 Personal finance practice problem using OneNote. Estimated home price from monthly income. Get ready to get financially fit by practicing personal finance. OneNote. You're not required to but if you have access and would like to follow along we're in the icon on the left hand side. The practice problems tab down in the 7233 estimated home price from monthly income tab. Also take a look at the immersive reader tool. Our practice problems are in the text area too with the same name, same number but with transcripts. Transcripts that can be translated into multiple languages and either listened to or read in them. We've got the information on the left hand side. We're going to do some calculations in the blue area on the right and on down below. When thinking about purchasing a home there's a couple methods that we might use. The most obvious being that we might look at the homes in the area that we would like to purchase looks at the price of those homes consider how much down payment we would need such as a 20% down payment to determine how much financing we would need and then look into the options for that financing creating amortization schedules and budgets from that point forward in a prior presentation we also thought about the idea of first thinking about how much we can save on a year by year basis in order to accumulate up a down payment up to a certain point in time after a certain number of years and then based on that down payment try to determine how much home we can purchase for example and go from that angle we can also go from the angle as we'll talk here from the financial institution to try to determine how much financing the financial institution might be willing to provide us and how they would typically do that is based on our gross income they're going to be most comfortable with our gross income number because they can verify that more easily than our expenses numbers our entire income statement in other words is what we would probably want to use to budget for if we were trying to be accurate based on our personal spending habits and living standards and styles but from the finance perspective from the banks side of things from the financial institution side of things they want to be able to verify everything and have certain heuristics based on what they know to be true and they can verify the income numbers more readily so they might take your income numbers and then try to determine how much you can afford based on that to then have a loan and other costs for the home purchase once you get that number you might then be able to use that to determine how much financing they would be willing to give you and then determine how much down payment you would have to think about how much home you might be able to purchase so this is another angle that we can look at this in just realize however when we're talking about the bank and how much they will lend us that's different than our own personal financing on the personal financing side of things we would want to do our own budgeting on the banks side of things we're trying to do what we can to provide them with what they need in an honest fashion but in such a way that we can get available to us as much financing as we want we'd like to have a credit limit up to the moon but then choose how much financing we're actually going to take based on our budgeted information okay so we got the down payment that's 10% the loan in years is going to be 30 years the rate's going to be 6% we've got the property taxes and insurance per month it's going to be 600 and then we've got our financial information for our personal budgeting assets, the checking account savings emergency fund, IRA, car 1, car 2 total assets, liabilities the car loans, the net assets and then we've got our personal income statement which is our income in terms of gross income and we're going to assume we have two income sources here per year and then the net income so this gets a little bit tricky when you're thinking about our income numbers which we'll dive into in a little bit more depth here we might have multiple income sources and then we have withholdings and taxes that kind of skew that calculation as well then we got the expenses per month utilities, food, gas, credit card loan payment and the entertainment okay let's first think about calculating from a bank's perspective and the heuristics of the bank may change from period to period what you want to do is talk to your financial institutions about the current heuristics what kind of loan calculations they're currently using they're typically going to be using similar methods basing the income on the gross income often times because they can verify that number but remember you also want to do your own budgeting using a full budget I would recommend including your expenses and so on to see how much you can actually afford so notice down here we've got our income numbers that we're going to start from so we're going to assume the bank is going to be asking for our income numbers so if we work at a W-2 job we might give them our tax returns that they would want as well as our W-2 say pay stubs now the issue with those is the fact that there's withholdings on the income so when you look at your pay stub you might say if I was to think about what actually hit my bank account it's going to be net it's going to be lower than what my gross earnings was because my gross earnings were before payroll taxes, social security, Medicare federal income taxes and possibly other withholdings that would be in play so typically the bank is going to want the gross income and that's what we also want to be giving them because our goal with the bank is to get the highest amount of credit that they would be willing to give us that doesn't mean we want to take out a loan for that amount because we're going to do our own research to think about how much money we actually want but I want to be able to take out as much as I can and therefore I want to look as good as possible to the bank and so I would like to give them if they would accept it if that's what they're asking for the big number, the gross number which is typically the case notice if you're getting this from like a QuickBooks or something like that if you do bookkeeping with software and you're doing it on a cash basis then you're probably pulling in the net which would be after the taxes into your books we'll talk more about that when we get to the income statement but remember you're trying to look good to the bank so you want to give them the high number if that's what they're looking for so then we got the gross income is the $72,000 on the second W-2 withholding so that's going to give us our gross yearly income of the $119,000 and then we're going to say that we're going to break this down into the months now notice when you give them your pay stubs and your W-2s you might get paid every week you might get paid bi-weekly semi-monthly so you have to determine the appropriate way to annualize something and then give something a monthly calculation annual when you get down to a monthly calculation based on the W-2 what you typically want to do is annualize it and then divide it by 12 because there's a difference for example between bi-weekly and semi-monthly and the easiest way to kind of figure it is to first annualize it to get the annual number and then divide by 12 typically so now I'm going to take this is my annual number I divide by 12 there's the $917 on a monthly number and then we're going to use a rate as a guideline for the principal this is the interest tax and insurance sometimes known as the P-I-T-I so this is the number you want to basically ask your financial institutions about and just make sure that you're using the latest kind of heuristic so notice they're going to use this number to help determine based on your gross income they're not asking for all your expenses possibly they might still want your tax return it's another information but this basic heuristic we're going to base it off of your gross income so the affordable amount toward home is going to be the $3968 so all they did then simple calculation that we're expecting the bank to do $9917 times .38 and you could do this yourself when you're doing the budgeting that would be the $3768 so that's the affordable amount towards the home there's still an issue though because what I'd like to get is break that number down to just the amount that's going to be the monthly financing because if I know the monthly financing on the loan then I can figure out how much loan they would give us and notice that this number includes other stuff for the principal interest it has as the payments as the taxes and the insurance and it might include other debts as well so in other words they're trying to pack everything into this one number so it's not a perfect system it's a very like heuristic type of system it's just an estimate based on the gross income and the reason they do that in part is because the gross income is something that they can kind of verify and that's the big number so then we're going to say okay we're going to pull out the stuff that isn't the amount of the payment so I'm going to pull out the car loan and I'm going to pull out the property taxes and insurance in other words I'm going to try to get this number down to the point where I'm just talking about the financing on the loan so if that includes the car loan amount and the property taxes and insurance I'm going to try to subtract those out so if I had the 3768 minus the 295 that they're going to say for the loans and then minus the 600 that's going to give us our 2873 so I'm hoping that I'm getting to a number here where the bank is talking about they would be willing to finance us just based on the loan amount and then I can use that to try to figure out the amount of loan that they might be willing to give us so based on that number how much loan might they give us now this one it's a calculation that you might be not as used to in Excel but it's pretty straightforward calculation because most of the time when we calculate the loan the loan item we're trying to figure out how much payment on the loan now I have the payment and I'm trying to back into the loan amount so in other words usually I use the payment calculation here to calculate the payment if you type in the payment calculation you'll note that what we're looking for the unknown now is the present value which is usually the loan amount in the payment calculation so I can use the present value calculation in other words in Excel and we do do this in Excel so you can check it out there to figure out how much loan I could get in other words if the bank is willing to say that I could afford $2,873 just for the loan monthly payments related to the loan then how much loan could I get in order to have a payment be that amount and I'm going to we're going to assume that there's a 6% rate and that it's a 30-year loan so that would be a present value calculation the rate would then be the 6% and then we divide it by 12 the number of periods would be 30 because we're saying 30-year loan times 12 and then the payment is going to be that $2,873 about because there could be rounding involved so that would be a pretty substantial loan of the $479,248 that we're assuming we can get a loan for based on that information so if the affordable so now we're going to take a look at the purchase price if that's the amount that they can get financing for which notice that that's over like a jumbo loan kind of thing so you got to be careful if you get into these higher numbers but just for the purposes of the practice problem let's say that we've got we've got that number and then we've got the percent financed so if I know if I think I can finance for that much and I have to put 10% down then that means I'm financing 90% meaning I'm going to put 10% down instead of our standard 20% we use 10% this time so that means I'm going to finance 90% therefore how much home could I purchase the 479,248 about it's rounded divided by 90 we could possibly purchase a home for 532,498 in other words if I look at it this way if we said the affordable home purchase price was 532,498 and then we said the down payment was 10% 10% of that would be the 53,250 and that would give us the amount of financing so let's do that this is the way we're normally going to see it we've got the 532,498 that's the amount of the home times the 10% instead of 20% down 10% down we're going to say for this purposes there we have the amount of the down payment we would need so the 532,498 minus the 53,250 would give us the 479,248 about so notice we can kind of tie all this out to basically what what we expect that the bank might be able to finance us so if we expect they could finance us that much we might try to back into how much home we can purchase there's a couple of assumptions that are being made here of course we're assuming that we're going to have a 30 year fixed loan we're assuming 10% down which might be different than the normal like 20% down assumption and we're assuming of course the interest rate we're trying to figure out what the interest rate would be on a standard loan if you get into more complex loans those things those factors can vary but based on that information I could go from basically my gross income and try to figure out how much home I might be able to purchase it also of course assumes that I have a down payment that I could come up with a down payment that is required in order to make this happen and again if you go over a high loan amount over a jumbo loan status then of course you got to take into consideration the differences and qualifications for a larger loan but that's the general idea now note that even though you think you might be able to get fined even if the bank was willing to give us financing a 479-248 that doesn't necessarily mean that we want to take that amount out and notice that their calculation up here is really generic this is a really generic heuristic calculation here it might not reflect our personal spending habits at all our personal spending habits might be greater or lesser than that we might be in a higher or lower cost of living area then this kind of average speculative number is using they might be using this number partially for regulatory reasons and partially for banking reasons and it's an average so that's not really what we want to use our goal from the bank side of thing is to get as much financing as we could meaning similar to a credit card if I can get a credit card that finances up to infinity a million dollars or something like that that's great am I going to spend a million dollars on the credit card no but it's nice to know it's there in the case I have some kind of a million dollar debt that comes up or something right and that's the same thing for this thing we would like that but then we're going to do our own kind of budgeting which might look something like this we would actually put together an income statement and you might do this just by hand you might do a similar kind of process or you might use software software is getting better and better kind of like putting together personal income statements like a quick books or something there's free stuff out there that you can do but and and you can do it based on your bank statement but just note on the income side of things that if you're trying to use a cash flow basis and you're trying to pull everything in after it hits the bank this income side of things gets messy because on your personal budget remember that when we when we gave this information to the bank we used we use the gross number the higher number that's what they want but if I'm trying to do this on a cash basis in our bank we might wait till it hits the bank which means everything that got withheld has been reduced so the bank that we actually hits our account is going to be the lower net number you can still do your income statement either way but you got to you got to recognize that when you're doing it so then so then you've got your total income if this was our income line items and then we've got our expenses which would be the same under either method so we've got our utilities our food our gas our credit card payments and that would be this would be if you're on a like a doing like a cash flow kind of system we got the entertainment and there's our total expenses under either system so if I was to subtract this out if I did it on the gross side of things 9917 minus minus the 1390 would be the 8572 on the net side of things 7833 minus the 6 minus the 1390 would be the 6443 but but then we have to take in the difference over here the difference between these numbers I'm assuming is taxes it could be other things you could have benefits in there but 9917 minus the 7833 I'm assuming that's federal income taxes social security and Medicare those are your taxes those are basically expenses so we really should on the income statement have the total you know gross income and then recognize the expense for all the stuff that got withheld which would be taxes and possibly benefits as well so this income statement on the left is actually kind of the more proper income statement but if you did this from just a cash basis using like a quick books that tries to drive everything from from the bank statement you're using a cash basis method this would be more what it might look like and you just got to recognize that your taxes and some withholding some of your benefits are just are scrunched into this number that you never actually paid out of your bank account it never hits your bank account because your your income was withheld from you before it went into the bank account so you just got to you've got to realize that and notice that this number is what you might then base how much you can afford on you might do your own budget from a month by month I would recommend doing that and it might be substantially different then what the bank comes out to using their heuristic up top in terms of how much you know you they can afford and you might and you might say well I can afford more or I can afford less because your living standards might be way different then then the standards living standards of other people that are in a similar situation which their heuristic is kind of based off of so that means that you may be feeling more or less comfortable with more or less financing so the goal is get as much financing as you can try to look as good as possible to the bank and then determine how much financing you can afford the bank is not your financial planner the bank is someone that you're trying to get financing from the bank is not someone to determine how much financing you could get the bank is hopefully there to give you as much financing as you want and you determine how much financing you want to have that's where you'd like to be okay so then we're going to say that we can do our calculation for our loan so now that I know how much loan we can have up top we can then do our amortization schedule and we can start to budget going forward in terms of how much the home would cost in terms of our yearly cost and so on so if the home was the 532 498 down payment 53 250 the loan 479 278 interest 6% 30 year loan the payment is that 2873 that 2873 that we saw up top here and we that's what we started with basically this time and that we built this whole thing around it and we said okay so now I can make my amortization table we can do this online with online tools or we can do it in excel I recommend doing it in excel because within excel we can break down this monthly amortization table into say a yearly amortization table as we've seen in the past so I won't go into it in a lot of detail but if you can break it down into a yearly table now we've got the payments per year which can help us with a cash flow calculation on on that side of things we've got the interest per year you can see the interest changes goes down substantially per year that helps us with our tax calculations and projections if we want to pull it from here the loan decrease that can help us with our budgeting and calculations for the equity equity being the difference between the loan value and the home value having at least two factors we can consider one being that if the home value stays the same and we pay down the loan the principal of the loan going down the value of the home if it stayed the same the gap between the two would be going up because you're paying down the loan and or the loan balance could go up hopefully going up it could go down too because of just increase in the value of the market so that can help us to determine where we will stand in the future the loan balance representing the ending point after like 12 months here's the 473 363 that's going to help us to determine where we stand from a net asset kind of standpoint as well at the end of each of these years which could help us with our planning going forward so from this point we can then use this information to build our budgets our projections going forward to help us determine whether it be a good decision so notice here instead of us starting with the home value and then calculating the down payment to figure the loan amount and then going into our budget we started first with our gross income number and tried to think from the bank's perspective in terms of what's the gross income number and their heuristic based on it to trim it down to what the monthly loan payment would be which again could change from period to period so you want to make sure that you got the proper heuristic and what's included in like this PITI number so that you can get this calculation correct and then we went from there to basically think about how much financing we could need to to then the how much home we can purchase to then thinking about the the actual loan calculation and then we can go into the budgeting from that point again just like we've seen in prior practice problems if you do this properly you can set up your whole excel worksheet from a set of data which you can then change and and that will help you to run multiple projections so we do do this in excel if you want to check it out over there and try to build something out and you can see if these tools would be applicable to you and your personal decisions