The table will not apply to every single case, but does indicate about how expensive a home can usually be bought with a given income.
It shows cash expenditures only and does not outline a complete cost accounting system for home buying. The fact remains that the family takes charge of its own rent bill, and reduces the loan each month untill finally the house and lot is owned free and clear, whatever it may then be worth.
There is no calculation in the table for loss of interest on money used for the first payment, nor for loss of interest on amortization payments that might have been deposited or invested elsewhere. It is also true, nevertheless, that in most cases savings devoted to paying for a home would not be made if the family continued to rent and had not entered into an obligation to save.
Nothing is charged for depreciation, but, on the other hand, no allowance is made for possible increase in the value of the land.
If rents should rise generally there would be a further saving not accounted for in the table, and when the debt is canceled in twelve or fourteen years the only expenses comparable with rent will be taxes, insurance, and upkeep.
The value of the house and lot is the basis from which other expenses in this table are computed.
For figuring probable expenses when a home is offered at an odd price, say $4,350, the necessary percentages may be obtained readily from the last column in each section of the table by moving the decimal point four places to the left. Thus, in Section I the total annual expenses (item 7) required are 14 per cent of the value of the house and lot, and for the $4,350 house, in the case of a 20 per cent cash payment, would be $4,350 by 0.14=$609.
Of a number of families with the same income it is unlikely that any two picked at random will wish to spend the same amount for shelter. It is for this reason that the income groups in the table are made to overlap. The size of the family, its preferences as to location, the ages and number of children, varying conditions between cities, and other circumstances make the problem one that each family must solve for itself. No rule can be set up that will apply in all cases. It is assumed, however, in this table, that the value of the house and lot will lie between 1 2/3 and 2½ times one's annual income, the ordinary proportion being around 2 times.
For example, a family has an income of $2,700 to start with. Then 1 2/3 by $2,700 =$4,500; and 2½ by $2,700 =$6,750. The family will, therefore, expect to occupy a house worth from $4,500 to $6,750.
To illustrate differences between families, it is apparent that one living in a small town and able to have a vegetable garden and keep poultry might afford a more expensive home than a family with the same income living on a smaller city or suburban lot with higher taxes, and with street car or railway fares added to the cost of living.
Section I assumes a cash payment of 20 per cent of the value of the house and lot. Sections II and III are based on cash payments of 30 and 40 per cent, respectively, and show how much the burden of financing is reduced by a larger cash payment. As stated in the text on page 12, it is not always necessary to have as much as.20 per cent of the total value of the house and lot in hand to start with, but with less it is harder to obtain loans at a low rate of interest, and the annual financing charges become greater.
It should be remembered that in many communities there is at one time or another a shortage of money available for loaning to home-owners, and lending institutions may be able to serve the public best by lending first to those who have a large cash payment in hand. Again, where the price of homes is inflated, banks may be serving the real interest of borrowers as well as of themselves by declining to make loans for a higher percentage of current selling prices of homes.
The amount of the loan or loans required is obviously the difference between items 1 and 3.
In Section I this item amounts to 12½ per cent of the amount loaned as shown in item 4. This is slightly higher than the 12 per cent given in Sections II and III, because, in the first case, a second mortgage may be necessary, with less favorable interest rates or other terms. The sums paid for financing may vary, as noted under the sections of the table, and according to local prevailing rates of interest and amortization required. It generally is considered best to pay off indebtedness within fifteen years, or less, and the plan of payment should be arranged on such a basis. This does not mean, however, that mortgages should not run for a shorter period and be renewed when due. This may be best if interest rates are high at the time the loan is made.
For most families, monthly payments are far more desirable than payments at three- or six-month intervals.
Where a loan is obtained at 6 per cent interest, it can be paid off in less than twelve years by payments each month of 1 per cent of the whole original loan, totaling 12 per cent each year. If the loan is at 7 per cent interest, then only a smaller part of the regular payments is left for paying off the principal, and it will take about twelve months longer to cancel the loan than when the interest rate is 6 per cent.
One plan used by many banks and building and loan associations requires fixed monthly payments, but all sums above interest on the outstanding loan are applied directly to reducing the principal. The principal, therefore, decreases regularly and a larger proportion of the payments is used each month for amortizing the principal until the entire loan is paid off.
Under a plan used by some building and loan associations, the whole loan is nominally left outstanding until the payments in excess of interest, which are applied toward "shares," and which draw compound interest, amount to enough to pay off the loan. Although this plan may under certain circumstances be of some disadvantage to the borrower, the net result to him, provided all goes well, is nearly the same as with the plan described above. With the same monthly payments applied against the same loan, it would be retired in about the same number of months.
Sometimes the payments for amortization are applied directly to reducing the loan and are at a fixed rate, say $250 a year for a $3,000 loan, and the interest payments, therefore, become steadily less. This plan has the disadvantage, for many people, of requiring the largest payments at first, but it is safer than plans which provide for gradually increasing total payments each year..
According to most schemes, it would be possible, after the first few years, to cut down the payments. For instance, in the tables a new arrangement at the end of seven years might reduce financing charges one-half or more, but this would mean that the loan would not be retired so soon.
Local tax rates on real estate usually amount to 1½ to 2½ per cent of the market value of the property. Fire insurance rarely amounts to one-half of 1 per cent of the value of the house alone; yearly upkeep is frequently estimated at 1 per cent of the value of the house itself; but .... it varies greatly with the age and quality of the house and the attention that the owner himself gives it. In any city the tax and insurance rates can easily be found out, and it is believed that many home-owners find their expenditures for item 6 amount to less than the sums stated in the table. In each case in the table this item amounts to 4 per cent of the value of the house and lot.
The sums in this item are obtained by adding the amounts in items 5 and 6, so it follows that nothing is allowed under this heading for water, fuel, gas and electricity bills, telephone, special assessments, or accessories and improvements. Some of these are contingent expenses that do not have to be allowed for when a family is renting, but may add to the value of the property.
The majority of people, while they are paying for a home, probably spend between 18 and 35 per cent of their income for the purposes of item 7.
In Section I, the sums in item 7 amount to 35 per cent of the minimum income given in each column for item 2. This includes for the first year, 12½ per cent for savings and 22½ per cent for items comparable with rent. In Section III the sums in item 7 amount to 18.7 per cent of the larger incomes in item 2.
This item represents the amount that is paid out during the first year on the principal of the loan, assuming that half of item 5 is paid for interest and half for amortization. The annual savings grow larger progressively as the principal of the debt becomes less.
The amount that can be saved for amortization varies with each case. Thus, a family of two with an income of $1,800 a year, having neither children nor relatives to support, can pay off a loan faster than a family with several children and perhaps an aged parent to take care of.
The figures opposite this item equal item 7 minus item 8, or the difference between the total expenses for the home the first year, and the amount of savings that is used toward paying off the loan. This item grows smaller as item 8 increases, and, finally, when the home is paid for fully, the only ordinary expenses will be taxes, insurance, and upkeep.