Buying a home 3x income ?

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tomwood
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Buying a home 3x income ?

Post by tomwood »

I’ve read people who discuss 3x income as a rule of thumb for purchasing a home. Does that mean the home’s purchase price should be 3x or less income, or the mortgage should be less than 3x?
anoop
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Re: Buying a home 3x income ?

Post by anoop »

tomwood wrote: Tue Mar 10, 2020 6:28 pm I’ve read people who discuss 3x income as a rule of thumb for purchasing a home. Does that mean the home’s purchase price should be 3x or less income, or the mortgage should be less than 3x?
House price. 2.5x - 3.5x is the rule of the thumb.

In other words, if one is sitting on a pile of cash but has low income, one should probably not buy an expensive house for cash because they may have trouble maintaining it.
averagedude
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Re: Buying a home 3x income ?

Post by averagedude »

I have always heard (since the 80's) that the rule of thumb is 2.5 times the purchase price to your salary. I wonder if low interest rates has changed this rule of thumb to 3 times, or financial institutions and realtors have done this.
anoop
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Re: Buying a home 3x income ?

Post by anoop »

BTW, this is what price to income looks like around the world.
https://www.numbeo.com/property-investm ... urrent.jsp

These are my thoughts on house affordability.
https://anoopsplace.blogspot.com/2010/0 ... uying.html
Triple digit golfer
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Re: Buying a home 3x income ?

Post by Triple digit golfer »

I believe that rules of thumb are mostly somewhat useable, but not in this situation, and the reason is fixed expenses.

A $50k single income household with a couple kids probably can't afford a house at all in many parts of the country.

A $250k household can probably afford a $1 million house. A 3.5% 30 year mortgage for $800k would cost around maybe $60 or $70k a year after taxes and insurance. After income and payroll taxes that family still has probably around $100k for other non mortgage expenses.

The way to do it is lay out your take home pay, deduct for expenses and investments and see what's left. Pick a number your comfortable with.
as9
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Re: Buying a home 3x income ?

Post by as9 »

We bought a house at 4.2x income with only 10% down in a new state while my wife was 7 months pregnant with our second kid.

Not exactly the Bogleheads way, but sometimes a risk is worth taking. It's now 2.85x income (and likely to drop again soon) and the house was just appraised for almost 12% more than we paid.
lessismore22
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Re: Buying a home 3x income ?

Post by lessismore22 »

House price...but that depends on the trajectory of your HH income. Are you really good at your job? It's not out of line to stretch a bit if you're confident that total income will increase shortly. We bought our last house at 4.XXx our income. Worked out fine.

Note: I do not fall into the camp of posters who believe you need to be prepared to lose your job, at the same time your spouse loses their job, at the same time your home plummets in value, at the same time your car breaks down etc. during the next recession.
mega317
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Re: Buying a home 3x income ?

Post by mega317 »

Thumb size is regional. I'm in a 3x income house in Socal. in the Detroit suburb I grew up I'd lose my family in a house half the price. In my job, income would be pretty similar anywhere, maybe higher outside socal. So I agree that it's more about your other expenses and own situation.
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MoneyMarathon
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Re: Buying a home 3x income ?

Post by MoneyMarathon »

anoop wrote: Tue Mar 10, 2020 6:45 pm In other words, if one is sitting on a pile of cash but has low income, one should probably not buy an expensive house for cash because they may have trouble maintaining it.
This isn't necessarily true. They should have a cash reserve for maintenance. For example, someone who "won the game" and has low income / high net worth should buy a house, if they haven't, in order to protect against inflation.
technovelist
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Re: Buying a home 3x income ?

Post by technovelist »

That would scare me to death.
I worried when I bought my current home for 1x my salary at the time.
I was out of work for almost a year in 2001; if I had had a higher mortgage payment it would have been very painful.
In theory, theory and practice are identical. In practice, they often differ.
anoop
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Re: Buying a home 3x income ?

Post by anoop »

MoneyMarathon wrote: Tue Mar 10, 2020 8:34 pm
anoop wrote: Tue Mar 10, 2020 6:45 pm In other words, if one is sitting on a pile of cash but has low income, one should probably not buy an expensive house for cash because they may have trouble maintaining it.
This isn't necessarily true. They should have a cash reserve for maintenance. For example, someone who "won the game" and has low income / high net worth should buy a house, if they haven't, in order to protect against inflation.
True. I wrote about affordability and assets in a different post. My attempt to try and quantify it.
https://anoopsplace.blogspot.com/2017/0 ... ssets.html
finite_difference
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Re: Buying a home 3x income ?

Post by finite_difference »

Those rule of thumbs don’t take into account interest rates or property taxes.

Therefore I like my modified rule of thumb:

(Monthly PITI) * 3 < (Monthly Net Income After Tax).

So if your net income is $4k/month you’d want PITI to be about $1333 or less.

Obviously can be adjusted but this is a better way of thinking about things in my opinion.
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Ron Ronnerson
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Re: Buying a home 3x income ?

Post by Ron Ronnerson »

It's obvious but I think it's important to mention in any case: Just keep in mind that rules of thumb ignore individual circumstances.

A quick example:

Person 1: Has an income of $100k. Able to put down 5% on the house and would then have an empty bank account and owes lots of money on credit cards, student loans, and car loans. Spends tons on eating out, travel, and child care for four kids. Has poor credit and would have to pay a high interest rate to get a loan.

Person 2: Has an income of $100k. Has a lot of money saved and no debt. Has no children and lives very frugally. Has excellent credit and is able to qualify for a low rate.

The rules of thumb say to just look at the income. To me, the rules-of-thumb leave out details that are just too important to ignore.

We bought a house that was over 4 times our income and it was easily affordable because our other expense categories were lower than many people’s. I would suggest looking more holistically rather than going off income alone.
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mmmodem
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Re: Buying a home 3x income ?

Post by mmmodem »

I grew up with no more than 4x income for the mortgage. You can buy a $1M home if you please as long as your mortgage is no more than 4x your income.

It's a rule of thumb so all those saying it isn't accurate enough needs to understand that is the definition of rule of thumb. You start there and then add the details. As Ron Ronnerson points out, 4x works for him but may not to someone with car and student loans. I was told nothing exists for under 4x for us in the Bay Area. Our first home mortgage was 1.5x in a nice neighborhood with good schools.
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geerhardusvos
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Re: Buying a home 3x income ?

Post by geerhardusvos »

tomwood wrote: Tue Mar 10, 2020 6:28 pm I’ve read people who discuss 3x income as a rule of thumb for purchasing a home. Does that mean the home’s purchase price should be 3x or less income, or the mortgage should be less than 3x?
My advice: Buy as little house as you can reasonably live in, and make sure it’s a good/desirable location. There are so many costs that most people don’t account for when buying more house.
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cherijoh
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Re: Buying a home 3x income ?

Post by cherijoh »

geerhardusvos wrote: Wed Mar 11, 2020 9:54 am
tomwood wrote: Tue Mar 10, 2020 6:28 pm I’ve read people who discuss 3x income as a rule of thumb for purchasing a home. Does that mean the home’s purchase price should be 3x or less income, or the mortgage should be less than 3x?
My advice: Buy as little house as you can reasonably live in, and make sure it’s a good/desirable location. There are so many costs that most people don’t account for when buying more house.
+1
Ron Ronnerson wrote: Wed Mar 11, 2020 8:49 am It's obvious but I think it's important to mention in any case: Just keep in mind that rules of thumb ignore individual circumstances.
...

The rules of thumb say to just look at the income. To me, the rules-of-thumb leave out details that are just too important to ignore.
Also keep in mind the impact of interest rates. Whatever multiplier you use only applies to a narrow range of interest rates. I purchased a condo in 1982 when the prevailing interest rate was > 14%. It was a stretch at 1.4x homeprice/salary, but I was still in the period where my nominal salary was increasing quite a bit (in part due to inflation).

In 1992, I purchased my current home in 1992 with an initial mortgage interest rate of 7.75%. My home price/salary ratio was closer to 2x ths time, but I had a full 20% down payment and was able to avoid PMI. This house really wasn't a stretch financially - a very good thing since my condo didn't sell and I needed to qualify based on 2 mortgages.

There is also an interest rate impact on home prices. When interest rates are high, that puts downward pressure on home prices or at least the velocity of increasing housing prices - people won't be able to get outrageous prices for their home because the percentage of people who could afford it is too low. Housing prices are a matter of supply and demand. Buyers may be able to reduce their costs by refinancing when mortgage rates fall so they may be willing to stretch a bit initially.

Conversely, when interest rates are already at historic lows, the likelihood of lowering costs via a refi are reduced as is dramatic increases in home value.
Last edited by cherijoh on Wed Mar 11, 2020 11:12 am, edited 1 time in total.
Thorsbane
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Re: Buying a home 3x income ?

Post by Thorsbane »

Keep in mind that rule of thumb is just that. It is not a practical principle for every individual. For example, if you have 3 kids in daycare eating up your monthly budget, you should factor that into any decision. Best approach is what are you able to afford given your budget and back up into how a monthly payment translates to a mortgage. Also consider home owner expenses that will catch you off guard or recurring expenses that are hard to factor in.
barnaclebob
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Re: Buying a home 3x income ?

Post by barnaclebob »

It all depends our house was a little over 4x income but the loan was 2x income on a 20 year loan. The loan payment is about 40% of our takehome (takehome was after 30% 401k contributions). Its been perfectly comfortable.
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Ramjet
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Re: Buying a home 3x income ?

Post by Ramjet »

Matters where you live. 3X rule in NE Ohio is a lot of house
adamthesmythe
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Re: Buying a home 3x income ?

Post by adamthesmythe »

Ramjet wrote: Wed Mar 11, 2020 11:02 am Matters where you live. 3X rule in NE Ohio is a lot of house
As Ramjet and others have suggested- it depends on individual circumstances.

A freshly minted engineer in Silicon Valley- with no kids and a reasonable expectation of continuing salary increases- might want and need to go well above the 3X number. Someone with a family and steady job in the midwest, with only inflation increases in wages, could (and should) stay below that.

What is needed in both cases is a rather careful look at predicted budgets.
ponyboy
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Re: Buying a home 3x income ?

Post by ponyboy »

I would say no more than 3x income. No reason you have to spend 3x what your income is. When we bought our house, we spent 1.3x our salary on a home. We could have easily bought a mcmansion in the east bumble region we live...but chose not to. 15 year mortgage...yes please
alfaspider
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Re: Buying a home 3x income ?

Post by alfaspider »

I'm not sure what the usefulness of a "rule of thumb" in this scenario. Perhaps if you are just thumbing through the listings and daydreaming it's useful to keep you somewhat grounded. But when it comes time to purchase, you should be working in your total budget and risk profile before pulling the trigger.

You should have a pretty good idea of what your positive cash flow will be post mortgage and expenses, which should give you a good idea of whether buying will make you "house poor." You also have to included tax, upkeep, cost to furnish, and other ancillary items.
dsmil
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Re: Buying a home 3x income ?

Post by dsmil »

I wouldn't put too much into that ratio. I would see how the monthly payment and estimated maintenance expenses fit into your budget. Low interest rates, high income, and a large down payment can all help stretch that ratio out. If you really want to use a ratio, I prefer the ratio that your monthly payment should be less than 25% of your gross monthly income.
sailfish2
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Re: Buying a home 3x income ?

Post by sailfish2 »

I think it's a max, not a recommended allocation.
Some of us prefer to "under buy", because we can do so in our area. Additionally, some folks prioritize having a second home, a RV, boat or expensive hobby that takes up discretionary income (raises hand).
somekevinguy
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Re: Buying a home 3x income ?

Post by somekevinguy »

I think this rule of thumb is very geographically and income dependent and thus not very useful for some of us.

In some areas, like the VHCOL Bay Area where I live, even with a 500K income (just as an example), you're going to be hard pressed to find a house for 3x income in many areas.

Similarly, if you have a 500K income, that doesn't mean all your other expenses go up accordingly vs someone with a 100K income. So, if you basically live the same lifestyle as someone making 100-150K in say, Chicago, then your non-housing costs are essentially the same (with some modification for COL). That means the extra 350-400K (conservatively let's call it 200K post tax) in income could go to fund housing if you really wanted and were very content living a 100-150K lifestyle (which is still obviously great but not nearly as luxurious as someone living a 500K lifestyle in Chicago or Cleveland).
SanAntionetta
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Re: Buying a home 3x income ?

Post by SanAntionetta »

We also did about 1.3x salary but it’s nice to know we can get by in one salary. We would have spent more if property taxes were not so high (they are approx 33% of our mortgage payment)

We’ve thought about getting a bigger house now as a family of 4, but I always promised myself not to fall into the lifestyle creep cycle. I live in CT and the other issue is that more expensive houses don’t hold their value well.

So to me it all depends on
- comfort level
- property taxes
- real estate market
Count of Notre Dame
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Re: Buying a home 3x income ?

Post by Count of Notre Dame »

I think this was alluded to earlier, but at higher incomes even purchasing an expensive home (we purchased 2.6x), you still have lots of disposable income because not all of your other spending scales (I didn't suddenly start drinking DRC wine every night!). I have a significant amount of disposable income. Knowing your spending and your habits will inform how comfortable you are with your home purchase.
MathIsMyWayr
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Re: Buying a home 3x income ?

Post by MathIsMyWayr »

What counts is not the house price to income ratio. You have to focus on the free cash flow prospect (income - taxes - expenses - savings target) vs. housing expenses. I bought the current house almost at 4x. Now 15 years later, both income and the house value each almost doubled. I feel I always under-bought.
campy2010
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Re: Buying a home 3x income ?

Post by campy2010 »

Mortgage (or PITI) = 3x income makes more sense as a rule of thumb. You're paying the mortgage and taxes not the home price. Interest rates and property taxes matter.
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