How Much Can You Afford?
Or do you subconsciously avoid the question and go with a gut feeling? That feeling is usually wrong. But you subconsciously knew that as well, didn’t you?
Back to Basics on Affordability Testing
What’s worse, 12% of homeowners (9.2 million total) spend more than 50% of their gross income on housing costs. This was in 2007. These are the people that taxpayers are bailing out in 2009.
Many personal finance advisers are recommending using back-to-basics affordability metrics for mortgage and housing expenses. It used to be called the “28/36 rule.” According to this test, a family should spend no more than 28 percent of gross income on housing costs (mortgage payments, taxes and insurance). No more than 36 percent of your gross income should be spent on debt of all kinds, including car loans, student loans, and credit card payments.
You may laugh and say “no can do.”
Well, a lot of people “did” over the years. Those were the families that, for the most part, were able to survive repeated economic downturns. The 28/36 standard provides quite a firewall against economic disaster. Believe me, you could do a lot worse than follow this simple little rule of financial planning while ignoring most others.
Expanding the Affordability Tests
Continuing with the “Can I afford it?” theme, I came across a slide show that Business Week put together called How Much Can You Afford. The editors apparently consulted wealth managers and statistical consumer spending data to arrive at “affordability indexes” for different spending categories and for different income ranges.
As one example, here is the affordability index data they compiled for a family income level of $50,000:
Mortgage/Rent: Up to $14,000
Car: Honda Civic DX, $16,105
Dining Out: $2,520
Health/Car Insurance: $4,100
Federal Income Tax: Married: $6,665 / Single: $8,688
This piqued my curiosity so I decided to compare the Mr. and Mrs. ToughMoneyLove spending levels in these categories with the “How Much Can You Afford” indexes for families with our approximate income.
What a shocker. I thought I was merely a conservative spender or perhaps even a cheapskate. Based on the Business Week affordability data, I’ve been promoted to “skinflint.” Our spending is well below the indexes in every category except insurance and taxes. (I’m not sure what the “IRA” spending index means because the amounts listed exceed the annual contribution limits.)
I would like to think this is more a matter of the “What Can You Afford” index numbers being aggressively high. Maybe the editors took the spending data from families who weren’t yet bankrupt or in default but still lived paycheck-to-paycheck.
What is your reaction? How do you compare on the “How Much Can You Afford” indexes?
Image credit: Chrysophylax