A five million dollar house is big bucks in every single city in America. Once you cross the $5 million mark, it is classified in the luxury territory, even for cities such as San Francisco and New York. Therefore, I thought it would be fun to calculate the minimum income necessary to own a five million dollar house.
When it comes to buying a home, a good rule of thumb is to spend no more than 3X your gross income on the price of a home house. It is part of my 30/30/3 rule for home buying to help people buy responsibly.
In other words, if you want to buy a five million dollar house, then you should earn about $1.67 million a year. In addition, you should have at least a $1,000,000 down payment and ideally another $500,000 buffer in the form of cash or liquid securities. The buffer is just in case you lose your job or something bad happens to your house.
Does needing a $1.67 million income to buy a $5 million home sound like too high a hurdle? After all, once you make over $1 million a year, you have a lot more disposable income. Just know that in the past, people would buy their homes with all cash. So the minimum income to buy a $5 million home also depends on your net worth and cash balance.
I understand very few people can afford to buy a $5 million home. But it's always fun to dream as home prices get higher and higher over time. Further, it's always good to plan ahead. For those of you who currently own a $1-$3 million dollar home, $5 million may be the next step if so desired.
How To Afford A $5 Million House
As I just calculated, having a $1.67 million annual income to afford a $5 million house is recommended. However, in this permanently low interest rate environment, you can stretch to buy a home up to 5X your annual gross income.
In other words, you can make as little as $1,000,000 a year, to buy a $5 million home. Your minimum income should also be consistent over the next several years. However, without a large cash buffer, you will feel stressed and a little paranoid during the initial years of ownership.
Having a $4 million mortgage after putting $1 million down is a lot. At a 3% mortgage rate, we're talking a monthly payment of $16,864. That's $202,368 in yearly mortgage payments, before paying taxes. But people who buy five million dollar houses generally put way more down than just 20%.
If you pay a total effective tax rate of 32%, then you would need to earn $297,600 in gross income just to pay $202,368 a year in mortgage payments. Then, of course, you've got to pay for everything else in life.
If you plan on buying a $5 million home, you probably want to put down a greater down payment percentage. For example, a $2 million mortgage after putting $3 million down is only $8,432 a month at a 3% interest rate. That's only about 10% of your monthly $83,333 gross income figure if you make $1,000,000 a year.
The people I know buying $5 million homes and up are often putting down 40% – 100%. Further, most people I know who make over $1 million a year don't have a $1 million base salary. Instead, their base salaries are much lower, more in the $200,000 – $500,000 range. The rest of their compensation comes in the form of stock grants and year-end bonuses.
When I was working in banking, an Executive Director had a base salary of $250,000. An ED's year-end bonus could range from 0% – 200% of base salary. Depending on the size of the bonus, a portion of it would be in deferred stock and cash compensation over three years. The greater your bonus, the larger percentage of the bonus was deferred.
The Cost To Own A Five Million Dollar Home
When you own a $5 million house, remember that your homeownership costs will be magnified as well. We’re talking $60,000 – $150,000 a year in property taxes alone, depending on the property tax rate by state. Hawaii has the lowest property tax rates while Illinois, New Jersey, and Texas have the highest property tax rates.
To maintain a $5 million home, there are also higher heating bills during the winter, higher homeowner's insurance, higher maintenance costs, higher cleaning costs, higher landscaping costs, a bigger mortgage, and so on. If you've got a leak in your roof, like I had during our “Bomb Cyclone,” it becomes much harder to find!
Therefore, don't think about the cost of a five million dollar house as just the initial purchase price. Think about the ongoing cost to maintain a five million dollar house. Then there is the cost to furnish a larger home. The opportunity cost of owning a $5 million home is also the cost of not renting it out.
One of the reasons why I sold my old house in 2017 was because it had four bedrooms and three bathrooms for just my wife and me. The market rent was between $7,500 – $8,500 a month at the time, which we weren't willing to pay. Further, there were between $50,000 – $85,000 in upcoming maintenance issues we may have needed to do. These included:
- Rewiring the entire house from knob and tube to ROMEX wiring: ~$50,000
- Replacing windows in the back of the house and waterproofing, which the new buyers did: $35,000
The property taxes and recurring maintenance are the main reasons why buying an expensive house can be a bummer. The more you have, the more you have that can go wrong. A smaller, more manageable house is often the way to go for those who want to achieve financial freedom sooner.
Minimum Income Necessary To Afford A $5 Million House
The absolute minimum income necessary to afford a five million dollar house is $1 million. The recommended income for owning a five million dollar house is $1.67 million. An acceptable income to own a five million dollar house is $1,250,000.
In other words, the multiple of total income to own a five million dollar house is between 3X – 5X. Once you get beyond 5X, you will likely be unable to comfortably sleep at night for at least the first year.
You would need a massive cash or liquid buffer after stretching so much to feel OK paying that much. Or, you would need to know with extreme confidence that your income will continue going up over the next 12-24 months.
Remember, once you get to the five million dollar level, everything gets amplified on the upside and downside. Be mentally prepared to deal with expensive fixes and more frequent issues.
The Recommended Net Worth To Afford A $5 Million House
If you follow my primary residence no greater than 30% of net worth guideline, then your net worth should be at least $16.7 million to afford a $5 million house. And if you want to bring your primary residence down to the ideal level of 20% of net worth, then you should have a net worth of at least $25 million.
Ideally, you will have a minimum income of $1 million and a net worth of at least $16.7 million before you buy a $5 million house. But most people probably don't have such a net worth level before buying. The good thing is that, over time, one's primary residence tends to decline in value as a percentage as one's overall net worth grows.
$1 Million Income Family Budget Owning A Five Million Dollar House
Below is a realistic budget for a family of four living in an expensive city earning $1,000,000 a year. Each parent is responsibly saving $20,500 a year in their 401(k) in 2022. Each parent will continue to max out their 401k every year they work so they can both end up 401(k) millionaires.
After putting $1 million down on a dream $5 million home, the family is left with a $4 million mortgage that costs $202,368 a year. With home maintenance, property taxes, and insurance, the total gross cost to own their $5 million home is about $281,000 a year. Luckily, they have over $500,000 in cash and liquid stocks to draw from in case of a financial emergency.
The next biggest expense is their two children, who attend private grade school. Not only is the family paying $110,000 a year for private tuition, they are also paying $15,000 a year for extracurricular activities. Finally, the parents are contributing $15,000 each a year to their kid's 529 plans.
They could be contributing a total of $30,000 to each child for a total of $60,000 a year. However, the family also wants to donate $25,000 to charity and live a rich lifestyle.
$1 Million Income Budget Analysis
As you can tell from the $1 million family budget, by the time all expenses are tallied up, the family doesn't have much cash flow left. The first big hit to income is taxes. Paying $352,610 in federal and state income taxes is pretty painful, which is one of the main reasons why you want to make more passive investment income. Passive investment income is taxed at a lower rate.
If President Biden successfully gets his way, the family's income tax bill will likely go up by another ~$9,155 a year (2.6% higher tax on income over $647,850). That said, perhaps there will be a nice offset if the SALT cap deduction limit gets raised from $10,000. We shall see.
Spending a $1 million income is relatively easy to do in a big city with two children. The family is also saving for retirement, saving for their children's college education, and building equity in their five million dollar home.
Sure, there are plenty of items to cut. But when you're working so hard and making a million dollars a year, you also want to enjoy some spoils as well. Below is a recap of the income tax rates for married, filing jointly in 2022.
Should You Buy A $5 Million Home And Up?
Since the best time to own the nicest house you can afford is when your kids are at home, some of you might be looking for an incredible new home. At the very least, it's fun to look at $5 million homes and up online.
Even if you make at least $1 million a year, I'm not sure it's worth buying such an expensive home. The upkeep can really be a bummer, especially if the home was not well-constructed.
Consistently earning over $1 million a year is also hard to do. You can ride a good luck wave for several years. However, the economy tends to move in feast-or-famine cycles. It certainly was this way when I worked in banking. And it certainly is this way as a small business owner.
Therefore, I do believe having at least a $16.7 million net worth is necessary before buying a $5 million home. Your net worth is more certain than your income. But even your net worth is highly susceptible to declines, depending on how it is allocated.
Another thing to note is the type of home or condominium you are upgrading from. Going from renting a small studio to a $5 million home might be too overwhelming. You may not be able to appreciate all that a $5 million home has to offer.
On the other hand, upgrading from a $3 million home to a $5 million home may be much more digestible. You won't feel as big of a shock. And, you'll also be better experienced in knowing how to best utilize the new space. Therefore, for maximum appreciation and adaptability, you probably don't want to upgrade in price by more than 100%.
Getting Out Of The Real Estate Frenzy Zone
Finally, I want to point out that once you buy a five million home, you are well outside the real estate frenzy zone. The real estate frenzy zone is home prices around +/- 25% of the median home price of your city. In other words, it's the zone where the most number of homebuyers can afford a home.
If there is ever a downturn, luxury properties will likely be the first to get hit. Or, they'll just turn completely illiquid and not trade for years. I've noticed this with luxury property in Honolulu. Some of the properties I've eyeballed since 2015 are still on the market!
Nobody needs a $5+ million home, which is why they are most at risk during a downturn. At the same time, during a massive bull market, the $5 million mark is considered “affordable luxury” in some cities like San Francisco and NYC. These homes can get bid up quickly.
Personally, my family is enjoying our much cheaper home forever home. We're utilizing all the rooms on a daily basis and that feels great. As an economics buff since college, having economic waste is a real bummer.
However, by 2025, if our wealth grows, we might seriously consider buying a five million dollar house. But by then, $5 million homes might be $6 million homes!
A Better Way To Invest In Real Estate
While you are building your income and down payment for a new five million dollar house, I would invest in real estate to keep up with the market. You may want to follow my BURL strategy for real estate investing. It states you should Buy Utility (high rental income homes) and Rent Luxury (rent $5 million homes).
If you follow my BURL strategy, you could generate enough passive rental income to rent your five million dollar home and have a lot of income left over.
For example, instead of buying a five million dollar house with a 3% cap rate, you could rent the house for $150,000 a year instead. You could then invest $5 million in multi-family properties generating a 7% cap rate for $350,000 a year in passive rental income.
After paying $150,000 a year in rent for your five million dollar house, you'd have $200,000 left over to do as you wish. Meanwhile, the properties you invested in may also appreciate in value as well, especially if they are in rapidly-growing 18-hour cities.
Here's a fun video of a $25 million house to make $5 million feel like nothing. When it comes to real estate, there is an endless amount of money to spend!
Earn More Passive Real Estate Income
Check out Fundrise, the leading real estate crowdfunding platform today with over 300,000 investors and $3+ billion in assets under management. With elevated inflation, we should continue to see rising rents and rising home prices for the foreseeable future.
Also explore CrowdStreet, a real estate platform that focuses on individual deals in 18-hour cities. 18-hour cities tend to have lower valuations, higher yields, and faster growth rates. Sometimes, CrowdStreet offers funds as well.
Personally, I've invested $810,000 in 18 real estate crowdfunding deals and a fund to diversify away from my SF real estate holdings. I want to earn more passive income and take advantage of demographic shifts. The demographic trend towards lower cost cities is real. Take advantage!
The Minimum Income Necessary To Afford A $5 Million House is a Financial Samurai original post. It is my next price point if I were to upgrade as we bought a nice home in mid-2020.