2167/mo for just the mortgage. At 6%, it will fund $361K, at 5%, $404K, at 4.5%, $427K. So, the range varies but is within your 3-5. Your ratio is below the low end, so again, I'd say the concern should be the payments, but the downpayment being so low.

By the way, taxes - If I recall correctly, Utah's state income tax is 5%, right? So about $4000 for you. Since the standard deduction on Federal taxes is $5800 this year, you probably don't itemize (unless you donate over $2K/yr, in which case, you do). This means that your mortgage interest and property tax are nearly all deductible. The combined interest and property tax will be about $17K, which in effect, will come off the top of your income. You'll start as if you made $63K or so. Can you live on that?

Answer 3

For me there are two issues.

1. Borrowing against 401K is never a good idea. See this article for an overview of key concerns. Note the mention of it being a sign of financial distress.
2. The room-mate @700 per month is meaningless - you must work your numbers on the assumption that you do NOT have anyone in the condo paying you rent. If you can't make it work without the rent, you're stretching yourself too thin.

So, what to do? You have the basics of a very strong position coming together. A good salary in a good city. I'd be patient and work on consolidating my position for another year to 18 months (including building a rainy day fund) and look to buy then.

Answer 4

My primary concerns.

1. you might be able to afford the payments, but I think a downpayment is the real issue.
2. borrowing from 401k for this is NOT good (see many examples of why in other answers)
3. You'd exhaust cash reserves and be living hand-to-mouth for a good while, with no ability to deal with any financial emergency. (relying on the 401K for 'emergency money' is also not good.)
4. With no reserve, any financial hardship could very rapidly place you in a position of having to sell with little to no equity, into what is presently very much a buyers market.
5. Without 20% down you'll have to pay PMI which is a substantial waste of money for you.

There seems to still be a fair bit of distressed property (forclosures etc) on the market at current, which might well keep prices down for the next year or so that it takes to finish flushing that stuff out of the market. The gist I get from most experts/pundits is that There will be good deals around for while to come still

I'd advise you wait. Go ahead and do the math to figure out what total you WOULD be paying would be, and charge yourself that much a mohth for rent in your current place, pocketing the difference in a savings account. You'll be able to get a feeling for what it's like to live with that kind of house payment, and if you can do it sans any room-mate (something you can't always count on) If you can manage it, then you have a much more realistic idea of what you can afford, AND you'll have saved up a bunch of money to help with a down-payment in the process.

If for example your Mortgage plus taxes and insurance ends up running around say $1450 a month, plus another $150 for the HOA, well then, that's charging yourself $1600 a month for your 'rent' which means $1000 per month going into the bank, in two years that's nearly the same as what you have now in the $401K, and you'd have a really good idea if you can afford that much per month in housing costs.

If you are bound and determined to do this now, then here's a few other things to consider.

You might to shop around a bit to see how typical those HOA fees are. Yeah you don't have the expense and hassle of needing to mow the lawn, paint the place etc but still, 150 a month translates to around another 1.5 mortgage payments a year.

You might be able to get around PMI by splitting the mortgage into two pieces and doing a 'purchase money second' of around 15-20% and 75-70% of the value for the main mortgage. That way the LoanToValue on your primary loan is under 80%, which could be worthwhile even if the interest rate on that second loan is a little higher (at least it's deductible, paying PMI is just money lost to you) although trying to do any kind of creative financing these days is a lot trickier

Answer 5

If you are not planning on living in your condo for at least 10 years don't do it. For about 5 years your mortgage will be more then rent, after 5 years you start to break even and may start paying less. On the other hand, if you plan to be there for 10 years or more it might be a great savings tool,

Answer 6

$260k mortgage is pretty high for $80k salary alone -- if you have expensive tastes, be prepared to tune them down. The make or break for you will be taxes and other recurring fees. If property taxes are trending higher than inflation in your area, you'll have trouble down the line.

Decisions like this are really market driven, and I don't know much about Salt Lake City. In general, condo values get punished relative to single-family homes during bad market conditions. So if this is a really nice condo in a good building in a desirable part of the city you're probably going to see the value of the property increase as the general economy improves.

If the property is good, go for it.

Answer 7

Plugging the numbers into this mortgage calculator (screenshot below), we can see that your payments will amount to around $2,000/month including principal, interest, taxes, insurance, PMI, and HOA dues. This represents about 25% of your salary, which is approaching the upper limit of what banks will allow you to take on. Such a high payment may make it difficult to replenish your emergency savings or save for other things like your 401k or future home renovations.

I'd advise against borrowing from your 401k as the drawbacks almost always outweigh the benefits.