I had my mind blown last week while trying to make sense of how expensive it is to buy a house, and now I feel like I’m looking at the housing market the way Neo looks at the Agents at the end of The Matrix when he can see the underlying code.
Why? Because of this concept I’ve been learning called debt-to-income ratio, or DTI as the pros call it.
Now, when I see new housing data like the NAR’s most recent housing affordability index, I can look past “lower affordability” headlines and instead focus on the simple math of affordability.
The NAR puts out data showing how much of a median family’s income would go towards a mortgage payment each month. The latest available data (November 2018) show the average mortgage payment is 17.4% of a family’s income, up .4% from the previous month.
Queue the affordability crisis headlines, right?
Wrong. Affording a home is all about DTI, which you calculate by dividing your total monthly housing and non-housing bills by your total monthly income to get a percentage.
If you’re not paying as many other non-housing debts (car, student loans, etc.), or those bills are manageable, a slight uptick in your mortgage and interest payments because of rate market fluctuations isn’t going to shut you out of the housing market.
Lenders let your total monthly housing and non-housing bills go as high as 50% of your income (“up to a 50% DTI” in lender lingo), and if you did this, you may very well be strained. But it’s all about how you and your lender are calculating your DTI:
-Are you using gross or take home pay?
-Are you counting a car or student loan payment that’s going away within a year?
-Are you counting credit card payments even though you pay off your card monthly?
There’s a lot of nuance in DTI calculations, and this is the nuance to focus on when it comes to affordability, NOT the nuance of how alarming a particular headline is. That has nothing to do with how you’d actually afford a home.
So what DTI is a good target for your lifestyle?
Lenders will allow you to go higher than you may want to go, and that’s because everyone has a different tolerance for how much they want their lifestyle to revolve around their home. Also the DTIs lenders use are based on pre-tax numbers, so it leaves out homeowner tax benefits.
Everyone is different, which is why understanding DTI is so important so you can determine what’s comfortable for you. But a decent rule of thumb is that if your DTI is 30% or less as a homebuyer, you’re not going to experience a major lifestyle adjustment in most markets relative to being a renter.
Why am I telling you all this?
I know a lot of you have killer student loans (and so do I), which pushes up your DTI. However, if you’re like me, you haven’t had a chance to build up credit card debt because you’re either living with your parents or just can’t afford to start racking up that bill every month.
With me so far? If you are, you’re probably wondering why I’m nitpicking such a small point.
My mandate at The Basis Point is to represent normal people’s views on the housing market and to cut through attention-grabbing bad news. There’s a never-ending stream of negative housing headlines on every screen I lay my eyes on. It used to totally bum me out and make me think I’d never own a home or get out of my parent’s house.
Whether we like to admit it or not, the media we consume affects the way we think, and I didn’t understand how thoroughly it affected my view of housing literally until this past week when I had my Neo “whoa” moment.
You’re going to see me hammer these points about affordability a lot while my professional journey to understand all this tracks with my personal journey to get off my parent’s couch.
Follow along instead of trying to dodge every “Affordability Crisis” bullet—because when you understand DTI, you won’t have to.
Also click the image above to enlarge. It’s pretty sick artwork by our creative director Dennis.