How Much House Can I Afford?

Jeremy writes in with the following question regarding maximum mortgage payments for a new house:

What percentage of your net income should go towards a mortgage?  I don’t want to rush into anything so I was hoping you could give me some ideas as to what to avoid.  Would you consider giving me a couple pointers?

Thanks for your question, Jeremy. Before we get into specific numbers, I have to commend you for even taking the time to ask the question. Unfortunately, many people are still rushing out to sign up for a mortgage without considering the years of financial obligation they are taking on, and what impact that will have to their overall financial plan down the line.

The 28/36 Rule

There are several ways to look at the answer to, “How much house can I afford?” Some people, including most Realtors and mortgage brokers, banks, etc. use what’s called the 28/36 rule. The formula means mortgage lenders like to see your monthly mortgage payment come in at less than 28% of your gross income, and your total monthly debt payments, including your mortgage, represent less than 36% of your gross income. Notice I said gross income, as in before taxes and deductions. The fact you asked your question specifying “net income” means you are on to something.

When someone asks how much our annual income is we typically respond with our annual salary, and any other income from self employment, etc. But the number we use to budget from, and live off, is much lower after Uncle Sam stakes his claim along with benefits deductions for health insurance, and other employment-related expenses that come right out of our paychecks. So why not use this figure to determine mortgage affordability?

Because using gross income increases the amount of house agents can sell you and mortgage brokers can lend you, which means higher commissions and larger interest payments in their pocket. It’s not that they are doing anything wrong, it is just a different way of looking at the question of affordability.

The Frugal Mortgage Calculator

I actually have a more frugal formula for determining how much you can borrow for a home. I personally would not spend more than 25-30% of my take home pay on housing. So if your combined household income is $4,000 a month, meaning the direct deposit or paychecks from your employer totals $4,000 a month, then I would not spend more than $1,200 a month on a mortgage. To do so would mean giving up money towards another financial goal such as debt freedom, kids college savings plans, or even an early retirement.

What If the House I Want Comes With a Higher Mortgage?

Well, this is a case of suffering from champagne tastes with a beer pocketbook. Who doesn’t want to buy more than they can afford at some point in their lives? As I see it, you have three options.

  • Ignore my advice and buy the bigger home with a bigger mortgage payment.
  • Save up for a larger down payment to drive down the amount financed, and the resulting monthly mortgage payment.
  • Shop for a more modest home.

Of course I would strongly consider option number three, because larger homes come with larger expenses (taxes, utilities, maintenance, etc.), even if you can get the monthly mortgage payment lowered with a large down payment. Still, option two does have some advantages. By waiting to save a larger down payment, chances are you can also clear some debt, which may improve your credit score and qualify you for a lower interest rate (and a lower payment). Still, consider the increased costs of owning the larger home, even if you technically qualify for it based on income.

If you are wondering, we currently spend about 18% of our monthly take home pay on housing. But that wasn’t the case when we first moved in (fortunately our income has increased over the years) – and it caused a real pinch those first few months. Don’t make the same mistake we did!

Ask the Readers:  How much of your take home pay are you currently spending on housing?

Comments

  1. We bought a fairly modest home two years ago. We spend 22.5% of our monthly income on housing. We hope to refinance, though, to a lower interest rate (and a 20 year loan), which will result in a slightly lower mortgage payment.

  2. This came just in time. I was going to do some research on this. Me and my husband just experienced a huge drop in income and most likely will have to move because we can no longer afford our current house. We will probably be renting instead of buying. Do the same numbers apply?

  3. @Shanna: Yes, I would apply the same numbers to rental housing. You may find you can rent a slightly better home since taxes and insurance aren’t part of the equation (though you should consider renter’s insurance to protect your contents–it is fairly cheap).

  4. Zero. We paid our mortgage off this year. We had planned on upgrading to a larger, more expensive house but decided with the economic downturn to stay where we are. Instead we have built a huge deck and arbor and finished a bathroom in our basement, all with money we had saved. We have zero debt. Feels great!!

  5. Very interesting article. I wonder if this is one of the occasions where using a % figure is only useful as a guide.

    If you earn $10,000 per month net then spend 25% on your mortgage then you’ve got $7,500 to spend on everything else. Not so easy when you earn $2,000 a month and have $1500 left.

    I think my point is to look at all your out-goings and see what is left. Only then can you decide how much mortgage you can afford.

    Great site – keep up the good work.

  6. Dear Frugal Dad,

    I am living in the Netherlands. In september 2008 I was finally able (aged 42) to buy my first own appartment. I am currently spending 43% of my income before taxation (or 55% after taxation)on interest and mortgage re-payments. Although at first having my own home seemed a very nice idea, now it just really is too much trouble and worries. Luckily I met a wonderfull lady and we are planning to start living together. First we shall live together in a small rented appartment and save up. Living together will save us about USD 1.725,00 a month on mortgage (re)payments. In one or two years from now we hope to have been able to save up enough, not only enough for a move to a (tad)larger rented appartment, but also beeing able to live a really nice live as a family as well. Will we buy ourselves a home in the future? Not likely, saving up is a far less risky investment and being able to move house on a short notice is a very relaxing idea. (I also decluttered a lot)

    Thank you Frugal Dad for helping us to decide and to choose the right thing to do (and not spending our money anymore on stuff we do not need)!!

  7. We just recently refinanced to a 15 yr at 4.5% and our payment comes to 23% of our take home pay. We follow Dave Ramseys baby steps (Total Money Makeover) and are on baby step 6, Pay off the house early, so we are putting extra principal payments into our budget which is nice to do now that we are debt free but the house!

  8. Our house payment is now about 25% of our net take home pay, Right about where it needs to be. That will drop slightly when we finish our refinance.

    Now to start making extra payments on that mortgage after saving 15-20% for retirement, and we’re well on our way!

  9. Wow, our rent is about 1/3 of our take home pay. Granted, we do live in downtown Chicago, but wow.

    And that will be going down courtesy of a rent decrease.

    I’m comfortable with that, though, because we choose to spend less on other things – we don’t really go on vacation, and we have a cheap car (yes, it’s necessary, even in downtown Chicago for us), and we don’t really go out.

    Frugality’s all about choices, I guess.

  10. Zero. Paid cash for house.
    7% if you include taxes and insurance.

    My personal rule is 25% of take home pay, if
    I get into buying a home again.

  11. We currently rent and our rent is about 23% of our net income. We’re currently saving up for a house and plan on our mortgage insurance taxes being no more than our current rent. I like having information like this as a guide because it can give you a good idea of how tight money will be if you make a certain decision.

  12. We spend 24% of our take home pay on the house payment. That includes taxes and insurance which I am not sure if you meant for us to include those or not.

  13. @Marci: Have I told you lately you’re my hero?! Don’t meet too many people these days that have the discipline to pay cash for a home. Even if they have the cash, they justify the mortgage for “tax purposes” and use the cash elsewhere. Not owing a mortgage or rent payment must feel great.

    To the rest of us–imagine how fast we could build wealth, or experience financial freedom, with no housing payment! If you are like me, and didn’t pay cash for a house, the next best thing would be paying it off early like Bible Money Matters mentions above.

  14. @Vicki and Marci:

    You RULE! I aspire to be more like you.

    My minimum mortgage payment is 8% of my gross (I work very hard, with 60 hour weeks and what amounts to three jobs). I make extra payments because my mortgage must die. It’s the last of the debt… no student loans, no car loans, etc.

  15. If I pay $1,000/mo to rent an apartment, how much should I expect to be able to afford on a house if I want to maintain my current monthly payment, assuming an average interest rate, taxes and other expenses? My wife watches a lot of HGTV and seems to favor houses around $250,000. That seems quite a bit out of reach at this point to me.

  16. Ours is going up from about 19% to about 29% this week actually…we move on Thursday. We’ve planned and planned for years and feel totally comfortable taking on a higher mortgage. We also hope to pay it off in about 15 years, right before our son starts college, should he choose to do that.

  17. It is also important to consider related costs for where you live. We bought a more expensive home – it’s right under 30% of our take home pay – but it has great access to mass transit for my husband, and I can walk to work. (And our kids to school.) This means we’re that rarity in the US – a one-car household. And our car is long since paid off. I’m still a little nervous having such a high ratio, and we’re extra towards our mortgage to lower that ratio. But when we chose between this home and one farther out? The math favored the higher mortgage.

  18. @Frugal Dad – Thanks :)
    Only fair to say that I did not pay cash for the previous house tho, but it did come in at about 30% of take home pay. Took a 30 yr mortgage and paid it off in under 10 years. When it sold, I saved the cash til I was ready to buy another home. Then I paid cash for this house, and paid cash for the remodeling, and learned to do a lot of it myself :)

    Kudos to all of you who are making double mortgage payments, or paying extra every month to get those mortgages paid off early. Let me tell you it is TOTALLY worth it not to have a mortgage!

  19. Paid cash for a house? Exactly how much was the house?

    I know quite a few people who work and have good income. Savings, etc. Don’t know anyone who could afford to pay cash for full price of house, closing, etc for what houses are going for anywhere in our area.

    I’m far more interested in hearing how much you paid and just how long it took to accumulate the cash…and what, if anything else, you had to spend money on.

    If you lived with someone else, or with your parents, and paid no rent for a couple of years, yea, maybe an average person could get a sizable downpayment.

    But pay cash for the whole thing? Before somebody is praised as being a “hero” one should know the whole story. Especially if there are some frugal tips involved.

    Because maybe you just inherited the money…
    Or other scenarios?

    And if you’re wealthy and can pay cash…really, what does that have to do with being frugal? You have the money that others don’t.

  20. 30.9% of net for mortgage taxes and insurance.

    But we could get lower if we chose the crappy health insurance and ditched saving in our 401k. I see the rationale of excluding taxes but I don’t see the rationale of deduction insurance premiums and retirement monies.

    So 27.6% out of true net (after taxes).

  21. IRG – I am very frugal by nature. I live on under $20,000 yr, and save most of it. I am an older single woman with grandkids – so that should tell you my age close enough.

    I EARNED EVERY PENNY OF THE MONEY FOR THE HOUSE MYSELF – mostly by working more than one job, none of which have ever paid over $14/hr tops.

    Anyone can do it who decides that it is important enough to forgo all the toys and gadgets that some people think are necessary for life. No lattes, no starbucks, no fast food, no TV cable, no ipods/gadgets, etc. No hair dye, saunas, fake nails, fake tanning. Think how much $$ gets used up that way :)

    I am far from wealthy – just very frugal, hardworking, and determined. My grocery budget is about $80/month, as I do a lot for myself.
    You might consider buying in a less expensive area – there are sure bargains to be found now.

    You might also consider buying a fixer upper and applying the elbow grease yourself – amazing what an old woman can learn to do all by herself with just how-to books from the library and a sense of determination. Sheetrock, plastering, woodwork, landscaping, etc. Plus I painted the entire house, inside and out, myself. Like I said, anyone can do it who is determined enough to find a way to do it! But it takes a LOT of time and self-discipline and living simply, which a lot of people just won’t do.

  22. We currently pay 24.5% on our first mortgage, 31% including the second mortgage. We are 2.5 months from retiring that second mortgage, which we are obviously very excited about!

    Marci – you are an inspiration! Thanks for sharing your details so graciously; I was already a few steps along that path and your story has really boosted my motivation to continue despite the discipline. Thank you!

  23. Keith Morris

    If you can only afford to pay $1000 a month on rent then a $250,000 house is not going to work. My house is a little over that and our mortgage payments are a little over $2000 a month.

    I am the reason my husband got a house this expensive. He wanted a lower range and like your wife, I wanted something fancier. It’s not worth it. Trust me. Shop around to find something cute in your price range.

  24. @IRG: I’ve known Marci through this blog for a while now, so my declaration of her as my frugal “hero” was not premature. I knew her path to debt free homeownership would include a frugal lifestyle and disciplined savings.

    Like you, I have heard other 100% down success stories only to later discover they bought their parents’ home for loan balance, or received an inheritance. But that doesn’t mean they took an easy path to debt free homeownership, necessarily, as there is always a more expensive option. There is still some level of sacrifice involved, though some sacrifice much more than others.

  25. Jason – Thanks again!

    Lisa – you guys rock! Glad to see someone else chime in with a way to do it also! I’ve saved up again to pay cash for a patio to ‘finish up’ the looks of the house and add living space. And then I’ll save up again to pay cash for a garage… if I decide I need it that badly.

    Matthew – thank you! Keep reading this great blog for more inspiration :) – I sure find handy hints here on a regular basis also!

    Squeaky – you’ll get there! I always enjoy your comments here!

  26. Great story Marci. As someone who felt elated by the experience of paying off a car and subsequently driving that paid off car for years, I can only imagine the feeling of walking through the door of a mortgage-free house someday.

  27. Kevin – yep great feeling of paying off the car – Now multiply that 100% and you’ll know the paid off house feeling!

    Lisa – hats off for doing it with kids :) Yep, I lived in a construction zone for 2 years as I slowly renovated. First purchase for the new house was a shop vac, not a vaccuum cleaner, to come home from work and get the sawdust and sheetrock dust up before bedtime :) Still walking on a subfloor in the living room, but the flooring is bought, just not yet down. And door trim to go up – got the pieces for that from the scrap lumber pile at the dump, “my favorite shopping center”, as I call it :)

  28. Here’s another rule of thumb on income ratios. Take 28/36 and reduce each by 1/3. That produces approx 19/24.

    My rationale for this is as follows: If you were to lose your job, you probably would have little trouble finding a job that pays 1/3 less than your current pay. The problems usually kick in when you absolutely need to fully replace your salary in order to pay your bills.

    19/24 works out to be curiously close to the number in the original post (18%) or using 28/36% of net income rather than gross.

    With any of these you’d be well positioned if the worst should happen.

  29. marci, you’re my hero! I want to pay off my house early!

    I just bought a house, and I won’t even venture to guess my percentage of net–but it’s pretty high. Yet, I’m still sending in a tiny bit extra every month–and since I divided my mortgage payment in half and take it from every paycheck (doing it myself), I’ll make an extra payment every year.

    Going in, I knew I’d make some sacrifices. The location was very important to me, so I’ll go without a shiny new car, big vacations, and a trendy wardrobe. None of those are important to me.

  30. My partner and I are in our early 20s and we bought our house about 6 months ago, it’s hard work! we decided it would never get easier than it is now to sacrifice everything we possibly can to pay off as much of our mortgage as quickly as possible. One day we’ll have kids and pets and we wont be able to get away with only having a carton of eggs and a loaf of bread in the fridge!! Our mortgage is about 31.8% of our take home pay but we pay extra into the account so that we are actually paying 43.5% back. (i dont know if that’s possible in America, we live in Australia). Our generation tends to think we are mad but our parents and older people are very supportive and understanding. I think it’s definitely worth it. I just cant wait until we have paid it off.

  31. I dream all the time about having a paid off mortgage! Knowing what I know now, I might have waited a few more years to save more of a downpayment or just kept renting.

    Having said that, we looked for a house we could afford on my husband’s income, knowing I wanted to quit work when we had kids, which I did (and more importantly was able to do with no worries). We were also able to find a house that is actually a duplex, though you can’t tell by looking at it. The upstairs was rented out when we bought it and still is, by the same guy. He’s an ideal tenant and pays over half of our mortgage.

    Our mortgage (not including taxes/insurance) is 16% of our net income, not including the rental income. If I take the amount that our tenant pays off the mortgage amount, then what we pay for our mortgage is 7% of our net income.

    Either way, not bad. I still would rather bank that money than pay it to the bank. I hate seeing over half of that payment go to interest! GAH!

  32. We currently pay 25% of our net pay to our mortgage. Against advice we’ve had a flexible interest rate which I’m so glad for now because it has payed double onto the principal (which let me tell you folks is still diddly squat). Our house is worth $200,000 more than we bought it for so I’d say that’s a good investment for 4 years. The best thing we’ve ever done is to pray before any major decision.

  33. Here’s a different take on mortgages: I live in Northern California ($$$). I purchased a 1700 sf townhouse in 2001 for 390k. It’s now worth 575k per 2009 appraisal. My monthly payment is about 50% of my take-home pay. This is percentage is skewed partly because I save 22% of my earnings in my 401K, plus add 6K to my Roth every year. I also put 2K into a Flex Health Plan (pre-tax). I have a big, fat emergency fund, no consumer debt, no car payment (I’m lucky enough to have a company car). I travel frequently. Through creative frugal living and careful budgeting, I am able to stretch my dollars so that I can comfortably make a 50% mortgage payment. I get to live in a nice place with wonderful neighbors and beautiful surroundings.
    Here’s the point: You can’t afford to buy ANYTHING until you have a grip on your finances. What you can afford to spend on a house depends on how much you spend on everything else. Pay off your debt, save like crazy until you have a good (20%) down payment, manage your fixed costs and then think about house hunting.

  34. Excellent advice! Where were you when all the sub-prime mortgages were be handed out? Our neighborhood is going downhill really quick because several people overbought – they could not afford the homes they were buying, and/or they got themselves in a pickle with an out of control ARM. The fine print stinks in all directions.

    A home is a nice thing to aspire to – but renting is not so bad either. I wish my husband and I had taken our time with our first apartment and lived there longer in order to save more money for expenses. Don’t get me wrong – I loved our first house, but saving that money would have come in more handy than getting that house. But, hindsight is always 20/20.

    Andrea
    Save Money to Make Money

  35. What’s ironic is that I got the exact opposite advice from my parents. Back in the day, my parents made most of their money stretching themselves on real estate early on and reaping the gains later.

    The mortgage payment on your house will stay the same in the long term(assuming a fixed mortgage). Meanwhile your income will constantly increase so doesn’t it make sense to stretch just a little bit? Looking back, do you regret stretching with your house? Who knows, maybe if you went with a smaller house, perhaps you might have outgrown it by now. In any case, this sort of logic probably goes against the frugal principles of this blog:)

  36. Kelly (47)–Your parents advice was well intentioned, but I don’t know how many people realize how much different things have become in the past 10-20 years. Sure incomes may have risen, but expenses are rising faster, and employment isn’t as certain.

    Property taxes and insurance have been rising annually at close to double digits. If you have an HOA fee, that’s probably gone up too. Even if your mortgage is a fixed rate, your payment is probably a good bit higher than when you bought.

    Twenty years ago I heard the term “house poor” in connection with the elderly, the classic situation of a person having a house with trememdous equity, but no income to support it. Now it seems a lot of young people are in the same boat, but not always with nearly the big equity position.

    We probably all need to be more conservative in buying a house. But if your house payment is 36% of your take home pay after 401k, you’re not in as bad shape as a lot of people. The last 10 years have seen a lot of people at 36% (or more) of GROSS income. How they’re managing…might be reflected in the foreclosure stats.

  37. The minimum payment on our mortgage is only 10.69% of our (my wife and I) overall net income. However, after seeing the various dollar figures going to interest vs. principal, we quickly decided to triple our monthly payment which equates to ~27.7%.

  38. I love reading all these comments.

    My parents were also of the mindset “buy the biggest house you can afford.” My parents have always, and still are, real estate aficionados–my Mom has jokingly diagnosed herself with “House Lust” after reading the book of the same title.

    I disagree with this advice wholeheartedly, but in their defense, times were different in the 70′s and 80′s when they were buying.

    Most importantly, the most expensive house one “could afford” was based on far more conservative estimates than we find today, or at least we found a couple years ago. Also, as a career military officer, my Dad enjoyed the benefit of a very generous pension after 20 years of service, so in a sense, his retirement “savings” was already covered. His job was obviously very stable, medical costs were non-existent, we bought used cars and got rid of them when only the junkyard would buy the scrap heaps, we took vacations only to visit family, we went out to eat rarely, and to places like Pizza Hut.

    But they loved the various houses, and spent a good deal of time working on them, refinishing used antique furniture, etc.

    So, it depends on your priorities and what else you’re willing to sacrifice, your income stability, your other emergency savings, etc., etc.

    On the other hand, my wife and I enjoy moderate vacations and eating out at family restaurants fairly regularly, etc. So, for a number of years before children, we had two full time incomes and lived on less than one, saving ALOT for a 60% down payment in order to “buy down” our mortgage payment when we bought a house.

    When we bought the house, the principal on the mortgage was less than our gross annual income. And that’s a nice feeling. So is making double payments (30 yr fixed), and I absolutely can’t wait until the mortgage is history.

    For the general rules, it’s nice to have a sense of perspective and comparison when considering the monthly budget (the 28/36 rule), but it’s also important, like many of the previous commenters have said, to consider the bigger picture. One third of your monthly income going to a 15 year mortgage is much better than the same 1/3 going to a 30 year. And a 22 year old taking out a 30 year mortgage is in a much different situation than a 50 year old.

    And finally my pet peeve: People often brag about refinancing and how much they’re saving each month. Part of the savings, yes, comes from the lower interest rate, but often times a big chunk of the monthly “savings” simply comes from the fact that the loan has yet again been re-amortized for another 30 years. But these folks can only think in terms of monthly cash flows, so they don’t see the huge downside to these savings, that are now freed up for more frivolous spending.

    God bless you all!

  39. Ryan, strong point on refinancing. Every time you refinance you reset the payoff clock back to 30 years. In the past 15-20 years, with people refinancing every few years, either to get a lower rate or to take out equity to consolidate debt or making home improvements, a lot of people are still back where they were shortly after buying their houses.

    This is an underappreciated reason behind the foreclosure problem, especially, we can guess, the walk aways.

  40. Going forward, taxes will be a big concern.

    The large house where I grew up sold last year for double the price our family sold it for 20 years earlier.

    But property taxes on that house nearly quadrupled over the same period.

    And that’s in a southern state with a relatively low tax burden.

    Not a trend that bodes well for future homeowners.

  41. Well…I’m pretty frugal and I’m currently looking for a house. But my number at 30% is $864. That’s pretty close to my rent 1 bdrm) but I’ll never be able to find a house for a mortgage at $864 even at the lower end market and at 20% down (which I don’t have). I’ve read so many articles and crunched so many numbers it really comes down to what your comfortable with. I think the housing bubble really ruined the market. It blew things so out of proportion to false inflated prices that people are still holding on to. It makes it very hard to do what some of you are doing by doubling payments and choosing 15 year mortgages. I’m not giving up though, I’m still looking.

  42. Mike – that means you can finance $160,000, plus whatever the down payment is that you have… Might try moving to rural america – there are PLENTY of houses available around here for under $175,000. I just got in too late on a nice one for $139,000 on 1/4 acre, in immaculate condition, 2 huge bedrooms 2 full baths, with garage – 1200 sg ft house, and a huge deck out back with great landscaping.

    Lots of homes available here :)

  43. Before my wife’s pay increase, we were around 10%, now around 6%.

    My idea for how much we can afford for our next home is to start saving the difference between a projected payment and our current payment. It’s a virtual new mortgage, with the savings being available for DP. If we realize in a few months that we’re stretching, then we’ll know that we’ll want to aim lower.

  44. Like Mike, Even if I put down 20%, I cant even afford a $200k mortgage. (Eventhough I save 60-75% of my income each month, the bank that is loaning you doesn’t care ‘too’ much about that). I may have decent savings, but my income is not sufficient to be able to afford Vancouver living.

    There is nothing for sale under $200k.

    That’s why I have a side business now, to boost my income by $1000 a month. This, along with a decent D/P, is the most important factor in buying RE. Even though I could afford 50%-60% a month on a mortgage, and I would be renting it out 10/12 months a year, and I expect my income to increase every month, I still rather wait until I can ‘officially’ afford the place I want.

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