How much house can you afford based on salary?

September 13, 2012 — 27 Comments

Here’s the rule I use to determine how much house you can afford based on your income – let’s call it to the 2x income rule.  Simply, you should only spend two times your annual gross income on a house.  I’ll discuss some other financial rules for home buying below, but this is the most simple.

How much house can you afford based on your annual salary?

$25,000 a year salary = $50,000 house

$50,000 a year salary = $100,000 house

$100,000 a year salary = $200,000 house

$200,000 a year salary = $400,000 house

This may seem low to some people, but if you want to control your money, this is a great way to do it.  It’s easy to get sucked into spending the bank pre-approved limit which is usually much higher, but they don’t have all of your best interests in mind.

In addition to the 2x annual income rule, you should also try to pay 20% down and use a 15 year fixed loan.  Easy as that, right?  Of course not, but this will at least give you a guideline to think about.

We bought our first house with a 30 year loan and didn’t pay 20% down because we wanted to use our extra cash for a much needed renovation, but we did stay within the 2x income rule.  The only way we could get into the neighborhood we wanted was to do it this way.  I know, excuses, excuses, excuses.  However, from here on out I promise to use the 20% down payment rule and hopefully pay for future houses with cash!

Today’s mortgage rates are incredibly low so it makes mortgages more affordable.  Let’s see how it’d look if you followed this rule to home buying across multiple interest rates:

    Annual Income        Mortgage Amt          3%       5%       8%      18%
 $         25,000  $       50,000  $       345  $       395  $       477  $       805
 $         50,000  $      100,000  $       690  $       790  $       955  $     1,610
 $       100,000  $      200,000  $     1,381  $     1,582  $     1,911  $     3,220
 $       200,000  $      400,000  $     2,762  $     3,163  $     3,822  $     6,441

Remember, the mortgage amounts listed above don’t include all of the other housing expenses – insurance, property tax, etc – which can increase the payment about 20-30% depending on where you live.   Also, you’d add your down payment amount on top of the total mortgage amount listed above.

It’s incredible how much more affordable housing is with low interest rates… I still can’t imagine how crappy it would’ve been to go through the early 80s when rates were in the high teens!  The 2x income rule for buying a house would probably have to go down to 1x!

The monthly mortgage payment ranges right around 30% of total monthly net income when using the 5% interest rate.   A 3% rate would take you closer to 25% of your monthly take home pay.  The 2x annual income rule keeps you in a pretty comfortable range where you won’t be overspending on the house.

That brings us to the next set of financial recommendations for how much house you can purchase.  Mortgage lenders typically use the 28/36 ratio rule to determine how much mortgage you can afford.  Basically, they look at your monthly gross income and want to keep you from spending more than 28% on the total monthly house payment – including insurance and property taxes.

The 36% rule takes a look at your total monthly debt and says you shouldn’t spend more than 36% of your monthly income on all of your debt combined.  What does this do the income ranges we were looking at earlier?  Based on your monthly gross income, you could spend this much on a monthly mortgage payment using the 28% rule:

    Annual Income           28% rule     
         $25,000         $583
          $50,000        $1,166
        $100,000        $2,333
        $200,000        $4,666

As you can see, this rule allows you to spend more on a monthly mortgage than the 2x income rule.  If you add in the property tax and insurance to the 2x rule it’s a little closer, but 2x keeps you more in line with what you should be spending.

Based on that assessment and the current interest rate environment, I’ll stick with recommending the 2x annual income rule for home buying.  What do you think?  Have you stayed close to that rule?

One other thing, if you’re buying a car, remember to use the 20% rule!  Do you agree with the 2x income rule to determine how much house you can afford based on income?

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27 responses to How much house can you afford based on salary?

  1. Where were you when I needed to understand this stuff? Like when we bought our first house? LOL We are currently stuck with 2 houses. We found a house we really wanted but the market was crap so we could not / would not sell the house we already had. So we are renting out the first house and periodically offer it for sale. So far we still have it. Perhaps the universe is trying to tell us we need that house for some future purpose. Oh well….

    • GG – sorry I wasn’t there for you when you really needed it . The housing market has been crazy for the last 5+ years so I’m sure there are many people in the same position. It’s awesome to find a great deal on a new house, but it’s hard to accept the fact that the current house has to sell for so much cheaper now!

  2. A few years ago I looked into buying a house. I calculated what I could afford using monthly payments; I had a mortgage broker calculate how much I could afford using a different method. We both came up with ~$100K. It would have been more if I didn’t have so much student loan debt. But it was roughly 2x my gross income. So I agree with that rule.

    I say “Ouch” because, at the time, I was already earning more than most people I knew my own age (I was about 25). What stopped me from buying a house was that I couldn’t find one for $100,000 or less that would work. Everything I found either required so much repair that it really would have cost $120K – $150K, or it was so far from work that including the commute cost significantly decreased what I could afford.

    How do people buy houses these days? At that point in my life I should have been able to afford a small starter home, but couldn’t. I admit I didn’t look very hard before I abandoned ship. But still, it seems this market is serioulsy flawed.

    • Julia – it really is scary how overextended some people get when buying a house. It may feel good to be able to get more than you expected, but it will hurt in the long term if your payments are too high. Renting is an excellent option for starting out because it controls your cost much more than home buying. You should use your first couple of years to save up a nice down payment which will increase the amount of home you can buy even if your salary doesn’t change.

  3. We found you via LinkedIn, thanks for a very detailed post! As a fellow Real Estate blogger I’ve had a great time browsing your site! These income to house price ratios are even more important with the current state of the real estate market. The good news is that with the ultra low mortgage rates being offered right now, more and more people are able to buy their dream homes.

    • Jacki – thanks for stopping by! It’s incredible how much the lower interest rates affect how much house you can purchase. I didn’t realize how significant it was until I ran the numbers. Bozeman – what a fun place that must be to do real estate in!

  4. According to your table, I think, we bought a home, more expensive than we could afford. I am really going to try to increase my income

    • Bindhu – a lot of this is location dependent. For example, if you were in the Silicon Valley, it’d be nearly impossible to stick with this rule because houses are so expensive. You’d have to be willing to make sacrificies and cut backs in other areas. Of course, increasing your income is also a great option to strive towards!

  5. what a great post! I love the table that compares the interest rates! When I was going through the house-buying process a few years ago, I made less than $40,000 and the banks kept telling me that I quailified for $200,000+ mortgage. I don’t know where they got THAT number from. I knew what I could afford though and kept firm on that limit (in spite of my realtor trying to show me houses above my comfort range).

    • Karen – that’s awesome you were able to stick to your limit. A lot of times it’s easy to fall into the “authority” mindset and believe the loan officers way more than we should. Maybe that’s why they call themselves officers… to try and gain even more authority!

  6. According to your 2X rule almost nobody in the Orange County, California area would be able to buy a home. The median income in Orange County for a family of 4 is $75,000. The 2X rule would mean limiting home price to $150,000. The median price of a home in Orange County is $561,000 🙂

    This is a multiplier of 7.5X, yet people are buying homes in droves here… there are multiple offers on properties and they are getting bid up.

    In an ideal world people would spend 2X but the current situation is that in some areas people are spending 6-8X their annual income. Again, it’s the government that is facilitating this as the FHA has been underwriting loans with as much as 60% DTI and 3.5% downpayments. Our government is the biggest culprit in encouraging fiscally irresponsible behavior.

    • I totally agree with you here too… there’s definitely certain metro areas where this rule doesn’t work if you ever want to buy a house. Maybe I need to add a high cost of living adjustment to it! California could be 3x… so 3x times 2x and you get 6x.. maybe closer to reality there!

      Even though I live in New Orleans, I work in Silicon Valley quite a bit and house prices there make me sick. I’m happy to make commensurate wages but to live in a cheaper area!

      • I understand your logic, though there’s another approach. Some say buy affordable others say buy to your maximum limit if you have sustainable employment. Looking at a rough consistent capital growth of 4% yr the more expensive option will make money quicker.

      • Dan,

        Stick with it even in the OC.

        Even if your average family of 4 has 75k borrowing 150k is still the right answer. They may need to then save another 350k; but if they are socking away 1.5k a month by being frugal then after a decade of investing that money in a good growth mutual fund they’ll be at 350k. And in addition they will have a property that grows in value instead of massive interest payments.

        Yes, at average income one should not own a home in the OC unless they have socked away substantial savings. If everyone followed this advice the price on homes would reach some reasonable ratio. But as-is, the cost of home ownership does not outweigh the benefits if you have to take out 6-7x your annual income to buy the thing.

        Don’t let home ownership come to mean that the home owns you.

  7. Although I can agree with not spending to the max you are pre-approved for, I’m not certain I agree with always paying at least 20% down and doing a 15 year loan. With rates still so low, it seems quite logical that your capital would perform better and achieve a greater net gain in something like an S&P 500 index fund. If you qualify, it seems like using a 30-year VA loan and investing both the down payment and additional monthly cost of a 15-year loan you’ll end up much further ahead in interest gained. Looks like I need to dust of my spreadsheets and verify this logic.

    • Hey Cody – glad I’m giving you a reason to dust off the spreadsheet!! I like the 20% down because it saves you from paying PMI – which can easily cost $150-$250 per month. Also, I like the more guaranteed return of paying off a house, because depending on market timing, your down payment turned investment return may not grow a bunch in fifteen years (like if you invested in 1999 at the top and fifteen years later the return hasn’t been that great). Amortized loans are killer on the front end with interest, so the more I can put down, the less I pay. Let me know if you run the numbers, would like to see it!

  8. JackBlack is right, this ratio is wayyy too low unless you live in the sticks. The average home price in Seattle is $441,500. I think 1/4 is far more realistic.

  9. I did the 2X annual income based upon one income (even though we had a two income household)

    The choice to do this has helped weather all sorts of financial storms life throws at you.

  10. Great idea but how can you apply this to where I live? In Melbourne Australia the average house price is $800k and the average income is $76k. A basic 2 bedroom apartment is about $450k to $500k. A studio apartment is $300k. What do I buy? I intend to have kids in two years (my partner will need some time off) and a studio apartment won’t work for two people, a dog and a baby. I make slightly above the average income in a professional job where I have two degrees and I’m in my early 30’s. I have $50k of university debt to service as well. Be thankful you live in a cheap country!

  11. Those are incredibly “low” numbers! If this is the way it is, at least half of America or more, can only buy a tiny house that needs alot of work for $200,000 home and a salary of “100,000???!!

  12. My wife and I just bought a house for $200,000. We did manage to put down 20% and did a 30 year loan at 4% Interest. We currently Gross 100K per year combined. We currently have zero outstanding debt other than the mortgage. The house is in a very nice neighborhood, but does need to have quite a bit of updating eventually. I must admit I am a bit nervous because we put most of our $ into the down payment to avoid the PMI and now have just a bit in savings. How do you think we did?

    • Better than us. We purchased a home for 315,000 and our gross is 135000. We’re in the same boat in terms of current savings, but most of our budget still allows us to save 20% of our income per month. This is after retirement savings has come out btw.

  13. Ive never read any thing as daft in my life, my annual income is 31k, so by your reconning i can only by a house for 62k ha ha ha ha ha. You try buying a 3 bed semi for that. It would cost more than that for the land alone in my area.
    I’m all for keeping to a tight budget and not overstretching ones self but you have to be realistic.
    I stand corrected if this article was written in the 1970’s and i’m commenting too late.

  14. If Gross income is $100K, is it a good idea to buy a $300K house?

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  1. Can I afford this much house? Home purchase question - Saving Advice Forums - December 17, 2012

    […] you should spend based on what you have today. I use the very conservative rule of only spending 2x annual gross income on a house. Granted, this may not be applicable in some more expensive cities, but it's a good strategy to […]

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