Everybody's Wrong About How Much House You Can Afford

By Matt Bell on 9 November 2016 2 comments

A home is one of the most expensive — and most emotional — purchases you'll ever make. That high cost and high emotion combination can be dangerous, tempting you to spend so much on a house that it ends up owning you.

Instead, buy a house you can actually afford. What is a reasonable cost, you might ask? For starters, ditch the conventional homeownership wisdom, and consider this plan to help you buy a home you can truly afford.

A Reasonable Percentage

I've spent a lot of time crunching numbers to come up with recommended cash flow guidelines, showing how much various sized households with various levels of income can afford to spend on everything from clothing to vacations. All that spreadsheet time gave me more than a headache; it gave me a deep appreciation for the importance of keeping housing costs under control.

Here's what I found: If you're going to be able to save for emergencies and near-term purchases, invest for longer-term needs such as retirement or your kids' college costs, live generously, and enjoy some financial breathing space, you have to keep your total housing costs (mortgage, property taxes, homeowner's insurance, and association fees, if applicable) to no more than 25% of monthly gross income. Preferably, no more than 20%.

Even more radically, I recommend that two-income couples run the numbers on what they can afford based on just one of their incomes.

I know this all probably sounds ludicrous, but hear me out.

But I Qualify for More!

Mortgage lenders will typically allow you to devote 28% of your gross income to housing costs. They assume you'll have other debts as well and will be fine with that as long as it takes no more than 36% to 40% of your gross income to cover your housing costs and these other debts.

But mortgage lenders aren't the ones who'll be making the payments. You will.

Keeping your monthly housing costs within the parameters I suggested, and holding no other debt, will do wonders for your solvency and stress level.

Why Not Use Two Incomes?

If you're a double-income household, think twice before basing your housing decision on both incomes.

If you don't have kids but would like to someday, and if one of you would like to step out of the paid workforce for a period of time in order to be home with your kids, it'll be a lot easier to transition to that life if your home doesn't require two incomes.

That was the single best financial advice my wife and I received before we got married. Following that advice meant renting for the first 10 months of our marriage and then buying a condo in what our realtor optimistically described as "an up and coming neighborhood" in Chicago.

After our first child was born and my wife left her job to be home full-time, the financial transition wasn't very difficult at all.

The key to getting acclimated to living on one income is not getting acclimated to living on two incomes in the first place.

If you don't plan to have kids, or if you do but you both plan to continue working full-time, it can still be dangerous to buy a house that requires two incomes. What if one of you loses your job?

Choosing to transition from two incomes to one because one parent wants to stay home for a period of time is one thing. Being forced to make that transition because one spouse goes through an extended time of unemployment is far more painful.

What If You Already Have a Two-Income House?

Very often, when people say they can't afford to save, invest, or support charitable causes they care about, it's because they're spending too much on housing.

If you're in that situation, consider something radical. Consider moving to a home you can more easily afford.

There's nothing easy about moving. I realize that. But I know two couples that have sold homes they realized they really couldn't afford. In both cases, moving was difficult, time-consuming, and even embarrassing. But both couples are so happy to have made the move. It's been better for their finances and their marriages.

Keeping your housing costs reasonable is an essential part of wise money management. That means keeping your housing costs to no more than 20% to 25% of monthly gross income — and preferably basing that on one income. It's a radical idea, but it may just enable you to enjoy your home without financial worries. And that's worth more than extra square footage any day.

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Guest's picture
Guest

What an excellent article, Matt Bell! Americans need to hear your advice in this article over and over again!

Guest's picture
PurchaseWisely

And for those of us who are single and live in Southern California, best of luck following this advice. I purchased a house for below market in a not-so-great area because it needed major repairs (roof, drains, pipes, etc., which I budgeted for). The payments (including taxes, no PMI) on a loan with a 4% interest rate are still almost 40% of what I take home. I consider myself fortunate because I have no other debt, so I can still save for retirement and put a little aside for emergencies, but not much. Rent was even higher than my mortgage, so this made more sense, but only because I'm a DIY-er with a construction background.

Matt Bell's picture

Purchasewisely - Keep in mind that my guidelines are based on gross income, not take-home pay.

Still, I hear ya. Those living in high housing cost areas may need to devote more of their monthly gross income to housing. Of course, that means you'll need to spend less than I recommend in other areas, such as entertainment or vacations.

But my bigger point is that no matter where we live, the ability to save and invest adequately, live generously, and enjoy financial margin will usually require spending less than most other people around us spend on housing.