If you’re in the market for a home, chances are you’re wondering how much you can afford. A common misconception is the amount you’re qualified for at a mortgage company is how much you can afford. But that’s not necessarily true.
The amount you’re qualified for is only the amount of risk the bank is willing to take on you.
And that risk amount could be more than what you can safely afford to spend on your home. As we saw in 2007 through 2009, don’t assume the bank has your best interests at heart.
Instead, there’s a simple rule of thumb, called the 28/36 rule, which you can use as a starting point to determining how much of your salary you can spend on a house.
How Much Of Your Salary Can You Spend On A House?
Let’s talk about the 28/36 rule in more detail. Don’t worry, it’s easier than you think.
The 28/36 Rule (A Starting Point):
A common guideline is the 28/36 rule. This suggests that:
- Housing Costs ≤ 28% of Gross Monthly Income: This includes your mortgage principal, interest, property taxes, and homeowner’s insurance (often abbreviated as PITI).
- Total Debt ≤ 36% of Gross Monthly Income: This includes your housing costs plus other debts like car loans, student loans, and credit card payments.
Example:
If your gross monthly income is $6,000:
- Maximum Housing Costs: $6,000 * 0.28 = $1,680
- Maximum Total Debt: $6,000 * 0.36 = $2,160
Factors Beyond the 28/36 Rule
While the 28/36 rule is a useful starting point, it’s essential to consider these additional factors:
- Other Savings Goals: Are you saving for retirement, a down payment on a larger house in the future, or other significant expenses? These need to be factored into your budget.
- Location: Housing costs vary dramatically by location. What’s affordable in one city might be impossible in another.
- Lifestyle: How important is having a large or luxurious home to you? Are you willing to sacrifice other spending to afford a bigger house?
- Interest Rates: Higher interest rates mean higher monthly mortgage payments, which can impact affordability.
- Down Payment: A larger down payment reduces the amount you need to finance and can lower your monthly payments.
- Maintenance and Repairs: Don’t forget to budget for ongoing home maintenance and potential repairs. These costs can add up.
Dave Ramsey’s Approach
While the 28/36 rule is a great starting point, it’s also not the only formula.
For instance, Total Money Makeover author and radio host Dave Ramsey’s view differs slightly. Ramsey recommends that your monthly mortgage payment (including principal, interest, property taxes, homeowner’s insurance, and Private Mortgage Insurance if applicable) should be no more than 25% of your take-home pay.
He emphasizes a 15-year fixed-rate mortgage to accelerate payoff and minimize interest paid (although I don’t recommend 15-year mortgages because they pigeonhole you into a much larger monthly expense).
He also strongly advises against buying a house until you are debt-free (except for the house itself) and have a fully funded emergency fund of 3-6 months of expenses.
It’s important to note that this 25% is based on your net income, not your gross income. Net income is after taxes are taken out. It’s the amount deposited into your checking account.
This is a more conservative approach than the 28% rule (which uses gross income). Ramsey’s approach prioritizes rapid debt payoff and building wealth through investments, often advocating for smaller, more affordable homes to achieve these goals.
In the end, there’s no one-size-fits-all answer.
The best approach is to carefully consider your financial situation, goals, and priorities. Creating a detailed budget and exploring different scenarios can help you determine how much you can realistically afford to spend on a house.
Talking to a financial advisor can also provide valuable personalized guidance.
