House Cost as a multiple of post-tax income

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ace1400
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House Cost as a multiple of post-tax income

Post by ace1400 »

Hi,

Longtime reader, first-time poster. I haven't found anything in the archives specifically addressing this.

My wife and I recently purchased a home, on the perfect lot, in our dream neighborhood. The house itself isn't great, and by this I mean it is highly unusual, and arranged in such a way that it marginally livable. We purchased the place for land value.

Our family is expanding, and changes definitely need to be made to accommodate children, so we are looking at a major renovation or teardown and new construction.

My question is this: From a Boglehead perspective, what is a reasonable multiple of one's post-tax income to spend on a home? I'm talking total here, not for a monthly mortgage payment. For example, if I make $250K/yr after taxes, should I be looking to spend a total of $500K on a house? $750K? $1M? Only $250K? Real Estate taxes are less than 1% of value.

I know this is somewhat handwaving, but I am looking for a ballpark reasonable about to spend, whether I finance the purchase or not depend on the rate/terms/opportunity cost etc, so mortgage payment related metrics don't help. I specify after tax because, well, most posts don't specify and rates probably range from 10% to 50+%.

Thanks,

Ace
Rodc
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Re: House Cost as a multiple of post-tax income

Post by Rodc »

Depends hugely on your details

I would skip this exercise and focus on dollars not percent. Look at your bills now and in the foreseeable future. What do you want for discretionary spending. What margin for a cushion do you want. Etc.

Depending on the details the answer can be all over the map.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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ResearchMed
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Re: House Cost as a multiple of post-tax income

Post by ResearchMed »

The first things to consider are your annual income, and how stable that is.
Then, what is approximately 25-33% of that, in terms of the TOTAL monthly expenses (PITI) of a mortgage you'd be likely to qualify for - plus in your mind some additional for maintenance.

And of course, what down payment do you have? Are you putting down 20%? Less? More?
Will you still have an adequate emergency fund?

What YOU might feel comfortable paying monthly might well differ from what a lender would feel comfortable with you paying, and that can go in either direction.

Finally, if you are doing serious renovations/re-design or building new, both the total cost and the time it will take will be MUCH (as in **MUCH**) more than you think. It always happens... :shock:

But you'll probably end up with the home that *you* want.
Just keep in mind future buyers, in terms of not making design/finish choices that are too quirky (even if you *think* you'll be there for decades).

RM
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ace1400
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Re: House Cost as a multiple of post-tax income

Post by ace1400 »

Ok, so the way it is usually discussed (25-33% of pretax annual income being total housing expense: PITI + maintenance) sounds like the best way to think about it. So this would be true even if not financing the purchase? I plan to finance a relatively small amount of the cost, probably 50% (we have been saving knowing this was planned). I am certainly planning on at least 20% down and 15 yr term (fixed rate). I will, of course, have an adequate emergency fund (1 yr+).

Is it reasonable to think of the 25% of pretax annual income being total housing expense (PITI + maintenance) pretending the purchase was financed at 15 years fixed with 20% down even if I pay cash, as a measure of affordability?

Ace
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ResearchMed
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Re: House Cost as a multiple of post-tax income

Post by ResearchMed »

ace1400 wrote:Ok, so the way it is usually discussed (25-33% of pretax annual income being total housing expense: PITI + maintenance) sounds like the best way to think about it. So this would be true even if not financing the purchase? I plan to finance a relatively small amount of the cost, probably 50% (we have been saving knowing this was planned). I am certainly planning on at least 20% down and 15 yr term (fixed rate). I will, of course, have an adequate emergency fund (1 yr+).

Is it reasonable to think of the 25% of pretax annual income being total housing expense (PITI + maintenance) pretending the purchase was financed at 15 years fixed with 20% down even if I pay cash, as a measure of affordability?

Ace
The "affordability" from the homeowner/buyer's perspective and from the lender's perspective don't always match.

To a great extent, it depends upon what other expenses you have, both (relatively) fixed and discretionary.
The lender won't know that the buyer wants/enjoys several vacations each year, or has sports/music lessons, camp, etc. for several children.
Similarly, the lender won't know that the buyer is a really frugal Boglehead (and not all of us here are).

So you would want to look very carefully at the total of your expenses for the previous year, and see what you are already spending on "housing", and is there more for a bigger/newer home.
And also think ahead about the costs of those children, both in terms of child-rearing AND in terms of saving for college.

However, it is all too easy to underestimate the costs of owning (or building) a home, so it's best to overestimate the costs, just in case.
Ditto the costs of children!

RM
niceguy7376
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Re: House Cost as a multiple of post-tax income

Post by niceguy7376 »

The 25% is what I have heard as general rule that most feel comfortable upto a max of 31-33% range. Thats what most lenders look at too along with all other factors of credit score, debts and such. Another way is to look at salary times 3 as max value that we can think of as the house value and then 20% of that as down payment.

All the above are generic rules.
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ResearchMed
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Re: House Cost as a multiple of post-tax income

Post by ResearchMed »

Another factor is what is your overall income.

Someone at a high income has a lot more choices of "how to spend the money" than someone on a more limited income.
But someone earning "twice as much" might NOT really need a twice-as-expensive house.

Especially because you are not planning to seek financing for 80+% of the cost, YOU need to consider what your cash flow will "allow" and also what you think is prudent to spend on housing.
If you are only financing 50%, you'll probably find that financing won't be too much of a problem. The lender is "protected", because they have only lent half of the value, and they could most likely recover their costs in a sudden sale. (2008+ in some locations didn't work this way, unfortunately for buyers and lenders alike.)

RM
Rodc
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Re: House Cost as a multiple of post-tax income

Post by Rodc »

ace1400 wrote:Ok, so the way it is usually discussed (25-33% of pretax annual income being total housing expense: PITI + maintenance) sounds like the best way to think about it. So this would be true even if not financing the purchase? I plan to finance a relatively small amount of the cost, probably 50% (we have been saving knowing this was planned). I am certainly planning on at least 20% down and 15 yr term (fixed rate). I will, of course, have an adequate emergency fund (1 yr+).

Is it reasonable to think of the 25% of pretax annual income being total housing expense (PITI + maintenance) pretending the purchase was financed at 15 years fixed with 20% down even if I pay cash, as a measure of affordability?

Ace
Again, percentages don't really matter. What matters is how many dollars you can afford and what you are comfortable with.

And that means you have to look at your specific income and expenses, feelings about risk, etc etc.

If I can live comfortably on $40k because I am single and make a steady $100K and expect to make more in the future, and have a company pension I could easily spend 50% of my post tax income.

If I make $200K, but have to support a family of 5 and I need to save for three college educations, have no pension and need to save for retirement, and need pay for three cars, and build a great emergency fund because my job is a little shaky and I will likely never more than this, I might only be safe spending 15%.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
MrMatt2532
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Re: House Cost as a multiple of post-tax income

Post by MrMatt2532 »

There are many rules of thumbs out there. The better ones (imo) are the ones that don't relate house cost to income but instead relate PITI(+HOA) to income.

The rule of thumb that I recommend is somewhat conservative and is to keep your PITI(+HOA) to less than 25% of your after-tax income.
sscritic
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Re: House Cost as a multiple of post-tax income

Post by sscritic »

When I bought my house, it was 6.5 times my after tax income, if by after tax income you mean AGI - federal taxes, where AGI does not include tax-exempt income nor untaxed social security and is reduced by the $3000 capital loss carryover. This is not strictly after tax, because I did have to pay state taxes. Hey, but I know what those were; wait a sec. Make that 6.9 times my after tax income, not including not taxed income. (This is really not fair if you have a lot of untaxed income - I need to redo this, but not now.)

The bigger question for me was what percentage of my net worth would I be spending, or rather, what percentage of my after-tax net worth (as opposed to my net worth after taxes), i.e., not in tax-deferred accounts. That you didn't ask, and I am not telling.
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White Coat Investor
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Re: House Cost as a multiple of post-tax income

Post by White Coat Investor »

I have two rules - mortgage size no more than 2 X gross income, and housing expenses no more than 20% of gross income. Might have to stretch it to 3 or 4 X in the Bay Area or Manhattan, but that'll cost you a few years of work or some vacations. 10 X is nuts.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
Lafder
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Re: House Cost as a multiple of post-tax income

Post by Lafder »

Relation to income matters more for affordability month to month on a mortgage.

Value of house as a percentage of net worth seems to be a different question.

What if I bought a house 10x my income but put down an 80% downpayment? And that was only 5% of my networth?
Versus what if I bought a house equal to my 1x annual salary with zero down and I have limited savings?

Our home cost about 2.5 x our income. We "qualified" for more of a loan, but did not take it. And we put down more than 20% to not have a jumbo loan.

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Re: House Cost as a multiple of post-tax income

Post by Lafder »

Don't forget that property taxes will likely go up significantly if you do a big remodel or a total rebuild.
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sscritic
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Re: House Cost as a multiple of post-tax income

Post by sscritic »

EmergDoc wrote:I have two rules - mortgage size no more than 2 X gross income, and housing expenses no more than 20% of gross income. Might have to stretch it to 3 or 4 X in the Bay Area or Manhattan, but that'll cost you a few years of work or some vacations. 10 X is nuts.
What's your rule when you pay cash? I don't see that the original question asked anything about a mortgage.
what is a reasonable multiple of one's post-tax income to spend on a home?
I guess if taxes are 2% and upkeep is 2%, that makes housing costs 4% of total cost. If 4% is then 20% of gross income, oh man, algebra time.

4% of house = 20% of gross income
multiply both sides by 25
100% of house = 500% of gross income

house <= 5 x gross income [you did say no more than]

And there you have it; I did it for you.

OP has to use the relevant tax and upkeep percentage for OP's not yet purchased house.
travellight
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Re: House Cost as a multiple of post-tax income

Post by travellight »

My house was about 4x my annual income at the time I bought it over 20 years ago. My income has doubled but then so has the house value so it is still about 4x.

When I did a remodel 3-4 years ago, I spent 350k and financed it myself; it was done in 2 stages a year apart. I didn't even think of it in terms of these multiples. I doubt I would spend more than 1 to 1.5x my annual income on a big remodel.

You know how to calculate affordability. I would consider whether you are over-investing for the neighborhood and if you are likely to recoup the money you put in.
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Mingus
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Re: House Cost as a multiple of post-tax income

Post by Mingus »

What's up with the house? Was it renovated in the past by someone with terrible taste, and they messed it up?
buckstar
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Re: House Cost as a multiple of post-tax income

Post by buckstar »

sscritic wrote:
EmergDoc wrote:I have two rules - mortgage size no more than 2 X gross income, and housing expenses no more than 20% of gross income. Might have to stretch it to 3 or 4 X in the Bay Area or Manhattan, but that'll cost you a few years of work or some vacations. 10 X is nuts.
What's your rule when you pay cash? I don't see that the original question asked anything about a mortgage.
Not to put words in EmergDoc's mouth, but if you're paying cash then it probably doesn't matter....
I think the mortgage <2X gross income is fairly good, simplistic "rule of thumb", but it does vary from situation to situation. We are at about 0.5 X gross income, but that is all the house that we need. When we bought our first house, it was about 3.5 X gross income, that ended up being a huge mistake.
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ace1400
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Re: House Cost as a multiple of post-tax income

Post by ace1400 »

Many thanks for all the responses. My question may not have been the most precise, but at this point I think I have a feel for what range I should be looking at. Having a formula is comforting to me, so I think that regardless of the method used to pay for the renovation (pay cash vs bank loan) I should think about it as if I was financing 100% and judge affordability based on something like PITI+HOA+reserves for replacements < 25% of post tax income. Further rule of mortgage size < 2x gross income seems reasonable.

Obviously paying cash brings up a bunch of different questions regarding how much of one's net worth should be tied up in a asset that doesn't generate a return. The cost of the home when you are paying cash is the opportunity cost of the money, which probably validates my formula above (though I hope my opportunity cost is higher than mortgage rates).

I will investigate if there is a way to determine the effects of the remodel on property taxes - that is an important point.

I continued to wonder why we talk about things in terms of gross income - a person paying Mitt Romney tax rates (10%?) has a completely different Gross to Net income relationship than people paying >50% overall (not marginal) tax income rates (high earned income in high tax state, including all payroll taxes, not including property or sales taxes obviously).

Thanks again,

Ace
TRC
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Re: House Cost as a multiple of post-tax income

Post by TRC »

ace1400 wrote:Hi,

Longtime reader, first-time poster. I haven't found anything in the archives specifically addressing this.

My wife and I recently purchased a home, on the perfect lot, in our dream neighborhood. The house itself isn't great, and by this I mean it is highly unusual, and arranged in such a way that it marginally livable. We purchased the place for land value.

Our family is expanding, and changes definitely need to be made to accommodate children, so we are looking at a major renovation or teardown and new construction.

My question is this: From a Boglehead perspective, what is a reasonable multiple of one's post-tax income to spend on a home? I'm talking total here, not for a monthly mortgage payment. For example, if I make $250K/yr after taxes, should I be looking to spend a total of $500K on a house? $750K? $1M? Only $250K? Real Estate taxes are less than 1% of value.

I know this is somewhat handwaving, but I am looking for a ballpark reasonable about to spend, whether I finance the purchase or not depend on the rate/terms/opportunity cost etc, so mortgage payment related metrics don't help. I specify after tax because, well, most posts don't specify and rates probably range from 10% to 50+%.

Thanks,

Ace
Income is only one factor. What are your other debts and monthly expenses?
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