How Much Should You Spend on Your House?

A podcast listener asks:

There is a ton of information out there about how much people should spend on their homes. Payment as percentage of monthly income, multiple of net worth, multiple of household income; there is no shortage of strategies out there, but they all vary drastically.

I am curious to know what you two think about this topic. How much % of income should one spend on their home? Is there a net worth or income multiple that is a good rule of thumb?

For context, I am 26 in St. Petersburg, FL earning ~$150k. This qualifies me for a very nice home in my area. However, I like to save and invest a very large % of my income, so I don’t want to take on a payment so large that it detracts from my ability to invest. I own 1 rental property and have $200k in equity investments ($50k in retirement accts, $150k taxable brokerage). Not yet married, no kids.

Should I splurge a bit and buy myself a nicer home, or buy smaller since I am still so young and keep saving a larger % of my income?

First of all, kudos to our listener for having their financial house in order at such a young age. A high income helps but it’s not always easy to avoid the trappings of spending most of that money when you’re just starting out.

I also like the fact that this person is wary of spending the max amount they’re preapproved for. There’s no rule that says you have to spend the maximum amount allotted on your house just because the bank will allow it.

This question becomes more relevant by the day as housing prices are skyrocketing.

Housing is the biggest line item in the budget for the majority of households but it’s hard to know exactly how much you should spend.

How much is too much? When does it make sense to stretch to the high end of your range? What if you spend too much and you become house poor? What if you don’t spend enough and you regret your decision?

There are some financial rules of thumb when it comes to this stuff but like most financial decisions, these rules always require some context.

There’s the old 50/30/20 rule that states you should allocate your budget as follows:

  • 50% on necessities (housing, transportation, healthcare, food, etc.)
  • 30% on wants (dining out, travel, entertainment, clothes, etc.)
  • 20% on saving (retirement, emergencies, debt repayment, etc.)

Depending on where you live this budget might sound reasonable or it might sound impossible. If you’re in a high cost of living area you could be spending that entire 50% on housing alone (or more in some cases).

I’ve seen personal finance people recommend no more than 30% of gross income towards housing costs.

The problem with rules of thumb is they don’t take into account your personal circumstances. This decision involves math, emotion, circumstances and trade-offs.

Before I get into some qualifiers about how to think about this question, I have to state upfront that you don’t have to buy a house. Owning a home is not for everyone.

I know there’s a ton of FOMO out there right now because home prices are rising at such a fast clip but there are downsides to buying a home (especially as a young person).

You lose some flexibility if you wish to pack up and move somewhere else in a hurry for a new job, a love interest or a new start.

It’s expensive to own a home. You have to pay property taxes, furnish the home, landscape it, maintain it, insure it and pay interest on the mortgage.

Plus, there are frictions involved when buying and selling. There are closing costs, realtor fees, moving costs and the headaches involved in buying and selling a house.

And most people have no idea what the actual return on their home is because no one bothers to calculate the all-in costs involved.1

Don’t buy a house just because you feel peer pressure or an obligation to do so.

With that disclaimer out of the way, here are some questions I would ask myself as a 20-something thinking through this decision:

How long do I plan on living in this home? This one is the first question all potential homeowners should ask themselves. Homeownership can be a profitable venture under the right circumstances but rarely if you only live in the house for a short period of time.

The majority of your payments go towards interest costs in the first 2-3 years of paying down your mortgage so 7-10 years is a good starting point for the minimum length of time in a home.

Anything less than that and you open yourself up to the possibility of selling into a bad market or eating up any equity with switching costs.

Could I see this being my forever home? I have a few friends who bought a home when they were bachelors before they settled down and got married. None of them ended up staying in the house they bought.

You may think you have great taste in neighborhoods, homes and decor but until you go through this process with another person, it’s an entirely different story.

There’s nothing wrong with buying a starter home.

Just understand that buying a home when you’re single could be a mistake if you eventually end up in a relationship with someone who has different ideas of what a home should look like.

The longer you live in a home, the better your odds of seeing a positive outcome but it’s hard to know ahead of time the curveballs life is going to throw your way.

You might expect to live in the same home until life gets in the way. My wife and I thought our first home could be a forever home until we found out we were having twins and needed more room.

How much am I comfortable spending on housing? The down payment can be a problem in certain housing markets but for most people the monthly outlay is the biggest determinant of how much you can spend on a home.

That monthly payment includes not only your mortgage payment but also insurance, property taxes and potentially PMI if you don’t put 20% down.

In terms of figuring out a price range I like to think about it this way — every $10k in price is an extra $40 or so in monthly payments (based on a 30 year fixed at 3%).

Let’s say your range is $250k-$400k. The monthly mortgage payment range for these prices is $1,054 to $1,686 (before accounting for a down payment). That’s a difference of more than $630 a month or nearly $7,600 a year.

You have to think through the opportunity cost of those payments.

If you don’t have a good grasp on your budget, time horizon, current financial status and local real estate market it’s going to be difficult to figure out how much to spend on a home.

If you think you’ve found your forever home, I don’t have a problem with looking at homes in the high end of your range. The wonderful thing about fixed rate mortgage payments is they don’t change.

If you’re looking for a starter home, I do have a problem with looking at higher-priced homes. If you’re not going to live in the house for at least 7 years or so you should seriously consider whether it’s worth it or not.

Further Reading:
Are U.S. Houses Becoming Unaffordable?

1It’s much easier to focus on the change in price than the actual ROI. My guess is the ROI for most people on their home isn’t all that great if they’re being honest about all of the costs. But this is circumstantial as well of course.

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