Mortgage rule of thumb

[gasdoc86]

OK quick question. The rule of thumb that I've seen around here is don't buy a house worth more than 2-2.5x your annual income. So does this apply to the mortgage amount or house value?

Example: House price = 650K. After 20% downpayment, the mortgage amount is 520K. For an income of 250K/yr the mortgage amount is less than 2.5x annual income, but the price of the house is a little bit above 2.5x the annual income.

Is this too much house? Or would it fit within our rule of thumb?

[ENT Doc]

Not sure I'd split hairs on this one.  Do you expect your income to go up?

[MPMD]

2x (not 2.5x) is mortgage not home price.

to echo Jim's points 2.5x isn't going to kill you but it's going to mean that you work longer, save less, retire with less etc.

only thing to realize on top of that is that more house is more tax, upkeep etc.

budget 1% purchase price/year in upkeep.

I personally think that even 2x is stressful, would much rather be in a 1-1.5x range.

 

 

edit: 520k on 250k is certainly not crazy and you will probably be fine.

[gasdoc86]

ENT Doc wrote:

Not sure I’d split hairs on this one.  Do you expect your income to go up?

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I didn't post my actual finances, just a made up example so I understand the rule. But I actually expect my base salary to be slightly higher than what I posted, and I also didn't include incentive pay. But it doesn't seem smart to factor in incentive pay when deciding how much house to get.

MPMD wrote:

2x (not 2.5x) is mortgage not home price.

to echo Jim’s points 2.5x isn’t going to kill you but it’s going to mean that you work longer, save less, retire with less etc.

only thing to realize on top of that is that more house is more tax, upkeep etc.

budget 1% purchase price/year in upkeep.

I personally think that even 2x is stressful, would much rather be in a 1-1.5x range.

 

 

edit: 520k on 250k is certainly not crazy and you will probably be fine.

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Yeah I would definitely prefer to keep it in the lower range for sure. The area that I live in is rapidly morphing into a HCOL area though.  :?

 

[mobilehomegurl]

In real estate, it's usually 1/3 of your monthly income (no more) should go to the monthly mortgage. Just my experience!

[MPMD]

mobilehomegurl wrote:

In real estate, it’s usually 1/3 of your monthly income (no more) should go to the monthly mortgage. Just my experience!

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that's way too high.

[FIREshrink]

It's a guideline, not a rule. Other factors such as student loans, other lifestyle choices, goals, etc, matter more than whether the guidelines is x or y.

[AnjaliFIT]

The rule of thumb is your total debt should not be more than 3x income.  Thus, if you make $500k then your total debt should not be more than $1.5M.  The other number lenders look at is your debt to income ratio which should be below 40%.  These are just rules of thumb which are not necessarily the best to use for your specific situation.  Instead of focusing on the rules, I would really take a deep look at your current cash flow and how much you are saving i.e., how much money is coming in and how much is going out to current expenses (fixed and discretionary).  Then factor in the cost of home (principal, interest, property tax and insurance) and how much of your savings is getting eaten up by the new home purchase.  If the savings level is at a point that you are comfortable with then it is probably a home that you can afford.  If the new home eats into savings or puts you in negative cash flow then you may want to reassess the purchase price.

[Peds]

gasdoc86 wrote:

OK quick question. The rule of thumb that I’ve seen around here is don’t buy a house worth more than 2-2.5x your annual income. So does this apply to the mortgage amount or house value?

Example: House price = 650K. After 20% downpayment, the mortgage amount is 520K. For an income of 250K/yr the mortgage amount is less than 2.5x annual income, but the price of the house is a little bit above 2.5x the annual income.

Is this too much house? Or would it fit within our rule of thumb?

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thats fine.

guideline is mortgage 2x income. so if you put 90% down you can buy a HUGE house haha.

HCOL ppl need to go 3x, maybe 4x.

you dont want to see 5x or more basically.

[KPInvestor]

Its hard or nearly impossible to make 2x the mortgage in many HCOL areas, unless you want to live in a small attached condo or live in areas with horrible schools that may be a bit unsafe.  I think Anjali said it best.  If you can save enough money after paying your mortgage and other living expenses, then it should be all good.

[White.Beard.Doc]

In a low cost of living area you may get a nice home at 1x annual income.  In San Francisco, good luck finding anything.  It really depends on where you live.  The simple ratio of 2x annual income is just a starting point.

[hightower]

KPInvestor wrote:

Its hard or nearly impossible to make 2x the mortgage in many HCOL areas, unless you want to live in a small attached condo or live in areas with horrible schools that may be a bit unsafe.  I think Anjali said it best.  If you can save enough money after paying your mortgage and other living expenses, then it should be all good.

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Which is why there are a lot of very house poor people in those areas who could otherwise be very wealthy elsewhere.  They are all living dangerously IMO because their net worth is at the mercy of the real estate market.  I wouldn't sleep well at night knowing that.  I don't even like have my current 0.8X mortgage.

It's a choice though.  If living in one of these areas is absolutely the thing that makes you happy and you're okay extending your working years just to own a house that is 3-4X your income, then good for you.  I do like visiting SF, LA, or NYC, but I wouldn't want to own property there unless I were making millions/year.

[MPMD]

Peds wrote:

gasdoc86 wrote:

OK quick question. The rule of thumb that I’ve seen around here is don’t buy a house worth more than 2-2.5x your annual income. So does this apply to the mortgage amount or house value?

Example: House price = 650K. After 20% downpayment, the mortgage amount is 520K. For an income of 250K/yr the mortgage amount is less than 2.5x annual income, but the price of the house is a little bit above 2.5x the annual income.

Is this too much house? Or would it fit within our rule of thumb?

Click to expand…

thats fine.

guideline is mortgage 2x income. so if you put 90% down you can buy a HUGE house haha.

HCOL ppl need to go 3x, maybe 4x.

you dont want to see 5x or more basically.

Click to expand...

We've all hashed this out on many other threads esp about CA real estate.

If you "need" to go to 4x to buy a house, you can't afford to live where you live, full stop. You might love it and think no where on earth compares but you can't afford it.

Looking at what the mortgage payment would be for us at 4x makes me cringe in terror. Those crazy real estate markets keep climbing right up to the minute that they don't anymore.

[hightower]

AnjaliFIT wrote:

The rule of thumb is your total debt should not be more than 3x income.  Thus, if you make $500k then your total debt should not be more than $1.5M.  The other number lenders look at is your debt to income ratio which should be below 40%.  These are just rules of thumb which are not necessarily the best to use for your specific situation.  Instead of focusing on the rules, I would really take a deep look at your current cash flow and how much you are saving i.e., how much money is coming in and how much is going out to current expenses (fixed and discretionary).  Then factor in the cost of home (principal, interest, property tax and insurance) and how much of your savings is getting eaten up by the new home purchase.  If the savings level is at a point that you are comfortable with then it is probably a home that you can afford.  If the new home eats into savings or puts you in negative cash flow then you may want to reassess the purchase price.

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1.5 million in debt on a 500k income?  That's insanity to me.  Why would anyone voluntarily sign up for that?  That is how you are guaranteed to be in debt your entire life and never have a chance to stop working.

"If the savings level is at a point that you are comfortable with..." what does this mean?  People need to be aware of two things at all times...1. Their actual net worth 2. What it would take to be financial independent so that some day they can retire comfortably.   They should use those two pieces of information to figure out what savings rate is actually  realistic to their situation.  IF someone loves their job and they want to work until they are 65-70, then they can look at what they make, what they spend, how much debt they need to pay off first, and calculate their FI number (at least 25X their annual expenses saved in investable assets).  IF they can still reach FI by their ideal retirement age with their savings rate, then they can probably afford the house they want.   But, I find it hard to believe that a 1.5 million dollar house on a 500k salary is going to get them to FI soon enough for them to retire comfortably, maintaining the same lavish lifestyle they've become accustomed to living in a millionaires neighborhood their whole life.    Because remember, with that 1.5 million dollar house they are going to have to pay for 50k/yr/child private schools, drive 75k+ cars, and furnish that big house with the latest "keeping up with the Jones' crap."  Not to mention all the crazy repair, maintenance, HOA bills, and other unexpected expenses they will have.

The 2X rule of thumb is conservative enough to prevent putting yourself into a situation like that.  It's also generous enough to let you live pretty lavishly without becoming house poor assuming you do all the other right things (pay cash for cars, max your tax advantaged retirement savings every year, etc, etc).

 

[MPMD]

hightower wrote:

AnjaliFIT wrote:

The rule of thumb is your total debt should not be more than 3x income.  Thus, if you make $500k then your total debt should not be more than $1.5M.  The other number lenders look at is your debt to income ratio which should be below 40%.  These are just rules of thumb which are not necessarily the best to use for your specific situation.  Instead of focusing on the rules, I would really take a deep look at your current cash flow and how much you are saving i.e., how much money is coming in and how much is going out to current expenses (fixed and discretionary).  Then factor in the cost of home (principal, interest, property tax and insurance) and how much of your savings is getting eaten up by the new home purchase.  If the savings level is at a point that you are comfortable with then it is probably a home that you can afford.  If the new home eats into savings or puts you in negative cash flow then you may want to reassess the purchase price.

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1.5 million in debt on a 500k income?  That’s insanity to me.  Why would anyone voluntarily sign up for that?  That is how you are guaranteed to be in debt your entire life and never have a chance to stop working.

“If the savings level is at a point that you are comfortable with…” what does this mean?  People need to be aware of two things at all times…1. Their actual net worth 2. What it would take to be financial independent so that some day they can retire comfortably.   They should use those two pieces of information to figure out what savings rate is actually  realistic to their situation.  IF someone loves their job and they want to work until they are 65-70, then they can look at what they make, what they spend, how much debt they need to pay off first, and calculate their FI number (at least 25X their annual expenses saved in investable assets).  IF they can still reach FI by their ideal retirement age with their savings rate, then they can probably afford the house they want.   But, I find it hard to believe that a 1.5 million dollar house on a 500k salary is going to get them to FI soon enough for them to retire comfortably, maintaining the same lavish lifestyle they’ve become accustomed to living in a millionaires neighborhood their whole life.    Because remember, with that 1.5 million dollar house they are going to have to pay for 50k/yr/child private schools, drive 75k+ cars, and furnish that big house with the latest “keeping up with the Jones’ crap.”  Not to mention all the crazy repair, maintenance, HOA bills, and other unexpected expenses they will have.

The 2X rule of thumb is conservative enough to prevent putting yourself into a situation like that.  It’s also generous enough to let you live pretty lavishly without becoming house poor assuming you do all the other right things (pay cash for cars, max your tax advantaged retirement savings every year, etc, etc).

 

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I think it's also worth pointing out that if you can't be happy in a 2x house you're probably not going to be happy in a 3x.