At the familiar yet daunting hour of 3 a.m., I wake up in a state of anxiety, drenched in sweat, with my heart racing. To calm my nerves, I reach for a sacred document that brings me comfort during times of uncertainty. This document, an article from Rocket Mortgage, has become so familiar to me that I practically have it memorized. According to this article, “No more than 28 percent of the borrower’s gross monthly income should be spent on housing costs.”
My panic attacks usually occur when a house becomes available in the neighborhood where my partner and I hope to move. If we were to bid significantly higher than the asking price, we could likely secure it. But my midnight distress revolves around one question: Can we truly afford it? Although the Rocket Mortgage article cannot provide a direct answer to this question, revisiting its words brings me a sense of calm. The precise percentages mentioned in the article feel like worry beads beneath my thumb.
Articles addressing the query of “how much house can you afford?” are published regularly, and they often present similar estimates. Along with the 28 percent rule, there’s another guideline stating that all debts, including mortgages and student loans, should not exceed 35 percent of your income. This means that if your mortgage is your sole debt, your housing costs alone could potentially consume over a third of your earnings. According to this rule, someone earning $60,000 per year with no existing debts could afford a monthly mortgage payment of $1,750, equivalent to a home priced at around $250,000. Financial guru Dave Ramsey offers yet another rule, recommending that no more than 25 percent of your take-home pay should go towards your mortgage. However, finding houses within that price range seems challenging now due to soaring interest rates.
Like many well-worn texts, these mortgage-advice articles provide parables rather than strict instructions. The numbers provided are incredibly diverse, and the difference between them can translate to thousands of dollars each month. Most of these guidelines fail to consider factors such as 401(k) contributions or high taxes for individuals, like myself, who occasionally work as self-employed. Furthermore, additional expenses such as food and child care, which have experienced inflationary increases, are not accounted for. While some of these percentages suggest that my partner and I could afford a spacious house, they may make it challenging to have children or even cover basic living costs. These figures are significantly higher than what we currently pay for our current home, which accounts for about 20 percent of our take-home pay.
My concern revolves around being locked into a substantial monthly payment that would prevent us from affording child care, weathering job loss, or surviving a downturn in the housing market. Throughout our home-buying “journey,” various individuals have expressed that real estate is a sound investment, offering reassurance that buying an expensive house shouldn’t be a cause for excessive stress. However, others have cautioned that the costs associated with home maintenance, repairs, and unforeseen expenses often surpass initial expectations, advising a more conservative approach. These conflicting perspectives leave me uncertain about the right course of action.
To gain clarity on why these numbers vary so drastically and determine the appropriate guidelines for myself, I interviewed nine real estate experts. They confirmed that the mortgage-affordability figures are indeed disparate, and although some lenders utilize them to approve mortgages, they are essentially educated guesses. “To some extent, they’re plucked out of the air,” commented Robert Van Order, an economics professor at George Washington University. Edward Seiler, the associate vice president of housing economics at the Mortgage Bankers Association, added, “A lot of these numbers are pretty arbitrary. It’s just based on people staring at data and thinking, What are the tipping points that force people into delinquency?” The lack of steadfastness in these percentages is evident.
Given the apparent arbitrariness of the established guidelines, I posed the question of how much a responsible individual should truly spend on a house. I disregarded the fantastical figures that optimistic lenders might approve and focused on an appropriate expenditure. The experts seemed puzzled by this premise. “What does the word responsible even mean?” pondered Morris Davis, a real estate professor at Rutgers.
According to the federal government, spending more than 30 percent of your income on housing renders you “cost burdened.” After persistent inquiry, most experts reluctantly disclosed this 30 percent figure, or roughly a third of your income, as a reasonable limit for housing costs. However, lenders often approve buyers for prices higher than this threshold, exceeding what they can realistically afford, as explained by Daryl Fairweather, the chief economist of Redfin. Instead of relying on online calculators, Fairweather recommends that individuals thoroughly analyze their accounts, tally up all their expenses, and determine their housing budget based on what remains. While this advice is sound, it becomes more challenging for those considering career changes or planning to have children. Another expert proposed an intriguing alternative: Seek a house that costs no more than two and a half times your annual income, allowing you to adhere to the 28 percent rule through simpler mental calculations.
Some experts suggested that, in today’s frenzied housing market, individuals should consider moving to more affordable areas to alleviate the burden of affordability. Davis questioned why people are hesitant to relocate to lower-cost places. (Interestingly, during the COVID-19 pandemic, many individuals did move to cheaper cities like Austin and Miami, inadvertently driving up the cost of living in these areas.)
“Where are you based?” Davis inquired.
I informed him of the name of the Northern Virginia exurb I currently reside in.
He pointed out that even in this location, over 25 miles from Washington D.C., home prices remain exorbitant. “Why?” he queried. “That’s quite far from D.C. … You’re a writer; you could be anywhere.”
“This is precisely the motivation behind my story!” I exclaimed. In fact, we were attempting to relocate to Florida, a generally more affordable state. However, even in Florida, houses were more expensive than we had anticipated. “I’m actively trying to move!”
Despite hearing the 30 percent figure from multiple experts, I was surprised to discover that most current homeowners spend significantly less on their housing costs. This also applies to most renters. The median homeowner with a mortgage devotes 16 percent of their gross income to their house payment, including taxes and insurance. Low-income households spend a slightly higher percentage, 24 percent, but still less than 30 percent. Renters allocate an average of 26 percent of their income towards housing. In other words, adhering to the mortgage calculators and spending 28 percent would mean paying significantly more for a house than the average American does.
However, in the current market, purchasing a house for just 16 percent, 28 percent, or even 30 percent of your income is incredibly challenging. According to Zillow, the average new homebuyer today spends 34 percent of their income on housing, the highest amount since 2004, the earliest year for which Zillow has data. This figure assumes a 20 percent down payment. Without that down payment, the cost burden becomes even greater. High housing prices persist due to a shortage of available homes. Individuals who secured mortgages at around 3 percent interest rates in previous years are now hesitant to move with rates hovering at 7 percent. “It is clear that affordability has become the No. 1 challenge for new buyers and renters in the housing market today,” acknowledges Orphe Divounguy, a senior economist at Zillow.
The most significant danger of overspending on a house is the potential inability to continue making payments in the event of personal or global catastrophes. Admittedly, the risk is relatively low. Even homeowners who allocate up to 38 percent of their income towards their mortgage tend to avoid default, especially if they possess good credit and paid a substantial down payment, according to Davis’ research. However, a substantial monthly payment can hinder retirement savings, emergency fund maintenance, travel to visit distant family, or even starting a family. It can impede various aspects of life.
In conclusion, determining how much to spend on a house is a complex decision. The widely varied guidelines presented by experts offer little consensus. While the mortgage calculators and rules provide a starting point, they should not be taken as gospel. Personal circumstances, financial goals, and the realities of individual markets must all be taken into account. Ultimately, finding a balance between affordability and meeting one’s needs and desires is key.
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