What follows is a simple mathematical calculation that banks and mortgage lenders used to use to consider an applicants application for a home mortgage.
I post it here in the hope that it will help those of you who will need to figure out their future finances and give pause to those of you who seem to derive their income by convincing other people that property investment is a path to incredible wealth -- and that any fool can do I!.
In an effort not to be sexist -- imagine your spouse makes $48,000 per year, and you too make make $48,000 per year. Total annual income $96,000 per year.
STEP 1
Calculate your Adjusted Monthly Income (AMI):
Total: $96,000 per year / 12 = $8000 per month
Now subtract any loans with 10 or more months remaining, i.e. car, student, personal, credit card etc. Let's say they all total $600 per month.
$8000 - $600 = AMI
Therefore, the Adjusted Monthly Income (AMI) = $7,400 per month.
STEP 2
Find Maximum Monthly Mortgage Allowable (MMMA):
Find 28% of the AMI x 0.28 = MMMA
Therefore, the Maximum Monthly Mortgage Allowable (MMMA) = $2072.00
STEP 3
Find a house to buy. The average home price in NZ is $332,000 so let's use that price. The norm. over the last few years is no-money-down"" so we are looking at 100% financing.
STEP 4
Find our Monthly Payment (MP) on a 25 year loan at 9.5% for $332,000
This rate equates to $8.74 per each $1000 borrowed.
$332,000 / $1000 = 330 x 8.74
This equals a Monthly Payment (MP) of $2901.68
STEP 5
Now we need to add our monthly Insurance fee and Property Taxes (Rates).
I'm only guessing on the Rates and the Insurance but both amounts will reflect the value of the home. Let's say $80 for Insurance and $180 for Rates (remember this is per month).
So, $2901.68 + $80 + $180 = $3161.68
STEP 6
Compare maximum monthly mortgage allowable to the monthly payment:
Maximum Monthly Mortgage Allowable (MMMA) = $2072.00
Monthly Payment (MP) = $3161.68
As you can see the Monthly Payment is higher than the maximum mortgage allowable so as a result a family with an annual income of $96,000 cannot buy a $332,000 house under the current scenario. But wait, you say, their current AMI is $7,400 -- they can easily afford this house! Why did you consider only 28% of the AMI?
This is of course, the way things used to be done. Lenders once only considered 28% of your gross income minus outstanding debt (10 months or more). I'm not sure where the 28% came from but basically it excludes 72% of your AMI for taxes (including rates), food, utilities, schools, children etc. and any other basic living expenses. Simply put, since “man” has been borrowing money there have been bubbles, unemployment, an unexpected events. I'm guessing that someone somewhere figured out that 28% equated to an approximation of built-in debt protection; given even before the loan was issued. A natural buffer, so to speak, that protects borrower and the lender. Sometime in the last ten years this good business practice went out the proverbial window and we are left in the mess we are in today.
So, how can this little math demo help you if you already have a home(s), or even considering buying a home, and are wondering what to do next?
Here's how:
Using the example above let's assume you did in fact purchase the $332,000 house at an interest rate of 9.5% on a 25 year schedule without considering 28% of your AMI.
Subtract your Maximum Monthly Mortgage Allowable (MMMA) from you current Monthly Payment (MP)
MMMA $2072 - MP $3161.68 = -$1089.68
If you come up with a positive number then you're probably in pretty good shape, but even so, it can't hurt reduce your exposure. There is always more you can do!
If you come up with a negative number (like our example) then you should strive to make up the difference. One way (using our example) would be to actually find a way to earn an extra $1089.68 (or more) each month. Another, could be to refinance at a lower interest rate equalizing the MP and MMMA or by putting down a large chunk of money during refinancing that has the same effect. Yet another is to Budget: eliminate $1089.68 per month in debt. I'll admit, no option is easy – so I can only hope that this post can be used as a guideline for those of you who are determined to hang-in-there and make it through this financial crisis.
I've included the cost, per thousand dollars, based on a 25 year schedule, borrowed below. Use the steps above to do your calculations.
Rate -- $ per $1000.00
7.0% – $7.70
7.5% – $7.39
8.0% – $7.72
8.5% – $8.05
9.0% – $8.40
9.5% – $8.74
10.0% – $9.09
10.5% – $9.44
11.0% – $9.80
11.5% – $10.16
12.0% – $10.53
Lastly, property is a valuable commodity and when you consider a long-term investment strategy over a short-term investment strategy; property takes on a whole other face. Buying back mortgage debt by investing in what you already have is always good in a falling market, so to is home improvement.
Good Luck!
I post it here in the hope that it will help those of you who will need to figure out their future finances and give pause to those of you who seem to derive their income by convincing other people that property investment is a path to incredible wealth -- and that any fool can do I!.
In an effort not to be sexist -- imagine your spouse makes $48,000 per year, and you too make make $48,000 per year. Total annual income $96,000 per year.
STEP 1
Calculate your Adjusted Monthly Income (AMI):
Total: $96,000 per year / 12 = $8000 per month
Now subtract any loans with 10 or more months remaining, i.e. car, student, personal, credit card etc. Let's say they all total $600 per month.
$8000 - $600 = AMI
Therefore, the Adjusted Monthly Income (AMI) = $7,400 per month.
STEP 2
Find Maximum Monthly Mortgage Allowable (MMMA):
Find 28% of the AMI x 0.28 = MMMA
Therefore, the Maximum Monthly Mortgage Allowable (MMMA) = $2072.00
STEP 3
Find a house to buy. The average home price in NZ is $332,000 so let's use that price. The norm. over the last few years is no-money-down"" so we are looking at 100% financing.
STEP 4
Find our Monthly Payment (MP) on a 25 year loan at 9.5% for $332,000
This rate equates to $8.74 per each $1000 borrowed.
$332,000 / $1000 = 330 x 8.74
This equals a Monthly Payment (MP) of $2901.68
STEP 5
Now we need to add our monthly Insurance fee and Property Taxes (Rates).
I'm only guessing on the Rates and the Insurance but both amounts will reflect the value of the home. Let's say $80 for Insurance and $180 for Rates (remember this is per month).
So, $2901.68 + $80 + $180 = $3161.68
STEP 6
Compare maximum monthly mortgage allowable to the monthly payment:
Maximum Monthly Mortgage Allowable (MMMA) = $2072.00
Monthly Payment (MP) = $3161.68
As you can see the Monthly Payment is higher than the maximum mortgage allowable so as a result a family with an annual income of $96,000 cannot buy a $332,000 house under the current scenario. But wait, you say, their current AMI is $7,400 -- they can easily afford this house! Why did you consider only 28% of the AMI?
This is of course, the way things used to be done. Lenders once only considered 28% of your gross income minus outstanding debt (10 months or more). I'm not sure where the 28% came from but basically it excludes 72% of your AMI for taxes (including rates), food, utilities, schools, children etc. and any other basic living expenses. Simply put, since “man” has been borrowing money there have been bubbles, unemployment, an unexpected events. I'm guessing that someone somewhere figured out that 28% equated to an approximation of built-in debt protection; given even before the loan was issued. A natural buffer, so to speak, that protects borrower and the lender. Sometime in the last ten years this good business practice went out the proverbial window and we are left in the mess we are in today.
So, how can this little math demo help you if you already have a home(s), or even considering buying a home, and are wondering what to do next?
Here's how:
Using the example above let's assume you did in fact purchase the $332,000 house at an interest rate of 9.5% on a 25 year schedule without considering 28% of your AMI.
Subtract your Maximum Monthly Mortgage Allowable (MMMA) from you current Monthly Payment (MP)
MMMA $2072 - MP $3161.68 = -$1089.68
If you come up with a positive number then you're probably in pretty good shape, but even so, it can't hurt reduce your exposure. There is always more you can do!
If you come up with a negative number (like our example) then you should strive to make up the difference. One way (using our example) would be to actually find a way to earn an extra $1089.68 (or more) each month. Another, could be to refinance at a lower interest rate equalizing the MP and MMMA or by putting down a large chunk of money during refinancing that has the same effect. Yet another is to Budget: eliminate $1089.68 per month in debt. I'll admit, no option is easy – so I can only hope that this post can be used as a guideline for those of you who are determined to hang-in-there and make it through this financial crisis.
I've included the cost, per thousand dollars, based on a 25 year schedule, borrowed below. Use the steps above to do your calculations.
Rate -- $ per $1000.00
7.0% – $7.70
7.5% – $7.39
8.0% – $7.72
8.5% – $8.05
9.0% – $8.40
9.5% – $8.74
10.0% – $9.09
10.5% – $9.44
11.0% – $9.80
11.5% – $10.16
12.0% – $10.53
Lastly, property is a valuable commodity and when you consider a long-term investment strategy over a short-term investment strategy; property takes on a whole other face. Buying back mortgage debt by investing in what you already have is always good in a falling market, so to is home improvement.
Good Luck!
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