Saturday, October 17, 2009

Right question. Wrong answer.

I'm back, and it only makes sense to start with a post about a mortgage calculator after a six month break. Remember the buy vs rent calculator? Well this is similar except the scary thing is I don't think it's broken.

Mike from the Albert Bubble blog commented on this mortgage calculator from President's Choice Financial.

How much can I afford?

I was shocked at the vast sums of money one could qualify for based on a 35 year amortization and a 2.25% VRM. Consider 3 cases:

Case 1

Income: $66,000
Down: $20,000
Debt payments: $0
Taxes: $2200
Heating: $75

Pre-qualified for a $391,970 mortgage! It was limited *not* by the income, but by requiring a 5% down payment.

Case 2

Income: $120,000
Down: $80,000
Debt payments: $100/month credit card
Taxes: $4000
Heating: $180

Pre-qualified for a $711,371 mortgage! The reason one can get qualified for so much money is it uses a rate of 3.64%.

Case 3

Professional Couple
Income: $170,000
Down: $80,000
Debt payments: $100/month credit card +
Debt payments: $300/month auto loan
Taxes: $4000
Heating: $180

Pre-qualified for a $ 1,058,721.73 mortgage!

Right question. Wrong answer.
3x income is probably a more reasonable measure and allows for more normal interest rates and some discretionary income.


Snakes and Ladders said...

"Mike from the Albert Bubble blog commented on this mortgage calculator from President's Choice Financial."

Welcome back BearClaw! Glad my post could inspire you to come out again. :)

I agree 100% with you, mortgages should be based on sensible values, like gross income x3 or a reasonable debt ratio amount.

A $1,000,000 mortgage over 35 years at "unknown future rates" is crazy! In fact, I bet in 35 years the people who took the mortgage out would be retired before it was paid off. Think how many times in 35 years you might be laid off, changing a job, moving, leaving the country or even your city. Kids? Maternity leave? Pay instability? No stress in retirement there eh? haha. I see PCF doesn't tell you how much interest would be paid on that over the 35 year term...

Don't forget that PCF also gives "big mortgage borrowers" a discount too on their fixed rates. Nothing like encouraging people to borrow even more than they can afford.

Radley77 said...

I like the rule of three times household income. Realistically, one has to consider other factors like projected personal income growth, allowance for higher interest rate environment, risks to job security of both themselves and spouse to come up with a realistic cash flow after tax. One also has to consider everything from maintenance costs to taxes and condo fees and also any preexisting debt servicing. They also need to come up with a retirement investment plan and savings rate that fits with their household budget.

I like the idea of buying a house that on average is three times household income, but can also vary between two to four times household income. At the end of the day, one really needs to sit down and do an analysis of what their household budget is projected to be.

Thanks for highlighting an important piece of financial advice.