By Michael Foster, CFA, CFP®
My wife and I have been “in the housing market” for some time now. We started passively looking to buy our first home all the way back in January 2021 but decided to hold off to save more for a down payment and, hopefully, watch prices cool down. For those of you unfamiliar with the Charlotte market, we were wildly wrong about the latter. There’s probably some anecdote I could make relating timing housing markets to capital markets, but I think we’ve got several other blog posts you can reference if that’s what you’re looking for.
Here we are 2+ years later with interest rates as high as they’ve been in years, home prices that have risen, and challenging inventory levels. Despite all of this, we are still interested in buying a home sooner rather than later. Why? We want a place to call our own, start a family, and set more permanent roots in the city that neither of us are from, but we’ve both come to love. It may not make as much purely financial sense when compared to a few years ago, but that’s not all that matters. Don’t get me wrong, it wouldn’t hurt to see some of that home equity appreciation I keep hearing about, but I revert to not timing markets or expecting the recent past to continue going forward.
While many external factors have changed during this process, our approach to how much home we can afford hasn’t. Instead of looking at sticker prices, my wife and I choose to focus on the monthly payment in relation to our overall monthly budget. Ben and I typically advise our clients to keep total home payments at or around 20% of gross monthly pay. This all-in payment percentage includes principal, interest, taxes, and insurance (PITI). This is much lower than the 28% of gross income many banks will lend. I’ve even read of some that will lend up to 36% in certain cases. We’ve found that clients that stay around 20% tend to have excellent cash flow that allows them more budget flexibility and greater prioritization of their financial goals.
This isn’t to say that anything over 20% is bad or always ill-advised. You can be betting on your future earnings increasing if your risk tolerance allows, have needs or wants that outweigh the benefits of greater cash flow, or a host of other legitimate reasons to cross the 20% threshold. These reasons may often involve tradeoffs from another area of the budget.
When seeing a home that catches our eye, my wife and I calculate what our estimated monthly payment will be and know where our limit is based on our earnings. There are a variety of home mortgage calculators online that can help with this while including line items for the components of PITI. This means that our top-line home price budget changes often as we continue to save towards a down payment and interest rates change.
There isn’t a perfect system that works for everyone, but we’ve found that many clients are grateful to have prioritized good cash flow when buying a home. Whether it’s getting to retire earlier than expected, helping kids pay for school, or being able to take that once-in-a-lifetime family vacation, extra cash flow can be a huge help in achieving your goals.
P.S. If you or a friend happens to be selling a cute, reasonably priced home in Charlotte, I know a guy looking to buy : )
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