Flavio is a financial market enthusiast with an economics degree and a master in strategy. He is a stock and real estate investor.
How Much House Can I Afford?
You decided to buy your own house, but unfortunately, you are afraid it might be a burden for you in the long term. The ultimate question you want to ask yourself is, How much housing can I afford?
The simple answer is to be able to cover all expenses easily. However, a solid financial plan should be considered ahead so you know even if your main source of income disappears you will not struggle financially in the future.
With this in mind, I would like to talk about how much you should be spending on housing by pointing three rules of thumb you can follow to have a more stable life.
Take your pick:
- The 28/36 rule
- The 30% rule
- The 25% rule
One of the most popular rules of thumb individuals use to assess how much housing they can afford is the 28/36 rule.
The 28/36 rule advises you not to spend no more than 28% of your gross income on your direct housing costs. This includes mortgage payments, interest, housing insurance, and property taxes.
Besides, it also states no more than 36% of your gross income should be spent on all costs considered in the 285 rule plus all other debts you may have. This includes not only housing spending but also student loans, car loans, and personal loans.
One of the main advantages of following this rule of thumb is that it includes the non-housing related debts you may have. Among the three it allows you to buy the second most expensive house for your monthly budget.
The weak spot of this rule of thumb is the large allocation of your income towards liabilities leaving little to no room to follow other pursuits, like paying off debts or investing or just saving.
The 30% solution is another rule of thumb and states you should not spend more than 30% of your gross income in housing costs.
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Two advantages of this rule is that it lets you buy the most expensive home of all three rules, and that it is flexible since it only tells what 30% of your gross income should go to.
The 30% rule is not recommended for individuals with high levels of debt in other areas. Unlike the 28/36 rule, this rule, by considering only where 30% of your income should go and disregarding other debt expenses, may leave you with a very tight budget to accommodate your living expenses.
The last rule of thumb I would like to share is the 25% method.
The 25% method allocates no more than 25% of your take-home pay to housing costs. This rule is the most conservative of these rules when buying a house.
If you follow the 25% method, there is little chance you will end up in financial stress. However, the big downside is it can be especially difficult to find a decent house in the most expensive areas.
If you do not mind sharing your house with roommates or renting your house temporarily on Airbnb, so you can share expenses or earn some cash, this method should not be so hard to adopt even in expensive areas.
The Most Important Thing Is Your Financial Picture
First, no rule of thumb is better than the other. Depending on your current financial situation and your financial goals, a different rule may be best.
The purpose of these rules is to look into your finances and adjust your monthly budget accordingly to your housing expenses.
This article only focuses on the current expenses you have. You must take account of a lot of other expenses associated with buying a new house, such as furniture, moving expenses, and taxes.
My recommendation is to use these rules as a starting point to develop your financial plan. Use them to understand what is your current income and your current expenses including the new costs from the housing you want to buy.
Since the house is one of the biggest investments most of us will ever make our lives, use these methods to keep from making rookie mistakes.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2019 Flavio Lopes