There are a lot of rules of thumb used to determine how much house you can afford:
However, I think both of these can lead you into bad decisions.
Knowing how much house you can afford is something you need to get right.
If you don’t, you will end up buying too much house.
And when you buy too much house, it is really hard to make progress financially.
One key to success financially is to keep your fixed expenses in line with your income (or below).
So how much house can you afford?
Let’s first talk about why each of those rules of thumb are not perfect.
1) You can afford 28% of your gross income going to housing costs (some use up to 35%)
I personally do not use net or gross in this calculation for my clients.
Why?
Because it doesn’t take into consideration anything else going on in your life.
If you use gross, what if you are in the 37% bracket + another 13.3% for a state like California?
This would mean that if you used the 35% number, most of your take home pay would go to your house.
On top of that, it does not consider:
This is exactly why you need to dig into all these variables to make a decision.
2) You can afford up to 40% of your net income going to housing costs
A lot of people like to use net, but I do not.
Net actually could deter people from doing the right things financially.
The person who:
Would be seen as someone who could afford less house, when in reality, they are actually someone who could afford more house than the person avoiding those things.
On top of that, all the other variables to consider still come into play.
So, how do you nail down how much house you can afford?
It all starts with understanding your own budget and what fits in there.
And I always start with an investment rate of 20%.
So after investing 20%, how much room in your budget do you have to spend on a house, inclusive of property taxes, insurance, and any other expenses you need to plan for?
Let’s say you make $600,000 and have an effective tax rate of 35%.
This means you would take home about $30,000 a month after your 401(k), HSA, and other benefits.
To be on track for a 20% savings rate, this person invests another $80,000 outside of their work benefits.
This means they have about $23,300 a month to spend.
Let’s say their expenses outside of their home are $12,000 a month.
This means, they have room to spend a total of $11,300 all in on housing costs.
This is truly how you figure out what you can afford to spend on a house.
You back into it.
If this person had an income drop coming, daycare starting, daycare stopping, etc. it would change what they could afford.
The only way to truly figure out what you can afford.
This ends up being about 23% of gross income.
If their other monthly expenses were lower, they could afford more house.
If their other monthly expenses were higher, they could afford less house.
You have to dig into all the variables to see what works for your life.
I have clients who spend 40%+ of their gross income.
And others who spend under 10%.
It depends on what you want and what fits!
Financial Advisor