Rules of Thumb: Max House Value as % of Net Worth?

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taxeconomist
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Rules of Thumb: Max House Value as % of Net Worth?

Post by taxeconomist » Sun Jul 24, 2016 8:29 am

What are some good prudent rules of thumb for one's max house value as a % of net worth? It seems a lot of people think about it from an income perspective, but I have not come across a rule of thumb for net worth.

Obviously this is a complicated consideration and dependent on many factors (e.g., when you want to retire, whether or not you want to pay house off, downsize later in life), but that's what rules of thumb try to approximate in light of various considerations. My experience in my part of the country is that there are too many dual-earner couples in the 30-45 year range earning $200k per year, are financing or leasing two cars, still have student loans (which means that even with a 10%-20% down payment, they may have a net worth of under $100k), may have plateaued from an earnings perspective, and yet they are buying up homes in the $850k - $1.1m range. I generally wouldn't care as I am decently conservative, but they are bidding up prices of homes which does impact me and what I can afford.

It seems a net worth rule of thumb probably should be more age-based than income-based, so what do you think about age at 30, the net worth: house value ratio should be 1:1 and age 40, should be 3:1? These are just educated guesses on my part, so interested in how everyone here thinks about it.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by whattodonow » Sun Jul 24, 2016 8:42 am

Financial Samurai has a number of posts regarding net worth by age.
Search 'The Average Net Worth For The Above Average Person'

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by jabberwockOG » Sun Jul 24, 2016 8:46 am

A very smart guy who consistently lives within his means, tries to do good in the world, and isn't out to impress anyone is Warren Buffet. His home value to net worth ratio is likely pretty unusual.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Jags4186 » Sun Jul 24, 2016 8:50 am

taxeconomist wrote:What are some good prudent rules of thumb for one's max house value as a % of net worth? It seems a lot of people think about it from an income perspective, but I have not come across a rule of thumb for net worth.

Obviously this is a complicated consideration and dependent on many factors (e.g., when you want to retire, whether or not you want to pay house off, downsize later in life), but that's what rules of thumb try to approximate in light of various considerations. My experience in my part of the country is that there are too many dual-earner couples in the 30-45 year range earning $200k per year, are financing or leasing two cars, still have student loans (which means that even with a 10%-20% down payment, they may have a net worth of under $100k), may have plateaued from an earnings perspective, and yet they are buying up homes in the $850k - $1.1m range. I generally wouldn't care as I am decently conservative, but they are bidding up prices of homes which does impact me and what I can afford.

It seems a net worth rule of thumb probably should be more age-based than income-based, so what do you think about age at 30, the net worth: house value ratio should be 1:1 and age 40, should be 3:1? These are just educated guesses on my part, so interested in how everyone here thinks about it.


I think it's too hard to say and too dependent on where you live. I think in general, it's going to to be a function of income, regardless of net worth. Where that income come from--whether investments or a combination of investments and earned income--remains to be seen.

I would like to keep housing costs under 25% of gross income. That of course includes opportunity cost of having a large lump sum tied up in a non-income producing property or having a mortgage which you need to feed with monthly payments. As long as you're at that level or below, I think you can afford the house.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by jjface » Sun Jul 24, 2016 8:58 am

It is based on income because that is what you pay a mortgage from.

Net worth has little to do with how much you can afford especially with retirement accounts that you cannot really tap to pay for the house except in an extreme emergency.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by DaftInvestor » Sun Jul 24, 2016 9:02 am

I agree with your summary about it being a function of age and this is a very interesting question. I do believe it also depends upon where you live, income, cash-flow, other-expenses, etc. so not sure if there is one single Net-Worth figure. I bought my first house pretty early and it was the majority of my net worth in the beginning - not having to pay rent and having home-equity building turned out to be very worthwhile. Now that I'm older it is a much smaller part of my net worth and I expect it to be around 10% of net worth by the time I retire.
I believe some people do go House Poor by getting the highest-mortgage they can afford at their income level. This might be okay if you are very young and expect your career to produce very good raises over a 10 year period but as folks get older if they keep buying up and keep their house net worth percentage high they end up either in a lot of debt and not being able to retire comfortably (or not being able to retire when they want to). So when you are young - I do believe a majority of your net worth being tied up in your primary home might be okay - but by the time you are 40 it should certainly be less than 50% and so on.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by taxeconomist » Sun Jul 24, 2016 9:12 am

Jags4186 wrote:I think it's too hard to say and too dependent on where you live. I think in general, it's going to to be a function of income, regardless of net worth. Where that income come from--whether investments or a combination of investments and earned income--remains to be seen.

I would like to keep housing costs under 25% of gross income. That of course includes opportunity cost of having a large lump sum tied up in a non-income producing property or having a mortgage which you need to feed with monthly payments. As long as you're at that level or below, I think you can afford the house.


I understand why income rules of thumb are geared towards what you can afford from a cash flow perspective (due to what banks will loan to you at), but hardly anyone thinks about it from a balance sheet or equity perspective. I surmise that the home value = 3x or even 4-5x income ratios are put out there by the real estate and mortgage industry to get people to buy more than they should, which effectively makes people long-term renters and runs contrary to building up net worth over the long haul.

From a financial literacy perspective, I think it would be useful to have net worth to home value rules of thumb. If taking a look at the Financial Samurai site (see http://www.financialsamurai.com/the-ave ... ge-person/), an above average 35 and 45 year old should have $429k and $914k in net worth, respectively. Assuming the above average person has the same house valued at $300k, the net worth to home value ratio would be approximately 1.5:1 at 35 and 3:1 at 45.

The Warren Buffet example is not a good one as a rule of thumb would be useful if set up to cover a broad segment of the population, not the third richest person on the planet. Also note that Buffet bought a 4,000+ square foot home at age 28 (and lived in it after he got rich and made additions to it and now it's 6,000 sq ft), the home sizes of which are prohibitively expensive even for millionaires in certain parts of the country.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Jags4186 » Sun Jul 24, 2016 10:03 am

taxeconomist wrote:I understand why income rules of thumb are geared towards what you can afford from a cash flow perspective (due to what banks will loan to you at), but hardly anyone thinks about it from a balance sheet or equity perspective. I surmise that the home value = 3x or even 4-5x income ratios are put out there by the real estate and mortgage industry to get people to buy more than they should, which effectively makes people long-term renters and runs contrary to building up net worth over the long haul.

From a financial literacy perspective, I think it would be useful to have net worth to home value rules of thumb. If taking a look at the Financial Samurai site (see http://www.financialsamurai.com/the-ave ... ge-person/), an above average 35 and 45 year old should have $429k and $914k in net worth, respectively. Assuming the above average person has the same house valued at $300k, the net worth to home value ratio would be approximately 1.5:1 at 35 and 3:1 at 45.

The Warren Buffet example is not a good one as a rule of thumb would be useful if set up to cover a broad segment of the population, not the third richest person on the planet. Also note that Buffet bought a 4,000+ square foot home at age 28 (and lived in it after he got rich and made additions to it and now it's 6,000 sq ft), the home sizes of which are prohibitively expensive even for millionaires in certain parts of the country.



Financial Samurai writes some good stuff, but it's mostly hypothesized and not very well at that.

A quick google can find quintile net worth by age as reported by the US Census Bureau shows the the 50th percentile household net worth for a 35-44 year old is only $35,000. The 70th percentile, certainly above average, is only $128,430. Financial Samurai is insisting that an above average, single, 35 year would have a net worth 3.3x the 70th percentile for all 35-44 year olds. That's a little high, don't you think?

Many here forget that the subset of people who read websites like Bogleheads or blogs like Financial Samurai are already likely living on the coasts, making incomes far about national averages, and since they have an innate interest in personal finance are already saving a significant amount of their income.

Unless you are fabulously wealthy, the home you buy should be a function of your free cash flow. Now you can decide how much of your cash flow you want to devote towards a home (5%, 10%, 25%, etc.) limited only by what a bank will loan you.

That said, with mortgage rates so low, most people can afford a higher valued house. So this question when a 30 year mortgage is 7% vs 3.25% would get different answers.
Last edited by Jags4186 on Sun Jul 24, 2016 10:20 am, edited 1 time in total.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by cherijoh » Sun Jul 24, 2016 10:16 am

Jags4186 wrote:
taxeconomist wrote:What are some good prudent rules of thumb for one's max house value as a % of net worth? It seems a lot of people think about it from an income perspective, but I have not come across a rule of thumb for net worth.

Obviously this is a complicated consideration and dependent on many factors (e.g., when you want to retire, whether or not you want to pay house off, downsize later in life), but that's what rules of thumb try to approximate in light of various considerations. My experience in my part of the country is that there are too many dual-earner couples in the 30-45 year range earning $200k per year, are financing or leasing two cars, still have student loans (which means that even with a 10%-20% down payment, they may have a net worth of under $100k), may have plateaued from an earnings perspective, and yet they are buying up homes in the $850k - $1.1m range. I generally wouldn't care as I am decently conservative, but they are bidding up prices of homes which does impact me and what I can afford.

It seems a net worth rule of thumb probably should be more age-based than income-based, so what do you think about age at 30, the net worth: house value ratio should be 1:1 and age 40, should be 3:1? These are just educated guesses on my part, so interested in how everyone here thinks about it.


I think it's too hard to say and too dependent on where you live. I think in general, it's going to to be a function of income, regardless of net worth. Where that income come from--whether investments or a combination of investments and earned income--remains to be seen.

I would like to keep housing costs under 25% of gross income. That of course includes opportunity cost of having a large lump sum tied up in a non-income producing property or having a mortgage which you need to feed with monthly payments. As long as you're at that level or below, I think you can afford the house.


jjface wrote:It is based on income because that is what you pay a mortgage from.

Net worth has little to do with how much you can afford especially with retirement accounts that you cannot really tap to pay for the house except in an extreme emergency.


Jags4186 and jjface are both correct in terms of how much you could afford according to the lender. But I think the OPs idea is interesting from the perspective of whether or not a home purchase would put you in the "house poor" category and how it might impact ones ability to be financially independent (FI). It could be used to put a prospective purchase into perspective when you can afford far more house than you actually need or in HCOL areas to decide whether it might make more sense to continue to rent for a while.

I think most people fail to think about the opportunity costs of buying their "dream house". I see a lot of people taking advantage of the low interest rate environment to buy as much house as they can "afford" - irrespective of their net worth. But current income doesn't necessarily reflect future income due to the potential of job loss, disability, wanting to have kids and be a stay at home parent, etc. Without having sufficient net worth as a backstop for an expensive home you run the risk of jumping on a treadmill that may be going to fast for you at some future date.

If you buy something that is reasonable relative to your net worth, then you will have a buffer zone to protect you from adverse financial events. A lot of people seem to blame the banks totally for the mortgage crisis, but IMO many of the homeowners who were adversely affected should have known better than to think they could afford the houses they were buying! :oops:

I bought a condo in the early 80s with very little net worth. It was actually sooner than I should have bought, but I was incented to buy because my employer was paying the closing costs (due to a recent relocation). Fortunately for me, my salary was increasing with 10+% annual raises and I was soon able to refinance to a lower interest rate. There was also a local shortage of apartments, so I ended up paying less for PITI (after I refinanced)plus HOA fees than an equivalent apartment would have cost - and that was before the mortgage interest deduction. But my more mature self looks back and sees that I dodged a potential bullet.

When I bought my house in the early 90s (in my mid thirties), it was a different story and my net worth was ~1.25 times the price of the house I purchased. At that point, I was no longer getting double digit raises, but I was again able to take advantage of falling interest rates to refinance after a few years. Now as I approach retirement, my paid-off home value represents less that 15% of my net worth. Having a sensible house has definitely contributed to my ability to retire early.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by goingup » Sun Jul 24, 2016 10:34 am

I'm curious about your new rule. Do you propose lenders adopt a net worth metric when lending? Or are you just proposing a new heuristic that will dissuade home buyers from buying a home that their income allows, but seems unwise because of existing low net worth?

I'm home shopping too, and there are bidding wars and all-cash sales. This is the reality in a summer of low inventory. Unfortunately there won't be any new rules introduced to cull low NW buyers!

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by taxeconomist » Sun Jul 24, 2016 10:41 am

cherijoh wrote:Jags4186 and jjface are both correct in terms of how much you could afford according to the lender. But I think the OPs idea is interesting from the perspective of whether or not a home purchase would put you in the "house poor" category and how it might impact ones ability to be financially independent (FI). It could be used to put a prospective purchase into perspective when you can afford far more house than you actually need or in HCOL areas to decide whether it might make more sense to continue to rent for a while.

I think most people fail to think about the opportunity costs of buying their "dream house". I see a lot of people taking advantage of the low interest rate environment to buy as much house as they can "afford" - irrespective of their net worth. But current income doesn't necessarily reflect future income due to the potential of job loss, disability, wanting to have kids and be a stay at home parent, etc. Without having sufficient net worth as a backstop for an expensive home you run the risk of jumping on a treadmill that may be going to fast for you at some future date.


cherijoh completely understands my question. What is a good rule of thumb at age 35, 45, 55, and 65 of net worth:house value that is consistent with a path to financial independence? Not how much can one afford based on cash flow considerations, as there are enough websites and affordability calculators out there already on this point.

I am also not sure that anyone thinks that a median $35k net worth figure for 35-44 year olds is consistent with financial independence. It's a shame that this is the median number nationally and indicative that financial literacy is not present at the median (or even the 70th percentile of US households for that matter). It is also indicative that too many people are thinking of this question from an income-based perspective as I have mentioned before.

Returning to the original question, I think 1:1 (age 35), 3:1 (age 45), 4:1 (age 55) and 5:1 (age 65 assuming work until 65) are reasonable net worth: house value ratios, but interested in how other people think about this.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by taxeconomist » Sun Jul 24, 2016 10:44 am

goingup wrote:I'm curious about your new rule. Do you propose lenders adopt a net worth metric when lending? Or are you just proposing a new heuristic that will dissuade home buyers from buying a home that their income allows, but seems unwise because of existing low net worth?

I'm home shopping too, and there are bidding wars and all-cash sales. This is the reality in a summer of low inventory. Unfortunately there won't be any new rules introduced to cull low NW buyers!


I am thinking about a rule that people can think about when evaluating home purchases at various points in their life (and tracking if they are saving enough), not anything that lenders should care about as those metrics and credit rating methodologies are already in place.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Jags4186 » Sun Jul 24, 2016 10:49 am

taxeconomist wrote:
cherijoh wrote:Jags4186 and jjface are both correct in terms of how much you could afford according to the lender. But I think the OPs idea is interesting from the perspective of whether or not a home purchase would put you in the "house poor" category and how it might impact ones ability to be financially independent (FI). It could be used to put a prospective purchase into perspective when you can afford far more house than you actually need or in HCOL areas to decide whether it might make more sense to continue to rent for a while.

I think most people fail to think about the opportunity costs of buying their "dream house". I see a lot of people taking advantage of the low interest rate environment to buy as much house as they can "afford" - irrespective of their net worth. But current income doesn't necessarily reflect future income due to the potential of job loss, disability, wanting to have kids and be a stay at home parent, etc. Without having sufficient net worth as a backstop for an expensive home you run the risk of jumping on a treadmill that may be going to fast for you at some future date.


cherijoh completely understands my question. What is a good rule of thumb at age 35, 45, 55, and 65 of net worth:house value that is consistent with a path to financial independence? Not how much can one afford based on cash flow considerations, as there are enough websites and affordability calculators out there already on this point.

I am also not sure that anyone thinks that a median $35k net worth figure for 35-44 year olds is consistent with financial independence. It's a shame that this is the median number nationally and indicative that financial literacy is not present at the median (or even the 70th percentile of US households for that matter). It is also indicative that too many people are thinking of this question from an income-based perspective as I have mentioned before.

Returning to the original question, I think 1:1 (age 35), 3:1 (age 45), 4:1 (age 55) and 5:1 (age 65 assuming work until 65) are reasonable net worth: house value ratios, but interested in how other people think about this.


I get the question. Home affordability is a function of cash flow though. You could have a significant net worth in non income producing or unavailable assets and not be able to afford the carrying costs of a home.

Here's an example: Say you are 35 years old and you have $400,000 in 401k and rollover IRAs. You also have $25,000 in cash and you earn $75,000/yr. You would not be able to afford a $425,000 home.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by technovelist » Sun Jul 24, 2016 10:57 am

In my opinion, evaluating the ownership of a house is divided into two parts:

1. The market value of the house regardless of mortgage balance
2. The mortgage balance

#1 is your gross exposure to the housing market, whereas #1-#2 is your home equity.

The contribution to your net worth is the home equity.
But the problem is that #1 is likely to be well in excess of many people's total net worth, especially at young ages.

Let's look at an example.

Suppose you have a house with a market value of $300,000 and a mortgage of $250,000, so your home equity is $50,000.
You also have $100,000 in stocks and $100,000 in bonds.
So your net worth is $250,000, of which 20% is home equity, which doesn't sound too bad.

But if you look at your gross exposure instead, it looks like this:

$300,000 housing (concentrated in one asset, not just one asset class)
$250,000 mortgage (negative bond)
$100,000 stocks
$100,000 bonds

The total net worth is still $250,000, but look at the breakdown!

120% extremely concentrated real estate
-100% negative bonds
40% stocks
40% bonds

If you believe in diversification, this should fill you with dread.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Strayshot » Sun Jul 24, 2016 11:03 am

How are you defining net worth and house value? Is house value the amount that the home would sell for in the current market? How is equity factored in (considered part of net worth?). It would seem to me that if you propose a 1:1 net worth to house value at 35 you are implying that someone would technically own their home at that age (if all net worth was equity in the home).

I think there are far too many factors around home ownership to boil it down to a rule of thumb related to net worth, and many real estate markets in pockets of the country are so badly messed up from a valuation perspective that it wouldn't apply anyways.

The best rule of thumb for a house in my opinion is to buy one you can afford :moneybag

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by taxeconomist » Sun Jul 24, 2016 11:18 am

Strayshot wrote:How are you defining net worth and house value? Is house value the amount that the home would sell for in the current market? How is equity factored in (considered part of net worth?). It would seem to me that if you propose a 1:1 net worth to house value at 35 you are implying that someone would technically own their home at that age (if all net worth was equity in the home).

I think there are far too many factors around home ownership to boil it down to a rule of thumb related to net worth, and many real estate markets in pockets of the country are so badly messed up from a valuation perspective that it wouldn't apply anyways.

The best rule of thumb for a house in my opinion is to buy one you can afford :moneybag


House value is market price of home (not just the equity in home)

Net worth is total assets minus total liabilities (including mortgage on said home).

Therefore, with a 1:1 ratio at age 35, if someone had a $300k market-priced home, their net worth would be $300k, but it could mean they have a substantial balance on their mortgage (which is also consistent with a prudent asset allocation at that age).

I sense a lot of resistance to this concept of a rule of thumb that is net worth-based rather than cash-flow based. I am not sure it's that complicated (other than it's increasing with age) despite everyone's comments and not really different than the old adage of being "house poor."

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Jags4186 » Sun Jul 24, 2016 11:22 am

taxeconomist wrote:I sense a lot of resistance to this concept of a rule of thumb that is net worth-based rather than cash-flow based. I am not sure it's that complicated (other than it's increasing with age) despite everyone's comments and not really different than the old adage of being "house poor."


You're getting resistance because it's not a good way to measure home affordability.

A 35 year old making $100k with $100k in savings can buy a $200k and be on a better path towards financial independence than a 35 year old making $50k with $200k in savings buying the same $200k home.
Last edited by Jags4186 on Sun Jul 24, 2016 11:23 am, edited 1 time in total.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by edge » Sun Jul 24, 2016 11:22 am

There is none. This is not a good question. Home affordability is normally about income and human capital vs. expense.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by joebh » Sun Jul 24, 2016 11:25 am

I'm financially independent.

I have 2 homes. The combined value is about 40% of my entire net worth - but I would still be financially independent without any house value at all.
The value of both homes happens to be increasing rapidly, due to the local housing market.

Should I be worried? Should I be happy? Or should I ignore a rule of thumb that seems to have no real meaning for me?

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by cherijoh » Sun Jul 24, 2016 11:26 am

Strayshot wrote:How are you defining net worth and house value? Is house value the amount that the home would sell for in the current market? How is equity factored in (considered part of net worth?). It would seem to me that if you propose a 1:1 net worth to house value at 35 you are implying that someone would technically own their home at that age (if all net worth was equity in the home).


I looked at my taxable and tax advantaged assets plus my 20% down payment vs. the purchase price of the house when I calculated a 1.25:1 ratio.

I guess technically you are correct, but only if you use all your assets and purchase a house outright - which is not a likely event. This rule of thumb could be appropriate for a home purchase with a typical down payment in the range of 10 - 20%.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Non7WoodUser » Sun Jul 24, 2016 11:29 am

Consider home ownership if and only if the price per sq ft < $100 OR the purchase price < 30% of your net worth.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Strayshot » Sun Jul 24, 2016 11:32 am

Only the equity in the home should count towards net worth, and because most home buyers in the US use mortgages (generally a 30 year conventional) the home contribution to net worth is minimal until long into the mortgage.

Take someone who is 35 and has 200k in non-home assets. In one case that individual just bought a $1M house and put 10% down. They would have a 300k net worth and a $1M home. In another case, that individual bought a 200k house and put 100k down. They have a 300k net worth and a 200k house.
So the ratios are case 1: .3:1 and case 2: 3:2

I would argue that that both cases could be totally fine from an overall money standpoint for those individuals and the ratios are meaningless and/or irrelevant from a rule of thumb standpoint........If folks like me seem resistant to the concept it is because I can't understand what value it adds to decision making for home ownership.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Rodc » Sun Jul 24, 2016 11:35 am

Would also depend greatly on where you live. Bay area, Boston, etc is not the same as Atlanta or Peoria.
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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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Jags4186 » Sun Jul 24, 2016 11:39 am

Non7WoodUser wrote:Consider home ownership if and only if the price per sq ft < $100 OR the purchase price < 30% of your net worth.


I've seen this posted by you before and it just baffles me. For many parts of the country that is simply unrealistic.

Now you could say "just rent in those places" but that assumes renting is cheaper than owning a like property, which it very well may not be.

You could also say "move out of X location" and again I would posit that if you're moving to a place where home prices are under $100/square foot your income would directly reflect that decrease in house price.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by afan » Sun Jul 24, 2016 11:45 am

I agree that available assets and cash flow matter more than networth when considering a purchase. The ratio of networth to house value as the years go by will depend on things completely out of your control: price appreciation on the home and behavior of the financial markets. One could get lucky on market value of the house, unlucky with a period of low financial returns and the house could be a large share of networth. That does not mean the homeowner cannot afford the house.

If financial markets do well and real estate does poorly you get the reverse situation but it does not imply anything about the wisdom of buying that house or whether one should sell.

In low cost of living areas one can get a very nice home for a relatively low cost. In HCOL areas houses and rents cost more. Hard to come up with a rule that would be applicable in a Midwest small town and in San Francisco..
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by afan » Sun Jul 24, 2016 11:47 am

Jags4186 wrote:
Non7WoodUser wrote:Consider home ownership if and only if the price per sq ft < $100 OR the purchase price < 30% of your net worth.


I've seen this posted by you before and it just baffles me. For many parts of the country that is simply unrealistic.

Now you could say "just rent in those places" but that assumes renting is cheaper than owning a like property, which it very well may not be.

You could also say "move out of X location" and again I would posit that if you're moving to a place where home prices are under $100/square foot your income would directly reflect that decrease in house price.


In my area the only places at $100/sq ft are condemned properties. Not just in desperate need of repair, but not legal to occupy.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by investingdad » Sun Jul 24, 2016 11:54 am

We are a good example of, "if I had known then, what I do now...".

We have a nice home in a nice neighborhood. We paid 360k and financed 240k. That was six years ago, we sold our first house in the process. We were probably making about 160k at the time.

Today, our base income stands at 97% of our original mortgage. And, in hindsight, we could have bought an amazing home in an exclusive neighborhood. Some people would trade up. We are ramping up savings even more and now doing two nice family vacations per year...and staying where are.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by qwertyjazz » Sun Jul 24, 2016 11:58 am

I think having some heuristics would be great. Of course each person is different. But a starting point from which to deviate - anchors - help with the issues. I think 25% cash flow for housing and then something about risk of losing job and housing market might be a good first start.
Something about a percent chance of loosing your job and historical home prices in case you had to sell.

Any ideas?

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by JGoneRiding » Sun Jul 24, 2016 12:05 pm

I always thought of it as amount of NW that is tied up in equity. If you are just starting out and putting money in a 401k and saving for a down payment. the down payment might be the majority of your NW but you only have half your NW tied up in equity if you have also been socking away into the retirement and that should continue to rise at a faster rate then paying down the principal. But no way could you count the ENTIRE house value as a percentage of your NW starting out. First off it isn't you only have a tiny amount of equity, second no one could buy a house for a long time with any sort of value if you counted the whole house value as a precent of NW.

For example I have been working professional for 9 years. I have almost a mil in real estate loans right now between me and my husband. but the equity in the homes (actual money in) only represents about 30% of my total NW and I am actively increasing investing rather then equity. (we have rentals in case that wasn't obvious)

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by livesoft » Sun Jul 24, 2016 12:24 pm

I don't think there can be a rule-of-thumb without considering location, location, location.

For instance, look at homeowners in Texas and California. Many Californians use their home as a 401(k) because otherwise they would not be able to afford a home. OTOH, homes of the same size in Texas could be 1/4th to 1/3th the cost leaving money to contribute to a 401(k) or two.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by taxeconomist » Sun Jul 24, 2016 12:30 pm

This is my last post as it seems I hit a nerve here. Here's my logic: Assuming there is a path to financial independence (and it occurs at some period of time before one retires), I have the following facts at hand:

1. Net worth is increasing with age.

2. Home value is increasing with age (and then maybe plateaus or decreases when downsizing in retirement). (Real) home prices are tied to the rate of inflation over long periods of time. This assumes 2 or 3 homes over one's lifetime and assume one always owns a home post age 35 (of course there will be exceptions).

Think about those two time series over time (age). There is a ratio that can be calculated. I am just asking about that ratio over time.

This ratio has nothing to do with what you "can afford". That is tied to cash flow considerations (e.g., what you can pay on a monthly basis) and banks will cap that amount based on their credit rating models.

I am not sure I even buy the argument around bi-coastal, HCOL areas as being proof that such a rule doesn't exist as, there are many of my colleagues (dual income couples in those areas with $200k-400k of annual income and very likely under $500k of net worth) competing against all-cash offers in $1m - $2m range. The response is that the local market conditions are crazy, but I would say those folks are competing for the same homes with people with much higher net worths (ergo all-cash offers). Yes, they can afford it, but that affordability may or may not be consistent with a path towards financial independence.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Nowizard » Sun Jul 24, 2016 12:36 pm

Ours represents approximately 1/6 of our net worth, excluding equity in the house itself.

Tim

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by qwertyjazz » Sun Jul 24, 2016 12:46 pm

How about
Home should be no more than a 50% chance of being 2.5 times gross income and investments

25% housing a year for ten years
Times the percent of time likely unemployed (average expected time unemployed over 10 years)
Then add in all investments

If the house is more expensive than that - then it is possibly too high
One could take the chance but this could be a heuristic

Any modifications?

One possible is change definition of investment to those that you feel that you have enough working years left to recover from if lost

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by afan » Sun Jul 24, 2016 7:40 pm

Our house, Zillow estimated market value, is 1/6 of the value of all our other investments. Our equity in the house is 13% of our networth.

I have no idea whether that is good or bad.

If we were to buy another house it would be smaller and cheaper. But the hassle and transaction costs of a sale, purchase and move are such that we are unlikely to do this before retirement, if ever.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by obgyn65 » Mon Jul 25, 2016 6:52 am

For what it's worth, I bought my main condo about 10 years ago in cash. At that time, it was about 10-120% of my next worth. There is no way I could have retied at age 50 if I had bought a $1MM house.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by technovelist » Mon Jul 25, 2016 9:49 am

obgyn65 wrote:For what it's worth, I bought my main condo about 10 years ago in cash. At that time, it was about 10-120% of my next worth. There is no way I could have retied at age 50 if I had bought a $1MM house.


That is a very big range! :happy
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by obgyn65 » Mon Jul 25, 2016 5:13 pm

Sorry for the typo. I meant 10-20.
technovelist wrote:
obgyn65 wrote:For what it's worth, I bought my main condo about 10 years ago in cash. At that time, it was about 10-120% of my next worth. There is no way I could have retied at age 50 if I had bought a $1MM house.


That is a very big range! :happy
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by Meg77 » Mon Jul 25, 2016 5:43 pm

My grandparents are worth about $10MM and live in a paid off $200K home. I met a new client Friday (also retirement age) who is worth about $17MM but has a $4MM home and a $5MM second home (both paid off). Crazy difference in ratios, but both families can afford to ride out the rest of their lives without too much financial worry.

It's impossible to establish a rule of thumb for this kind of thing because net worth - not to mention preferences and cost of living - varies so much for so many reasons. Some middle aged folks may have inherited money that dwarfs their income, so their homes should be a smaller portion of their net worth. Some young folks have high incomes but low net worth because they are just starting out (esp docs and lawyers with 6 figure student loans), so they can justify quite large home purchases compared to current net worth. Retirees may have huge net worth but no intention of spending a large chunk of that on a house if they are in a cheap area, so their ratios will be lower.

For most people, their first home's value is going to be much higher than their total net worth. The way the average person builds much of his or her net worth is often through owning real estate long term, so that ratio could change over time as net worth (presumably) rises faster than the home's value.

I bought a $145K condo when I was 22 making $45K a year at my first job with a net worth of about $275K (leftover college funds in my name mostly). I lived in that condo for 9 years, and when I moved it was worth $165K and my income was $115K and my net worth was $700K or so. My fiance and I bought a $485K town home with a combined net worth of about $950K and a combined income of about $220K. Now the value of the town home is $600K but we make $300K a year and have a $1.4MM net worth.

As you can see, the home/net worth ratio has changed a lot due to many variables. Ideally I'd like our home to be less than 15% of our net worth once we are near the end of the accumulation phase and are in the home we plan to live most of our lives in. But ironically, the higher your net worth is, the more you can justify spending a higher percentage of it on your homestead.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by lazydavid » Mon Jul 25, 2016 6:09 pm

afan wrote:
Jags4186 wrote:
Non7WoodUser wrote:Consider home ownership if and only if the price per sq ft < $100 OR the purchase price < 30% of your net worth.


I've seen this posted by you before and it just baffles me. For many parts of the country that is simply unrealistic.

Now you could say "just rent in those places" but that assumes renting is cheaper than owning a like property, which it very well may not be.

You could also say "move out of X location" and again I would posit that if you're moving to a place where home prices are under $100/square foot your income would directly reflect that decrease in house price.


In my area the only places at $100/sq ft are condemned properties. Not just in desperate need of repair, but not legal to occupy.


Our area's not quite that expensive, but I agree with you wholeheartedly. If you exclude the basement square footage (as required by MLS listing rules), we're at about $160/sqft, and we live 23 miles from work. A similar house within 5 miles of our jobs (still in the suburbs, ~17 miles outside of the city) would be more like $400-500/sqft. But we're not house poor. Based on the current Zillow estimate, we have 61% equity, and our mortgage payment is just under 10% of our NET income (after taxes, benefits, 15-17% 401k contributions, and other miscellaneous witholdings). That will go up to about 13% after we finish our refinance, but we'll be on track to being paid off before either of us turns 55.

House equity is about 30% of our total net worth, average age 38.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by absolutFinance » Mon Jul 25, 2016 6:26 pm

this post is the best example of how there isn't really a rule of thumb for this sort of thing. it depends on your risk tolerance, living expenses, planned future earnings/savings, etc.

most BH would disapprove of my NW % in my home (50% with NW 4M+) but it makes sense for our situation (HCOL, schools, age [mid-30s] and future earnings/savings)

Meg77 wrote:My grandparents are worth about $10MM and live in a paid off $200K home. I met a new client Friday (also retirement age) who is worth about $17MM but has a $4MM home and a $5MM second home (both paid off). Crazy difference in ratios, but both families can afford to ride out the rest of their lives without too much financial worry.

It's impossible to establish a rule of thumb for this kind of thing because net worth - not to mention preferences and cost of living - varies so much for so many reasons. Some middle aged folks may have inherited money that dwarfs their income, so their homes should be a smaller portion of their net worth. Some young folks have high incomes but low net worth because they are just starting out (esp docs and lawyers with 6 figure student loans), so they can justify quite large home purchases compared to current net worth. Retirees may have huge net worth but no intention of spending a large chunk of that on a house if they are in a cheap area, so their ratios will be lower.

For most people, their first home's value is going to be much higher than their total net worth. The way the average person builds much of his or her net worth is often through owning real estate long term, so that ratio could change over time as net worth (presumably) rises faster than the home's value.

I bought a $145K condo when I was 22 making $45K a year at my first job with a net worth of about $275K (leftover college funds in my name mostly). I lived in that condo for 9 years, and when I moved it was worth $165K and my income was $115K and my net worth was $700K or so. My fiance and I bought a $485K town home with a combined net worth of about $950K and a combined income of about $220K. Now the value of the town home is $600K but we make $300K a year and have a $1.4MM net worth.

As you can see, the home/net worth ratio has changed a lot due to many variables. Ideally I'd like our home to be less than 15% of our net worth once we are near the end of the accumulation phase and are in the home we plan to live most of our lives in. But ironically, the higher your net worth is, the more you can justify spending a higher percentage of it on your homestead.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by TravelforFun » Mon Jul 25, 2016 6:50 pm

taxeconomist wrote:What are some good prudent rules of thumb for one's max house value as a % of net worth? It seems a lot of people think about it from an income perspective, but I have not come across a rule of thumb for net worth.

What could you do with that number? If it were decided that that number is 1 or someone who has a net worth of $200K shouldn't buy a home costing more than $200K, should people who have no positive net worth not own homes or billionaires should own billion dollar homes?
Last edited by TravelforFun on Mon Jul 25, 2016 7:02 pm, edited 1 time in total.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by tennisplyr » Mon Jul 25, 2016 6:53 pm

Think I just sold my house which is 50% of my net worth.....one happy camper :sharebeer :sharebeer
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by cme » Mon Jul 25, 2016 11:52 pm

My retirement plan includes fully owning my house by the time I retire.

My proposed rule of thumb is that for every $1MM of additional house value at retirement, I need to have an extra $750K of retirement savings to service the incremental housing costs.

I figure I'll spend 3%/year on the additional housing costs (1% on property taxes, 1% on maintenance, and 1% on utilities & furnishings), or $30K/year, which requires a portfolio of $750K with a "safe" portfolio withdrawal rate of 4%/year ($1MM x 3% / 4% = $750K).

Putting that into practice: I have the option to retire in SF or someplace like Chandler, AZ, where a house that fits my family's target lifestyle at retirement might cost $1.5MM or $0.4MM, respectively. For the sake of this exercise, let's say my target retirement NW is $3.0MM without housing. So if I want to retire in SF, I need $3.0MM + 1.5MM + 1.125MM = $5.625MM. If I want to retire in Chandler, I only need $3.0MM + $0.4MM + $0.3MM = $3.7MM.

The former has a NW/house ratio of 3.75 while the latter has a ratio of 9.25. I don't think either of these ratios is necessarily more prudent than the other, though the former likely has more flexibility - "excess" equity could be unlocked in an emergency through further downsizing.

So I can propose a ratio of [house value] / [NW required to service the house]. But I am not able to translate this to house value / total NW, or to propose that ratio by age.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by White Coat Investor » Tue Jul 26, 2016 12:46 am

taxeconomist wrote:What are some good prudent rules of thumb for one's max house value as a % of net worth? It seems a lot of people think about it from an income perspective, but I have not come across a rule of thumb for net worth.

Obviously this is a complicated consideration and dependent on many factors (e.g., when you want to retire, whether or not you want to pay house off, downsize later in life), but that's what rules of thumb try to approximate in light of various considerations. My experience in my part of the country is that there are too many dual-earner couples in the 30-45 year range earning $200k per year, are financing or leasing two cars, still have student loans (which means that even with a 10%-20% down payment, they may have a net worth of under $100k), may have plateaued from an earnings perspective, and yet they are buying up homes in the $850k - $1.1m range. I generally wouldn't care as I am decently conservative, but they are bidding up prices of homes which does impact me and what I can afford.

It seems a net worth rule of thumb probably should be more age-based than income-based, so what do you think about age at 30, the net worth: house value ratio should be 1:1 and age 40, should be 3:1? These are just educated guesses on my part, so interested in how everyone here thinks about it.


I think you can't have a rule of thumb because I think the ratio should be much higher early in life and much lower later. If you have a $200K net worth and a $200K income, I think it's fine to buy a $500K house. But I wouldn't want to retire with a $2M house and an $800K portfolio.
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by marlowefamily » Tue Jul 26, 2016 5:55 am

Yes, I think this varies greatly with age and area and overall goals.

Buying a house in an area because it has the best schools for ones kids and there is limited supply/high demand for homes and one plans to pay it off within 10-15 years -- I think affords more lattitude.

In my area, the average home price >=$300/sq ft. We would have to seriously downgrade and move quite a bit to get <$200/sq ft..

Regardless, I'm not so worried about NW:Home ratios as much as I would be concerned about the speed at which mortgages are paid off, how much total interest is being paid on a mortgage, and the the mortgage be paid off and there be sufficient total networth in general before retirement.

If someone wants to push themselves in their 30's/40's in order to be in a great spot in their 60's.....good fortune to them (I just hope they have a job with sufficient security/stability to make it happen).

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by SQRT » Tue Jul 26, 2016 7:45 am

Obviously depends on your age and whether you are still working or not. Most people have the vast majority of their net worth tied up in real estate when they are starting out. Little other savings, a family to raise, etc. Once you retire though, I think it is a valid question. How much of your net worth do you want tied up in a non earning asset such as real estate?

In my case about 20% of my net worth is tied up in personal use real estate (no mortgages). This leaves enough other earning assets to pay the cost of these homes (3-5% of mkt value) as well as other expenses in retirement. So in my case my real estate costs 60-100bps(3-5% X 20%) of my portfolio, or about 20-30% of my total 4% SWR, excluding real estate. Really depends on how "real estate dependant" your chosen lifestyle is in retirement. Many people like to downsize in retirement and would have a relatively low proportion of their net worth in real estate, maybe even under 10% if they live in a LCOL location. Others derive a lot of utility and enjoyment from their more expensive homes and might go as high as 30%? To be comparable you should, of course, capitalize you pension value and include this in your net worth.

Edit to add: just read CME's post and he raises some of these concepts.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by searhapsody » Tue Jul 26, 2016 9:31 am

I think that banks due factor networth into what they will loan you not just income. We recently sought a loan based on my husbands credit/income alone because mine is frozen. The loan they offered would clearly not be supported by his income, but the assets in his name would have to spent down to cover it.

In any case, we think about this issue a lot as we are currently house shopping. It doesn't make sense to us to base our house purchase price solely on income as that can and does change. (At least, we hope that it will because we would like to have children and the option of one parent staying home) We are almost 35 and would like to keep our home purchase price to about 1/2 of our current net worth.

We are also in a place where there are multiple cash offers abound on any affordable properties. Houses are going for 100K+ of what they sold for just 2-3 years ago. It makes you think we are in another bubble.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by qwertyjazz » Tue Jul 26, 2016 9:40 am

How about age minus 30 as a percentage?
Thoughts?
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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by bpr » Tue Jul 26, 2016 9:56 am

House value as % of net worth is not a good measure because most people don't want to constantly change/upgrade homes as the net worth increases.So we start with a higher (often negative) % and eventually rebalance as we increase our net worth.

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Re: Rules of Thumb: Max House Value as % of Net Worth?

Post by searhapsody » Tue Jul 26, 2016 9:58 am

qwertyjazz wrote:How about age minus 30 as a percentage?
Thoughts?


Wouldn't that mean that it would go up as a percentage of your net worth over time? I think in most instances its the opposite. If you kept the same house, over time it would be a smaller and smaller percentage of your overall net worth.

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