How Much Can You Afford?

March 24, 2009 by  
Filed under Spending

empty_pocketsWhen considering a purchase of goods or services, how many times have you asked yourself “How much can I 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

I wrote yesterday about how the government’s “Making Home Affordable” program has gone belatedly old school by imposing a 31% mortgage payment to income requirement as a program goal. That came too late for a lot of people.  The most recent U.S. Census Bureau “American Community Survey” tells us that 38 percent of homeowners spend more than 30 percent of their monthly gross income on housing costs.

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
Entertainment: $1,920
Clothing: $1,800
Travel: $1,500
IRA: $7,500
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

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13 Responses to “How Much Can You Afford?”
  1. HomeFree says:

    TML – You are neither a skinflint nor a cheapskate – you are prudent and wise. When we learn the difference between needs and wants we take the first step on the journey to financial freedom.

    We need housing – we don’t need a McMansion.

    We need transportation – drive a paid for car – not a car payment.

  2. I had always thought I was a bit of a big spender, but those numbers from Business Week strike me as ridiculously high.

    As for the 28/36 rule, that had always seemed a little high to me as well. If you can’t keep total debt payments below 36% of gross, you’re in serious trouble. I would much prefer a guideline like 20/25 as a more reasonable breakdown. Of course, “payments” are a misleading measure, as extended terms can reduce just about anyone to these levels, although at a significant long-term cost.

    Maybe I need to be downgraded to “cheapskate”…

  3. Rick Beagle says:

    I hate to point out the obvious here, but if one of the household bread winners loses their job (600,00/month) then what had been a prudent/responsible debt/income ratio suddenly becomes irresponsible? Again, I realize that this characterization of these folks makes you feel good (perhaps superior), but you need to put this data more into context. If any of you lost your jobs, what would your debt to income ratio be?

    I am not saying that many of these people don’t deserve a slap on the back of the head for their misguided view of their own financial well being, but to arbitrarily decide that everyone fits nicely into this group of miscreants is erroneous, arrogant, and callous.

    Rick Beagle

    • Rick: I’ve said it before and I will say it again: None of these mortgage bailout plans can help a person who has no income. That problem has always existed and always will exist. The only thing that can really save an unemployed homeowner is a substantial emergency fund and marketable job skills.

  4. Rick Beagle says:

    My apologies for hitting submit comment too soon.

    In context of the post however, I am right there with you at skinflint level. We had the “fortune” of being hit with a rather large number of financial “strains” early in our marriage. It is difficult to admit, but those tough times probably helped us in the long run financially. Sometimes I wonder if we would have been more reckless if the money had just kept rolling in (like it has for many of the young couples I know). BTW, the early pains were medical related, and my uncanny ability to find companies willing to hire me that all failed in less than a year (four companies has to be a record). LOL! What doesn’t kill you, literally makes you a lot cheaper….

  5. MasterPo says:

    Like I’ve said before, there is soooooooooooo much more to owning a house than just the mere mortgage payment.

    I know people live paycheck-to-paycheck all the time as a matter of life style. But that doesn’t make it right. Let a good number of them loose for once and see the lesson that is taught. And more over, the lesson others learn by watching. Some won’t but most will.

  6. TMN says:

    Apparently I live like a guy with less than half my actual income “should”. Those numbers are way out of line. I would be a nervous wreck if I spent what they recommend, and I’m horrible with money.

  7. goldenrail says:

    I’m a little nervous. My rent is very close to what’s listed there. And I’d easily believe that I spend that much on clothing and travel in a year (in my defense, I’m usually traveling for career related things). However, I’m hoping I somehow balance out by not having any car payments and in no way spending that much on entertainment. Out of curiosity, where’s ‘dining in’ and utility bills?

  8. ryan says:

    the important thing to remember is not to worry so much about what exactly can you afford, just how much you can spend and still be considered “responsible” or “frugal”; but rather how big of a safety margin can you build for yourself and your family.

    From month-to-month, safety margin is pretty boring. Year to year it compounds pretty quickly, and then all of a sudden you realize that you could responsibly spend a heck of a lot more.

  9. MasterPo says:

    Also keep in mind: Costs ALWAYS go UP!! Never down!

    So whatever you’re paying the first year in your house for utilities, insurance, property tax (that’s a factor often over looked) you can bet it will go up as the years go on.

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