The best home-buying rule I can offer you is my 30/30/3 home-buying rule. I came up with the 30/30/3 home-buying rule back in 2009 and many publications and industry pundits have promoted it since.
If you follow my home-buying rule, you will have a greater chance of surviving any financial downturn. My 30/30/3 home-buying rule will also help you keep you disciplined when buying property during a hot market like the one we’re in now.
Even if you just follow one part of the rule, you will also be able to enjoy your property more because you will be less stressed about your finances. But ideally, you follow two or more parts of the three-part home buying rule.
Way too many homebuyers overextended themselves during the 2008-2009 financial crisis. As a result, most of us paid the price. Having your neighbor conduct a short sale or foreclosure isn’t good for your wealth even if you borrowed well within your means.
There is a lot of demand for real estate during the pandemic. Interest rates are low, work from home is growing, and people want to own a real asset that appreciates in value over time. My housing market outlook is bullish. I just want all of us to buy a home responsibly.
Please follow my 30/30/3 home-buying rule. Not only will the rule save you from a lot of stress, but it will also better protect our economy.
The 30/30/3 Home-Buying Rule
Here is my 30/30/3 home-buying rule to follow. The goal is to follow each part of the 30/30/3 home-buying rule to be a financially responsible home buyer. If you can’t, you must follow at least one.
Home-Buying Rule #1: Spend no more than 30% of your gross income on a monthly mortgage payment.
Traditionally, the industry says to spend no more than 30% of your gross income on your monthly mortgage payment. However, as mortgage rates continue to decline, more people are tempted to increase the percentage.
When mortgage rates are lower, you can already buy more home if you keep your spending as a percentage of gross income fixed. The danger emerges when you break this home-buying rule percentage to buy an even more expensive home.
The people most at risk of breaking the first rule of home-buying are middle income to lower income people.
Spending 40% of your monthly $50,000 gross income on a mortgage still leaves you with $30,000 in gross income. However, spending 40% of your monthly $5,000 gross income leaves you with a much smaller cushion.
You must be able to take care of your basic needs with the remaining money. Therefore, it is safer to spend less of your monthly gross income on a mortgage the more income challenged you are.
Home-Buying Rule #2: Have at least 30% of the home value saved up in cash or semi-liquid assets.
Before buying a home, you should have at least 30% of the value of the home saved in cash. 20% is for the downpayment to avoid PMI insurance and get the lowest mortgage rate. The other 10% is for a healthy cash buffer just in case you run into financial trouble.
I realize that there are programs that allow you to put down a smaller down payment. However, during times of maximum uncertainty, it’s better to have a larger financial cushion.
The homeowners who got blown out the quickest during the previous recession had minimal down payments. With minimal equity, the temptation to walk away from a mortgage is much greater. The thousands who did between 2008 -2012 missed out on one of the largest real estate recoveries ever.
If you are planning on buying a home within the next six months, keep at least the 20% down payment in cash. It is unwise to invest your downpayment in stocks and other risk assets if your home-buying time horizon is so short.
If you don’t have at least 30% of the value of the home saved up, it’s time to curtail your desires. Eat ramen noodles for the next six months to save money. Start a side hustle to boost your income.
Borrowing the downpayment from the Bank of Mom is pretty common nowadays. However, before you do, you need to ensure that you aren’t putting your parents at financial risk.
Home-Buying Rule #3: Limit the value of your target home to no more than 3X your annual household gross income.
The final part of my 30/30/3 rule is great for doing a quick scan at homes you can afford.
Home affordability based on cash flow is a function of the price you pay for the home. If you are able to meet the first two home-buying rules, then you can tie it all together with the final home-buying rule.
Rule #3 is a quick way for homebuyers to screen for homes in an affordable price range. The rule also takes into consideration down payment percentages and prevents one from stretching too much, even with a high down payment.
If you earn $100,000 a year, you can comfortably afford up to a $300,000 home. Or maybe you are lucky enough to earn a top 1% income of $500,000 a year. If so, then you can comfortably afford up to a $1,500,000 home.
Again, with mortgage rates collapsing, housing affordability has gone up. Therefore, you could stretch the third home-buying rule and extend the home value up to 5X your annual household income.
Just know that 5X a larger salary not only means more absolute debt, but also higher property taxes, maintenance expenses, and so forth. Make sure you run all the numbers before you make any home purchase.
With the expansion of the multiple up to 5X, you can also name my home-buying rule the 30/30/3-5 rule.
Home-Buying Examples Using My 30/30/3 Rule
Two examples of following or closely following the 30/30/3 home-buying rule
You make $100,000 a year and have $120,000 in cash saved. You desire to buy a $300,000 home. After putting 20% down, you have a $240,000 mortgage. The monthly payment is $1,012 or just 12% of your monthly gross income. With a $60,000 cash buffer left, you have almost five years of mortgage expense covered.
With the same income and cash savings, you decide to live it up a little and buy a $400,000 home instead. After putting 20% down, you have a $320,000 mortgage and still have a good $40,000 cash buffer. Your monthly payment is $1,349/month at a 3% mortgage rate. The payment is still only 16% of your monthly gross income of $8,333. This is good compared to the 30% maximum recommendation.
Thanks to low mortgage rates, you can see how stretching to buy a house worth 4X or even 5X your annual income is possible. However, I do recommended sticking to a 3X multiple if you want that wonderful feeling of financial security.
If America was filled with homebuyers like this, then the 2008-2009 housing crisis would not have been nearly as bad. Unfortunately, too many homebuyers didn’t follow the 30/30/3 home-buying rule. Most of us suffered as a result due to foreclosures and short-sales that brought our property values down.
An example of someone not following the 30/30/3 home-buying rule
You make $120,000 a year and have $100,000 in cash saved at 32 years old. Not bad. However, you’re also salivating for an $850,000 home, which equates to 7X your annual income.
You can’t put 20% down so you only put 10% down. This leaves you with only a $15,000 cash buffer and a $765,000 mortgage.
Due to a lower down payment, the best mortgage rate you can get is 3.75%. This is still low by historical standards. However, your monthly payment of $3,543 is 35.4% of your $10,000 gross income. It’s probably closer to 40% due to PMI. You have now violated all three of my home-buying rules.
If you lose your job, you will run out of cash in four months. You may get lucky holding on with enhanced government unemployment benefits and a couple stimulus checks. However, think about how stressed you will be during this time period.
Instead of buying this home now, first save up another $155,000 to get to $255,000 in cash and semi-liquid investments. With 30% of the home price saved, you can put down 20% and have a nice $85,000 cash cushion.
Further, your mortgage will decline to $680,000. At a 3.25% mortgage rate, your mortgage payment would be $2,959 or 29.6% of your monthly gross income. If your income increases while you are patiently saving for a larger downpayment, even better. Shop around for a better rate.
Another example of a terrible violation of the 30/30/3 rule
Rule #3 helps prevent a homebuyer from going off the deep end. Sometimes, people confuse their own true buying power with reality. Receiving a windfall can play tricks on some people.
Let’s say you make $70,000 and have a $500,000 down payment due to an inheritance. You feel rich! As a result, you may be tempted to buy a $1 million home since you can put $500,000 down.
If you do, your $2,316 monthly mortgage payment equals 40% of your monthly gross income. But then you get furloughed shortly after purchase with no pay. Three months into furlough, your boss says they won’t ever be hiring you back. You are screwed because you have no cash buffer. You thought the $500,000 windfall would be a regular thing. But people only die once.
You end up going into foreclosure. Your credit and finances are ruined. The property values on your block all take a hit thanks to you. Your financial life is over for several years.
Or in one man’s case after foreclosing on his home, he went on to get a job at The New York Times as a finance columnist. That’s right, even after deciding not pay back his mortgage, he still got a job giving financial advice. Anything is possible folks.
Ways To Get Around The 30/30/3 Home-Buying Rule
Although the 30/30/3 home-buying rule may seem stringent in such a low interest rate environment, just know plenty of people pay all-cash for their homes too. This idea of taking on lots of debt to buy property hasn’t always been the norm.
If you want to violate the 30/30/3 home-buying rule, then at least consider the following:
- Rent out a room or a portion of your house
- Create a business on the side to have a legitimate way to deduct a home office and other expenses like internet
- Be in line for a raise or secure a new job with a raise and promotion
- Build new passive income streams to help pay for your homeownership expenses
- Be really good to your parents and rich relatives
Income And Net Worth Necessary To Buy A Home Using The 30/30/3 Home Buying Rule
For those of you looking for an easy chart, here’s one I created that shows how much you should make and what your net worth should be before buying a home. The recommendations follow my 30/30/3 home buying rule.
Have Discipline When Buying A Home
I get your desire to own a nice home. I’ve been a real estate fanatic since I was in college. We want to live life to the fullest now! What’s the point in working so hard if we’re just going to hoard our cash right?
A home can be a solid investment. It not only provides shelter, but it can also be rented out. Your home could even appreciate handsomely in value over time. Due to home price appreciation, many people I know have effectively lived for free over the decades.
Further, if your kid graduates with no employment prospects after four years of college and $200,000 in tuition expense, he can live in one of your investment properties. There would be no need for your adult child to live with you. This option may be worth a lot to some investors.
Despite all these benefits of investing in real estate, just don’t overextend your finances when buying a home. The stress is not worth it.
For those of you who are looking to achieve financial independence sooner, follow the FI home-buying rule. This rule recommends you keep your home expense to no more than 10% of your monthly gross income. If you follow this home-buying rule, your path to financial independence will be much swifter. You may even start feeling as light as a bird.
At the very least, please follow my 30/30/3 home-buying rule before making one of the biggest purchases of your life. It’ll be good for you in the long run. It’ll also be great for your neighbors and the entire financial system as there will be less of a chance you’ll be foreclosed.
Best of luck in your house hunt. Please stay disciplined! I expect the real estate market to stay strong for years post-pandemic. But that doesn’t mean you should go overboard when buying a home.
Real Estate Recommendations
1) Explore real estate crowdsourcing opportunities.
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise. Fundrise is one of the largest real estate crowdfunding companies today with diversified eREITs. It’s free to sign up and look.
If you like to invest in individual real estate opportunities and are an accredited investor, take a look at CrowdStreet. CrowdStreet focuses mainly on real estate opportunities in 18-hour cities, where valuations tend to be cheaper and growth rates tend to be higher.
Personally, I’ve invested $810,000 in real estate crowdfunding to diversify my real estate exposure, take advantage of low rates and lower valuations across the country, and earn income passively. The spreading out of America is a permanent trend post-pandemic.
2) Refinance your mortgage before rates go even higher
Check out Credible, my favorite mortgage marketplace where prequalified lenders compete for your business. You can get competitive, real quotes in under three minutes for free. Mortgage rates are still very low, but they are ticking up. Take advantage and save.
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The 30/30/3 Home-Buying Rule is a FS original post. FS has been around since 2009 and is one of the largest independently owned personal finance sites in the world. Everything is based off firsthand experience.
Thanks for the article! The last rule “limit price of house to 3x annual gross income” seems too conservative though.
In your example: “You make $120,000 a year and have $100,000 in cash saved at 32 years old. Not bad. However, you’re also salivating for an $850,000 home, which equates to 7X your annual income.
Instead of buying this home now, first save up another $155,000 to get to $255,000 in cash and semi-liquid investments. With 30% of the home price saved, you can put down 20% and have a nice $85,000 cash cushion.”
Isn’t this person still violating the 3x annual income part of the rule, though? What’s the point at which having 30% of the price saved compensates for the house being worth >3x annual income?
It is. Hence why I highlight it as a suboptimal decision and the need to come up with a larger downpayment and buffer.
I discuss stretching to pay up to 5X your household income for your home in a low-interest rate environment. But that’s the limit. I wouldn’t go over that.
While building up your downpayment, I would be investing in real estate in other ways, such as in public REITs or private real estate funds. The idea is you want to ride with the real estate market so if it explodes higher, you won’t get too far left behind.
Hi Sam –
I’m looking at a 650k house with annual taxes of 14k. We have 340k in cash. 200k in 401ks. 26k of debt. With the rate hike, I’m nervous. My annual salary has increased YoY, but I’m usually a conservative person. So let’s say it’s 180k combined. Can we afford it? Would you recommend a larger 40% down to lower the monthly rate due to cash flow concerns?
Yes, you can afford it. Just bargain harder with rates up. Putting $240K down and leaving yourself with $100K will let you sleep very well at night.
I think now is finally one of the better times for buyers. Froth has faded.
Hi sam,
I agree to your method.however,how bout someone who dont have same amount of income every year.
Currently my net worth is around 2,6 mills( 700k in my current house,and the rest are in stock and gold).
In 2019,i paid all my debt included business debt.
In 2020,my net income is 350k,while last year my net income is 850k.The fluctuation is a lot.I am not sure this incoming year net income yet.
My plan is to purchase a land with 800k-1 mills in value.i am gonna save 300k before i proceed with the plan.i will also build the land much later on,prob within 3-5 years.
Thanks,
Denny
Samurai,
I was wondering if you think my situation is worth breaking rule #2 for you…
I make 95k gross, single guy, 25 years old. I have 15k saved for a down payment, and am looking at maximum 300k in the Tampa Bay area. I am planning on renting 2 of the 3 bedrooms to my brother and a friend. I am trying not to count on them in case things change, who knows when someone decides to move out, but I can at least count on them for a year or two. I could also likely find others to room with if that time comes. I have 30k left of student loans, but no other debt. Including my student debt, 401k, misc. assets, and additional cash savings, my net worth is still quite a ways shy of your minimum at 15k. I need a place to live relatively soon, and If I am paying this little for a mortgage with today’s rates, it seems much better than renting for more money monthly and no equity. By the time I could save 20% of the down payment, I would spend thousands in rent that could have gone towards building equity. Another pro is the tax breaks I would get for owning a home. What do you think? I appreciate your advice,
John
I do exactly this, John. Buy a single family home with a 5% down payment, rent the spare bedrooms, then ask for the PMI to be dropped if the house appreciates.
I don’t understand the logic to use gross income to calculate how much someone can afford for a monthly mortgage payment. Doesn’t it make more sense to use after tax monthly income? If a couple has a gross income of $150,000 and they max 401k and HSA , they are left with roughly $7100 after taxes and all deductions…. But you’re saying 30% of gross income would leave someone with a payment of $3750 per month… $7100 – $3750 does not leave a family with hardly any money left over per month.. why don’t we calculate mortgage payments based of what someone can afford after all deductions? That makes way more logical sense.
You can do either. Gross is a way to make an easier apples-to-apples comparison given everybody has different tax rates and tax-advantaged retirement contribution amounts.
A percent of gross income is also what lenders use, so it is consistent.
Ok, fair enough. Thanks for input.
Honestly, the 3x gross income for a house is spot on. That’s the best advice for sure….
Hey Sam!
Great article, I wanted to see your thoughts if you think these rules still apply if you plan to house hack (i.e. Rent by the room, live in one of them) which covers your mortage and allows to live for free.
Best,
Adrian
I actually missed the rent bullet, which makes sense to me, what rules(if any) do you think still apply with the rent by the room?
I would view renting out rooms for income as an insurance policy first. Don’t include the income when using the 30/30/3 rule.
However, renting out extra rooms for income is definitely a great idea and one I did in my late 20s and early 30s for several years. We had a garden room we rented out that was separate from the main house.
Hi Sam,
Great article. For the first rule, what about closing costs? Property taxes, homeowners insurance? How do you factor all of that into it?
Thank you
I like your formula and it’s easy to understand. Thank you. We are wanting to purchase for sometime now (dying to buy already) we can do Rule #1 and Rule#3 and in 6-8 months time I’m sure we can do Rule #2 but I’m afraid the housing market may get worse for us buyers. Should I buy now??
I do believe the housing market will continue to do well over the next three years. There are pockets of opportunity to buy. This summer is one as people go travel and kids have time off.
The other opportunity is during the winter holidays.
See this post for a thorough analysis: https://www.financialsamurai.com/why-the-housing-market-wont-crash/
Thanks for the article, Sam.
Your article made me realized I haven’t been spending ENOUGH on my primary. I essentially live free because I live in one unit of the duplex and own a short-term rental.
The YOLO mentality has creeped in due to the pandemic years, my wife and I are looking to spend more. With recent promotions, run up on real estate and stocks, we are feeling comfortable. However, we don’t feel “rich” yet even though we are now 40% to our fat FIRE number. We, too, don’t know how to spend money.
Now we are thinking of converting the duplex to a SFH. Why? Duplexes are cheaper than SFH with by sq footage when you compare fixers and full-remodeled properties. Or we could buy a 3rd house, not sure yet.
What you’ve done is very smart, living in one unit and renting out the other. That is actually what I wrote I should have done instead of buy a single family home in SF in 2005. More efficient and better returns for sure.
The thing is, if you don’t have kids yet, the extra space really won’t be used.
Hi Sam, great article! My husband and I bought a house in LA this past Apr 2021. For those who think your 30/30/3 rule is impossible to follow in a high cost of living market; it’s tough, but doable!
During our search, it was so hard to stay disciplined. We make 250K annual combined and it was too easy to increase our budget and justify it to ourselves because we live in LA. Our budget was at 750K but we could have stretched it to 1M…. We’d almost given up and joined the crowd, then we found our current house. It was listed for $825K, our offer was accepted at $820K and ultimately negotiated down to $795K during escrow. We shopped around at SO MANY banks and ultimately locked in a 2.75% 30yr fixed rate.
Rule #1 – Our monthly mortgage is about 14% of our gross. Rule #2 – We put down 20% and have 10% saved in liquid assets. Rule #3 – The house is 3.18 (0.18 over rule #3) but we have a tenant in an adu that brings in monthly income, which we think makes up for it!
I share my story in hopes of inspiring others in high cost of living areas to stay the course. It’s hard; but don’t join the crowd and keep your eyes open for opportunity! I recognize that this transaction would not have been possible on one income alone. If I was home buying by myself, I’d scale down to a smaller size property, maybe a condo vs a SFH, or look in areas where my budget would have still worked 1 hour outside of LA. Best of luck!
Nice work! And isn’t it great to own a home that doesn’t financially stress you out? Times are good now. But sometimes, things turn south. To be able to comfortably afford a home over the long term is what it’s all about.
Hi Sam,
Thanks for this article and read. I realize all situations are different but we are a dual income household making 290k a year before large commission checks. I am basing our household income sans commission and am not comfortable assuming differntly. We are in the market and have the 20% downpayment and are currently in escrow on a 1.38 million dollar home, with a 3.1% interest rate. We certainly do not adhere to the 3% suggestion (although we live in CA and see you can go up to 5X), but adhere to the 30% Gross income rule (you are referring to Gross correct?) and 30% savings IF you taking into account our 401ks and stocks/index funds (which we hope to never touch). My question to you is how often do you think people still fail when they are very close/ hit the mjaority of your rules? This is stemming from an impeding doom feeling financially after we have already entered into the escrow process. Our numbers/budget at up, but the cost seems to ludicrous and irresponsible. ADditionally we do not have children yet and are currently auto saving about 1,500k a month under our budget mode. Which DOES not feel like enough since we are used to packing away about 40% of our income into savings to hit the money for the down payment. In summary, not that we have what we need, we are still feeling doubts. Kindly advise on if the numbers above sound fiscally responsible.Thank you!
Sam, love your newsletter, BUT your 30/30/ 3 rule is way too restrictive for the middle income people in a high cost areas like LA, OC, SF, etc. I have owned my own mortgage company for 40 years now. The average mid income earner in a high cost area cannot save very much money. It would take them 10 years+ to save 20% down. The money lost in just the utility value of real estate without any appreciation is devastating. Lastly, in 2004 I did 13 media interviews of the upcoming financial disaster. It was very predictable because the lending guidelines were gone. 100% financing, stated income, etc. Today it is tough to qualify for loans. I do consumer educational events, one speaks on this topic it is titled “Build Wealth & Retire WITHOUT Saving Money thru RE.” I teach a real world solution to the enormous number of people that cannot save money on how they too can become financially secure and retire. Keep up the good work! MP
Agreed. There is absolutely no way for the 30/30/3 rule to work in the SF Bay Area.
By your logic, people/families with 300k income shouldn’t buy more than 900k home. That doesn’t exist here.
Or 400k income: a tiny number of 1.2m condos perhaps, but they wouldn’t be big enough to have even a small family.
The entry level home price in San Mateo or Santa Clara Counties is just about 2m which would require 666k annual income. That’s top 1% range. So only the top 1% can buy in these counties, and only a starter home at that.
The rule clearly doesn’t work here.
Hence why I’ve suggested you can stretch to 5X your household income. But that’s it. I wouldn’t go beyond that.
But you’ll be surprised that ~20% of Bay Area homebuyers pay CASH. So they clearly stick to the 30/30/3 rule.
See: Income And Net Worth Recommendations To Buy A Home At Every Price Point
And How Much Should You Make To Afford A $5 Million Home
Thanks!
Those 20% that paid cash are among the lucky with huge stock payouts, usually from Tech. Clearly in the top 1% for the area. Can’t base general financial advice on this segment of the population.
That’s the wacko bay area market. Only the top ~ 5-10% of earners can buy ANYTHING because the supply/demand curve is so out of balance. Yes, there are exceptions, but it’s basically now the rule. Haves and have-nots. Which will play out over the generations. People that bought 10, 20, 30+ years ago are golden, and anyone coming of age now has to leave to buy anything.
How will this 30/30/3 rule work in current Bay area market ?
1. You mentioned mortgage spending 30% of income, is it after tax?
2. Rates are already a bit high now, so getting 3% on 30 years is difficult, wont 10 arm be a good idea?
3. Even if someone can afford it, I am not clear – if it is wise to pay almost 30K in yearly property tax on a 2M+ value?
4. As a general rule – how much growth in the property value one should count for – 4 to 5% appreciation in 10 years in Bay Area CA for 2M property? or much less ?
Thanks,
I think what this post illustrates more than anything is how unaffordable housing has become in the last 2-5 years. This is near impossible for the majority of the population looking to buy a house and build financial security.
I’m not sure that is correct, regarding the majority not being able to buy a house. Housing demand is so strong right now and people are buying houses with low mortgage rates and improving economy. The latest data shows that home prices were up 10% you are a year in 2020 because of such great demand. People are cashed up and Many are doing well during the pandemic. If Mani weren’t doing well, there wouldn’t be so much demand for real estate right now.
It is true though, generally, the longer you wait, the more unaffordable real estate becomes because the absolute dollar value of a piece of property is generally much higher than one’s income. If a $500,000 property appreciates by 10%, you would have to double your income just to stay even if you make $50,000 a year.
Hello,
What is the calculus for someone who may have a high net worth but not necessarily the income to make the mortgage payments work? Would you recommend a higher down payment in that case? For example if a household makes $260k and has $2MM net worth in equities or other investments, would you view that differently from someone who makes $350k with only $500k net worth.
Thanks.
This.
I really like the advice you give. One question I have related to the “30% of gross income rule” (which I know is widely given as a rule): why gross income vs net? 30% of gross income is a big slice of pie that may negatively impact someone’s ability to save for retirement, save for college, and generally enjoy life. (Note: I am mostly going off gut feeling on this)
Is this rule specific to the US? I live in the UK and we don’t really have property taxes like in the US here, except a stamp duty at the time of purchase. I can comfortably satisfy the 30/30 part, but not the 3 part. The price of my home will likely be around 4.5 to 5 times annual gross income. But this is more or less standard here, at least in London.
For places like London, the 3X generally goes to 5X, especially given rates are so low. I think it’s fine so long as you run the numbers and are confident with your income future.
Does 30% include property taxes + insurance or purely mortgage.
If you want to put down 40% and take home is 180-200. What is safe?
How the hell would I apply this rule in Denver, CO? Homes here average in the 500k range.
What do you mean? The household requirement would therefore be $167,000 for a $500,000 house.
Not factored in are all the costs associated – home insurance, property taxes, and how about those that inspire to get a 15 or 20 year loan. I’d rather live in a smaller house that’s paid off then get myself into big debt that’s going to take an additional 15 years to pay off. Also, living in high property tax areas can really eat into what one could be saving instead. For example, property taxes in the Austin, Texas area are 2.25% or more. That’s almost $1000 a month on a $500,000 house in taxes. Finally, with the new tax law all the tax advantages of mortgage interest are gone. If you are single or a couple look into buying a duplex or four plex.
If you follow the 30/30/3 rule, all those costs should be easily digestible. That’s the beauty of my rule.
It all depends on your situation. My mortgage is about 65% of my take home pay and my wife doesn’t make much while in grad school. My wife and I travel a lot but still save every year. We plan to remain kid-less while in this home and I can not lose my job so our situation works, and meanwhile we have gained a lot of equity in the home. You have to crunch the numbers and also understand your situation, now and future.
I hope all is well. I posted in the FS forum, yet haven’t rec’d many responses. My wife and I are in the process of potentially buying our first home. We have 2 children and are interested in a relatively affluent suburb in the Northeast where we have various family members. I simply wanted to know what you thought was a reasonable and acceptable amount to spend on a house/housing expenses. My wife and I are both in the advertising industry and make approximately $420Kish gross combined. Additionally, we have saved over $2.5M in savings, of which $2Mish is in taxable accounts. These assets are predominantly in equities.
We would expect to have relatively modest growth in our income.
We were thinking of spending around 1.75M with approx 1.2% property taxes. Additionally, we are open to an interest only mortgage option to make the payments more manageable or a 10/1 Arm. Do you think that is reasonable or too much money to spend on a house. Any feedback would be greatly appreciated! Thanks.
You’re good. In fact, it’s kind of obnoxious that you can do a 10/1 ARM on a $2M property and you’re posting it as a “concern.”
I get it, but the answer you deserve is: be less of a spoiled rich person and buy less house if you’re worried, or sell the Bentley?
Theoretically, you have a crazy good familial safety net if they own in the same neighborhood?
Tell us more about how you’re wringing your hands over Carrara or Quartz,, while a firefighter and teacher who inherit ZERO generational wealth, struggle to save 5% down and make 2k/ month payments on a run-down 1 bedroom unit where you’d die before sending your kids to school.
I feel like the fed has tricked society into the massive increase in home prices by pushing interest rates so low. If everyone would follow the rule of not financing more twice your annual income for a home purchase as suggested in the Millionaire Next Door, then housing prices would naturally stay down and be affordable for the masses. I realize the book was written in the early 90s, but even if interest rates were at 14% like they were in the 80s then you would be at 28% DTI on a 30 year note. Take your now 3% interest rate and apply the 2X rule and you are only at 10% DTI, allowing much more room for investing and growing your net worth outside of a non-income producing asset. Put it on a 15 year note like Dave Ramsey suggests and you are still only at 16% DTI. I really like the 2X rule.
How did you calculate DTI change from the interest rate ?
Sam, longtime fan of your site. You did a post a while back on how to invest a downpayment. I was wondering if you have any additional thoughts on this topic in light of the current economic climate. I am currently sitting on a few hundred thousand in cash, which I’ve set aside for a down payment on a larger home. Am hoping to buy within the next 6-18 months. Trying to think through whether it makes sense to invest some portion of this as a hedge against inflation.
That’s why geographic arbitrage is so important. I lived in a high cost area (DC) for 5-6 years, built up experience/networking, then moved to a lower cost area (Colorado) and purchased a home before real estate got insane here. My total payment (mortage + taxes + insurance) is < 10% of my monthly gross, and I'm using this margin to pay down the loan in 5-6 years. Plan is to have the house paid off before I'm 42 (I'm 37 now). Already up 40% on the home value from the purchase price, and looking at "up and coming" areas to invest in real estate (Idaho, Utah, etc.).
We're all planners on here, so I definitely suggest either moving to a cheaper (up and coming) part of the country to live/invest if you want to maximize your ROI and retire early. I agree with Sam's "Investing in the Heartland" strategy – the coasts have become too pricey.
Aloha,
Since you write about Hawaii, what is your thought on how much you should pay?
Also, what is the dollar value of your regret of not moving to Hawaii either before ar after Covid and how much more happy are you in SF?
Cheers,
Johnny R
Hi Johnny, how much should I pay for what? Besides the 30/30/3 rule?
My plan has always been to relocate when my son turns 5 in 2022.
The only kink in the plan is that preschool is temporarily shut down.
How about you?
I like these rules. Too many people try to stretch to buy a home. When there is recession they get burned.
Aloha,
My wife and I currently live in Honolulu and own a 1 bedroom apartment with a kid on the way. We are looking to purchase a home within the next year or so, but even with the equity from our apartment it will be very difficult to follow the 30/30/3 rule. As you know homes start at 1m+ in decent areas. We make around 200k a year so a home could push us past the 5x or 6x threshold.
I realize more info is needed based on our financial situation but any advice is much appreciated.
Steve
I own 3 homes one had a 3.5% down payment, the other had 10%, and tbe other had 5%.
2 of them are multi family homes which make me $5,000 profit a month after my mortgage and taxes are paid.
My 3rd home is a single family. My mortgage is $3,000 a month.
Hence I can Still profit $2,000 a month. I basically broke the rules but I think it worked
I’m not sure I agree with the second part of this rule. I’m a little confused, especially since you live in the Bay Area so you know it’s not really feasible to follow this rule here. I live in Santa Clara, so a 1200 sq ft home here costs $1.3M, which means I better be making $400k/year to buy a small 50-year old home? That seems crazy.
Yes, $260,000 – $434,000. You can stretch to 5X after a 20%+ DP, but I wouldn’t go past that.
But in that case, the vast majority of people living here shouldn’t be buying homes. The median income in the county is $120k. Even the nicer cities in the county like Saratoga and Los Gatos, the median income is still $150k. But you’re going to be hard-pressed to find any homes below $500k. Searching on Zillow for my zip code (by no means a nice zip code) shows that the cheapest place to live for $500k, which is a 600 sq ft condo, 1bd 1ba. There are no townhomes or houses in this zip code selling for less than $1M (technically there’s some for $998k, but that’s basically $1M). Even stretching to 5x, there’s no way for the majority of people to buy their residence here, especially if you have kids and need 2 or 3 bedrooms.
I think a lot of homebuyers are dual income households. Further, many Bay area home buyers have tremendous Down payment help from their families.
What is your household income situation and what are you looking to buy?
They are, but the numbers I cited are median household income, not individual, so it accounts for that.
I’m not looking to buy for a while, I don’t have much saved up for a down payment as I just started working and may not settle in the bay (but wherever I am in ~5 years I would like to buy a house, so I need to start focusing on a down payment soon). I make decent money as I work in tech ($140k/year after bonuses and RSUs), so I’m not too worried, though of course I could get laid off and that would throw a money wrench into everything. But anyway, maybe you have some advice as to how much to start saving towards a down payment vs retirement? Assuming that I’ll need $100k-150k in cash in five years, should I just divide that by five and throw that into bonds/CDs each year? Or should I save less now and more closer to the purchase year?
Hi Sam,
No offense, but your advice specifically for HCOL areas seems often to be contradictory. On the one hand you have frequently pushed buying property in San Francisco, but as Anonymous points out (and others below) this post appears to suggest that only a small fraction of the City – perhaps less than 10% – should buy real estate. It leaves me as a reader confused.
Thanks for any clarification you can provide!
No offense taken. What is the contradiction that you are seeing?
I’m saying for a high cost of living areas, you can stretch to five times your annual household income to my house, especially with interest rates so low. But I wouldn’t recommend going over that. Because we are already violating the 3X rule.
Not everybody can buy home. Dual incomes are often needed, as well as help from parents. But those are the type of people who are buying homes in HCO living areas.
I’m sticking with 3X to no more than 5X.
I think you’ll be surprised at how many people were buying $1.5 million homes are making between $400,000 to $500,000 as a couple.
(for posterity)
Remember that home sales aren’t going to the median income person in the community. The median income for the buyers on the market is considerably higher. Existing home owners bought in the past when it was cheaper, and can use their equity in a trade up. For that latter reason, I question the use of the ratio against the value of the home, rather than the amount of the loan.
Great article, even more important to follow given the current economic environment.
Mortgage rates are rock-bottom which is appealing to the mortgage-holder – I personally refinanced at the beginning of the pandemic and was able to bring my 30yr fixed down from 4% to 3.25%.
However, low rates aside, I think it’s somewhat of a risky time to purchase a home. Many are unemployed and banks likely won’t approve mortgages without income coverage. It’s also not the best time to commit a lot of money towards a down payment – people need to beef up their emergency funds.
With that said, there are many deals to be had – lots of people may want to get out of their homes because of the pandemic (perhaps drive to the suburbs), so some will do the work to get a great deal on a house at an all-time low interest rate.
The variability and riskiness keeps me on the sidelines at the moment (I’ll rent out my current home and purchase a second in the future), but thank you Financial Samurai for some great insights!
– Journeytoretire
Hi Sam, what about using RV ratio to see if a home is a good buy or not? If it is a good tool to use won’t I be missing some good areas because they are pricey for good reason. FOr instance, Analyzing some areas like Bend, Oregon, the prices look too high but people are willing to overpay thus increasing values of the place over the long term. Applying RV ratio it’s too expensive. I know a bit more about stocks: if I analyzed PE ratio of some tech stocks like Apple, it looks expensive relative to its decent valuation a decade ago. But warren buffett seems to be willing to overpay. So exceptions apply to a few areas in the real estate market? Am I over relying on RV ratio when analyzing if a property is a good investment?
Good thoughts, Sam. I even think 30% of gross income towards your mortgage payment is a little high, although my perspective is skewed by living in an area where home prices are very affordable (partly by choice). But if your goal is to maximize saving – then 30% seems a stretch.
Sure. 30% is the max recommendation. I recommend 10% or less for all living expenses. See: Housing Expense Guideline To Help You Achieve Financial Independence
Hi Sam,
If I remember correctly, you were looking for a discount before buying. Are you still waiting or ready to pull the trigger at current pricing?
Hi Sam,
I am a fellow Bay Area resident, almost 2 years into my first job as a chemical/environmental engineer at a small consulting/design firm in Santa Clara. I’m making $70k currently and think that $100k+ in 4-6 years is a reasonable projection.
In addition to saving just under 25% of my income for retirement, I’m contributing just under 25% to a 50/50 bonds/stocks account for a down payment (the account is set up to slowly increase weight in bonds over time). I’ve been poking around on MLS sites to get a rough feel on the market. It seems like almost everything in San Jose, Milpitas and Fremont starts at $500k for 1 bed condos and 600-700 for 2 bed/2 bath condos and townhomes (SFHs and anything up the peninsula are fantasies, and anything in the Tri-Valley or further north than Fremont would make for an unappealing commute). Saving up for the 20% down payment and 10% cash buffer would easily take me 7-10 years, and I would need mortgage rates to remain near the current historic lows to meet the first part of your rule. But even then, my salary would be nowhere near enough to qualify for the 3x rule!
It is crazy how expensive real estate is in the Bay Area. Buying here on a single non-tech income seems like quite the challenge.
Hi Matt – Good job being diligent saving. Yes, if you are a single homebuyer you are at a disadvantage to the vast majority of buyers who are dual income buyers. Not only that, they have dual income + RSUs + Bank of Mom & Dad. It’s not a fair fight.
I realized this back in 2005 when all my neighbors in my old neighborhood had their parents pay their downpayments. The same thing in my current neighborhood. A Massive Generational Wealth Transfer Is Why Everything Will Be OK
For the Bay Area.. it’s really more a 5X rule.
Nothing wrong with renting!
I lucked into an extremely low rate for a room in North San Jose – minutes walk away from grocery stores/restaurants and 15 min drive or 30 min bike ride from my office. I’m holding onto this spot forever until my girlfriend and I move in together or I have to relocate for a new job!
What is your opinion on the value of 1bed/1bath condos vs 2bed/2bath? After reading around, it seems like most people point to the 2bed/2bath option – cheaper per square foot, ability to rent out the extra room if HOA allows.
2/2 will appreciate more, hold its value more, and has more flexibility imo.