Looking back at my Financials and Mortgage.

One of the comments to my sarcartic "ways to pay my mortgage" posts was as follows:

Well, considering that you just bought the house, you really should have budgeted for the mortgage payment already... What percentage of your income is servicing your mortgage? The old rule is that it should be under 30%.

There is one little problem here. The 30% (or 1/3) rule does apply well in maybe 70-80% of the country. But does not apply well in areas such as the Seattle area or the SF Bay Area. Did a little bit of math just for the heck of it.

Now in 2004, the median income for King County WA was slightly above $55,000 per household (according to the Seattle PI). At the same time, according to the Seatte Times, the median housing cost was $405,000 in 2006. I know the years are off a little but this should be good enough for the sake of argument.

With the assumption that the house is financed at a 100% LTV, with a reasonable interest rate of 7%, this means a monthly mortgage payment of $2700. If we disregard income tax, with the median income this means a debt ratio of 58.6%. Running the same assumption with a 80% LTV (yay you had money for a 80K down payment!), this means a mortgage payment of $2160 per month and therefore a debt ratio 46.9%

So technically speaking, it is not possible for an average household to purchase an average house and remain in the 1/3 rule. Of course this is unless you are older and were able to purchase before the price boom and have a good amount of equity in the bank. The fact is banks in most of the higher cost of living area generally follow a rule closer to 1/2, some even allow 60% depending on the income level.

In regards to my situation, the problem in itself is not the mortgage but the accumulation of other debt and obligations that has just piled up. Of course the mortgage seems the worst as it is the biggest chunk of my paycheck. Some of the debt came out of emergency, reduced income due to my extended leave and some of it came from my publishing business (it does cost at least 10-20K to publish a book) but then it can take 6-12 months to start seeing checks from the distributor. The fault is all on my side, better budgetting and planning would have most likely avoided digging such a deep hole. But a few things I have learned:

  • Budget, Budget, Budget. I know it sucks. Don't need to be an accountant but you at least need to have a good idea of where the money is flowing. And you can therefore make better decisions when it comes to spending as to whether or not you can truely afford the purchase

  • Have a buffer! This is probably the hardest. At least for me. Having money just sitting in the saving account can be a life saver. But I do hear it scream to be spent.

  • Only use credit for things that either will have a return (business expense) or can have an appreciation/depreciation (house/car).

    • In the case of a house, the investment is generally worth it as the market appreciates and the tax benefits generally reduces the overall interest costs

    • For any item that depreciates (such as a car), don't finance it for anything longer than it's useful life

    • For business (or I should say income generating expenses), well do the math. If the conservative return on investment beats the interest paid then it's a positive gain.

    • NOTE: This does not mean you can't use your credit card for other daily expenses such as groceries, but for anything that doesn't fall above it should be budgeted so that you can pay off these purchases before you pay interest on them (do you really want to keep paying your groceries from 6 month ago)

Anyways, that's my take. Of course I still have to fix my situation but at least I can share my lessons learned...



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