How Much Home Can I Afford?

We want to address the issue of “How Much Home Can I Afford?” 

Buying a home is one of the smartest investments on one hand. But on the other hand,  it can also destroy your budget, life and create an incredible amount of undue financial stress. That’s why it is important to answer the question, how much home can I afford? 

It is far too easy for most anyone to buy too much house.  Yes, we all want a little more house, a nicer house, a newer house, etc. We get that.  But we have yet to meet someone who purchased too large of a home for their budget who didn’t later regret it.  

In other words, we have yet to meet someone who is happy about being “house bankrupt.” 

The sad part is that a home is often a status symbol. And although it is one of the smartest investments with some of the lowest risk, if you can’t afford it, you can’t afford it. Period. 

How ’bout that million-dollar beauty? 

I always like to give this example when sharing home buying ideas with others at our live speaking engagements or in one-on-one conversations.

That example is this: 

“Yes, you might find a two-million dollar home on the market for one-million dollars. That is an amazing deal! But it is still a million dollars and you can’t afford it. So stop thinking about it!”

I obviously use the one million mark to make it a little more far-fetched for most of us, but the same can be said for any price home. It’s all relative depending on where you are at in life.

Someone who makes $4 million a year, the above scenario is a “RUN…don’t walk” type of deal for them. For the rest, this is a “RUN…the other way and don’t stop to think about it!” 

You don’t want to be house bankrupt. 

What does it mean to be house bankrupt?

Being house bankrupt means that you are financially strapped because of your house.

It also means that when those home repairs happen, you are really strapped, sometimes to the point that you can’t make those repairs. And it often means that you certainly can’t make any updates!  

What kind of a fulfilling life is this? Living in a home and being so financially strapped, that you can’t do anything? 

We already know what it feels like to be so financially strapped, and this was before we ever even owned a home. It was an awful place to be. To not have any financial freedom, but in financial prison, the financial prison that you bought. Don’t do this. It will not be worth it. 

Today, we love having the freedom to be able to travel, do things spur of the moment, save for retirement, make double-house payments on a 15-year loan. Or in other words, enjoy life with a little less financial worry. It is far more enjoyable than the financial stress other readers, friends and many other we know endure on a monthly, even daily basis. Yes, they many have a nicer house than us, but we have a little more financial peace. 

There is no price you can put on this. 

We really, really want to encourage you that before you sign on the dotted line for any house, you need to deeply consider the lifestyle consequences of what you are about to do. It’s not easy to get rid of a house. It’s not a decision you can easily fix, nor is it is a decision that should be taken lightly. 

Yes, it is a great investment and one of the best investments you can make overall, but only if you can afford it. 

We also think it is a decision that you need to decide and determine for yourself, not your mortgage lender or your real estate agent. 

Why YOU need to figure your price point

YOU figure out your pricepoint before you talk to any realtor or mortgage lender. PLEASE! 

They will give you figures that are far higher than we think you can afford. Don’t even start looking at homes out of your price range. It will breed discontentment and frustration. If you don’t know what it is that you can’t have, then you will be far more content with what you can actually have. 

Have you ever seen those HGTV shows where someone says they want a 5-car garage, 7-bedroom house, pool, fireplace, 4-levels, 6-bathrooms and 10-acres and their budget is $300,000? Yes, and the realtor will take them to their “ideal home” and they “fall-in-love,” only to be told moments later that this house is three-times their budget? The people on the show are now upset and discontent with anything else. And while I don’t necessarily think it is a problem to be knocked back down to reality, it’s not a good idea to start off discontent. 

Instead, determine what you CAN afford and only look in this price range from the beginning. Tell your realtor, don’t let your realtor tell you. 

Our First Home

In our lives, when we have been house hunting, both towards the beginning of our marriage and later on, both the realtor and mortgage lender had given us a figure that was MUCH higher than we had personally calculated. MUCH higher than we were comfortable with. So we immediately ignored the figure these two groups of people gave us and we went with our own figures. 

Yes, we made huge financial mistakes from the very beginning of our marriage (having to get a loan to check out of the hotel on our honeymoon, and subsequently accumulating over $100k of consumer debt in just four years). But one area that we actually, by some miracle, had some slight sensibility was in the area of a mortgage payment and buying a house.

We share the whole story of how we got into $108k of consumer debt, along with our home buying experience, including our first house in our book, The 2% Rule To Get Debt Free Fast. So you can read the full story there, but I will share some things here for the purposes of this article. 

A $225,000 home? Really? 

When we were looking at buying our first home, both of us were working full-time making less than $55,000 together. We got “pre-approved” for a home up to $225,000. This was an astronomical amount in our minds! We had planned on me being a stay-at-home mom one day and so we really didn’t want to include my pay in the equation. But in that pre-approval process, they calculate it with every penny you are bringing in. At the time, they were calculating it based on your total debt obligations not exceeding 45% of your gross income. Honestly, having your debt obligations be nearly 50% of your gross, when you generally only take home about 75% of that, really straps you financially. 

Now mind you, we didn’t have a ton of debt yet. A small maxed-out credit card, a loan from when we checked out of our hotel, student loans and Alex’s vehicle. Listing it out, it is a ton, FAR more than we would recommend anyone have, but for where we were going to be headed, this wasn’t much. 

With our debts, our $55k combined income, the mortgage lender said we could look for homes up to $225,000 (keep in mind that pre-approval does not guarantee an actual approved amount when you actually apply for the loan).

We had a $0 downpayment. This meant that our payments would be around $1,500 before taxes and insurance. This exceeded one of Alex’s monthly paychecks. So the monthly payment would require one of his full paychecks, plus mine! Half of the month, we would be in the hole. 

A More Comfortable Option

We already knew that this is not what we wanted. I grew up with friends whose families were “house bankrupt” and they were miserable in their big house. My friends had no freedom to do anything. I didn’t want to be that way. My family, growing up, lived in a smaller, older home, but my family traveled, could spend money at holidays, birthdays, etc. I could actually do things when I was growing up. Little did I know that we would quickly find ourselves nearly literally bankrupt with consumer debt a short time after buying our first home, but it wasn’t the homes fault. 

In the end, we wanted to find a home that was under $100,000. We found a perfect starter home for $88,000 with four bedrooms and two bathrooms.  Keep in mind that this was several years ago, in a small town in Idaho. After property tax, PMI and insurance, we were about $850 a month. More than half of what the mortgage lender said we could do. 

Should You Go Into Debt for a Home?

Now we realize that there is not a “one size fits all” definition of this, thus we don’t have a “one-size-fits-all” solution. We don’t want to make the same mistake that the realtors and mortgage lenders make. Instead, we want to share an idea and the principles that you can live by when getting ready to either buy your first home, or getting ready to buy your next home. 

We are not opposed to going in debt for a home. In our book, we outline how you can pay cash for a home in 7-10 years. We don’t necessarily think this is for everyone, but it is a good idea to work towards, especially for someone that is younger and just starting out. Waiting 7+ years to buy a home and save and pay cash is brilliant! But most of you reading this are not 17 and have a first job. 🙂  So the idea of buying your first house with cash seems like an impossible feat and if we tell you to only buy a house with cash, you will may feel defeated financially before you even start. We don’t want that.

In the end, we think if you are making a monthly payment, it is better to be building equity in real property rather than rent. Also, when you have debt like a mortgage, you are often times more motivated to put your extra income towards paying it down vs. sticking it in a bank account to save for a future house. There is a bit more fire under you when the reality of it has already happened. People tend to pay down a house they already are living in faster than the abstract idea of being in your own home one-day. Some people can do it! Some can save for a house before they are in it and save fast! 

Say “no” to minimums! 

Now, although we are not opposed to mortgage debt, we are opposed to making minimum payments and holding onto your mortgage for 30 years.

It’s expensive to borrow money for a home.

In fact, in our book, The 2% Rule To Get Debt Free Fast, we do the math over several pages and show you just how much your home is costing you…if you just keep paying the minimum. It’s actually terrifying to see how much it is costing you.

So our goal is to get you into a house you can afford and then pay it off as quickly as possible, even as early as 7-10 years! We share the 7-10 Mortgage plan in our book too. This plan will save you tens of thousands, possibly hundreds of thousands. And all of this can be implemented shortly after purchasing a home if you follow the basic principles we have laid out here. 

What’s the formula and basic principles to determine how much home can I afford? 

Before looking at a mortgage, we have some basic principles that we recommend:

1. Debt load:  The first thing is that if you have debts beyond a car(s) and student loan(s), we really, really advise you to pay these off before you even look at purchasing a home. If you have expensive cars, you will have less of a house. If you have cheaper cars, you can probably afford a little more house. Car debt should be gone as soon as possible, but we are not saying you MUST have no car debt before considering a house. Same with student loans. Try to ditch these fast, but at least have all of your other consumer debts paid off. 
2. Primary Earner’s Income: Calculate what you can afford based on the primary earner’s gross income. Why? Life changes and life changes fast. Do you always plan on both of you working? Most people that we talk to where both spouses are working outside of the home, it is just a “temporary” solution to get ahead. And that’s fine, but remember this when we calculate what you can afford. Base it off of the long-term goals, not what you are doing right now. 
3. 25% Rule: Our general rule after the first two is to base it off of 25% of the gross income. None of this 36-45% silliness. 😉 Seriously though. Please figure how much you can afford based on 25% of the main earner’s monthly income. This will help you be able to pay off the house quick, not be in financial prison (at least due to your home), and live a more financially free life. You can actually simplify this even more by making a generalization of 3-4 times your annual gross income. 
4. Implement 7-10 plan: Once you are a homeowner, plan to implement the 7-10 mortgage plan, starting immediately with the bi-weekly payments. You may actually find this to be easier anyway and pay off your 30-year mortgage 5 years sooner and save tens of thousands in interest with just this first easy step. 

Should I have a 20% down payment? 

Now the above principles don’t include having a 20% down payment. If you can do this, it would be all that much better! And you can buy 20% more house if you wish. But we are not even going to say that you have to have a down payment.

I know, it seems against what everyone else is saying.

The main reason why others say to have a down payment is because the industry really promotes this, but also, it does reduce additional monthly expenses, like the PMI. If you buy a house with less than 20% down, you are required to pay the monthly premium for the Primary Mortgage Insurance. No, this is not a home owner’s insurance, you have that regardless. This is insurance for the lender, but you are paying the premium if you buy a house with less than 20% down. This insurance protects your lender in case you default on the loan. 

The amount of PMI that you pay depends on your lender, but it is generally .05% to 1% of the loan value annually. So if you buy a $100,000 home, this is $500 – $1,000 per year, or about $42-$84 per month. Yes, that is a monthly expense you want to get rid of. And we encourage you to use these tricks here to get rid of it as soon as possible if you did not come with 20% down. But we still personally don’t think the lack of 20% down should be the stopping factor for you.

Most consumer debts? Yes!

No downpayment? No. 

Again, we would highly encourage you to come in with 20% down, but if you can’t we also don’t think it is a stopping point for owning real property and building equity sooner.  

If the least you can do is no down payment, as long as you can afford the home you are buying, we would encourage you to pay down the house as quick as possible. Then when you get to 80/20 (80% value and 20% equity), refinance for a 15-year loan. Then you have the best of both worlds in a short time – dropping the PMI and paying down fast, having an excuse to refinance for a lower rate and faster payoff time. 

The above scenario is worst case. If you can start off with 20% down AND 15-year mortgage, this is the BEST way to buy it short of paying cash! 

What does 25% look like? 

We wanted to give you some hard numbers on our “loose” 25% rule. And by “loose” we mean if you need to factor in less, factor in less, but cautiously increase. We really don’t recommend more than 25% of your gross income, but we also know there is not a one-size-fits-all. Just proceed with extreme caution for anything higher. In our first home buying case, and in our second, we came in under 25% both times. 

We are going to give three scenarios for you, but you can also figure the math yourself for your specific situation. Note that these are base bottom figures. Sample scenarios for those that are starting with nothing and coming into home buying with nothing down. 

If you make around $35,000 a year – 

You may be able to afford a house that has a payment of around $730, which is about a $129,000 house with today’s average interest rate for a 30-yr loan (4.25%).

Here’s the math:

• Gross = $35,000 annual, or about $2917 per month
• Net may be approximately 25% less average (taking out taxes, benefits, SS, etc.) = $26,250 or about $2187.50 per month
• House payment = $730 (please note, that this includes average property tax, homeowners insurance and PMI which adds about $100-$200 more). 
• Remaining monthly income after house payment: $1458.50

The question is, can you comfortably live off of $1458.50 per month? This includes all remaining debt obligations and living expenses. 

If you make around $60,000 a year – 

You may be able to afford a house that has a payment of around $1,250, which is about a $230,000 house with today’s average interest rate for a 30-yr loan (4.25%).

Here’s the math:

• Gross = $60,000 annual, or about $5,000 per month
• Net may be approximately 25% less average (taking out taxes, benefits, SS, etc.) = $45,000 or about $3750 per month
• House payment = $1250 (please note, that this includes average property tax, homeowners insurance and PMI which adds about $100-$200 more). 
• Remaining monthly income after house payment: $2,500

The question is, can you comfortably live off of $2,500 per month? This includes all remaining debt obligations and living expenses. 

If you make around $100,000 a year – 

You may be able to afford a house that has a payment of around $1562, which is about a $298,000 house with today’s average interest rate for a 30-yr loan (4.25%).

Here’s the math:

• Gross = $100,000 annual, or about $8,334 per month
• Net may be approximately 25% less average (taking out taxes, benefits, SS, etc.) = $75,000 or about $6250 per month
• House payment = $1562 (please note, that this includes average property tax, homeowners insurance and PMI which adds about $100-$200 more). 
• Remaining monthly income after house payment: $2,500

The question is, can you comfortably live off of $4,688 per month? This includes all remaining debt obligations and living expenses. 

If you are upgrading and coming in with equity, or you have saved and coming in with money down, then you can add it to the sales price of the home for a potentially comfortable payment, but more house. 

So if you make $35,000 a year and you are coming in with a $20,000 down payment, you can buy a house worth $149,000 potentially comfortably. 

A super quick calculation method:

calculate how much house you can afford based

on 3 – 4 times gross income =

a super generalized summary of what you can afford! 

Other factors to consider:

The above figures are very loose because there are far too many factors to determine exactly what you can afford.

• Current interest rates
• Cost of your homeowners insurance 
• Property Tax
• PMI

A slight change in the interest rate plays a dramatic effect. Play around with a mortgage calculator and really try to find a good rate! It makes a big difference! 

The property taxes also play a HUGE factor. We live in a place where property taxes are $150 a month. We are a little below the national average of $180 per month, but some places have an INSANE amount of property tax, eding up close to $1k. 

I love this map from CNNMoney to get a quick view of the property tax amounts across the country. There are obviously pockets to avoid! 

Don’t forget about homeowner’s insurance. Surprisingly, this is not a huge monthly expense, but it is a factor to consider. The average rule is about $35 per month for every $100,000 of house you own. But honestly, you can get it for much less than that in most parts of the country. Aim for more like $50 per $200,000. 

Finally, don’t forget the cost of your PMI. We addressed it above, but you need to consider this cost until you can ditch it fast! 

In the end, we hope that you can calculate a mortgage payment that is reasonable and will keep you on track with your financial goals, while building equity in real property and a real investment.  I hope that we have answered the question of how much home can I afford. 

What are your thoughts on this? 

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