Archive for the ‘Real Estate Investment’ Category
Real Estate Investing in a Bear Market
The seemingly bleak landscape of American real estate investing has turned thousands of potential buyers away from some truly golden opportunities. Ever since the precipitous collapse of Lehman Brothers in 2008 and the subsequent sub-prime mortgage meltdown, homebuyers and real estate investors have been confounded with countless reasons for staying away from the closing table. Years of negative housing reports may be to blame for the dull real estate market, but there’s yet another aspect of the housing downturn that is often ignored by house hunters—affordability.
Homebuyers are often too preoccupied about factors such as location and the proverbial “Is it good time to buy now?” question. While location is undeniably crucial when looking for a home, there is no silver bullet to accurately determine when the time is right to buy a house. Real estate investing is more about risk allocation than it is about market timing. The real question potential homebuyers should ask of themselves should be “How much house can I really afford?”
The best way to figure out whether home affordability is within reach is to approach it in the same fashion a banker or mortgage lender would. The current approach is decidedly conservative. Credit and lending guidelines have tightened significantly ever since the heady days of the housing bubble. This means that mortgage underwriters are paying closer attention now than they did a few years ago, and they will not approve an application to purchase a home unless they are certain the buyer can truly afford it.
The National Association of Realtors publishes a monthly and quarterly Housing Affordability Index which is based on the following assumption: Home buyers who make a 20 percent down payment on a home purchase will need at least 25 percent of their monthly income to cover basic housing expenses such as principal and interest payments, taxes and insurance. Banks call this assumption the housing expense-to-income ratio, and it is one important component of housing affordability.
The other key ratio to consider when purchasing a home is the long term debt-to-income ratio (DTI). To calculate DTI, mortgage underwriters take into consideration consumer debt as a whole. The minimum monthly payments made to other existing mortgages, car loans, credit cards, and student loans are computed. This figure is then added to the housing affordability ratio and divided by the monthly household income reported on the home loan application. The final DTI ratio should fall below 36 percent in order to truly show that a borrower can afford to acquire new real estate. Mortgage lenders love to see low DTI ratios; they are a good sign of financial responsibility. In the heady days of the housing bubble and the sub-prime mortgage frenzy, it wasn’t uncommon to see DTI ratios of 50 percent.
In today’s strict lending environment, banks are still willing to work with borrowers who are able to prove their credit worthiness and ability to repay. A homeowner who spends 28 percent of his or her income to cover basic housing expenses can expect to be approved for a mortgage loan with a reasonable interest rate. But a borrower paying more than 40 percent of his or her income to credit card issuers cannot be sensibly expected to be able to afford a new home, even with today’s historically low interest rates and inexpensive, median home prices.
This post’s author is Holly Miller, a writer for Coupon Croc, the best place to find savings on everything you need to streamline your finances, including your insurance policies with Prudential Home Insurance discount codes.