Updated. Buying a house is always an exciting yet terrifying time. Deciding on how much we can “afford” is often limited by how much someone will lend us. Mortgage lenders use income size, income stability, credit score, down payment size, and other factors before approving a loan. Let’s explore the idea of a “rule of thumb” to greatly simplify such a complicated matter. The most common way to express affordability is as a multiple of your household or individual annual income.
CNN Money says 2.5 times:
The rule of thumb is to aim for a home that costs about two-and-a-half times your gross annual salary. If you have significant credit card debt or other financial obligations like alimony or even an expensive hobby, then you may need to set your sights lower.
The now-defunct Washington Mutual Bank suggested up to 4-5 times:
As a broad generalization, most people can afford to purchase a house worth about three times their total (gross) annual income, assuming a 20% down payment and a moderate amount of other long-term debts, such as car or student loan payments. With no other debts, you can probably afford a house worth up to four or even five times your annual income.
Investopedia offers up 2 to 2.5 times:
Generally speaking, most prospective homeowners can afford to mortgage a property that costs between 2 and 2.5 times their gross income.
Running Your Own Numbers
Where do these numbers above come from? Most government-backed mortgages utilize the following ratios for their underwriting:
- Front-end debt-to-income ratio = housing-related costs (PITI) divided by gross income. PITI stands for principal, interest, taxes, and insurance.
- Back-end debt-to-income ratio = housing-related costs (PITI) plus all recurring monthly debt, all divided by gross income. Recurring monthly debt includes student loans, car loans, credit card debt, and alimony/child-support obligations.
Essentially, they want to be sure that housing costs don’t take over your entire budget and also that you can still handle your total monthly debt load. (Left out are things like food, transportation, other insurance, health care, etc.) Each of the major lending agencies has their own set of DTI limits, but let’s use the standard Federal Housing Administration (FHA) limits of 31% for front-end DTI and 43% for back-end DTI.
You can insert your own numbers here, but let’s use these statistics based on the average US household:
- Household income. Government statistics have the median US household earning around $52,000 gross a year, or $4,300 a month.
- Taxes and homeowner’s insurance. Depending on the survey, the national average is somewhere between $2,000 and $3,000 for annual property taxes and roughly $1,000 for annual homeowner’s insurance premiums. Together that’s roughly $300 a month.
- Credit card debt. The Federal Reserve reports the average household credit card debt to be about $7,500. The underwriting guidelines use minimum payments, so if you assume a 3% minimum payment that’s $225 a month.
- Car loans. Experian reports that the average monthly loan payments was $450 for new cars and $350 for used cars. Let’s use $400 for this exercise and assume one new car per household.
- Student loans. For households with student debt, Brookings estimates that the average monthly payment is $240.
- Current 30-year fixed mortgage rate. Bankrate and HSH report this to be about 4.25%. You can always refinance your mortgage to lower your rate as well.
20% Down Payment, 31% Front-End Ratio
Using a 31% front-end ratio, that means PITI (principal + interest + taxes + insurance) can be $1,333 a month. Taking out $300 for taxes and homeowner’s insurance, that leaves us $1,033 a month for principal and interest. With a 20% down payment and a 4.25% interest rate, that works out to roughly a $210,000 maximum loan size and $260,000 maximum total home price = 5 times gross income.
20% Down Payment, 43% Back-End Ratio
Using a 43% back-end ratio and the average consumer debt numbers from above, we start with $1,850 and take out $300 for taxes and HO insurance, $225 for credit card payments, $400 for car payments, $240 for student loans. That leaves us with $685 for the mortgage payment at 4.25%. The resulting $140,000 max loan size with 20% down payment gives a $175,000 total home price = 3.4 times gross income.
5% Down Payment, 31% Front-End Ratio
The minimum down payment amount for a FHA loan is actually only 3.5%, but you will be subject to additional Upfront Mortgage Insurance Premium (UFMIP) of 1.35% of the loan amount plus an ongoing PMI of 0.80-0.85% of the loan amount annually based on your loan-to-value ratio. Having to pay PMI means less money available to go towards the loan, so our numbers now only give us a $185,000 max loan size. With a 5% down payment, that means a total home price of $195,000 = 3.75 times gross income.
5% Down Payment, 43% Back-End Ratio
Doing the same calculation using the 43% back-end ratio which takes into account other debt payments, you end up with only roughly $110,000 max loan size and loan and total home price of $117,000 = 2.25 times gross income.
By doing this exercise, we see that someone with a car note, credit card debt, and student loans is certainly going to have a much different measure of affordability than someone without such pre-existing obligations. Perhaps there is no easy rule of thumb? If I had to, I would say that a household with “significant” debt could start at 2x income, while someone with very little debt could start with 3x income. But it shouldn’t be too difficult to use this example to get much more accurate numbers.
Most importantly, just because someone is willing to lend you a certain amount, doesn’t mean you have to take it! Here are some posts that may help you get the most value for your housing dollar:
- Size of house? How many square feet do you really need? and Increase in Housing Quality vs. Increase in Housing Prices
- Shorter commute and smaller/more expensive, or longer commute and bigger/cheaper house? Housing Search Trade-Off: Price vs. Commute Time and Expert Says: Biggest Waste of Time is Commuting
- Moving to a different city? Roundup of Top 10 Best Cities Listsand What cities are people actually moving to?
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Just wanted to point out that it’s not an apples-to-apples comparison — the Northwest CU figure is how much you can borrow, whereas the CNN and WaMu figures are for the house’s value.
What about maintenance, which at CEPR estimates at 1/12 of 1% of the purchase price per month? I think that’s an extra $140-170 per month in your two examples. And of course there’s HOA fees for condo owners etc… On a completely anecdotal note, a friend of mine was horrified to find that her local property taxes (in a shiny new subdivision) are MORE than her monthly mortgage payments. Ouch! Really important to know that number, precisely.
On another topic, I think it’s a really good idea you have to “live” off of one person’s income (i.e. the other person doesn’t work, or you both work part time, or you save the second income), such that you calculate affordability of a house based on a single income. The LA Times pointed out in a really interesting series on “economic risk”, that in the past, when a family lived under one income, if that income was lost another family member could go to work (think “Mr Mom”). Now a second income is often used to increase the standard of living, leaving the family open to more risk.
That series is here:
http://www.latimes.com/business/la-newdeal-cover,0,6544446.special
Good calculation if your area is low for property tax. My house is roughly that value with the property assessors office, the taxes and insurance run closer to $450 per month.
That = $750 payment @ 6% = $125k or about $156k before a down payment.
I think I fall more into the perspective that 1.5% is a good place. A place that lets you live. The funny thing is my mortgage would be effectively @ the 1.5% of annual income if I had sold my first home outright instead of carrying paper. So, I’m inline in my eyes.
Less is more.
Of course your using 30 years, which I personally prefer 15 year mortgages and I try to stay away from anything over 3 times my salary. So I honestly like CNN’s definition.
Funny how the credit union wants to protect you and tell you only 1.5 times your salary and then the big bank Wamu tells you go ahead and get 5 times your salary. I personally like CNN’s definition that I do believe at most you should get 3 times your salary, but borrowing 2.5 is probably a better safer. I wouldn’t ever go above 3 times my salary personally and I’m willing to get the majority of people who have foreclosed were at least 4 or 5 times.
A person making 50k doesn’t want to hear that they can only afford 125k or 150k house. They really want to keep up with the Jonesesssssssssss so they’ll go with the 250k house that Mr. Jones purchases 5 years ago for 85k. It seems this mentality helps push real estate to unaffordable prices. There’s nothing like living paycheck to paycheck and being house rich.
I really enjoy your blog and this is my first posting. Great site.
I think you misread what Northwest Community Credit Union says. It says you can borrow 1.5 times the gross annual income, not a house that is worth 1.5 times the gross annual income. So assuming a 20% down payment, one can purchase a house worth $93,750.
“In reality, these days it?s really not that hard to find a lender to give you a loan for 5 times your annual income. Theoretically, this means that they think that you can ?afford? such an amount.”
Perhaps the question is: are lenders nowadays bearing the same risk as they always have with borrowers, or have they figured out a scheme to move risk up the lending chain to foreign investors?
I tend to think that the current mania has to do with borrowers not understanding how their risk and the lenders’ have diverged in recent years.
Don’t forget all the new furnishings you’ll have to purchase (fridge, stove, washer, dryer, etc..) assuming you are buying brand new. You should factor those in as well.
Good catch on the credit union borrowing amount, that would make it more like 1.8 times.
I do think lenders are much more lax now as they can package and resell loans to reduce their own risks.
The rule of thumb I’ve always heard is that your monthly housing expenses (mortgage, property taxes, insurance, HOA dues) should be no more than 1/3 of your monthly income 40% MAX. This is what lenders typically use to qualify you. Additionally it good advice for renters too (stay under 1/3 of income on rent).
To me that makes a lot more sense than X times your income since X times your income has no account for interest rate variations on a loan which is much more significant than the price of your house.
i.e. 10% interest on a 100k ($833/mo) house vs. 4% interest on a 150k house ($500/mon).
Don’t forget about utilities as well. Some people suggest that housing (including utilities) be no more than 30% of your gross annual income.
Great post. We bought a house about 3 times our annual income. I did the numbers and it is affordable after taking money out for savings and investments, but I think we will have to be more conscious of how we are spending vs. just buying what we think we need.
I’ve heard of the 4X your gross salary as part of what you want to use for a maximum amount. Now, this is all dependent upon where you live too – up here in NH you are lucky to get a small condo for 150K. So you sort of have to go 4X your income in some places (if single at least).
If you base that 4-5X gross salary from one worker of a possible two, I think that threat gets a little less scary. Whereas, it certainly is something to consider if you are single. Rent alone, in certain area’s up here, can be more than that monthly payment (though if you’re city, you may be able to hit around $700/month.)
I would just add that one should also consider the alternative cost – renting. let’s say I am renting a house for $1000/month which is $12000 per year. If I take a mortgage, I pay interest, taxes and maintenance every year (the rest goes to the house equity). so say the interest rate is 5% (after accounting for tax benefit), 1% property tax and 2% maintenance, that is 8% total. so to be equivalent to renting, the house should cost $12000/0,08 = $150,000 (assuming $0 down, for simplicity). so unless I can buy the house for $150K or less, I am better off (financially) renting.
anyway, thanks for the blog, I enjoy it very much.
To RK, your equation makes sense at first glance, but you have to look a lot deeper (and also on a situation by situation basis) to truly see if renting is the better option. You have to consider the return you will get on the excess cash you have if you rent versus the return you get on that cash if you put into equity in your home.
In a place like NY/CA where a moderate/small home can cost 400K+, you are paying the interest/tax/maintenance cost in order to own a highly leveraged asset where your return could be much higher. If you plan on selling sooner rather than later and the market gets hot, you could end up making a decent amount in a short period of time.
Finally, if you plan to keep your home, at some point you will pay off your mortgage and elminate the majority of your housing costs. For most people, this makes no difference as it is 30 years away, but if you can afford to pay off the mortgage in say 15 years, there is a significant advantage. If you rent, you always have that expense.
The biggest benefit of home ownership is that it is a hedge against inflation. Your housing cost is locked in / fixed for 30 years. Whereas your landlord can increase your rent by 3% or 5% each year, your mortgage payments never increase. If the there is major inflation, the number of dollars your home is worth can increase substantially, but your cost of owning it never increases.
In a place like New York (the tri-state area, NY, NJ, CT), that small $400,000 house also comes with a very large tax bill. It is the norm there for homeowners to pay well in excess of $10,000 a year for property taxes for a 1,300 square foot house, and a larger house pays even larger taxes. Since property taxes keep rising, your monthly costs do, too. Pay off your mortgage, and you still have a $1,500 payment for taxes and insurance.
Why do these calculations always look at gross income instead of net? It just seems like a realistic formula would start with how much you actually have in your pocket each month rather than gross.
Those rules of thumb usually arrive at you paying half your net income of more for housing.
We’re looking in TX and the property taxes come into play in a big way here. You did include them here, but everyone needs to know that not all states are equal (or even close).
I live in New Jersey and pay 14,000 in property taxes..
Why lenders always look at gross income is an interesting question. All the underwriting ratios are based on gross income. I assume that it’s simply easier to find out someone’s gross income?
Those TX property taxes keep the housing prices nice and low though! No state income tax either, I want to move to Texas 🙂
They probably look at gross income because mortgage interest and property taxes are both deductible, and that’s most of what you’re paying on a 30 year loan for the first 10 years or so.
Two schools of thought:
* The traditional 30-year fixed yada yada…
* Buy the biggest house on the most land you can afford. Use ARMs, Neg-ams, interest-only loans, whatever so that you have zero or little equity in your home. Plan on appreciation and refi in two years – pull out that money. (This theory is from my mortgage lender friend in San Fran. He’s pulled a half million out of his stupid house in five years).
It all depends on the Fed. If they lower rates then go crazy (option 2); if they raise rates then go boring (option 1).
Does it make much sense to have any equity in a home? In the past yes it did (to some degree), but those days are over.
A wreckless Gov’t/Federal Reserve is destroying the world’s currency (the U.S. $). This has nothing to do with republicans/democrats. We (America) are beyond bankrupt and the only way out is inflation. A recession would destroy banks, industry, american jobs.
If the fed lowers rates this year then goodbye dollar. Only assets (real estate) will keep up with the dollar death spiral. This will mean ARM-type mortgages are a good choice – option 2. If the fed bends over to foreign banks (the real financiers of the Federal Gov’t) then expect the biggest foreclosure auction in world history, along with no jobs, no banks, and no future for our college grads…
While these various formulas and rules-of-thumb look at finances only, as they should, they don’t take into account life itself.
That is, if you plan to live in a house for awhile (say 10 years or more), and you don’t want to move, then owning gives you the security of staying put as long as you’d like. With a rental, the landlord could decide to sell the place, have their kids move it, kick you out for any number of reasons.
Furthermore, if the part of the idea of a home is enjoying where you live, then there’s far more incentive to fix up your own place than a rental.
Sure, money counts…but so does life. And a home is much more a life-factor for many people than solely a money-factor.
You’d have to pay me to live in NJ. I just read about some new other taxes they’re introducing.
Did I read somewhere what the NJ motto is? “If you can dream it, we can tax it.”
hey, without overlystating NJ: werent there budget in crisis after July4th, and they shut the government, and the governor supposedly promised some type of property tax relief?
In regards to this post: True, banks may allow you 3-5x’s your gross income for loan. However, you, and ONLY YOU, have to figure out if this is realistic or if the bank is taking you over-the-limit. Would you feel comfortable paying 33%, 40%, 50%, or even 65% of your gross income on housing expenses???? (plus, if you do work, an estimated 7.5% goes to fica,medicare; 20% federal; 5% state; and then health, dental insurance; and how about some 401k to possibly get company matching?) Only YOU have to answer this question, and whether you feel comfortable with that in a new home.
I have a different viewpoint… you shouldn’t close on a house unless you know you will have at least $20K in cash (adjust with size of house)… the ratio of debt to me is irrelevant. All sorts of things come up with a new house (not to mention new debt) and if you don’t have the cash you are taking a serious financial risk.
I leveraged out when I bought my place with 40-45% debt/monthly income….. I had to dip into my cash every now and then for the first year and the safety cash is definately something I am going to analyze prior to any future purchases.
To buy a house the safe way you should save 6 months of expenses as an emergency fund. Then buy a house that you can get where your monthly mortgage total is no more than 25% of your net monthly income.
(deleted upon request)
I liked the idea of deciding how much you can afford to BORROW rather than making the rule of thumb based on the total purchase price.
We own a very modest house now, but I’d like to buy in a better neighborhood in the next few years. Our current house is worth somewhere between 120K and 150K, I’m not really sure and don’t like to overestimate. I owe a little under 50K on it. I’d like to upgrade to a house worth 300K-400K. But I can’t afford to borrow hundreds of thousands of dollars. So my plan is to save like crazy until I have enough to make a 50% downpayment on a nicer house. That way, I’ll still be borrowing only, say, 1.5 times my gross income.
The other idea, if I can swing it, is to keep my current house when I upgrade, but I don’t think I can save enough money to upgrade without using the equity in my current house, so that’s more of a wistful idea than an actual plan.
People, “rule of thumb”, lets lok at rule of thumb of people who take a house 4-5x a persons salary, I like to call it forclosure. A person that makes $50,000 gross salary cant handle a 2000 a month morgage. Lets figure out weekly salary:
961.54 a week, minus about 30 % of what the gov’t robs from us $288 which leaves us 673.00 dollars. OK we have to eat lets figure we eat light only 50 dollars a week ok thats $625.00, now lets figure out car Ins. another $25 thats $600 left. Lets not forget about our property tax and you know how jersey loves to rape all of us, $50 thats $2400 a year (NOT IN THIS DAMN STATE) ok thats $550.00 a weak left so far. OK now our company we work for like many other companies today charge for our medical, another $40 gone $510.00 left over. This is looking really grim. OH shoot I have car insurance I have to put gas in the little crapper another 25 dollars a week. OK can’t pay the morgage now. People wake up and hope the housing market tumbles. The houses are not worth the money.
Everyday people can afford the depts they put themselves into. A morgage isnt for a year it’s 30 yrs. We couldn’t make a $2000 morgage with my numbers really, really low. And besides dont you want Little Johnny to have a good school, or dont you want to retire we have to save money how the hell are we going to do that when we can afford the morgage. Your right we will all be living on the streets. So I say the hell with you and your 4-5x. Thank you have a nice day
How much house can I afford if I can only dedicate about 800 total/mo on my housing bills (mortgage, ins, utilities)??
Someone will hopefully give me an answer.
Dave Ramsay recommends limiting mortgage loan payments to 1/4 of your take home pay, and doing a 15 year fixed. I tried to estimate what this would be in terms of annual gross salary; I think you’d have to earn 200K gross to afford a 250K mortgage. :-O
i think buying a house is complete hogwash. all you hear nowadays is real estate agents and home builders telling you that now is the ideal time to buy. Why? Interest rates can go NOWHERE but UP in the coming years because our dollar is sinking like a stone and we are in debt up to our eyeballs in this country. The only way for anyone to get into a house is with a creative financing package… it’s just looking so grim for us all.
I’m 26, I’m getting married in March. My fiance and I live in California. We both moved back in with our parents so that we could save money for the wedding and a down payment on a house. We make a combined salary of $105,000.00. With this 1.5-4% logic, we could barely find a house that is liveable after then insane 1.9% tax rates. Factor in the fact that there is absolutely NO guarantee that the housing market is an investment and I think we are better off renting, then taking the money that we are saving (say approx $1500 difference between mortgage and rent) and invest it in something a little more stable (5% cd/mm account) and I think we make it out a little better.
Newlywed-to-be: You’ve left one thing out of your equation:
The government encourages people to become homeowners by giving you SERIOUS TAX BREAKS on your income taxes. That should also be taken into account.
But, yes, when it comes to the housing market in So. Cal. (I live out here too), REALITY and AFFORDABILITY are two diametrically opposed things! It’s truly insane. I’m not surprised at the housing bubble bursting now. It’s not so much due to the sub-prime mortgages, I think, but to the fact that the whole thing was basically a PYRAMID SCHEME: As long as people kept coming in at the bottom (or rather, buying at the “top” of the market, in this case), everyone kept making money. However, once people “came to their senses,” the bubble burst.
Two years ago I, for one, looked at moving and simply BALKED. I would NOT pay $650,000 (PLUS taxes, plus HOA, etc. etc. etc.) for a 2 bedroom condo! That was when I knew the bottom was going to drop out of the housing market. People were going to wake up and realize the Emperor has no clothes. And, so, here we are now.
Nevertheless, over the LONG TERM, buying a house can still be a great investment (if you can find an affordable one to start off in), not only because of the tax breaks I mentioned above, but also because you ARE at least building equity – rather than throwing away the money for rent each month. Not to mention the fact that as long as California continues to experience population growth (both internally and thru immigration), the housing market will continue to grow steadilly (over the long run, that is).
Some things to consider. And, btw, congrats on your upcoming nuptials!
I can tell that I am reading a blog with posting by Americans (no offence I am a dual citizen – Canadian and American). Let me tell you a big difference between our two cultures – Americans are HOUSE POOR and they live off credit to the max. George Bush says “support our malls” and since few people question their president they go max out their credit cards (sooooooo stupid). My relatives and friends in the USA think nothing of buying a house they cannot afford. Even with tax breaks (which we do not get here in Canada for owning a house) I find many people are paying off their house until the day they die.
If you want my advice get a nice home with a reasonable mortgage. Make extra payments towards the principle every month and then get your house paid off in 10-12 years.
Then if you really want to keep up with the Jones you can sell your house and have a massive down payment on the house of your dreams.
That’s what I’m doing and my 1st home will be paid in full by the time I am 34 years old. In a few years I’m going to get a house on the water = but nothing too flashy because even with a big down payment I don’t want to be house poor.
my wife was the one who had great credit and was employed when we financed our first home 5 years ago; mine was ok but by no means great. we have made about 25% in equity since we bought, unless we have to way undersell our home. we did use about 33% of that equity to make some improvements, but these helped the house value, etc. basically, we own about 20% home after 5 years. not too bad i think.
now, my wife is staying home with the kids – a conscious choice and one we agreed upon, mind you – so we have been living on my income alone rather than the double income when we got our mortgage. since we are now looking to relocate due to a new job for me, i went and got pre-approved for a mortgage to help us be more serious. the lender found both of us to have “A1 credit” (my scores were almost too good to be true) but we were easily approved for a FHA loan that would be about 2.5 times my current gross salary. the lender said she could probably get us a loan for even more (about 3.25 my current salary) but i said “no way! i know we could never pay that back.” the lender applauded that reaction, actually. besides, the ace up mysleeve is that my salary is going to increase by about 13% with the new job. however, my goal is still to only get a loan for what i can afford now.
i realize that i must use credit to buy my home, but the key is notto overextend. unfrotunately, i just dont have enough cash lying around to buy a house outright. (maybe i can get a 3-4 year advance on my pay, eh?) basically, we live within our means so we can live. if anyone lives beyond their means, they will be homeless one day (and soon).
Great to read this in hindsight. We all know what happened to WaMu.
It almost seems crazy to me that anything in the 4 to 5 X income would be acceptable. Assuming you make $50K, you’re probably bringing home close to $3,100 a month. .MAYBE.
How much of this $3,100 do you really want going to your house? Then you have to worry about cars, kids, eating is always nice, car insurance, clothing, gas, utilities, repairs on the house.. it’s a long list.
We personally try to stay at 2X income as a rough number, assuming that you put down 20%. I’d recommend building a cash budget and see what you can afford. 30 years is a long time to be house poor. I know that we spent about $200K on our house and the payment after 20% down was about $1,500. Do you really want 50% of your $3,100 going to the house? We took out a 15 year mortgage (when I was 30 & kept it for about 6 years. We later refinanced and now our payment is less than $940 a month (even more manageable now that we have 3 elementary aged children) & we now have about 55% equity. Fortunately, our incomes have kept up so our ratio is now less than 1. We could easily pay the house off today if we really wanted to, but we’ll probably just wait a few years… maybe 5 or so.
The real point is, at no time were we ever house poor. We built out 3K sq ft (1/3 acre lot), 5 bedroom house in 2002 and watched our budget. The banks would of certainly given us more money, but I didn’t like their numbers or the real estate guy’s numbers. . More importantly, I’m the one having to live with & make the payments.
Safety is always a concern (no one cares more than you do). What happens if a spouse is unemployed, becomes ill.. you have to protect yourself & not get in over your head. Worst case, you’ll sleep very well at night knowing that even though you may not live in the fancy $500K homes or drive the really nice cars, etc. You have a little money in the bank and you’re not house poor. And you can still take 2 – 1 week vacations every year. After all.. it’s just a house.
good luck.
clicclic was dead on! Too bad more of us didn’t bet against the housing market and become stinking rich. (see john paulson)
How’s that 4x to 5x annual salary working out for everyone these days?
It all seemed so logical in 2007.
I wouldn’t go much over 2x salary and a 20-year mortgage. That would give you enough to spend on other things.
I am a first time buyer, recently out of college, with an economic paranoia. I currently am in sales/account management and am on a draw not commission income. I have been working at my current job for 2 years now. The draw says if I hit my numbers I will make 55k. First year I made 65k, second year 57k.
I am looking to buy a 2 bedroom condo for 250k (CA) range with 20k down, so a 230k loan. I will have a friend renting the other room; he’s good for the money; so no responses about relying on others is a bad idea ect; plus I know a lot of people in the area.
My question is, is their an equation to see how much I’d be making if the HOA is $350 a month, property mortgage insurance $150 a month, property taxes (whatever Southern CA is avg), housing expenses (avg, but in a new condo development so not as much as old), ect…………..Assume I am renting the room for $800 a month and assume I am getting a 5% interest rate on 30yr and assume I am for sure going to sell the condo in 5 years. Assume the condo does not appreciate nor depreciate. I am just confused with all these stupid expenses like HOA/PMI/interest rates/taxes if I am even making money or how much equity all have in the house after 5 years. I live in Southern CA OC, so all condo HOAs are high, and if I waited to buy a 3-4 bedroom detached house it would probably be a MINIMUM of 380k which I can not afford. I am single, no kids, ect. I get 400 month for car at my work, gas paid, cell phone paid, toll road paid, expense card for some lunches/breakfast, benefits ect. I do pay $50 month for student loans, and $100 for car insurance.
So can someone do all that math for me for like how much equity all have after 5 years. I assume a 230k loan with all the expenses like hoa,pmi, taxes my monthly payments will be like $1600, give or take 100-200, does that sound right? Do you think all qualify for 230k with only 2 years working income and a credit score of 700 only signing by myself?
Mel, i think if its 230k loan principal, 5 % interest FHA loan, $300 monthly HOA, its going to be about 2k monthly pmt and after your 60th month (5 years) it’s like $18,794 principal paid off + that original 20,000 equity so like about $38,794 equity.
Actually “rule of thumb” was a law back in the olden days. It meant a man could hit his wife with a stick not larger in diameter than his thumb.
Trish: The wikipedia entry on the topic contradicts that origin.
I look at it from the perspective of how much can I afford a month. I the extrapolate and figure out how much that adds up to over a 20 yr loan. I know I only want to spend x amount on housing per month. I will not buy more than I can afford.
These figures from rules of thumb should be taken as with confidence as the time it took time calculate them. Use it as a starting point, but (as this website has said) you should create a household budget. That will clearly give you an idea of what kind of money you may spend on a house knowing currently where all your money goes in a month. Take the time to create a budget and you will be rewarded.
I feel so low-tech. My rule of thumb was just the amount of house that worked out to a payment comparable to the rent I was paying before I bought the house.
That was three years ago. Now that I’ve refinanced twice since then, my required mortgage payment is a good bit less.
i think readers will also need to keep in mind current legislation regarding dissolving fannie mae and freddie mac. with new proposals stating banks will either have to keep 10% of loans on their books or/and take 10% losses of principals, their risk will have to raise consumer’s rates
I restrained myself to purchasing a property only 1/3 of my qualified mortgage amount with more than 20% down to avoid paying PMI. The realtor and mortgage lenders were eager to put me in something more expensive. Luckily, I read “Your Money or Your Life” in my 20s and decided quality of life was much more important to me than possessions. As others have mentioned, property taxes can be a burden. After I purchased, property values went down so much that my property taxes were significantly lower than what I had budgeted. Yay!
I generally use 3x gross income. 4-5x seems high unless you are willing to sacrifice in other areas (fewer vacations, dining out, etc).
The calculators and rules of thumb never seem to take into account one’s age and/or retirement plans. Saving for retirement is another area that by all reports is lacking and really, really, really, needs to be accounted for when planning budgets and how much home you can afford.
Agreed. Seems like NOTHING discussed today takes into account that all young people buying houses right now have to save all of their retirement funds themselves. Maxing out an 401(k)takes about $18k a year. Can millennials afford that AND a house that is 4-5x their gross?
I agree that 2.5x sounds reasonable. But is is feasible? Not always. I live in the Midwest, and here houses are relatively cheap. A 1200sq/ft house in a middle-class neighborhood that is clean and safe is going to run you about 120-150k. Getting something cheaper than that, that is also not in a bad area, is unrealistic. Very few people I know in my state makes more than 40-45k per year. That limits them to a total cost of 100k. Seeing the problem here?
Jonathan,
I’d like to get your thoughts on renting vs buying, especially after reading the below blog posts from Go Curry Cracker (a FIRE blog). I have always believed, based on popular opinion alone, that it’s better to buy vs rent except for a few isolated cases. Having never run the numbers myself, these posts shocked me. I can’t find fault in his logic. After having read these articles, the only reason to own, in my mind, is for the peace of mind that comes from the notion that owning a house offers more stability vs renting and also having the ability to do what you want to your house.
http://www.gocurrycracker.com/renters-for-life/
http://www.gocurrycracker.com/how-i-made-102k-in-real-estate/
In case you’re wondering, I have no affiliation with the Go Curry Cracker blog. I just wanted your opinion on the buy vs rent argument.
I have no horse in this race; buying or renting is a personal decision and it involves both math and personal preferences. There is no single answer for everyone. Certainly if I could rent an condo/apartment in Taipei for $1,400 a month when it would cost $1.5 million to pay, I’d rent. As someone who rented for 10 years of his life and only owned a home for 8, both have pros and cons. If you admit that the intangible benefits of homeownership have real value (one might be your spouse’s happiness) then that changes the decision too. Old post:
https://www.mymoneyblog.com/the-intangible-advantages-and-disadvantages-of-owning-a-home.html
Home prices will vary but big rent hikes have also been in the news recently. Stock market returns aren’t guaranteed, either. I don’t value mobility much anymore; I have no plans to move to another city. Being close to FIRE, I won’t have to in order to seek work. I’m happy owning my own home free and clear, not caring about the fluctuations in either future rent hikes or home prices.
These ratios are good starting points but a budget is the way to go since everyone’s situation is different.
Only one question…why would you want to buy the biggest house that you could?
Where did anyone say that? See last paragraph.
Only 2-3X your gross income? So much for the middle class being able to buy a home in California then.
Some great rules of thumb here. Getting a house can be a huge ordeal – but there are ways to figure out if you’re in the right ballpark. Thanks for sharing!
If you are not already rich and want to be rich one day, you should NOT take CNN’s junk literally. Instead you should change the quote to: “The rule of thumb is to aim for a home THE PRICE OF WHICH IS about two-and-a-half times your gross annual salary.”
Very interesting to read the comments and understanding the mindset in 07. I think spooky is a better word than interesting. Its like reading newspaper clippings and journal entries from a society that unknown to them at the time, was about to be destroyed. Sadly, I still hear opinions that favor 4-5x annual income. This could work for high-earners but for average-earning people, no way. The math is so simple that I don’t understand how people can get themselves in this type of hole. I literally am surrounded by more intelligent people than myself on a daily basis. I struggled through my college math courses and I can easily figure this math out. If you make 45-70k per year you cannot afford 4-5x your salary. You can’t. You can’t. You can’t. You might be able to maintain it for a while but when something big comes up like a 10k septic repair or a 15k roof you will be up a creek. If you cannot afford a nicer house then you cannot afford a nicer house. Same goes for living in California or New York.
In the San Francisco area, a condo for less than 1,000 square feet easily goes for $500K. A librarian salary is about $50K/year. This would be 10X the annual salary.
I built this Mortgage and Budget Calculator using Tableau Public. It is a great way to figure out what you can afford.
http://skrumz.com/2016/08/06/mortgage-budget-calculator/
The rule of thumb is merely situational. For a vet I know, he makes 53000 yearly. His health insurance is 100% carried by Tricare for him and 1 child. His only debt is 151.00 for student loans. His 401k is matched by his employer and outside his household bills, he’s able to save 1500 a month after purchasing a home for 220,000. He lives in the South east