Can you afford to own a home?

About 52 percent of U.S. households have had to make a sacrifice so they could manage their rent or mortgage over the past three years, according to the How Housing Matters Survey conducted by the MacArthur Foundation. The culprit is housing affordability. While home prices have increased some 20 percent over the past two years, wages have barely budged. Also, the slow jobs recovery, especially hard on young adults, has made it more difficult for them to save for a down payment or to afford a mortgage

The sacrifices folks make for housing are serious and include getting an additional job, not saving for retirement, cutting back on health care and healthy foods, running up credit card debt, or moving to a less safe neighborhood or to a location with worse schools.

Also, more folks are becoming skeptical when it comes to owning a home. About 43 percent of those polled in the survey say owning a home is no longer a good long-term investment or one of the best ways to build wealth. Over 50 percent say buying a home has become less appealing.

One of the concerns for those with a long-term view is that the future for home values is dim. Historically low mortgage rates today have nowhere to go but up, and that portends poorly for home values in the future. Home ownership rates, currently at 64.8 percent, haven't been this low since the second quarter of 1995.

Housing affordability ratios

Owning a home involves taking on a substantial loan and responsibility for maintaining the property. These obligations may require adjustments to your lifestyle, especially if you've been renting.

How much house you can buy depends on two things: the money you have available for a down payment and your income. Banks, mortgage lenders and realtors will offer to run your numbers and tell you the price of a house you could afford and the mortgage you could carry. Their estimates are usually based on the front-end and back-end ratios. Here's how they work:

Front-end ratio: The housing expense, or front-end, ratio shows how much of your gross (pretax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28 percent of your gross monthly income. To calculate your housing expense ratio, multiply your annual salary by 0.28, and then divide by 12. The answer is your maximum monthly housing expense ratio.

Back-end ratio: The total debt-to-income, or back-end, ratio, shows how much of your gross income would go toward all of your debt obligations, including mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36 percent of your gross income. To calculate your debt-to-income ratio, multiply your annual salary by 0.36, and then divide by 12. The answer is your maximum allowable monthly debt-to-income ratio.

Finally, factor in costs for maintenance and repairs before you buy. My rule is that the total of all housing expenses shouldn't exceed 25 percent of your gross income. Common sense should tell you that with about 25 percent of your gross income going toward house expenses and about 25 percent going to income taxes (federal, state and Social Security), that leaves you with only 50 percent of your income to live on, save for retirement, kids education and all other expenses.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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