Average Joe still can't afford a home

Mo Barakat, a senior financial adviser at Ameriprise Financial in Los Angeles, uses more conservative formulas. He says a person should spend no more than 20% of income on mortgage payments, 5% on property taxes and insurance and 5% on all other debt, including car loans, credit cards and student loans.

That means a person or family with a $100,000 income should spend no more than $2,083 per month on principal, interest, property taxes and insurance. If saving for college or funding a nice retirement is in the plan, housing payments should be even less.

• MSN Real Estate: Calculate how much house can you afford

The fact that a bank says you can afford a home doesn't necessarily mean you can, Barakat says. A lender is concerned about an applicant's ability to repay debt; it has no interest in whether there's enough money left for the borrower to send children to college or to invest for retirement. Many homeowners fail to recognize this and buy homes at the expense of other liquid assets and investments.

Furthermore, Barakat says, lenders will often allow people to exceed the 30% threshold. And once they do, it almost always has other financial consequences. "There are just too many consequences. You basically lose your savings rate. For the first time since the Great Depression, Americans have a negative savings rate of 4%. It's been captured or stolen by high mortgage payments," says Barakat.

While new homeowners may be happy to have a home, even if that means they're financially overextended, Barakat says their standard of living will actually fall when they buy a home they can't afford.

Cutting back on outings and vacations may decrease the fun in life, but saving less and putting away less for retirement also increases financial risk. There's more financial stress and, without an emergency fund, homeowners can find themselves further in debt when a crisis strikes.

Lawrence Yun, chief economist for the NAR, says that in many of the "superstar cities," such as New York, Los Angeles, San Francisco and Washington, D.C., real estate has always commanded a premium. Even with the recent declines in property values, prices remain out of whack with median incomes, Yun says.

Between the two coasts, homes are much more affordable, Yun says. There, he says, it is less about interest rates and prices and more about jobs. Yun points to Dallas, Indianapolis and Milwaukee as the types of markets where most middle-class residents with good credit and decent jobs can afford a median-priced home.

Sean Snaith, director of the Institute for Economic Competitiveness at the University of Central Florida, says affordability evaporated in some areas that saw rapid price increases over the past five years. In many parts of the country, home prices have risen to such levels that many middle-class residents have little choice but to move farther outside the city, increasing their commutes.

"If you want that single-family home, swing set and the American Dream, the reality is that in major metro areas, most of us will have to commute in order to enjoy that," says Snaith.

Celeste Ward, a resident of Martinez, Calif., says she and her husband sold their condo in 2005, when they thought the market was topping out. Now that they have a daughter, they're trying to get into a three-bedroom house but find they can't get back into the market -- even after the price decreases. They considered moving farther inland but plan to rent and wait for the market to fall further.

"We're just waiting and are seeing more desperation from sellers. Many homes are still overpriced, and there are so many out there. We're waiting to maybe get a bank-owned property or something where the seller is really desperate," says Ward.

Barakat agrees people should buy homes when their "personal economies" are ready, not necessarily when the housing market is ready.

In the past, many people were jumping into homes with exotic mortgage products and adjustable-rate mortgages that are now starting to reset. Barakat says that in most cases, people chose adjustable-rate mortgages because they couldn't afford the homes in the first place.

In January, Realty Trac reported default notices, auction sales notices or bank repossessions on 233,000 homes, 57% more homes than in January 2007. For all of 2007, more than 1% of U.S. households faced foreclosure -- almost double the rate of 2006.

Bubbles, while painful, need to burst to purge the excesses, says Barakat. "Many younger people have told me that they have been priced out of the market and that it was not financially healthy (to buy a house). With these current prices, it is now creating an opportunity for future generations to actually afford a home. I welcome that."

This article was reported and written by Craig Guillot for Bankrate.com.

Published April 17, 2008

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