Can you afford to buy a home? How much to spend on housing?
For most Americans, both renters and homeowners, housing is their largest expense. But how much is too much to spend on housing costs? Whether you rent or own, financial commentator and co-founder of AE Wealth Management, David Bach recommends, not spending more than 35% of your annual after-tax income on housing costs.
“The goal should be: No more than one-third of your income should be going to housing,” Bach commented, “Ideally, it’s even less.” For renters, housing costs include utilities and any other fees associated with the rental property. For homeowners, housing costs include mortgage interest, property taxes, home maintenance, and other renovations.
Another approach is the 28/36 rule. With the 28/36 rule, you spend no more than 28% of your gross monthly income on housing costs and no more than 36% on total debt, including your mortgage, student, loans, and car loans. This technique will help lower your debt-to-income ratio and may even increase your borrowing ability.
While limiting your housing spend is ideal, it’s also dependent on where you live. In higher-cost areas, it may not be possible to reduce your housing costs to one-third of your income. If you have ambitious saving goals you may have to downsize or adjust your lifestyle to save more.
With both rents and home prices rising, many renters fail to see the advantage of owning over renting. When you own your home, you have the advantage of building home equity with every mortgage payment. Unfortunately, when you rent, you are getting no return on your investment. Home equity can even be used responsibly to pay down other debt through a cash-out refinance, home equity line of credit. When you are making the choice to rent or buy, it’s not just about what percentage of your income you are currently spending on rent to what percentage you would spend on your mortgage payment. Consider how much equity you would be building long-term.
Renters looking to transition into homeownership find the biggest obstacle to buying is saving up for a down payment. However, with numerous low down payment mortgage loans and down payment assistance programs available, homeownership may be more achievable than previously thought. Choosing the right mortgage loan or down payment assistance program depends on your financial situation and your savings goals. Consult with a mortgage professional to set a plan that works for you.