How Much House Can I Afford?

By Trent December 21, 2013

Another common email I receive from readers concerns whether or not the sender can afford a particular house – or how much house they can afford. The stories vary a lot in detail – some people have a down payment, while others do not, and some people have other debts, while others are debt free.
Regardless of the situation, though, I give these people the same advice. Your total debt payment for a given month should not exceed 30% of your take-home pay.
In other words, if you bring home $4,000 per month, your total debt payments for that month shouldn’t exceed $1,200.
Let’s walk through a few of the specifics here.

This is take home pay, not gross pay. The only pre-tax number you might consider including is your 401(k) contributions, but I wouldn’t include those. I would never include taxes or other costs when thinking about this. Why? In the end, this is all about budgeting, and having 30% of your monthly income go straight into debt payments is a pretty hefty chunk of your money. This leaves the rest to cover utilities, food, household supplies, and other living expenses.

The percentage should be pretty close to that even if you’re earning a lot of money. Again, why? This is all about downside. You don’t want to have to sell your home in a panic if you lose your job or some other major lifestyle change occurs. You want to keep yourself afloat no matter where your ship goes.
Sticking with this policy usually implies a few things.

First, you’re going to be able to afford a bigger home if you’re debt free. If you’re still paying hundreds per month in student loans, the burdens of home ownership are going to be intense. If you want a home in the next several years, focus hard on freeing yourself from debt.

Second, you’re usually better off if you buy a smaller home rather than a larger one. Once you get beyond a certain point of home size, the excess space mostly just serves as storage for your excess stuff – mostly stuff you don’t really need.

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