Mortgage Question From a Reader - What do You Guys Think About This?

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Mortgage Question From a Reader - What do You Guys Think About This?

By JLP | June 8, 2007

I received the following email from a reader in California:

Hi JLP,

I just came across your blog - and found it extremely informative. I’m planning to spend a lot of time catching up by reading more, over the next few weeks. But I’m wondering what kind of advice you would give me - given our current scenario (if you don’t mind):

We bought our house in San Francisco in 2000 for $395,000 [almost exactly 7 years ago on June 6], and are considering moving up. It’s worth roughly $700,000, and we owe about $256,000.

We have a couple hundred thousand dollars in cash/equity, and earn roughly $150,000 a year, combined. The only liability we have is a car loan (2.9% interest @436/mo) with just under 3 years remaining. We have no children.

I contribute, of my $92,000 a year, 6% to a 401k, which matches 50% (up to 6%). I also participate in the company’s ESPP plan, with 2% of my money going toward buying the shares. So, right now our overall take home pay is about $7850 / month.

We have considered a house that would cost $900k, $1m, and $1.1m (welcome to San Francisco), which means our loan would probably be about $500k, $600k, or $700k, respectively - and therefore our obligation would be

mortgage only / mortgate + ins. + prop tax
$3160 / $4160 [500k loan]
or $3792 / $4900 [600k loan]
or $4424 / $5624 [700k loan]
for a 30 year fixed loan @6.5%

We don’t want to screw up, and we don’t really trust real estate agents and mortgage brokers because of all the stories we’ve heard (and even had to deal with in the past). Also, they never seem to ‘know’ much, when you really start asking more serious questions. In fact, when I bought my house, nothing was even mentioned about property taxes - we had to figure a lot of our additional expenses outside the basic monthly mortgage payment, out on our own.

What advice do you have? We definitely will move, but we need to know at what point we’re being unrealistic.

Thanks,
John

First off, I think I’m happy with my little $84,000 mortgage! LOL! Our payment WITH taxes and insurance is $1,047 per month! I seriously don’t know how people can afford housing in California.

Now, to answer John’s question, it looks like they have a lot going for them. Other than their house, their only debt is their car note. That said, even the lowest priced option will use up nearly 53% of their monthly income ($4,160 ÷ $7,850 = .5299 or 53%). Most “experts” recommend 35% of monthly income as the most that a household should spend on housing. I followed up with John to find out how much they are currently spending on their mortgage payments, which is $2,098 or only about 27% of their monthy income. So, their new mortgage payment would be quite an adjustment.

Personally, I wouldn’t go for it, but that’s just me. I wouldn’t be comfortable spending over 50% of my net income on housing. Instead, I would concentrate on building up the retirement account. He could be socking away another $10,000 or so per year on top of the $5,500 he is currently saving (not including the company match).

What do you guys think?

Topics: Mortgages |

Comments to “Mortgage Question From a Reader - What do You Guys Think About This?”

Cindy Says:
June 8th, 2007 at 7:34 pm

*sigh*

I’d like to be one of the first to comment, being a Californian myself (although having lived in 7 states). As long as you have an emergency fund or financial emergency plan, I would go for it… but go for the lower end of your budget ($900k). John doesn’t mention if he has kids or if he wants to move to a nicer/safer/more convenient neighborhood. Sometimes those location issues just make the expense worthwhile, especially in a big city.

I’m glad JLP didn’t rag on this guy too much about the cost of housing in CA. As a fellow Californian with a near $500k mortgage for a small condo, I do frequently get tired of PF blogs ragging on the expensive cost of housing in some areas of the country, and folks’ choices of living there.

John, don’t forget that personal finance folks will frequently quote suggested percentages of income for housing or other expenses. We just have to compensate our very expensive housing in other ways…. might want to make sure when your car is paid off not to finance another car. Or look at being more frugal.

Adam Says:
June 9th, 2007 at 2:37 am

“John doesn’t mention if he has kids or if he wants to move to a nicer/safer/more convenient neighborhood.”

“We have no children.”

Shana Says:
June 9th, 2007 at 6:09 am

Most mortgage brokers have a lot of restrictions on how much they can lend, and it is tightening now. Fannie Mae and whatnot (whose rules control most reputable places you would want to get a mortgage, except some special privately financed mortgages by large entities like Bank of America) have certain rules about % of income for a standard, fixed mortgage - therefore, despite what the rabid brokers promise up front, I think it would be very difficult to get the mortgage he is looking at - 53% of income - without taking a smaller mortgage plus a balloon payment at a higher rate.

D Says:
June 9th, 2007 at 6:55 am

I would recommend that John, take the new “expected payment” and make it for 6 months on his current place. It will only help to pay down his current mortgage. He will then get a feel for how it is to live with less disposable cash.

He sounds like he is doing everything “right” so now he should just check if it “feels” right.

Leslie T Says:
June 9th, 2007 at 7:12 am

Years ago, I took the route of saving rather than upscaling my house. I started working part time at 55 and am fully retired at 60, with a good nest egg and my house paid for. Yes, sometimes I look at the fancy houses my friends live in and feel a bit envious, but then I look at their hectic work schedules, compare that to my freedom, and am very thankful that I no longer have to work. So I’d vote for staying put, or moving to a nicer house of equal value to the one they have now, if one can be found. (One issue I worry about is that the increasing equity in my house will be marginally taxable, as it’s now over the single person’s exemption. But I’ve decided it’s not worth the hassle of moving to “reset the clock”.)

thefeeonlyplanner Says:
June 9th, 2007 at 8:55 am

What do they REALLY want? Will paying so much for the new house impair their retirement goals? Are they okay with working more/having less in retirement? If yes, they could go for it. They should also account for the much higher expenses of owning a bigger home, from utilities, maintenance and furnishing it.

Personally, I would not feel comfortable at all spending so much of my income for housing.

People make choices and have to live with the consequences. As I am getting ready to pay off our mortgage next week and be completely debt free, we are continuing to look for a bigger house in our depressed real estate market (Michigan). My wife knows she can retire in about 10 years, if we make the purchase she will have to work an additional 12 (on top of the 10)…The choice is hers, I am okay either way:-)

Jongasm Says:
June 9th, 2007 at 10:54 am

Just try to keep your mortgage under 40% of your income. I personally wouldn’t be comfortable with anything more than that.

I agree with Thefeeonlyplanner. Good post.

Basil Says:
June 9th, 2007 at 8:06 pm

Congrats on almost being debt free, Thefeeonlyplanner.

I agree that the situation in California is insane. My boss is tickled pink with her million dollar home, which compared to my parent’s $172,000 ranch house in Illinois is smaller in size and on less land. It certainly makes me see my folks’ house in a different light.

They ain’t makin’ more land, they say. Which brings me to this: weren’t we supposed to be colonizing planets by now? I thought for sure I’d be able to get a cheap mortgage on Alpha Luna N-17 by the time I was this old.

Sigh. Thanks, science-fiction-read-as-a-child. Thanks alot.

NCN Says:
June 9th, 2007 at 10:00 pm

Live on $50K per year for the next 7 years and save $100K per year. Buy house.

Chris Says:
June 10th, 2007 at 9:43 am

No one addressed this but…with all the homes for sale now and reports of housing prices overall coming down, is it a good idea to sell? It may be appraised for $700k, but what if you don’t get that? The last 2 people I know who have sold their house in the last month or so had to reduce their prices 3-4 times and ended up getting significantly less than appraisal. These were $250-$300k homes in affluent neighborhoods with excellent schools (one was actually in walking distance to the HS). Several houses were also on sale. A house down my street, very nice, has been sitting on the market for nearly half a year (I think the owners may be refusing to reduce the price or something).

Is it best to sell a home right now? Maybe wait a year or two?

53% of takehome is a lot for a house! Even with no debt, are they saving cash for large purchases like a new car when they need it or are they planning on taking on new/more debt in the future?

Medicated Money Says:
June 10th, 2007 at 1:28 pm

In September we make settlement on a house that we just purchased. Our mortgage will be about 38% of our income, which honestly, makes me a little nervous. I could not image spending 53%, however, I can understand the “California” exception.

Overall, I would 2nd what D stated in living off the “expected mortgage” for 6 months and see if it truly is doable.

And to add to Basil’s comment, didn’t we prove that time travel can be achieved with a simple flux capacitor and fueled by extracting hydrogen atoms from garbage per Dr. Emmett Brown.

-Medicated

John Says:
June 10th, 2007 at 1:38 pm

Thanks JLP for posting my information. Cindy, D, and NCN think more in line with the way I think.

I appreciate the advice from the rest of you guys, but I think Cindy and NCN seem to be more in touch with the market in the area of the country where I live and work.

Leslie, I used to have the approach you are describing. But after living out here for 8 years, my attitude about owning a house has changed, and the balance of investment vs. home has shifted more toward the investment side.

The people who keep concentrating on the %… 47% of my take home pay is $3700/month. What you guys are telling me is that if I want to take a $500,000 loan, I should have $7,725 extra spending money per month [would need to make $11,885 because 35% of $11,885 is $4,160]. Likewise for a $600,000 loan, I would need to have $9,100 left over per month, and for $700,000, I would need to have an extra $10,444 left over. For what? That just makes any sense at all to me. Not that I make that much, but if I did why should I be advised to have $10,444 left over? Richer people don’t have to pay more for milk, bread, and water.

D, your suggestion was one of the best, and you reminded me that last year I paid an additional $20,000 toward my house in two $10,000 payments. In 2005, I paid $10,000, and in 2004, $5000. So I have, in effect, been doing what you suggested for the past 3 years - and my money market account has continued to grow by $2000 to $3000 per month (last year), nonetheless. A quick review, and with the added $20,000 I paid last year, I could have paid for a home that costs somewhere between $900k and $1m - probably about $930k. Honestly - I haven’t felt any setback whatsoever, and I had several reasons for paying the additonal $20,000:

- Too much in my money market account - and I have to pay tax on the interest I draw on it each year. After a while it felt like I should put the money somewhere else. I appreciate how everyone feels about retirement plans, and I contribute to mine, regularly. But I like to control how much I want to lock up until I retire, because the better I do now, the less I’ll need when I retire. This felt like a safe way to move my money to some place where it might do more good.
- At some point I wanted to have my house paid off much more quickly, and $20,000 additional per year, would make me debt free in 7 years. [$30,000 would be 5 years! But hey, I had to draw the line, somewhere].
- I really don’t like seeing how much I pay on my mortgage going toward interest, and paying the additional $20,000 means I pay more toward principal than toward interest each month.

NOW…

I have a decision to make, and like I said - I will move (not I might move). Unlike Chris, who knows people who live in $250-300k homes in affluent neighborhoods with excellent schools, you can’t buy a tear down in San Francisco for less than $500,000. I live in $700k house which is at the low end of what I estimate the prices for houses like mine in this neighborhood. This is a working class neighborhood, with marginal schools. In contrary to what I hear about the real estate market on the national level, the prices of houses here are still on the rise.

Thanks again for your comments and suggestions. You’ve all given me a lot of helpful ideas and things to think about!

Miguel Says:
June 10th, 2007 at 8:27 pm

John,

I can deeply relate to your situation, as I am in the NYC r.e. market, which has similar characteristics. Try $1.3mm for a 2BR/2 bath apartment, not including the $1600/month building fees/taxes. That is what many of my co-workers are paying right now. The market is still strong in NYC - no frothy - but t still strong with no signs of abating. It’s not uncommon to spend 40-50% of pay on housing in this town, so your situation does not seem all that unusual to me.

As others have stated, the big question is priorities and future expectations. Awhile back we unpgraded our housing even though it would clearly mean I would be cutting off the possibility of early retirement. But, you know what - I’ve come to the realization that my lifestyle in the hear and now is more important to me than early retirement.

Ultimately, it comes down to choices and tradeoffs and only you can really decide that. Sounds like you and your spouse have been approaching the decision the right way.

mbhunter Says:
June 10th, 2007 at 9:53 pm

I’d have to be on crack to take out that mortgage, but that’s probably just me. (I don’t do drugs, except caffeine.) It seems barely affordable and the area is one where one should be selling, not buying.

Cathy Says:
June 10th, 2007 at 10:14 pm

I live in the Los Angeles area so I’m sympathetic to John! The thought of a mortgage that big is just a little scary - a big chunk of that emergency fund would have to go toward the mortgage in the event one or both of you lost your job, and speaking of those jobs, how secure are they? You mentioned the quality of schools in your current neighborhood, which makes me think you might be having kids in the future and are moving to a neighborhood with better schools. I can totally understand that, but I’d urge you to go for the lower end of the market when you’re shopping because kids are expensive, and more importantly, there’s a good chance one of you will want to take off more time after baby is born or even quit work altogether. Just a few things to think about - good luck!

thefeeonlyplanner Says:
June 10th, 2007 at 10:37 pm

First, let me repeat what Cathy said:

>>>>…kids are expensive, and more importantly, there’s a good chance one of you will want to take off more time after baby is born or even quit work altogether.

Oh, so true, so true!

Let me share with you briefly a bit on the approach I take:

Do you have an adequate emergency fund?
Are estate planning documents in place?
Are you properly insured (auto, home, life, disability, umbrella, earthquake?).

Have you figured out when you would like to be financially independent (I do not like the word retirement!) so you will have enough to last you until your preferred age of expiration:-)

Will you have kids? If yes, have you accounted saving for their college if you would be picking up at least some of it?

The above is the sacred long term money and you need to start socking it away ASAP, the more the earlier the better! The rest of your cash flow is gravy…Can you swing the house payments AND expenses that come with it easily WITHOUT touching the long term funding? Well, if you do and you are okay with what’s left over, go for it and enjoy it. Hopefully you have a safe job you enjoy and allows you to grow your income.

I personally prefer to have some cushion built in since no one is safe these days in our economy. Proof is all around me in foreclosed homes with former workers in the auto industry…We went house shopping today…Right in Ann Arbor you could get a 3,200 square foot house with full basement and deck and 3 car garage for a little over $350,000…, 4 seasons (winter is not that bad lately thank you global warming)commuting time to Ann Arborless than 10 minutes:-)

dave Says:
June 10th, 2007 at 11:19 pm

hi. moved my family to santa rosa from sf 20 yrs ago. worked in sf still, and had to wake at 3:50a for work and returned home mostly at 4pm for a 12 hr work day. worth it as home prices just a tad more affordable. especially with 2 children. so, have you thought of moving out of the city to save a few housing dollars?

Livingalmostlarge Says:
June 12th, 2007 at 5:19 pm

John, I feel your pain. I don’t know if I would do it. Maybe or maybe not. Is this your final home? Or will you move again in say 10 years? What is the likelyhood of your wife wanting to stay at home with kids? We make close to what you make combined, but seriously our $460k mortgage is a lot. I like an area just like SF, so my mortgage is for a townhouse only no less. I don’t think I could swing a $700k mortgage. When our income goes up more maybe.

Um, I don’t know how much you have saved for retirement, ef, etc. But it sounds like you can swing it because you are able to pay an extra $1k month on your current mortgage.

Foobarista Says:
June 12th, 2007 at 11:58 pm

If your neighborhood is improving, or you can afford private school for your kids, you may think seriously about remodeling or raze-to-the-ground renovating. SF is an awful place to do this, given the latte lefties running all things related to city planning and permitting, but it still may be cheaper than moving. Your Prop 13 tax lock-in will stay largely intact, since your “basis” would only increase by the cost of the improvements, versus being completely “reset” to the current market value by moving.

maria alvar Says:
April 15th, 2008 at 5:06 pm

Help!!

I have $3,700 in my hospital 401k avaiable december 20 2008. I’m loosing my house need to make a payment, need transportation.
Can someone wants to help me and buy from me now and collect december? please help give some advice. mai

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Mortgage Question From a Reader - What do You Guys Think About This?