How Much House Can You Really Afford?
The harsh reality is that no one is going to give you a straight answer — and for good reason. When you are buying a house, you are the customer. Your money pays everyone.
There is zero incentive to tell you the truth.
Your real estate agent just wants a sale. They don’t care if you can afford the house or not. In their mind, if a bank is willing to give you a loan, you can afford the house.
But the bank that underwrites your home loan also doesn’t have any incentive to tell you the truth either. They want to make as much money off your interest as possible — so they will approve you for a loan at the very maximum of your income.
But can you really afford that payment? How much house can you really afford?
What’s the Multiple?
On Wall Street, every broker, banker and firm are looking at the exact same companies and P&L sheets, except some analysts can call some companies “value” plays and others “growth” plays.
How can two analysts look at the same company and come to a different conclusion? What are they looking at? And what does their analysis mean? More importantly, how does that apply to your home buying experience?
What most people cannot see is that everyone on Wall Street is calculating multiples. What is a multiple? A multiple is a term used to calculate value. Some companies on Wall Street have high multiples, like 20x or 40x their earnings.
On the other hand, some companies only have a 5x or 10x multiple of earnings. Do the companies with higher multiples earn more revenue? The answer is not necessarily.
What most people don’t realize is that Wall Street is run by emotion and perception. When Steve Jobs was the CEO of Apple, he was able to get Wall Street to raise the multiple of Apple. The reason is Wall Street believed everything Steve Jobs said. If he said, they would earn $14 billion this quarter, they believed him.
Here’s the problem with multiples when buying a house. You cannot rely on emotions and perceptions. If you take out a 30-year fixed loan, that’s a debt payment for the rest of your life. How you feel about a house today, may not be how you feel about a house 10 years from now or 20 years from now.
That’s why you need to know the actual multiple you can afford, not the multiple the bank, wall street or your real estate agent want you to believe you can afford.
That’s why 4x is the multiple any family can afford.
That means if you earn $50,000 a year, you can afford a house that is worth $200,000. If you earn $100,000 a year, you can afford a house that is worth $400,000.
This equation pisses people off. And I’m sure you can see why.
Everyone that lives in New York, New Jersey, Connecticut, California and Chicago probably wants to yell at me right now. And the reason is because most people in those areas are living in homes that cost well above that multiple.
I understand why you’re mad. You know you made a risky financial decision. You can feel it. When you buy a home that is above the 4x multiple, you can actually feel the stress and anxiety on your shoulders.
The house payment itself weighs down on you.
Don’t get mad at me. It’s better to know the truth than to live in denial.
The mortgage crisis of 2008 occurred becuase people were allowed to buy homes that were well above the 4x multiple. Families were given interest-only loans with balloon payments that far exceeded the 4x multiple, so when those payments came due — it was catastrophic.
Not only did those families lose their homes, but they lost every dollar they paid in interest. In reality, those families were “renting” their homes, but were under the impression that they owned them.
Think about it, who do you trust more a Wall Street banker or a 20-year educator?
Analyzing Your Own Deals
If you are in the market for a new home, it’s important you make a good financial decision. Yes, owning a bigger house might make you “feel” more comfortable, but the stress and anxiety of the loan payment will ruin your physical and emotional health.
Is that trade-off worth it?
I can’t answer that question for you. All I can do is present what the numbers tell me. And based on the dollars and cents, you can afford 4x your annual income.