Why the 30% Rule Probably Isn’t the Best Idea When Buying a House

how much should i spend on a house

Ask someone the question, “How much should I spend on a house?” and there’s a good chance that they will respond with the 30 percent rule.

The 30 percent rule is a good place to start, but it’s not always the best gauge of how much should you spend on housing. You don’t want to base your entire financial situation on it — especially sometimes it’s not exactly clear what that 30 percent includes.

What is the 30 percent rule?

The 30 percent rule has been around since the 1930s, according to the Census Bureau. Back then, policymakers were working to make housing affordable. It was then discovered that you could spend about 30 percent of your income on housing and still have enough leftover for other expenses.

Over time, those numbers began to apply to home loans as well. A rough sketch of what you could afford, in terms of monthly payment, could be obtained by estimating 30 percent of your income.

Is the 30 percent rule right for you?

When deciding on your own 30 percent rule, it’s probably a good idea to base it on your take-home pay, rather than your gross income. Let’s say you bring home $3,500 a month. According to the 30 percent rule, you shouldn’t spend more than $1,050 on your housing payment.

Some folks like to use their gross income for this calculation, but that can get you into trouble in the long run. If you base what you spend on housing on an amount that you might not be bringing home, that can stress your budget.

Think about it: If your pre-tax pay is $3,800 a month, that means that you can expect to pay $1,140 on housing. That’s $90 more per month. But the reality is that you are bringing home $300 less than your gross income. Trying to come up with another $90 a month can put a strain on your budget.

Don’t forget about extra costs

You can use a mortgage calculator to figure out how much should you spend on housing. However, the calculator probably just includes principal and interest. This doesn’t take into account other monthly homeownership costs.

If you think you can afford to buy an expensive house, you might be forgetting about other costs. Insurance and taxes might strain your budget if you haven’t taken them into consideration.

Experts suggest that you base your 30 percent figure on all of your monthly payment costs, not just the principal and interest. So, try to take these extra costs into consideration.

What percentage of income should be spent on housing?

But it goes beyond that for some homebuyers. When looking into buying a home or an affordable place to rent, don’t just base your estimates on your monthly payment. You should also include estimated utility costs and an estimate for maintenance and repairs.

Houselogic suggests that you budget between 1 and 3 percent of your home’s purchase price annually for repairs and maintenance. I like the idea of budgeting 2 percent. So, on a $200,000 home, that means you can expect to pay $4,000 for repairs and maintenance — about $333.33 per month.

Once you start adding in all the other aspects of homeownership, suddenly that 30 percent rule is less cut and dry. If you’re more conservative, adding up all the monthly costs of homeownership and keeping it all under 30 percent makes sense.

You’re less likely to overspend that way. But it does often mean a smaller, less expensive home.

Consider the 28/36 qualifying ratio

Instead of relying on the 30 percent rule to answer the question, “How much should I spend on a house?”, consider using the 28/36 qualifying ratio.

According to Re/Max, many lenders use the 28/36 rule to figure out whether or not your finances can handle your home purchase. The 28 refers to the percentage of your gross monthly income that should be spent on your monthly housing cost. The 36 refers to the total debt payments you make. This also includes your mortgage payment.

So, if you make $3,800 take home pay, your monthly payment should be no more than $1,064. But, things get stickier when you add in the debt part of it. Your total debt payments shouldn’t be more than $1,368. That leaves you about $304 for payments of other debts.

Let’s say your credit card and auto loan payments total $500. That means that you’re going to have to adjust your expectations for what you can expect to pay for a mortgage. In fact, if your lender insists on the 36 part of the ratio, you have $196 less you can spend on your mortgage payment. And that might mean a less expensive house.

When figuring out what percentage of income should be spent on housing, base the calculations on your take-home pay. Even though Re/Max says many lenders use your gross pay for the 28/36 qualifying ratio, this way you’ll play it safe.

How much should I spend on a house?

Everyone has to answer the “How much should I spend on a house?” question for themselves. However, the biggest reason to ditch the 30 percent rule is that you might not be comfortable with it.

Are you really comfortable spending 30 percent of your income each month on your housing? When you consider your other payment obligations, does it makes sense for you to spend so much on housing?

If you aren’t sure about the 30 percent rule, use your own rule. You might be more comfortable with 25 percent on all of your housing costs. Or perhaps you modify the rule. Maybe you spend 20 percent on mortgage and interest and keep your total housing costs to 25 or 28 percent.

No matter what you decide, the important thing is to be responsible with your finances. Only spend what you feel comfortable with on housing or rent.

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Published in Buying a House, Mortgage