How much house can I afford based on my income? I’m leading with this question because the amount you spend on your home, is one of the biggest financial decisions you’ll ever make.
The purpose of this post is to look at two financial rules of thumb for buying a home that can protect you from making a big mistake.
Rule of Thumb # 1 for Buying a House = 10 Years
Before even considering buying a home, make sure you’re prepared to live stay there for 10 years. If you’re likely to relocate inside of 10 years, you’re better off renting.
If you haven’t thought that far ahead, try to answer the following questions:
- How is your job security?
- What are the chances you’ll have to relocate for your job?
- Have you ever dreamed of living somewhere else, but didn’t think it was possible?
- Is it likely that you’re going to change careers in the next 10 years?
- Will you outgrow this house in ten years?
- Will this house be too big for you in ten years?
- Will you want to move to get into better school districts?
The ten year rule of thumb might sound conservative to you, but I promise you it’s not. Just look at what has happened in the past five years in the housing market.
Rule of Thumb # 2 for Buying a House = 28% and 36%
If you really want to know, “How much house can I afford based on my income” here’s your answer–your principal, interest, taxes, and insurance on the house shouldn’t exceed 28% of your monthly income AND your total debt payments should never exceed 36%
The total amount you could afford, i.e. $250,000, will vary depending on what interest rates, taxes, down payment, and insurance premiums are at the time of purchase. The important thing to keep in mind isn’t to exceed that 28% or 36% mark.
This will seem small compared to what your mortgage broker or real estate agent might tell you, but do they really have your best interest in mind? A good mortgage broker or real estate agent is very helpful to the home buying process, but still, they shouldn’t be giving you financial advice. The more you buy, the more they make.
One more thing, if you’re currently a two income couple, who plans to have kids, in which one of you will be a stay at home parent, don’t calculate how much house you can afford based on both of your incomes. Since you’re going to be living off of one income in the future, only use one income to determine how much house you can afford.
How Much House Can I Afford Based on My Income?
Even if you plan on living somewhere for ten years and you can afford to buy a home for 28% of your income, don’t automatically think you have to buy a house. A house comes with a lot of responsibilities.
A day will come when you have to make a decision to do maintenance on the house or spend the money on something you enjoy. When the estimate for repairs is sitting on your kitchen table, and you have to make a choice, what will you decide?
In the comments, for those of you who have bought a home, what rules of thumb did you use? Did you make any mistakes? What did you do well?
For those who haven’t bought a home, would love to hear if you ever plan to buy. I know a lot of Gen Y’ers, who plan on renting for the rest of their lives. If so, why?
{ 11 comments… read them below or add one }
I currently rent even though I could qualify to buy. Not only do I not feel ready to commit to being in the same place for several years but I don’t want the expense! In my city real estate is extremely expensive (condos are $300,000 ish in the SUBURB I live in- not even a desirable area) yet I can rent an older apartment for only $500. Just wouldnt make sense to give that up then have to throw away money on strata fees and property taxes. I love that I could take off on one months notice at any time. (I’m located in Vancouver Canada)
Wow $500 difference. Makes me want to live in Vancover. Although, I wouldn’t want to be a fan of the team that gets beaten in the first round by the Blackhawks. (:
Hi! had this convo with a girl at a baby shower this weekend. We were talking about the fact that a lot of young couples get married and then buy a house right when they have their first kid, they feel like that’s what they “should” do in order to be a real grown up.
But, then they have another kid and they outgrow that house about 2 or 3 years later and end up trying to sell that first house to get in another bigger one, that can fit a family of 4. (They don’t buy the bigger one when they’re first married because they usually can’t afford it)
This sounds like a whole lotta buying and selling and moving to me. I don’t know why people don’t think about how large they think they want to grow their family, so maybe 2 kids, and plan around that? Rent during your first kid then buy once the second is on the way. Obviously all has to go smoothly for this in terms of rent prices, interest rates, job, ability to have second kid etc. Anyway….seems like a lot of people buy and then want to sell 3-5 years later after having another few kids. With a little planning they’d save time and money.
Oh, and If you’re buying a condo, don’t forget HOA’s, Home Owners Association dues. They can be hefty!
Kathryn – Great point.
Unfortunately, I’m one of those people who bought a house and then want to move in a few years. I could have used some advanced planning at the time, but as I’ve said, after I got married, I just thought the next step was to buy a house. So I know the hard way, exactly what you mean.
Alright, I think the perspective of the big bad mortgage guy is missing here, so I shall provide some quick points:
- mortgage professionals/real estate agents definitely have the ability to make more off higher loans, however, regulation and ethic standards have come far in the last few years. Anyone pushing a buyer to go higher on price than they feel comfortable is not only violating ethical practices, but my guess is there is a decent chance they would be reprimanded by regulatory enforcement. Not to mention the impact on that professionals reputation, which is important for the longevity of their career.
- Rj is right, the best question to ask yourself (and answer the best you can) is where will I be in the next ten years? In retrospect over the last few years, I think I would encourage younger buyers to rent just based on the idea that so much can change in your early/mid twenties. However, on the other side, when a potential buyer has made up their mind, its hard to make them think otherwise
- Lastly, I rent. But that isnt because I dont think buying a home is a great idea/good strategy. It’s because I know I don’t want to live in the area that I want to buy a home in, quite yet. This goes back to the looking forward idea. However, rents all over the city of Chicago are increasing. As they continually increase, buying a home becomes even more attractive. There are plenty of people buying now, paying less than what they do in rent, however, unlike renters, each monthly payment they make increases their equity in the home, not to mention that their monthly interest helps to reduce their income taxes (just throw appreciation out completely for the time being).
Just wanted to add some prospective from the other side.
A couple of thoughts
You’re right, they have gotten rid of a lot of the bad people out the business. I also didn’t mean to bash these people. I couldn’t have bought my house without their expertise. My point was that, you should never ask a realtor/mortgage broker how much house you should buy. You should make that decision based off of your situation.
It’s also extremely hard, once someone gets the idea that buying a home is the next step, to change their mind. I admit, I made this mistake.
We could probably go on and on about the short-term vs. long term advantages and disadvantages of renting vs buying. There really isn’t a perfect time to buy because you can’t predict the future.
You are dead on about that, people call expecting you to tell them they can only be approved for X amount when they can be approved for way more than they need. It is a better idea to call, knowing you only feel comfortable paying a certain about, and just make sure you can be approved for that amount.
I think the first litmus test is extremely important, especially in light of recent developments during the downturn. What I learned from the fallout of the sub-prime crisis: A home is a place to live, not a speculative investment. Restoring that mindset is critical.
When we first started looking we had a set number on what we wanted to spend, but then something strange happened, we actually went into the houses that were selling for our number. I have rented some pretty suspect places and there was no way I was going to spend $200k on a house that needed repairs, upgrades and wasn’t in the best neighborhoods.
When we went up to the full 26% range and decided to spend an additional $20k on the house the quality of homes increased dramatically and after almost two years we couldn’t be happier. I love the fact that this is our house and if we want to paint we can. I lived with white walls for ten years, it is nice to have color in the home.
Good to have you back Patrick!!!
Sounds like you did your homework and stayed in your price range.
I bought a house that I am intending to be an income property in the next 2 to 5 years. Fortunately, it worked out that a college buddy of mine needed a place to live and I had an extra bedroom, so it is already producing. Anyway, I have been kicking myself a little bit because I opted for the 15 year mortgage over the 30 year to save a quarter percent on my interest rate. But with the interest so low, I feel like investing the money elsewhere could’ve given me a much better return over that term than saving a quarter percent on the mortage. The quicker I pay the mortgage off though, the better I can cover my mistake up, but in buying vs. renting, there is a lot to consider outside of just what you want/need in a house. Being a Gen Y’er, this was the first time I learned how important the long term is for decision making.