Washington DC/Baltimore

[perlman007]

I am currently looking to buy in Arlington.  I feel like I make a pretty good living, but cannot believe the prices.  What do people do for work that there can be such upward pressure on prices and so many sales at or near $1M?  I thought all DC area folks were supposed to work for the Gov't.  Am I missing something?

[philip-gvinter]

With the low interest rates today people can afford about 5x their annual combined income. For close in areas like Arlington, Bethesda, Chevy Chase, etc that means a household income of somewhere around $200,000. That could be two senior civil cervants or another dual income household with both income earners making a good living or a single income houshold where the income earner is a doctor, attorney or in some other high paying profession. I completely understand your frustration as DC is one of the most expensive metro areas in the country.

[Venturion]

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perlman007 wrote:

I am currently looking to buy in Arlington.  I feel like I make a pretty good living, but cannot believe the prices.  What do people do for work that there can be such upward pressure on prices and so many sales at or near $1M?  I thought all DC area folks were supposed to work for the Gov't.  Am I missing something?

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Have you looked at government salaries?  I, for one, would love some austerity!  Cut 50% of government employees; first order return of decreased budget, second order return of improved efficiency - guaranteed.

The other aspect is rollover equity.  If you bought before 2002 and sat on that growing equity, you likely have $100K to $500K in appreciation you can roll into a new house.

[TangeloMozilo]

I hear you, man.  My wife and I both make good money, we live cheap, we save, etc.  Yet I ask myself the same question: Who are these people buying these $1million homes?

I have to beleive that a lot of them are just stretching themselves to the financial maximum.  Just to come up with a downpayment for something like that, you have to have sold a SFH that you bought pre-bubble, which would make these buyers in the 40s at least at this point.  Having dumped all of their gains into the new house, they have now taken on another 30-year mortgage that probably requires the same or more of a monthly payment than their old one.  By the time you are in your 40 or 50s, you should be thinking about how you are going to be mortgage-free at retirement -- not how you can leverage up and start from scratch with a bigger house.  Questionable financial planning to say the least.

Also, when you depend on both spouses' salries to make the mortgage payments, you aren't leaving yourself a lot of margin for error.

[xizor]

OK. Let's summarize. Some have several hundred thousand in home equity to put down.  Some have dual income. Some have high paying jobs -- starting salaries for 20 something's at large law firms are $160,000 a year.  Some inherit money. Others have some combination of the above.

As for over-leveraging in your 40's or 50's, if you can borrow at 3.7% for 30 years, get a tax deduction for the interest, and wait for inflation to wipe out your debt, I say back the truck in and load it up with debt. I don't find that financial planning so questionable.

[dss10]

If you are a GS-13 or above you could make at least 25% more in private industry as opposed to working in the federal government (that is including both salary and benefits). I took a 25% pay cut to work for the federal government at my current grade. The only people who really benefit from government jobs are those making less than 50K per year and those who do not have a high school diploma. This is due to the fact that few, if any of the private sector jobs at these salary levels  offer healthcare or retirement benefits.

As to who is moving into North Arlington, there are a lot of two lawyer families who have kids approaching school age and who understand that private school in DC and the close in suburbs will cost ~ 30K per child per year and that the Arlington school system will save them ~ 360,000 per child from 1st-12th grade.  I think this explains the disparity between south and north Arlington prices with the south arlington schools not being seens as good as thouse in the north.

If I were you I would not try to "keep up with the Jones" and live within you means. I would not listen to any realtor who would encourage you to spend 5x your gross household income but rather invest in a couple of sessions with a financial planner to understand what you can afford and still meet your other financial goals....... 

[philip-gvinter]

dss10,

The multiple to gross income is purely a function of interest rates. The traditional and very conservative mortgage qualification guideline was always 33% of gross income going to mortgage payments. Let's use round numbers to make the math easy. Assuming 10,000 in gross monthly income or 120,000 a year that translates to $3333 a month. at 4% interest the payment per $1,000 borrowed is $4.77. Ofcourse that $3333 has to include property taxes and insurance so let's try to calculate that in at the end. $3333/4.77=698.742. Now we have to subtract for the taxes and insurance. Property insurance in this area tends to be about $100 or less per month. That takes us down to $3233. Property taxes are about 1% to 1.25% of the value of the property a year. Let's use 1.2% per year which is .1% per month to be on the higher end of the range and once again make the math easy. To get back to my suggestion of 5X annual income we would be at $600,000 so the monthly bill would be $600 taking us down to $2633. 2633/4.77=$551,991 or 4.6X your annual income this is a highly conservative number. The traditional guidelines also assumed 38% total debt to income. If we assume no other debt and move the housing payment to 38% than we would get a total payment of $3800 a month. 3800/3333=1.14 or an extra 14%. $551,991x1.14=$629,332 or 5.24x the annual income. 5x is right in the middle of that range.

If we were to go back to historic interest rates of 8% where each $1000 borrowed cost $7.34 per month to pay back the story changes drastically. 3333/7.34=454.087 this is less than 4x the annual income and that is before we go through the excercise of taking out the money allocated to paying property taxes and insurance.

Taking the middle ground and assuming 6% interest rates we get a repayment cost of $6 per $1000 borrowed per month. Here we get 3333/6=555.5 or 4.63X the annual income before taxes and insurance. Once we take away the $100 for insurance, and the $555 for property taxes we are left with $2678 in mortgage payment. 2678/6=446.33 or $446,330 which is 3.71X the annual income. If we once again assume no debt than and multiply 3.71x1.14=4.24x annual income. Once again depending on how much other debt someone has, and the interest rate a reasonable range is 3.71x to 4.24x the annual income.

Lenders today typically allow 40% to 45% debt to income ratios, and in my opinion a 45% debt ratio leaves very little room for unanticipated expenses or any kind of negative surprises. This would allow someone to spend up to 6x or more of their annual income to buy a property, but just because someone is willing to give you a loan does not mean that taking it is necessarily a good idea.

Taking a look at the three scenarios above shows us that when interest rates are between 4% and 6% spending 4x to 5x ones annual income on a house can in fact be conservative financial planning. I don't think that having an inherent distrust of the advice you are given based on the profession of the person giving it is helpful in making an informed decision.

[beebs]

And what happens when interest rates do go up and you need to sell to people in the same income situation as yours?

[philip-gvinter]

If values stay and rates go up than the average income of the new buyers has to go up otherwise values are likely to stagnate or fall with a rise in rates. My point was simply to show what kind of income is neccessary to comfortably be able to afford a home right now. With low interest rates a mortgage of 5x annual income is not unreasonable, with higher rates it is completely foolish and unsustainable.

[cjwredfin]

5x annual income not unreasonable?  hahaha  That is ridiculous.  Maybe for an older couple with no kids and little need to save

Me and my wife gross just over 200k a year.  We bought a house in Gainesville for 375k.

With 2 kids in daycare (2300$ a month), 2 cars (800$ a month), property taxes (500$ a month) and all other living expenses, we are saving every month hopefully for a retirement, but not a ton.

Even with my kids out of daycare and both cars paid for, I would not even entertain the idea of a mortgage any larger than 550-600k.  At the very tippy top most. 

A house worth 1 million would result in just property taxes of well over 1000$ a month! just for taxes! 

If banks are still approving people for homes at 5x income regardless of situation... wife pregnant with twins.. who cares give them a loan for 5x income!...that is irresponsible and we've learned nothing.  Which is not surprising.