How much house should you finance? Follow the 20/28/36 rule.

[mcgurme]

Re: How much house should you finance? Follow the 20/28/36 rule.

This is one of the rare threads here where there is perhaps some misinformation or incomplete information at least.

1. Let's not overrrate higher education. It depends on what you plan to do with it. To quote Judge Smails.....The world needs ditchdiggers, too. Perhaps that overstates it. But it's funny.
...

Bruce, great post. But lets not underrate higher education. There are areas of real need for education to retain our ability to compete globally. Areas such as:

1. Engineering. People with HS diplomas cannot generally design bridges, microchips, satellites, spaceships, or buildings.

2. Software. While there are exceptions, the majority of programmers that develop software infrastructure have college degrees.

3. Healthcare. Would you want someone with only an HS diploma operating on you or prescribing your medicines? It is challenging enough to find a decent doctor *with* an MD (and, with the aging of baby boomers, the supply of health care workers is going to fall far short of the demand).

4. Science. This includes the development of antibiotics, batteries that power hybrid cars, technologies that allow fabrication of high density microchips, technologies for enhanced food production, development of new plumbing and building materials, and etc. Major leaps in science are rarely done by those without any college education these days (there are a few exceptions, but those are rare).

I agree with you that there are far too many people with degrees in areas that don't translate into real-world skills.

And I agree that far too many students are focused on things like their next spring break vacation.

But I can also assure you that the serious students in computer science, engineering, and science programs at the major universities do a lot of hard work focusing on their studies. I know this having been one of those students, and now being on the other end of the stick, involved in training students in the computational sciences. We work them hard.

I think the bottom line is that a college degree is still useful if you choose the right area and work hard. But there is also, as you point out, a need for people with practical skills like plumbing, electrical work, repair work, and etc, and it is unfortunate that people are busy getting MBA's just because it's the popular thing.

[c1ue]

Re: How much house should you finance? Follow the 20/28/36 rule.

Similar thoughts/questions have occurred to me on the advisability of buying a new home. If we do expect inflation to raise its head in the "not-so-distant" future and mortgage rates to rise from the low values of today, I suppose it makes sense to lock in those (fixed!) rates fairly soon. Perhaps not too soon as home prices are still in decline (actually not so much in the Houston area), but perhaps a couple of years out.

I personally hate to try and catch falling knives.

However, were you to try and buy a home in the near future, here's what I'd consider:

Input data:

1) interest rate as a divergence from historical average

2) price of home as a divergence from historical average

Calculation:

Present price plus present interest rate = $x monthly payment plus $y taxes. Assuming maintenance same.

a) What is the divergence interest rate w/ present price as a monthly payment?

b) What is the divergence price w/ present interest rate as a monthly payment?

c) What are the numbers above with taxes going up?

This will give you an idea how good or bad things can get. The point of this exercise is to not get caught up in price or interest rate, but to focus on the cash flow comparisons.

This exercise also gives you a better understanding in situations where one variable or another is above historical trend; for example it gives you an idea on future possibilities should prices be above trend but interest rates below. Why does this matter? because interest rates can change via a refinance, but prices are fixed once you pay them.

Again, for me I look at rent cash flow vs. buy cash flow and am perfectly willing to live in rentals if that is what it takes. But this is my own choice.

[zmas28]

Re: How much house should you finance? Follow the 20/28/36 rule.

Similar thoughts/questions have occurred to me on the advisability of buying a new home. If we do expect inflation to raise its head in the "not-so-distant" future and mortgage rates to rise from the low values of today, I suppose it makes sense to lock in those (fixed!) rates fairly soon. Perhaps not too soon as home prices are still in decline (actually not so much in the Houston area), but perhaps a couple of years out.

[Jim Nickerson]

Re: How much house should you finance? Follow the 20/28/36 rule.

This is one of the rare threads here where there is perhaps some misinformation or incomplete information at least.

1. Let's not overrrate higher education. It depends on what you plan to do with it. To quote Judge Smails.....The world needs ditchdiggers, too. Perhaps that overstates it. But it's funny.

I know this is a highly educated bunch but there is a whole world out there of non- information based jobs that pay decently and do not require advanced degrees. And when the economy does tank, there will be much more demand for a good electrician or better yet a car mechanic than for a FIRE economy brainiac who may be brilliant a financial analyst but can't even change a tire. Anything associated with ESSENTIALS will likely do well.

Part of our nations's problem is that we are teaching an entire generation that they are either going to have some 100% brain-powered job in an office or be destitute. That producing and creating, or providing a skilled service, is a path to poverty. This is why our poor darlings can't be bothered to get jobs that we all used to do as youngsters and we have to import immigrants to do what we now consider ourselves too good for.

100 is said to be the average IQ. So for every valedictorian at 130 there's another kid at 70. This means that not everyone's kid is suited to go to college. Forcing square pegs into round holes like that is doing them a disservice (and inflating tuition) Better an employed welder than a chronically unemployed MBA for whom the reduction of the FIRE economy means lean pickings in terms of job opportunities. Go ask a businessman how hard it is to find a trained machinist. Then go ask him how easy it is to find a kid with a degree is sociology.

2. Tell my wife she needs an MBA. She made $150K last year with a HS diploma...in FINANCE! Other than in official HR dept job descriptions, at no point was education even mentioned in the job hunt processes at any of her jobs in her 10 year "career". Experience learned on the job mattered much much more. MBA's are overrated and some of her employees had them and were just about worthless and went nowhere. I have a bachelor's degree in business and don't make as much as she. Anyone who goes $100K into debt to get a degree in business hasn't even managed to learn enough from it to realize that the opportunity costs are huge (4-6 years of lost wages plus actual out of pocket costs ).

What we need to spend more on is job TRAINING, not pumping the value of degrees where maybe 1.5 years of your time spent there is learning anything even remotely related to you field. College is great for a well rounded person. But he'll be a broke well-rounded person if he doesn't go into select fields which require that degree. Few 18 y/o's are capable of making that choice.

We also have a problem with kids being sold on the idea that they can educate themselves into high paying jobs. With a few exceptions like law or technical fields, that usually isn't the case. It gets you into the first door, that's all.

3. Loans? Anyone ever hear of working their way through school? I did. Costs may have been lower then, but it's possible to at least minimize debt by doing so. The idea of sitting on my rear end weekends, summers, and holidays while incurring massive debt to go to college didn't even occur to me. Today there seems to be money for spectacular spring break vacations and ski trips around Christmas, all borrowed of course. No wonder we have a labor problem. The college kids used to work. Now it's seen as something to protect them from.

4. I'm not getting this 7 year ARM thing. Rates on those are not suffciently lower to justify the risk in case you wind up staying and rates trend upwards. Right now, they're virtually the same as a 30 yr fixed rate mortgage. What if rates skyrocket as some think? What if you aren't able to afford a 18% mortgage on a nicer home in 7 years? What if you aren't able to afford 18% on your current one in 7 years? With a fixed rate, inflation works FOR you in terms of home affordability.

5. A plan based on owning a multifamily rental place is a risky one. First, it means you're instantly eager to move up and on to better things. That is by definition more expensive. Ok, so what if mortgage rates are triple what they are now by then and you hate living next door to the redneckersons or college party animals you're renting to? Then you're stuck living in a low-rent duplex. Better to, if you can, buy a MODERATELY nice single family place you could stand living in the rest of your life in if you had to, locking in the historically low fixed rates today. If rates go up, you let inflation help pay your mortgage off for you. Then you use the cash from that home to move up if you want. But if you do the old "I'll buy a duplex and rent out the other side" thing, you risk being stuck being a landlord.

I think this is a historic time for low mortgage rates vs the expectations for them in the future.

6. Better yet, if valuations don't make sense now in your area, rent and invest the difference. Just be aware that if home prices go down another 25% but rates skyrocket, your affordability factor may have gotten worse, not better.

Of course not buying when you can't afford it always applies.

Very nice thoughtful post, Bruce. It is good to see someone thinking rather than reacting.

Re: How much house should you finance? Follow the 20/28/36 rule.

This is one of the rare threads here where there is perhaps some misinformation or incomplete information at least.

1. Let's not overrrate higher education. It depends on what you plan to do with it. To quote Judge Smails.....The world needs ditchdiggers, too. Perhaps that overstates it. But it's funny.

I know this is a highly educated bunch but there is a whole world out there of non- information based jobs that pay decently and do not require advanced degrees. And when the economy does tank, there will be much more demand for a good electrician or better yet a car mechanic than for a FIRE economy brainiac who may be brilliant a financial analyst but can't even change a tire. Anything associated with ESSENTIALS will likely do well.

Part of our nations's problem is that we are teaching an entire generation that they are either going to have some 100% brain-powered job in an office or be destitute. That producing and creating, or providing a skilled service, is a path to poverty. This is why our poor darlings can't be bothered to get jobs that we all used to do as youngsters and we have to import immigrants to do what we now consider ourselves too good for.

100 is said to be the average IQ. So for every valedictorian at 130 there's another kid at 70. This means that not everyone's kid is suited to go to college. Forcing square pegs into round holes like that is doing them a disservice (and inflating tuition) Better an employed welder than a chronically unemployed MBA for whom the reduction of the FIRE economy means lean pickings in terms of job opportunities. Go ask a businessman how hard it is to find a trained machinist. Then go ask him how easy it is to find a kid with a degree is sociology.

2. Tell my wife she needs an MBA. She made $150K last year with a HS diploma...in FINANCE! Other than in official HR dept job descriptions, at no point was education even mentioned in the job hunt processes at any of her jobs in her 10 year "career". Experience learned on the job mattered much much more. MBA's are overrated and some of her employees had them and were just about worthless and went nowhere. I have a bachelor's degree in business and don't make as much as she. Anyone who goes $100K into debt to get a degree in business hasn't even managed to learn enough from it to realize that the opportunity costs are huge (4-6 years of lost wages plus actual out of pocket costs ).

What we need to spend more on is job TRAINING, not pumping the value of degrees where maybe 1.5 years of your time spent there is learning anything even remotely related to you field. College is great for a well rounded person. But he'll be a broke well-rounded person if he doesn't go into select fields which require that degree. Few 18 y/o's are capable of making that choice.

We also have a problem with kids being sold on the idea that they can educate themselves into high paying jobs. With a few exceptions like law or technical fields, that usually isn't the case. It gets you into the first door, that's all.

3. Loans? Anyone ever hear of working their way through school? I did. Costs may have been lower then, but it's possible to at least minimize debt by doing so. The idea of sitting on my rear end weekends, summers, and holidays while incurring massive debt to go to college didn't even occur to me. Today there seems to be money for spectacular spring break vacations and ski trips around Christmas, all borrowed of course. No wonder we have a labor problem. The college kids used to work. Now it's seen as something to protect them from.

4. I'm not getting this 7 year ARM thing. Rates on those are not suffciently lower to justify the risk in case you wind up staying and rates trend upwards. Right now, they're virtually the same as a 30 yr fixed rate mortgage. What if rates skyrocket as some think? What if you aren't able to afford a 18% mortgage on a nicer home in 7 years? What if you aren't able to afford 18% on your current one in 7 years? With a fixed rate, inflation works FOR you in terms of home affordability.

5. A plan based on owning a multifamily rental place is a risky one. First, it means you're instantly eager to move up and on to better things. That is by definition more expensive. Ok, so what if mortgage rates are triple what they are now by then and you hate living next door to the redneckersons or college party animals you're renting to? Then you're stuck living in a low-rent duplex. Better to, if you can, buy a MODERATELY nice single family place you could stand living in the rest of your life in if you had to, locking in the historically low fixed rates today. If rates go up, you let inflation help pay your mortgage off for you. Then you use the cash from that home to move up if you want. But if you do the old "I'll buy a duplex and rent out the other side" thing, you risk being stuck being a landlord.

I think this is a historic time for low mortgage rates vs the expectations for them in the future.

6. Better yet, if valuations don't make sense now in your area, rent and invest the difference. Just be aware that if home prices go down another 25% but rates skyrocket, your affordability factor may have gotten worse, not better.

Of course not buying when you can't afford it always applies.

[Slimprofits]

Re: How much house should you finance? Follow the 20/28/36 rule.

Are we talking about people who refuse to live at home and go to a decent but cheap state school

Such as UMass-Boston?

Not quite a bargain at approximately $10,200 per year not including books and transportation.

Or how about Framingham State College at approximately $8,458 per year, etc.?

And Salem State? Don't even ask, it'll make you sick.

In Massachusetts, there are no decent, but cheap state schools.

[spunky]

Re: How much house should you finance? Follow the 20/28/36 rule.

The other Cost item that has been outpacing inflation is health care. and that has been rising at 2 1/2 times inflation. See Health Care Costs 101

And Education and Health Care are the two places where any proposed solution is greeted by shouts of "SOCIALISM" (Gasp!!) :rolleyes:

Sorry got the wrong URL. It has been corrected now!

The dirty S word. Shame on you Rajiv; you know how much more happy, content and optimistic americans are than certain parts of the continent. We also enjoy our long frequent vacations, low stress and short work weeks

[Finster]

Re: How much house should you finance? Follow the 20/28/36 rule.

Very good summary, EJ.

With buying your third home, many people forget that one thing:
Around 50-55, their lifestyles change significantly, because either their kids move out of the house, or - if they don't have kids - their need for socialising and entertainment increases again (change of partner etc.). If they have kids, the move-out often implies the need to pay college tuition, so increasing even the need for additional funding.

Therefore many people simply forget about this empty-nest situation when making purchases and often end up having too big houses too far away from the spots where they really would like to live. As a result of baby boomers going to retirement and wanting to draw my prediction (which is to my memory close to your regional housing bubble scenario) is that especially in the US and the UK, larger houses in the suburbs will decrease on value on a larger proportion than smaller houses nearer to the city centres along with even a stabilisation or appreciation of values in the city centres.

I disagree here. As you see the living conditions continue to erode in the US, you will see the nuclear family phased out ( or decrease markedly ) , and extended familys phased back in. Multiple generations will again be living under one roof. Larger houses are needed for this. I am seeing this alot now with the patients who come in my hospital.

I agree with the premise of EJ's article but there are just to many variables
with housing to cast anything in stone. Location, your profession and skills, hobbies have to much to do with this. JMHO

As always I enjoy reading this forum

I share Spunky's skepticism except for a slightly different reason. Many people, myself included, simply define our standard of living primarily by the home we live in - more so than any other material amenity. Some may prioritize vacations, cars, travel, entertainment; others, their homes. This has become somewhat more common post-911, even to the point of having its own name coined - "cocooning". There is utterly nothing wrong with folks buying as much home as they want ... so long as they can afford it.

Of course people should take into account their long-term needs, espeically when it comes to buying something they're apt to have for a long time. On the other hand, it has almost become faddish in some circles to disdain someone's choice of owning a large home, as if it's somehow socially irresponsible. I fear some people are confusing owning a large home with buying one one can't pay for.

[lobodelmar]

Re: How much house should you finance? Follow the 20/28/36 rule.

Hi Jim,

Been away for awhile on travel, haven't been going online much.

To answer your question, the deal I took was an 80/15 loan, with a 6% fixed rate interest only mortgage. So I can pay IO for the first 10 years (or pay more to pay down principal) and then the remaining 20yrs I pay a 30 yr fixed rate 6% mortgage off in 20 yrs. In dollars and sense terms, the current Interest payments on this part of the loan are $1500 a month, and in yr 11 turn into $2100. The second trust on the remaining 15% is a 7.75% note with the same terms as the first. $350 now, $500 later, if I don't pay off the 15% note before that time is up. With my condo fees and taxes, my monthly payments are around $2100 per month, which was doable. And at least for now, despite only owning 5% (or less, since the market is down) of my condo, I am probably gaining something with the tax deduction than if I had rented the same unit at the market rent. At least that is what I told myself at the time. Better pay myself something than line a landlords pockets.

At the time I bought it seemed better taking this deal than a 5/1 ARM which might adjust up to 13% like many people seem to be experiencing these days, and I couldn't afford a standard fixed rate mortgage payment at 6.25%.

Lobo

[Jim Nickerson]

Re: How much house should you finance? Follow the 20/28/36 rule.

Great article EJ...

I really wish I had discovered this site before I bought my condo in DC in July 2005. I think I broke every one of your rules in this post...it was hard not to believe the advice from all of my highly educated friends who had recently bought, who whispered in my ear about low interest rates, never again seeing these prices, prices going to keep going up, booming local economy, my house doubled in value in two years, etc etc etc.

So I bought, 5% down, fixed interest only for 10 yrs, then a 20 yr payment plan for the principal. Seemed like such a good idea at the time.
That being said, I love my apt. and love the neighborhood. So I guess time will tell how it all pans out. Though I wouldn't do it this way ever again knowing what I know now.

Lesson learned. At least I know what to do next time I want to buy. If I need to sell in the next few years, it might be painful. Here's hoping I can ride it out.

Seawolf,

If you don't mind, what is the rate for the first 10 years, and how are the last 20 handled?

[lobodelmar]

Re: How much house should you finance? Follow the 20/28/36 rule.

Great article EJ...

I really wish I had discovered this site before I bought my condo in DC in July 2005. I think I broke every one of your rules in this post...it was hard not to believe the advice from all of my highly educated friends who had recently bought, who whispered in my ear about low interest rates, never again seeing these prices, prices going to keep going up, booming local economy, my house doubled in value in two years, etc etc etc.

So I bought, 5% down, fixed interest only for 10 yrs, then a 20 yr payment plan for the principal. Seemed like such a good idea at the time.
That being said, I love my apt. and love the neighborhood. So I guess time will tell how it all pans out. Though I wouldn't do it this way ever again knowing what I know now.

Lesson learned. At least I know what to do next time I want to buy. If I need to sell in the next few years, it might be painful. Here's hoping I can ride it out.

[Rajiv]

Re: that's exactly the type of info I was asking about

For a Canadian perspective on college education see
The Price of Knowledge 2006 and Is University Education in Canada More Affordable Than in the United States?

Thanks to Susan Chambers at Kwantlen University College for the links.

[spunky]

Re: How much house should you finance? Follow the 20/28/36 rule.

Skills are skills . You need skills in todays job market. Degrees are good to wipe your ass with. I have 2 of them, so does my best friend and he is making 9.75$ an hour repairing copy machines. Yea, Ivy league,George Bush is an Ivy league school grad, like that means something . Mabye " The Donald " can get me in Whartons School of Business.


Oh yea, I paid off my student loans in 4 yrs.

[jk]

Re: How much house should you finance? Follow the 20/28/36 rule.

the biggest bondholders are the people's bank of china, the bank of japan and a lot of middle-eastern sheiks. i don't see a lot of tears being shed for them when the dollar dives and long rates rise, giving their bonds a one-two punch.

[c1ue]

Re: How much house should you finance? Follow the 20/28/36 rule.

Here's a scenario I'd like to hear the brain trust cogitate on:

If there is indeed hyperinflation coming, then would it not make sense to buy a house with zero cash - but with payment sufficient that you could always absolutely afford to pay on the mortgage? For example cash in the bank?

In this scenario I do assume that cash is more likely to keep up with inflation than home equity. In the meantime hyperinflation will greatly reduce the purchasing power equivalent amount of money owed.

Similar to the tongue in cheek student debt vs. future income scenario above.

Of course, the correlary to this is that all those bonds based on mortgages are going to bite the dust - a clear case of helping the 'common' guy vs. the wealthy since most 'common' guys don't own bonds.

This leads to some interesting questions; I personally have doubts as to whether the government will screw the relatively wealthy (and their lobbyists) vs. find a way to stick it to the masses.