Updated on 08.28.14

#4: Paying for a Home

Trent Hamm

25 Rules to Grow Rich By

This is part of a series in which we re-evaluate Money Magazine’s “25 Rules To Grow Rich By”. One “rule” will be re-evaluated each weekday until the series concludes; you can keep tabs on the action at the 25 Rules index.

How Much Should My House Payment Be?

Rule #4: Your total housing payments should not exceed 28% of your gross income. Total debt payments should come in under 36%.

This is an unsurprising rule that is basically just a statement of the basic rule of thumb most lenders used when deciding on a home loan and is just a rewrite of yesterday’s nearly-identical bromide. But the fact is that this rule isn’t really hard and fast, either.

In fact, for most people 28% is beyond what they should realistically budget for while allowing themselves any room whatsoever to breathe. If you spend 28% on your mortgage payment alone, you’ve committed nearly 40% of your gross wages to your house payments, your property taxes, your insurance, and necessary upkeep, which puts many people on a path where they simply cannot afford to save any money whatsoever, since other taxes will claim another 25%, leaving you about 35% of your income to live on.

Here’s a better rule: figure this number in terms of your net income. This way, you can calculate how it will directly affect your monthly take-home after you’ve removed items such as your income tax withholdings and your retirement payments, which you should never touch just to buy a home. Figuring that you’re working with 28% of your gross income, let’s assume that you can potentially spend 35% of your net income on housing. Since you should be contributing, at a bare minimum, 5% of your net income into some sort of savings or investment in the event of the loss of your employment, this leaves 30% of your take-home pay that you can spend on housing. You can do a similar calculation and quickly determine that your total debt repayment shouldn’t exceed 40% of your net income. So let’s rewrite the rule:

Rewritten Rule #4: Your total housing payment should not exceed 30% of your net income. Total debt payments should not exceed 40% of your net income.

You can jump ahead to rule #5 or jump back to rule #3.

Loading Disqus Comments ...
Loading Facebook Comments ...
  1. Jeff says:

    You misread the original article. The 28% of gross figure is for total housing payments — not mortgage alone. The vast majority of families in America today spend well above 28% of their gross income on housing, even though we would all be better off if we stuck to this rule and chose more affordable homes.

  2. Phil says:

    In addition to Jeff’s clarification of the 28% TOTAL housing payments (mortgage, insurance, property taxes, HOA dues, etc), it is also worth mentioning that most homeowners will receive a tax deduction for the interest paid on their mortgage note. Depending on your tax bracket and/or state income tax, the tax deduction could be in the range of 20% to mid-30% of interest paid.

    If you fall into the category of homeowners who receive a tax deduction the interest paid on your mortgage note, you could adjust your income tax withholding accordingly (thus increasing your ‘net income’).

    I think 28% is a good, conservative guideline – especially considering that the general rule of thumb lenders use has increased over the past 20 years, and is now 38%-55% (depending on your credit score).

  3. chris says:

    Good luck finding housing that consists of more than some duct tape and cardboard boxes for that kind of a % if you start out with a modest single income.

    When I was in the market for a house, this would mean that I’d have been allotted $616 for a total housing expense. That’s laughable considering that my current utility costs are about that high. I wound up somehow getting financed for a 220K home at 6% (fixed 30) and 3% down. This meant a mortgage + escrow in the neighborhood of $1800 which was a ridiculous 82% of my take home pay (2200). You figure in cost of utilities, and I’m already running a deficit. I’m still at a loss to explain how I got approved for this loan. The realtor and accounted seemed optimistic at the time, stating that I’d be getting tax credit on the mortgage interest and real estate taxes. Sure, as if 16K in deductions on a 45K salary is going to remedy this situation and put steaks in the fridge.

    If you read Nickel and Dimed by Barbara Ehrenreich, one of her thoughts was that a lot of the problem with poverty in the US is that housing is simply too expense and places a larger burden on lower income individuals. I know it had the potential to sink me.

    I fought back by signing on 3 roommates to 2 year leases at 400 a month + a share of utilities. This was a ridiculously low rent for them considering the location and the home I bought easily accomodated us all. A job change led to more income and another job move improved my financial outlook yet again.

    Things aren’t all roses though, as the roommates are at the end of their 2 year lease and our group is disbanding for a variety of reasons. That leaves me with a lot of tough decisions and a long forgotten dream of making money (ha!) on this pit. House repairs are a necessity and the depressed market makes me want to go emo. Hey, at least I didn’t succumb to the sub-prime monster….yet.

  4. John Osmond says:

    Question: does the debt element of the mortgage payment fall under “Housing” (30%) or “Debt” (40%)? Or does debt mean other debt like loans/ cards etc. Thanks for any help.

  5. Kat says:

    If you live anywhere in a high cost of living area, say CA, you can not follow this rule. No one would be able to afford a house or condo or to even rent.

  6. Meg says:

    Our experience over the years, is the banks are always willing to loan you more than you really should undertake on your mortgage. Their % rule allow people to get into a home way bigger and more extravagant than most need to live. Perhaps this will change now with the sub-prime disaster going on in the financial markets.

    Also, those who do live in areas such as CA, as Kat states, get very little for their BIG BUCKS they put up. But hey, it costs to live in certain areas and until the markets get rational that is not going to change! Perhaps if those who could not really afford to buy in CA or other high rolling areas, if they left, would the market slowly become rational again ???

  7. Amanda says:

    Unfortunately that rule also doesn’t take into account the average cost of living in some areas. According to numerous website, if the cost of living in the US is 100, the cost of living in my zip code is 170, and that’s one of the cheaper zip codes! And that’s the average cost of living OVERALL. The average cost of HOUSING alone scores over 200.

  8. Rob says:

    I make 70k a year and there’s no way I could even afford a 1-bedroom bug-infested apartment in my area (NJ) under these rules. 28% for total cost of living is just absurd…I might be able to find it if I moved 45 mins to an hour away from my job, but that would drastically increase fuel costs and commuting time, which would worsen my quality of life a lot more than paying a little more for my house. There’s a lot more to this than a hard-and-fast percentage.

  9. Seattle Rez says:

    These rules are SO not one-size-fits all. Our budget for instance – 46% of take home is mortgage, our other expenses are 24% and we’re able to save 30%. We live very well and have room in our budget for restaurants, entertainment and other fun stuff.

    What we don’t have is 30k worth of cars in the driveway, vacations on credit or designer ANYTHING. We live within our means! What a concept!

    Also, this is on ONE income (64k/year) as my husband is finishing his master’s degree – as we are very happy with our lifestyle, any income he will bring in will go right into our mortgage!

Leave a Reply

Your email address will not be published. Required fields are marked *