Now that we've had some fun figuring out the minimum income and net worth required to buy a $5 million home, I thought it'd be nice to be more inclusive. This post will discuss the income and net worth requirements to buy a home priced from $200,000 to $50 million.
The income and net worth figures are determined by my 30/30/3 Home Buying Rule and my Net Worth Home Buying Rule. I truly believe the combination of these two rules creates the ultimate guide to responsible home buying.
My goal is to also provide a consistent home buying guide that works as we make more money and become wealthier.
Income And Net Worth Requirements To Buy A Home At All Price Points
Take a look at the chart below based on my two home buying guides. As you can see from the chart, the more expensive the home price, the more you need to make and the higher the net worth you should have.
You'll see the minimum income and minimum net worth required to buy a home and the recommended income and recommended net worth needed to buy a home.
The Ideal Home Buying Financial Combination
Now let me share the ideal combination from best to worst before buying a home. The ideal income and net worth requirements will help you buy with more confidence.
1) You Have Both The Ideal Income And Ideal Net Worth.
You make the Ideal Income and have the Ideal Net Worth before buying a home at a certain price point. If so, you will have minimal financial worries and will likely enjoy your home to the fullest. At times, you may feel like you should live it up more. But it is your financial discipline that got you to where you are today.
2) You have the Ideal Net Worth and at least the Minimum Income Required Income.
In this situation, you also won't have too much financial worry. Your net worth is well-diversified and generates a reasonable amount of passive income on top of your active income. You can probably make more active income if you want to.
3) You have a Reasonable Income and Reasonable Net Worth.
You're right in the middle. However, your goal should be to boost your net worth so that your primary residence gets below 50% of your net worth. In general, no one asset class should take up more than 50% of your net worth. A primary residence should be no more than 30% of your net worth.
4) You have the Ideal Income and Minimum Net Worth Required.
In such a scenario, so long as you are confident in your employment prospects over the next several years, you should do fine. In five years, your net worth will most likely grow strongly. Just keep on saving and investing in stocks, real estate, and alternative assets.
5) You have the Minimum Income Required and the Minimum Required Net Worth.
Buying a home with this combination is a stretch. However, you are bullish on your future income and net worth growth. As a result, each year you work, you will feel more comfortable affording your home.
The ultimate goal is to get your primary residence equal to 30% of your net worth or less by the time you retire or take things down a notch.
First-Time Versus Experienced Home Buyer
If you don't make the minimum income or have the minimum net worth, it is not recommended you buy a home just yet. If you proceed to buy a home with this suboptimal combination, you will be too financially exposed to sleep well at night. Any job loss or recession may cause you to lose your home to a short-sale or foreclosure.
For first-time homebuyers, the most likely financial combination is having the minimum income and minimum net worth. But for experienced homebuyers, having financial combinations 1-3 above is the optimal way to go.
If you become very wealthy (over $10 million per person), you might be able to stretch the rules further if you want to buy a nicer house. But my guide really does suggest keeping your primary residence value to under 50% of your net worth. Ideally, keep it to under 30% of your net worth, no matter how rich you get.
Once you become very wealthy, you tend to actually spend less of a percentage of your net worth on a primary residence. Most extremely wealthy people have the lion's share of their net worth in businesses or investments.
What About A High Down Payment Scenario?
Instead of just assuming a home buyer puts down 20%, there are certainly scenarios where some home buyers put down much more. It is estimated roughly 15% of all home buyers pay cash.
In a higher down payment scenario, both income and net worth suggested requirements can decrease. However, how much of a decrease will depend on how much cash and semi-liquid investments you have after buying a home and your future income.
Here's an example. Let's say you are a FANG tech worker with a 75% down payment because you have lots of appreciated stock. You want to buy a $3 million house, put down $2.25 million, and have a $750K mortgage. What should your minimum income and net worth be?
For the disciplined buyer, your income should still be at least 1/5th the price of the house, or $600K. Given you have $2.25 million to put down, your minimum net worth of $900K based on my chart is far surpassed. Therefore, you're good on the net worth front, especially since you should have more wealth behind.
But obviously, if you put such a large down payment down, you’ll have a lot less difficulty affording the mortgage. The reality is, if you only have a $750K mortgage after putting $2.25 million down, you can probably get away with as little as a $150K income (1/5 of 750K). But $150K is going to be really tight and leave little for saving and investing outside your primary. Therefore, I would not recommend.
If you are able to sell enough stocks to pay cash for a home, then you don't have to follow my home-buying guideline as strictly. Just know that you'll still have to pay property taxes and ongoing maintenance costs for the life of ownership.
Split The Difference When Buying
As a compromise, consider using the recommended income ratio of 1/3 of price of the home, applied to the mortgage balance. Hence, a more appropriate income in this scenario would be $250,000.
You would make $20,833 a month and have a $3,368 monthly mortgage payment at 3.5%. This would equate to an affordable 16% of monthly gross income.
If you follow this path, just make sure you keep your job or at least make a similar amount for the next three years at a minimum. Buying a home is an incredibly emotional and stressful process. Here's a podcast episode of my wife and I discussing the anxiety of moving forward with a new home purchase.
The Relative Importance Of Income And Net Worth When Buying A Home
Income is the most important factor for buying a home with a mortgage. Without a high enough income, you won't be able to get a loan. In this stringent lending environment, your income needs to be at least 20% of the price of the home you want to purchase. Most people with W2 income and a credit score of over 720 should be able to qualify.
If you are a freelancer with a more volatile income, then your income may need to be much greater than 20% of the price of the home. Further, at the bare minimum, you will need at least two years of minimum income before a lender will proceed. Therefore, you may want to refinance or purchase a home before giving up your W2 income.
As you get wealthier, lenders will be more willing to take into consideration your net worth when making a loan. This is called asset-based pricing, which comes in handy if your income falls below the 20% of home price threshold. For example, some borrowers with illiquid stock holdings can pledge their stock as collateral.
A High Net Worth Provides More Security
Between a high income and a high net worth, I would choose a high net worth. Not only does a high net worth provide more security, you will be better able to shelter it from high taxation. A high income is more a means to an end, which is a high net worth.
Therefore, the best combination, from a tax perspective, is to have a high net worth and just enough income to pay for regular living expenses and the house you want.
As I wrote in a previous post about 2022 income tax rates, the ideal incomes are:
- $170,050 MAGI for singles
- $340,100 MAGI for married couples
We can then select $12,060,000 for singles and $24,120,000 for couples as the ideal net worth. These are the estate tax exemption limits for 2022.
In 2023, the estate tax exemption limit goes up to $12,920,000 for singles and double for married couples! With this combination, you pay the least amount of taxes and still get to do whatever you want. If the estate tax exemption amounts get cut, then you would adjust accordingly.
If you happen to spend on something lavish, you can always draw down principal if $170,050 or $340,100 income is not enough.
A Bigger, More Expensive Home Is Not Always Better
I've been in several 10,000+ square foot homes before and I'm not sure I'd like to live in them with a family of four or five. As an economics major, I just find unused space to be wasteful. The ideal home size and layout is well utilized.
It makes me happy to have all or almost all rooms regularly used on a daily basis. I feel the same way when I load up my car with four or five people versus just me driving.
After about 1,500 square feet of space per person, it just feels like too much. The ideal house size and layout is likely closer to 700-1,000 square feet per person. Perhaps this feeling is a function of me living in expensive New York City and San Francisco since graduating college in 1999. But I feel plenty happy living in a house that is 750 square feet per person.
Eventually, if you have children, they will find somewhere else to live. As a result, you may eventually want a smaller home as well.
Larger Home, More Problems
The number of maintenance issues and potential problems seem to grow exponentially with larger homes. Then there are higher property taxes and insurance bills to pay as well. Personally, the maximum annual property tax threshold I'm willing to pay is $100,000. After that, it just feels like too much.
A house's floor plan is also extremely important. If you plan to work from home and raise small children, having a house that has multiple floors or sections is important for privacy and noise control. If you're older and are more susceptible to falling, having a home mostly on one floor is more ideal.
Finally, what is growing in demand is exterior space. Homes with multiple decks and large yards are becoming increasingly popular post-pandemic. The indoor and outdoor living combination is one of the reasons why places like Hawaii are so ideal.
What Causes People To Buy Underutilized Mansions?
I'm curious to know the psychology behind why people buy mega-mansions. Is it just because they can? One friend in high school owned a 12,000 square foot house with an indoor heated pool in Langley, Virginia. A couple decades later, he told me the house was the main reason why his family had to file for bankruptcy.
Having a mansion with a ton of land to run around on would be really nice. I'd love to have a water park, a playground, a tennis court, a basketball court, a lake, a paintball field, and a helicopter pad area. But other than that, what else does one need?
With a family of four, my limit is a five-bedroom, five-bathroom home. Ideally, it has about 5,000 interior square feet and one acre plot of land. I'm sure I could get used to a larger home. However, even if I had the money, I'm not sure I want one.
Invest In Real Estate To Earn More Passive Income
Stocks are very volatile compared to real estate. Therefore, if you want to dampen volatility, diversify your investments, earn more passive income, and build wealth at the same time, invest in real estate. Real estate is my favorite asset class to build wealth.
The combination of rising rents and rising capital values is a very powerful wealth-builder. By the time I was 30, I had bought two properties in San Francisco and one property in Lake Tahoe. These properties now generate a significant amount of mostly passive income.
My favorite real estate investing platform is Fundrise. With over $3.3 billion in assets under management and over 400,000 investors, Fundrise is the leading, vertically integrated real estate platform today. Investors can invest in their diversified real estate funds with as little as $10.
Fundrise primarily focuses on single-family, multi-family, and build-to-rent properties in the Sunbelt. With lower valuations and higher yields, Fundrise investments are in the sweet spot of a positive long-term trend. The strong demographic trend toward the Sunbelt is a powerful investment thesis.
Another great private real estate investing platform is Crowdstreet. Crowdstreet offers accredited investors individual deals run by sponsors that have been pre-vetted for strong track records. Many of their deals are in 18-hour cities where there is potentially greater upside.
If you want to get more surgical in your private real estate investments, Crowdstreet is a strong solution. I've met the people at Crowdstreet on two separate occasions and came away impressed with their risk-management and product offerings.
I've personally invested $954,000 in private real estate since 2016. To be able to earn more passive income in a less volatile way has been wonderful. It frees up time so I can do more of what I want.
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