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How much house can I afford?
January 4, 2012 3:48 PM   Subscribe

It is often said (by presumably reputable sources, such as FHA), that you can afford a house payment that equals 28% - 35% of your pre-tax salary. This seems like an astonishing large amount of money to me -- it's almost 2x what I pay now in rent. Even considering the tax deduction, how can this be right, in this day and age of low housing appreciation rates?
posted by yarly to Work & Money (35 answers total) 4 users marked this as a favorite
 
Cost of living in general (for things like food, etc) will have an effect on your calculation for what you can afford. This is a guideline... think of it as an upper bound, not a target.
posted by jeffamaphone at 3:50 PM on January 4, 2012


Cost of living in general (for things like food, etc)

Yeah, but since the basic costs of living are *roughly* inelastic, then why would the 28-35% figure be a blanket figure given for all income levels, including by the FHA (which is geared towards low income consumers)?
posted by yarly at 3:55 PM on January 4, 2012


The higher your salary, the more this is true. If you make a million dollars a year, you could afford to spend 50% of your salary on housing, 40% on taxes, and the leftover $100k for everything else wouldn't cause you any problem.

Most rules of thumb like this are not very useful unless you fall around "average" on things that they use as metrics, like salaries or local cost of living in this case.

I pay about 31% of my pre-tax salary towards my mortgage (and associated taxes and insurance). It is more than twice what I ever paid in rent before I bought a house. I can afford it because I had plenty of disposable income when I was paying rent.
posted by tylerkaraszewski at 3:56 PM on January 4, 2012


I think that you also need to factor in the fact that a lot of people pay 28%-35% of their pre-tax salary in rent. I don't have numbers, but it's certainly common in major urban areas along the northeast corridor where I've lived and I imagine the same is true for people in parts of the west coast. To me you seem in the enviable position of having either a really high paying job or really low rent. I'd struggle to find anything below what I currently pay for a studio in the DC area (at least for something that is close to the metro and relatively safe) and it's just about 28% of my pre-tax salary. Granted I currently don't have a great paying job, at least for this area, and I live alone so no partner to split living costs.
posted by kaybdc at 3:57 PM on January 4, 2012 [7 favorites]


I pay about 20% for all household related bills + rent in a low cost of living city. Houses aren't the strict domain of families, but they make more sense space wise so as the total income from a dual household rises, the amount of leftover real dollars is also higher even if the percentage is the same.

Basically, I'm saying this makes sense for a dual income family making 100k but maybe not for a single person making 50k. Those are just made up numbers.

This is why I live in a house with other people rather than have my own space. If I had a partner who worked, I'd get a single apartment with them or buy a house.

I think maybe I missed the point of your question in musing this out for myself, sorry. It always struck me as bad advice that everyone should own a home. No! Not everyone should!
posted by OnTheLastCastle at 3:58 PM on January 4, 2012


As a New Yorker, the 1/3 rule fits very well for renters - though we don't mind usually blowing past that. So, like tylerkaraszewski says, the higher your income, the less this generality works. But if you're only making 40k, that 1/3 rule "hopefully" works.
posted by Stynxno at 3:59 PM on January 4, 2012


Yeah with the FHA this is supposed to be a limit, not a suggestion. They specifically work with first-time home buyers on stuff like this so part of what they are doing is making sure you have a realistic assessment of what sort of mortgage you can get with your income. So basically you need to top out what you can pay for mortgage/taxes at 28% and optimally you shouldn't be spending more than 36% of your income on debt, period. You can see a few internet discussions where people talk about what they're really spending: Yelp, MacRumors, Ask MetaFilter. As tylerkaraszewski says, this will make more sense if you're in the center of the bell curve and less sense if you're way out on either end. It sounds like your rent is low relative to your income. Which, hey, good news. And one of the big differences is that when you're paying this into a mortgage, besides getting housing, like you do with rent, you're getting some level of equity. Of course the markets have been really weird, but that does make a big difference between your rent payment and your mortgage, though it's entirely possible that renting is the best idea for you in your current lifestyle. As a renter, I'm happy staying this way.
posted by jessamyn at 4:00 PM on January 4, 2012 [2 favorites]




As a New Yorker, the 1/3 rule fits very well for renters - though we don't mind usually blowing past that. So, like tylerkaraszewski says, the higher your income, the less this generality works. But if you're only making 40k, that 1/3 rule "hopefully" works.

I think the more you make the 1/3 rule works BETTER. A person with 100 dollars spends 33 and has 67 for food/etc. A person making 10 has 6.7 for food/etc.
posted by OnTheLastCastle at 4:03 PM on January 4, 2012 [1 favorite]


It sounds like your rent is low relative to your income.

Yes, I'm starting to realize that this is true. I guess my confusion is that I've always believed that I should get the cheapest rent possible for a place that I liked in a neighborhood I liked, if possible ... is this not the general financial wisdom, even for those with higher salaries?
posted by yarly at 4:04 PM on January 4, 2012


I guess my confusion is that I've always believed that I should get the cheapest rent possible for a place that I liked in a neighborhood I liked, if possible ... is this not the general financial wisdom, even for those with higher salaries?

yarly, that's just a cost vs. benefit thing. It is a personal preference.

Life rule: pay as little for something while not compromising quality to your satisfaction.

Where that line is in cost vs. a space you like is totally up to you. I'm sure there are some people that gain additional happiness from their home costing a bajillion dollars for no reason, but I wouldn't be one of them.
posted by OnTheLastCastle at 4:06 PM on January 4, 2012 [2 favorites]


I assumed it's a maximum.
If you can't afford a house with 35% of your income, you basically can't afford to buy a house.

And even if you are on a really high income (e.g. millionaire), going over 35% of your income means you probably aren't investing proportionally in retirement, savings etc, an 'emergency' account representing 6 months of expenses, and therefore are still buying too much house for your income (and what if you suddenly lose that job?).
And lo, bankruptcies on mansions.


If you want to be in a really good financial position, 25% is a good maximum, on 15 year mortgage. Thing is, is there anything in your area available for that?
For me there isn't.

The only good thing, is that given I'm just renting a small room in a share house, I'm not technically wasting any money, as I'm spending less money than the interest would be on a mortgage around here. :P
I'm trying to bank (25% of income - rent), for an eventual house purchase. Maybe. Many, many, many years in the future.
posted by Elysum at 4:11 PM on January 4, 2012


I've always believed that I should get the cheapest rent possible for a place that I liked in a neighborhood I liked, if possible ... is this not the general financial wisdom, even for those with higher salaries?

This is way more true of rent than of buying property, which is an investment and has other factors associated with it. (Although it is definitely common wisdom to buy the cheapest place on the nicest street you can afford.)

Often the less-expensive neighborhoods have issues that will affect the long-term property values, which isn't a concern when looking to rent. Other things like the age of the building, maintenance needed, etc, also don't come up for a renter but may justify spending more money on a house.

There's also the issue of down payment vs. mortgage - a bigger down payment means a smaller mortgage, but it also means you are less liquid. It's a balance, and it's fairly individual. If you have a lump of cash and a low income, you may be able to get a more valuable house and spend the same month-to-month than if you didn't have that cash. This, again, doesn't come up for renters.
posted by restless_nomad at 4:14 PM on January 4, 2012


P.S. When my income hit the point where my rent was > 25% of my income, I really really felt like I'd 'made it' in life.
Booyah!

I'm now well below that, but that's because fear of future financial instability has me living in a tiny sunroom, in a cold climate, with windows into the lounge (I think this explains my lack of relationship partners in the last year...), because this frees up enough income I can cover the rent for family members if needed.
posted by Elysum at 4:16 PM on January 4, 2012


Also, remember that the theory is that not all of your house payment is going into someone else's pockets. Some fraction of it is being paid to yourself in the form of a future sale. (Real estate doesn't always go up, as we all know now, but historically its value tracks inflation quite closely. Where I live, for example, we didn't get hardly any of the bubble, but it also means we got almost none of the pop. It's a gamble, as all things.) So if my, say, $1000 house payment is $400 interest and $600 principle, then really you can think of it as $400 in rent plus whatever you spend in upkeep on the place.
posted by introp at 4:20 PM on January 4, 2012


At first glance the basic maths behind your statement works out - you say a mortgage payment of 35% of your income would be about twice as much as your current rent.

This is because your mortgage is doing two things at once - it's both paying for the place you're using now, and also paying towards owning the property outright at the end of the mortgage. (when you buy a place, you are essentially leasing it from the bank who will turn it over to you at the end of the mortgage).

Back on envelope calculations show (making up simple numbers and totally ignoring things like inflation) that if you borrowed $400,000 to buy a $400,000 property on a 25 year term, at 6%, you would have paid roughly $800,000 by the end of it. $400,000 of that was for the value of the property, and another $400,000 of it was for the interest payments (to live there when you didn't own it yet).

Instead of paying $800,000 over 25 years, you could choose to rent for half the amount, paying $400,000 over the 25 years but then at the end of it you would not own a $400,000 house, so both scenarios end up exactly the same.

In an perfect world this would hold true but there are a bunch of factors influencing rent and mortgage prices... it's up to you to decide which one makes more sense to you.

For reference, in my city, rents for a single bedroom are upwards of $1200 per month, considering the median after-tax income is about $3600 per month, rents are definitely in the region of 30%-35% of net income and mortages about double that.
posted by xdvesper at 4:25 PM on January 4, 2012


From the Census Bureau: Who Can Afford To Live in a Home?: A look at data from the 2006 American Community Survey

Lots of interesting stuff, including where the 30% guideline came from. It also says: "The 2006 American Community Survey (ACS) shows that 46 percent of renters nationwide pay 30 percent or more of their income on housing costs." So your feeling that most people don't pay that in rent seems off.
posted by smackfu at 4:25 PM on January 4, 2012 [3 favorites]


The cheapest rent you in a neighbourhood and house you like is going to change as your income goes up, because your tastes and needs tend to change as well. (Also, I have frequently lived in cities where the cheapest rent found at ALL was still more than 30% of my income: forget about a house and neighbourhood you like!)

Also, higher income types tend to need/want to live more centrally, because they might work in finance or business where they need to be able to come in to work on the spur of the moment, etc. This equates to a higher cost.
posted by lollusc at 4:27 PM on January 4, 2012


Oh, also, my mortgage payment is totally twice as much as my rent was. That's because I can't afford to buy a place as nice or as central as I could afford to rent. This is one reason why many people who could afford to buy continue to rent instead, at least here in Australia.
posted by lollusc at 4:29 PM on January 4, 2012


Sorry, there were a couple of steps in logic missing there:

My mortgage payment is totally twice as much as my rent was.
It is still only around 40% of my income, because I waited until I was about to start a higher paying job before buying.
It would have been even more than twice as much as my rent if I had bought the same place I was living in as a renter, or somewhere nearby.
That's because I can't afford to buy a place as nice or as central as I could afford to rent.
posted by lollusc at 4:31 PM on January 4, 2012


From the Census Bureau: Who Can Afford To Live in a Home?: A look at data from the 2006 American Community Survey

Lots of interesting stuff, including where the 30% guideline came from.


Thanks, Smakfu. That report makes clear that 30% is considered the limit above which housing costs are a "burden" and unaffordable. I'm not sure, then, why people still float the 28-35% figure, when that's right on the edge of burden and the market is still so uncertain ...
posted by yarly at 4:34 PM on January 4, 2012


Around 30 percent is also the rule-of-thumb maximum for rent.

I don't remember where I read that, but it was in several places.
posted by maurreen at 4:39 PM on January 4, 2012


It's also kind of amusing since it says it used to be 20% back in the 50's, but the housing authorities couldn't run the projects for only 20% of income, so they bumped it to 25% and then 30%. So it sort of feels like a junk number to me.
posted by smackfu at 4:39 PM on January 4, 2012


It is often said by people who want you to buy a house, by people who want to make a commission, by people who want to loan you money, etc. This is the industry that helped screw up the economy by giving mortgages to people who couldn't pay them back.

People who have a specific desire or need to live in a particular place may spend more; they've made a particular choice. Housing is a big, fixed cost. Managing the cost makes a ton of sense. If you can afford to make more expensive choices, swell.

You sound fiscally responsible. Renting is probably a pretty good deal for you, but mortgage rates are low and housing prices might be low where you are. I like having a house, I built equity with a 2 family, sold before the market really tanked and probably spent too much on a small house with a big view. Keep up the fiscal responsibility; it's a good thing.
posted by theora55 at 5:12 PM on January 4, 2012


1- Yeah, it depends on what your income is. Housing costs can go as high as you like, but other costs are relatively fixed. My cell phone bill is 3% of my income, and if I made twice as much money, it would only be 1.5% of my income. That's another percent of my income I can afford to pay toward housing, if I saw fit.

2- Costs change over time. Food cost more (relative to income) in the 50s, so there was less money left over for housing.

3- The mortgage interest deduction isn't all that much, really. If you itemize, you lose the standard deduction, meaning you have to come up with ~$7500 in deductions before you start benefiting. And you only get to deduct the interest portion of your mortgage payment. And all that does is reduce your AGI some. So if you itemized and ended up with $10,000 in deductions, you are $2500 over the standard. Meaning you have to pay taxes on $2500 less income. So you "get" your tax rate * $2500 back. At 25%, that's $625. Nothing to sneeze at, but $50 a month probably isn't going to change any house buying decisions.
posted by gjc at 5:18 PM on January 4, 2012


FWIW, I always thought the rule was one-third of your post-tax income, not pre-tax. I've always used that rule with rent and it has served me well.
posted by breakin' the law at 5:22 PM on January 4, 2012


I'm not sure, then, why people still float the 28-35% figure, when that's right on the edge of burden and the market is still so uncertain

My understanding is that the 28% / 35% figures are based on what lenders require to qualify for a mortgage at all--in other words, above that and they've figured out that actuarially you'll too likely to default on your mortgage, but at or below that you should be able to continue servicing your loan. See here, for instance--many lenders require that the total monthly payments for your mortgage, taxes, and insurance can't exceed 28% of your gross income, and your total debt payments can't exceed 36% of your gross income. (The range of "affordable" thus accounts for the fact that some people have other debts like car or student loans, and some people have no other debts.) If you figure the average household potentially looking at buying a house has an effective tax rate of around 15%, and food nationally tends to run about 10% of gross income, you're left with 75% of your gross income for housing, health care, transportation, and discretionary spending. It doesn't seem unreasonable to me that people could spend up to about half of that on housing before getting themselves into a situation where they would be forced to default.
posted by iminurmefi at 5:33 PM on January 4, 2012


And, just to throw something else out there:

If you're looking for what you can "afford," I think it's reasonable to look at what lenders would historically lend to people given their income (that is, before the current insanity where banks and mortgage houses were lending to anything with a pulse under the assumption they could sell the debt on down the river). They have/had a lot of data about how much debt people could take on before they'd become more likely to default on their loan, and that to me seems like a reasonable standard for affordability--if you continue to pay for it, then we can probably assume that you can afford it. While your income going up or down may have an impact on whether something is affordable, whether the housing market is appreciating or depreciating shouldn't have any impact on your ability to afford a given mortgage payment.

What you seem to be getting at in your original question isn't whether buying a house is affordable but rather whether it's a wise investment. Lots of things are affordable that are piss-poor investments, like fancy cars that lose their 20% of their value the minute you drive it off the lot, or dinners at expensive restaurants, or vacations to far-off locales. Housing that is technically affordable in the sense that you can continue to make payments may or may not be a wise investment--and the rule of thumb I've seen for deciding that is NOT 28% of your gross income, but rather the rent ratio in your local area. If the mortgage for a place comparable to what you're renting now would be twice as expensive, it may be affordable but probably a pretty bad investment.
posted by iminurmefi at 6:09 PM on January 4, 2012


I'm not sure, then, why people still float the 28-35% figure, when that's right on the edge of burden

Well, in some places, you just aren't going to be able to buy a house for less than that, unless you have a super-high income, or have a pile of savings and don't have to get much of a mortgage. In the USA, and in my own culture, the idea that the average person should be able to buy a house is one of these cultural beliefs that everyone buys into. (This is not true in most of continental Europe, by the way). If that's the case, the 28-35% figure probably gets floated because it's one that can coexist with the idea that the average person can buy a house. Anything under that, and it will no longer be true.

The figures below are Australian, but I'm not sure they'd be much different in large US cities.
The median income of full time workers in Australia in 2011 was $54750. I'll assume this is pre-tax, but I'll also assume that many people have two income households, and maybe on average that balances out.
The CHEAPEST house for sale right now in my city (actually in the whole of the Australian Capital Territory) according to the largest aggregating real estate website, is $355,000 (I'm excluding retirement villages and townhouses ("condos") here). Plugging in the usual figures for a mortgage here right now, and assuming 10% downpayment, the monthly payment would be around $2,750. This is more than half of the average person's income (to buy the CHEAPEST house in town - which is a long drive from the city centre, and would probably need a lot of renovation).

So actually the 28-35% estimate is unrealistic for the average person in Australia, unless they live in a particularly cheap city (i.e. not Sydney, Canberra, or most of the other state capitals). But if we assume the USA has more cheaper housing options, and/or we include small apartments, 28-35% is probably the lowest figure that makes buying a house still sound affordable for the average person, and therefore in keeping with the "American (or Australian) Dream".
posted by lollusc at 6:10 PM on January 4, 2012


I'm not sure, then, why people still float the 28-35% figure, when that's right on the edge of burden and the market is still so uncertain ...

Those people are trying to sell you something.

I struggled with this same question back in 2007: if buying a house is such a great idea, why is it so expensive? How does it make economic sense to buy a place which costs more to live in than you could possibly rent it out for? There's all this bafflegab about appreciation and mortgage tax deductions and whatnot, but whenever I would add up the cost of interest, the cost of maintenance, the property tax, etc., it always came out so that buying a place would cost more than renting one. And of course the total monthly expense was easily 2x that of renting.

In retrospect, I'm really glad I stuck with my instincts instead of believing what all the real estate people told me, because it really was a giant con, and I really am better off renting.

I think the truth of it is that property ownership is more like running a small business than it is like renting a house. If you have some extra money you might choose to invest it by purchasing a piece of property and renting it out. Well, one common way people do this is to start by renting the property to themselves. But you don't just go from renting to buying: the buying-and-owning part is a whole new thing on top of your housing cost, and you should only get into it if you actually want to take on the time and expense of that new business.
posted by Mars Saxman at 7:06 PM on January 4, 2012


Mars is mostly right, except for this: you can't directly compare rent to a mortgage payment, because you will ALWAYS have to pay rent, but a mortgage is (optimally) eventually paid off and then you have a free place to live. Also, a mortgage payment is mostly fixed in today's dollars, but rent rises and falls. So if you play it out 20 years into the future, your mortgage payment is almost for sure going to be less than rent.
posted by gjc at 7:28 PM on January 4, 2012


We're just under 18% of gross income here in DC. When we bought, we were approved for a lot more, though, and we could afford more, if we wanted to pay off the house more quickly at the cost of daily comforts. We eat out, buy new furniture, fund our retirement and savings accounts, and have no other debt, at all. Also note that our mortgage payment includes homeowner's insurance and property taxes.

gjc makes a good point, too--you may struggle a bit to make the payments at first, but as your income rises, even if only due to inflation, your mortgage will be a smaller and smaller percentage.
posted by MrMoonPie at 6:58 AM on January 5, 2012


Mars is mostly right, except for this: you can't directly compare rent to a mortgage payment, because you will ALWAYS have to pay rent, but a mortgage is (optimally) eventually paid off and then you have a free place to live.

Well, this is true, but don't forget that if you were putting the saved money (the difference between your potential mortgage payments and your rent) into savings, eventually you'd have enough savings that the interest earned annually on those would cover your rent payments. When we ran the calculations for ourselves, it turned out that would most likely take a similar number of years to get to that point as it would to pay off the mortgage.
posted by lollusc at 7:18 AM on January 5, 2012


...you can't directly compare rent to a mortgage payment, because you will ALWAYS have to pay rent, but a mortgage is (optimally) eventually paid off and then you have a free place to live.

Not quite, because you will ALWAYS have to pay taxes on that house, and they'll keep increasing.
You'll also have to pay to maintain that house, and roofs and furnaces aren't cheap.
posted by Floydd at 8:00 AM on January 5, 2012


Basically, it sounds like you've got a reasonable living salary in a location with reasonable living rents. You're in an excellent position to be perfectly content without having to push toward the "more than 1/3 of your income is a bad idea" rule of thumb. There are plenty of reasons why other people might not be in that position, and the 1/3 rule wouldn't seem so easy/resonable.
To generalize, people who spend more than 1/3 of their income on rent are either:
- living in a place where even the lowest possible rents are still pretty high (see: NYC)
- a fairly minimalist lifestyle with a fairly minimal income lowers all other expenses but the housing market is non-negotiable (see: most grad students)
- earning so much money that there's no reason you'd need the other 2/3 of your salary to get by on.
- really not paying attention, and think that now they've got a real job that earns $40k/year they must start living the dream and getting a posh apartment all on their own, which then leaves not enough left over, and trouble ensues.

As a grad student, many landlords required co-signers for anyone with a $16000 stipend looking to rent a $700/mo studio, citing that 1/3 of income "limit". In practice, though, it was a reasonable budget, some people spent up to half their post-tax income on rent, because the grad student lifestyle didn't involve a car, impressive clothing, or enough time to go out and spend money, or having non-student friends who *did* go out and spend money. I chose to scrimp on rent, have roommates, etc, and set aside the extra $150/mo in an IRA. Being in a location that had housing for even less would have been even better, but it all depends on the situation.
posted by aimedwander at 8:08 AM on January 5, 2012


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