According to a recent study, most of us can’t afford our homes – but there are a couple of silver linings.
- Reapplying the “28/36 Rule”
- House-Poor Nation
- Two Silver Linings
- Building Equity with Your Own Home
Reapplying the “28/36 Rule”
The global housing crisis officially ended six years ago, but American families are still struggling to make ends meet. Although there were various powerful forces at play in the leadup to the residential real estate crash, the economic meltdown served as a wake-up call to rethink our finances and be careful not to overextend ourselves.
One way that financial advisors have responded is by reasserting the value of the traditional 28/36 rule, a nutshell guideline that can be used to build a smarter budget.
The rule is fundamentally focused on debt. It states that a family should cap the total amount spent on basic home costs (including mortgage/rent, homeowner’s/renter’s insurance, and property tax) at 28% of gross income. Beyond the amount spent on the home, only an additional 8% of income should be spent on auto loans, hospital bills, credit cards, student loans, and other debt payments – for a grand total of 36%.
Some advisers are questioning the specific idea of applying those percentages to gross earnings (pre-taxes), arguing instead that they should be applied to net income (post-taxes). Applying the rule to take-home pay makes it much more achievable for the average household, explains Joseph R. Birkofer of Houston-based Legacy Asset Management.
The key is that it’s doable. “I want people to have more than a house, I want them to have a life, too,” says Birkofer. “The application of the 28/36 rule can be an eye opener and a ‘go slow’ or ‘reform now’ sign.”
For many Americans, though, their immediate costs for debt are already in excess of the 28/36 rule. We may have gotten more conscientious about our housing costs, but many of us are either stuck in mortgages or living in cities in which the rental rates are skyrocketing (such as San Francisco – where the rent rose 15% between 2014 and 2015).
In fact, every other one of us (52%) has had to take a significant hit in order to pay our housing costs between 2011 and 2014, per a report funded by the MacArthur Foundation. People have adjusted by working additional hours, redirecting retirement funds toward everyday costs, reducing medical expenditures, building up credit card debt, and moving to cheaper communities.
The issue of home prices being out of reach for many people is a critical one, according to National Association of Realtors economist Lawrence Yun – who notes that the average sale price of a house went up 20% between 2012 and 2014 while wages stagnated. The only way the cost of those houses will go down is if more houses are built – and last year’s housing starts measured well below the 1.4 million average units constructed each year since 1959.
When we really get to the crux of the problem is when we look at how many Americans are living in areas where the average mortgage payment represents greater than 30% of the average salary. That’s the case in the areas where 15% of homeowners live. The most absurd examples of an imbalance between mortgage and income are seen in New York and San Francisco, where mortgage is 77% and 70% of earnings, respectively.
Young people are having particular difficulty transitioning to homeownership, according to RealtyTrac vice president Daren Blomquist. “The slow jobs recovery for young adults has made it harder for them to save and to get a mortgage,” he says. And it’s true: more than four in five young adults (84%) are putting off significant milestones, such as switching from renting to owning, due to market forces.
It may look as if people in their 20s and 30s simply want to keep renting, but that is not the case. In fact, 7 in 10 renters hope to one day become homeowners.
The issue is that many of us are still in recovery mode after the housing crash. Since 2008, 7.5 million people saw their homes evaporate in short sales or foreclosures. Even more, 9 million homeowners, still have upside-down mortgages.
Two Silver Linings
Not everything is doom and gloom, though. For one thing, equity has been on the way up. From the nadir of the housing debacle to 2014, homeowners gained $4 trillion of equity. That general trend has continued through 2015.
Furthermore, the building of additional houses mentioned above by Yun as a solution to rising home prices has actually started to materialize.
“Housing starts in the United States rose 6.5 percent to a seasonally adjusted annual rate of 1,206,000 in September of 2015,” says market resource Trading Economics, “following an upwardly revised 1,132,000 in August and beating market forecasts.”
Building Equity with Your Own Home
As you can see, many homeowners are still underwater. However, the housing market has recovered. For many of us, homeownership is the wisest next step to build a future for our families and establish equity rather than throwing our money away on rent.
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