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Buying a house should not feel scary. But if you buy too much, a house becomes a curse instead of a blessing in your life. Let’s do the math on how much home you can afford to stay in “blessing” territory.
With the different types of mortgages out there and choices of lenders, there are varying options that figure into how much you will pay up front (down payment) and monthly over time (mortgage payment). Your personal financial situation can dictate these two levers.
Check out our main blog post on everything home-buying to learn more about if home buying is right for you, how to save up for a home, and more here!
The trifecta of home buying rules
Rule #1: Aim to purchase a house that costs no more than 3x your pre-tax income.
Why? This will allow you to still have room to save for your future self and not feel the budget crunch. Housing is most people’s largest expense, so keeping this in check will save you from a lot of “three dollar decision” angst over lattes. By keeping the target price at no more than 3x your pre-tax income, you are ensuring that you’ll be able to comfortably handle the mortgage and expenses of your home while also being able to save up for eventual financial freedom. If you can ensure that after the purchase, you can still save ~20% of your pre-tax income, then you are super set.
Is there wiggle room on the 3x rule? You may have to stretch for high cost of living areas, but stretching is 4X, not 10X. Stretching comes with consequences—fewer vacations, less nice cars, no private school, a less luxurious retirement, and/or a longer career.
Let’s look at a quick example: If a family has $300,000 of pre-tax income, we would advise targeting $900,000–$1,200,000 as the house purchase price (3x–4x pre-tax income). At or below $900,000 would be very affordable, and anything above $1,200,000 would mean the family starts sacrificing financial flexibility, longer-term savings, and wealth growth.
Rule #2: Have at least 30% of the home value saved before purchasing.
If you have at least 30% saved up, on hand, ready-to-go in cash, then you are in a really great position to purchase a home. This accounts for a down payment (20%), closing costs (5%), and a buffer for any unexpected expenses—moving, furnishings, repairs (5%). Putting down anything less than 20% for your down payment will require you to pay for private mortgage insurance (PMI), which increases the cost of your mortgage. PMI protects the lender of your mortgage on the chance you default on your loan. The cost of PMI will either be added to your monthly mortgage amount, to the closing costs when you finalize your purchase, or in the form of a higher interest rate on your loan. PMI expenses will remain in place until you have paid down your loan to 75%–80% of your purchase price or reappraised home price.
You don’t want to be dangerously exposed in the case of emergencies. That means that after all the expenses and mortgage payments, you can still put aside 20% for your future self. Green lights from there from a financial standpoint!
On a $1M house purchase, this would mean $200,000 for down payment, and $50,000 for closing, and another $50,000 in buffer.
Rule #3: Do not spend more than 30% of pre-tax income on housing costs, your mortgage, and other debt.
Another useful guideline is to keep all housing costs (mortgage, insurance, taxes, and utilities etc.) and your other debt payments (student loans, auto loans, etc.) to less than 30% of gross income. You can use annualcreditreport.com to get a free report to figure out your monthly obligations. By keeping your debt-to-income ratio low (less than 30%), you will qualify for better mortgages. It also ensures that you will be able to handle all of your expenses after purchasing the home.
The reality is that you will probably qualify for more mortgage than you actually want to carry long-term, but we’re intentionally conservative here to allow you to still build wealth alongside enjoy the present with your house. You can accomplish this by putting down a larger down payment.
We’ve added up these rules together into a Home Affordability Calculator which you can play around with to determine what home prices will work for you. Check it out here!
If you’re looking for a specific yes / no answer, and want to walk through this decision with us? Reach out to me at firstname.lastname@example.org and schedule a call to set up a no-cost, no-obligation process for prospective clients.
Read more about all things home buying here:
- To Buy or Not to Buy a Home?
- Where Should I Save Up For a Home?
- How to Approach Financing Your Home Purchase
- How to Make Your Offer Stand Out in a Crowded Market
Interested in learning more about whether a home purchase is right for you and how you can best save for it?
Steward ‘s mission is opening up the 1%’s wealth strategies to America’s up-and-coming families with a combination of 21st century tech and trusted advisors. We help families determine how, where, and when to invest and save on taxes in plain-English, with minimal time and effort. Steward can help you determine if a home purchase makes sense, how much home you can afford, and how to invest and save in the most efficient way. Give it a try here.