MSN Money contributor Liz Pulliam Weston recently addressed the problems with the current formulas for determining mortgage affordability. An excerpt from her article:
"Here's what's changed in the 30 years (or more) since your parents bought their first house:
Inflation. Rapidly rising prices in the 1970s and early 1980s meant you could count on hefty annual raises. Today, you can't rely on double-digit income boosts to make your mortgage payment less of a burden each year.
Two-income couples. A generation ago, single-income families were more common. If the breadwinner lost a job, the other spouse could go to work to save the house. With more two-income families needing both paychecks to make the mortgage payment, there's no one on the sidelines to take up the slack -- unless you put the kids to work.
The lending industry. Thirty years ago, it was pretty tough to get a mortgage for more than you could really afford. Today, it's fairly commonplace. More lenders have loosened their criteria, knowing that the vast majority of their borrowers will do whatever it takes to pay their mortgage -- even if it means trashing the rest of their financial lives.
Retirement. A much bigger proportion of the workforce was covered by traditional, defined-benefit pensions 30 years ago -- which means they didn't have to save massive amounts of money on their own to have a decent retirement. Today, the onus is typically on you to carve enough out of your budget to fund 401(k)s and IRAs.
So how much should you spend on a house? The traditional way to calculate that is to add up all your income and make sure that your housing expenses -- mortgage payment, homeowners insurance and property taxes -- don't exceed a certain amount of that total. The traditional limit, still used by many lenders, is 28% of gross monthly income. Some financial advisers recommend capping your outlay at 25%; others suggest stretching to 33% or more.
The best way to figure out how much house you can afford is to do your own math. Figure out how much money you need to contribute to various goals, such as your retirement and your kids' college educations. Estimate how much your house is going to cost you in maintenance and repairs each year (figure about 1% to 3% of the home's total value annually, depending on its age and condition). Then see how much of your remaining income is eaten up by your housing costs (including insurance and taxes), and see how you feel about that."
For the entire article, visit http://articles.moneycentral.msn.com/Banking/HomebuyingGuide/Don