How Much House Can You Afford?
Buying a home is part of the American dream — it’s ingrained in our culture. Most people will go through the home-buying process at least once and since it’s likely to be the largest purchase of your life, it’s a decision that will have a lasting impact on your finances. Naturally, figuring out how much house you can afford is the first step.
Before getting into how to determine if a house fits your budget, it’s important to realize that buying a house is one of the most emotional decisions you’ll make. It’s much more of a lifestyle decision than a financial one. You spend a lot of time in your home. It’s a place to call your own, a refuge from the stresses of the world. It may be the place where you raise a family. It’s a significant decision.
Unfortunately, because of the emotional nature of the purchase, you’re likely to break most, if not all, of the financial rules you’ve set for yourself.
When you find the house that you’ve been looking for, you’ll immediately start talking yourself into it regardless of the price. The justifications are endless. You’ll know when this is happening when you hear yourself say things like, “It’s only slightly over our budget” or “I had a really good year at work!” or “For this neighborhood, it’s a steal! I can’t believe they’re listing it this low!”
The following video is a hilarious representation of the mental gymnastics we perform to justify buying the house we want.
Before you start on the emotional rollercoaster that is buying a house, you do need to take a look at the numbers and see what you can actually afford. The following principles will help guide you in your decision:
Keep your monthly mortgage payments under 25% of your gross income
For example, if your annual gross income is $100,000, your mortgage payment shouldn’t exceed $2,083 per month.
Being “house poor” means that your housing expenses account for a large portion of your monthly budget. These housing expenses include mortgage payments, property taxes, insurance, and utilities. Being locked into a monthly payment that’s too high will put a lot of stress on your finances. You’ll likely have to cut spending in other areas and typically, the first thing to go after adding too big of a mortgage payment is savings.
Keeping your monthly housing costs under 25% of your gross income will allow room in your budget to keep saving and spending comfortably.
Don’t use all of your cash for a down payment
A key financial principle is to have at least three months of living expenses set aside in a checking or savings account. This money should be put away to be used for emergencies or an unexpected expense. Don’t dip into that emergency fund for your down payment.
If you have to use all of your savings on a down payment to get the monthly payment to fit your budget, it’s probably too big of a house.
Don’t stop saving
Even though a house is an asset, when you consider inflation, home appreciation isn’t very impressive. Rarely do people sell their house and use the equity they’ve built to fund other financial goals. The equity will most likely be rolled into another home because you’ll always need somewhere to live. So, your mortgage payments should not replace long-term savings. Maintain your savings rate regardless of your housing costs.
If you’re monthly payments cause you to lower your long-term saving, it’s probably too big of a house.
If you can stick to these three rules, you’ll be in great shape. Although, even as I write them I know the allure of the “perfect house” will erase them from your memory. And I don’t necessarily think that’s a bad thing. House-buying isn’t a black and white financial decision; it’s a lifestyle choice. However, a simple and extremely effective way to have more money and build wealth faster is to spend less on housing. That means buying a house you can actually afford.
Thanks for reading!
*Shout out to Will Gochnour for helping me come up with the house-buying principles. Also, to Ryan Oldroyd for introducing me to the Louis CK video.