Guest Post: How Much House?

Greetings, Moms and Families of Prince William County.

As a financial advisor, I’m often asked by new and experienced homeowners alike:  “how much house can I afford?”

Prince William County is a particularly interesting case. Median home prices hover around $380,000, while family incomes hover about $100,000.  

But even though housing in Prince William County is relatively affordable, you can’t afford to be complacent when choosing a house. The last thing you want is to have yourself, or your kid, get stuck with an unaffordable monthly payment.

So in this article, we’ll cover the basics of real estate investing.  

Of course, before you make the final decision, I recommend you reach out to a qualified investment pro for individualized advice. That’s because a 2-3 hour consultation will be completely worthwhile once you consider the $ 100,000’s you’re investing in your primary residence.

But to get you started, here are my general guidelines to help you answer “how much house can I afford?”

Are you ready to buy a house?

Whether you’re looking to buy your first house, or upgrade to a larger one, consider these four things.

Consideration 1: Are you settled for the next 2-3 years? Once you buy a house, relocating for work or higher education can become an expensive hassle. Transaction fees in Northern Virginia average 4.9% of the home price, with average commissions reaching $20,400 in 2018.

Consideration 2: Are you consistently saving 15% of your income? While many people use their primary residence as a source of savings, don’t use it as your ONLY source. That’s because it’s hard to sell your house if you’re in immediate need of cash. And taking out a HELOC loan risks loss of homeownership.

Consideration 3: Have you paid off high-interest debt (above 8% APR)? Before you consider buying a new house, you should pay off any high-interest debt first. That’s because paying off these debts will let you set aside even more money in the future towards savings and mortgages.

Consideration 4: Do you and your household have a stable income? The #1 source of real estate problems is when people can’t meet their mortgage payments. If your family doesn’t have a steady income, you should consider either buying a much smaller property or renting until your income stabilizes.

How much house can I afford?

I’ll give you the same advice I give everyone else. When it comes to a significant financial decision like buying a house, it pays to be conservative. As we saw in the 2007-2008 financial crisis, mortgage lenders often don’t have the best interests of clients in mind.

So even if you qualify for a much larger mortgage, I suggest you check in with an advisor first before pulling the trigger. The only thing worse than not qualifying for a mortgage is if you took out one that’s far too large.

But to get you started, here are my three general rules:

Rule 1: Spend no more than 35% of your after-tax income on housing. Even better? Try targeting 30%. Housing costs include mortgage, interest, taxes, utilities, maintenance, and HOA fees. I use these numbers because it reflects the 50-15-5 Rule: where you spend 50% of your income on essential items (of which 35% on housing), 15% on savings, 5% on an emergency fund. You can spend the remaining on anything else.

Rule 2: Stay disciplined. It’s often tempting to go with a bigger house because you qualify for a jumbo mortgage. After all, your home IS the place to hang your hat. But that gets many people in trouble. Even though you might have a magnificent house, you’d be house poor. That’s when you’re spending so much on your home that little remains for spending.

Rule 3: Take out a mortgage no more than 4-5 times your annual after-tax income. For example, if you make $70,000 after-tax, that means taking out a mortgage no more than $280,000-$350,000. Most lenders will allow even bigger mortgages of 6.5-7.0 times your after-tax income. And some lenders will issue loans up to 8.0 times after-tax income! But I tell everyone this: you can always buy a bigger house later if you realize you’re underspending.

I rarely hear people complain, “I spent too little on housing!” Instead, it’s almost always the opposite.

How to calculate how much house to afford?

If you want to calculate how much home you can afford, here is a step-by-step approach.

Step 1: Find your household’s total discretionary income and multiply by 35%. First, find the dollar amount you have after deducting taxes, Social Security, Medicare, health insurance, and 401(k) contributions. After that, multiply by 35% to get your annual housing budget.

Step 2: Find your credit score. Lenders are much more willing to extend better terms to people with proper credit. And the lower your rate, the more house you can afford since less money will go towards interest payments. For a $2,500 monthly payment, a 4.5% interest rate means you can get a $493,403 loan. Those with better credit might qualify for a 3.0% interest rate, allowing a $592,973 loan on the SAME monthly payment.

Step 3: Talk to at least three mortgage brokers. In general, I suggest comparing rates to get the best deals. That’s because different mortgage brokers will have different criteria. You might find one that cares more about your debt-to-income ratios, while another looks at your credit score.

Step 4: See what deals are available. First-time homeowners should consider FHA loans. These are loans that require only 0-3.5% down payments for qualified investors. Credit scores can be as low as 500+, so most people will be eligible for SOME help.

Step 5: Calculate how much house you can afford. Now that you have the information you need, it’s time to run the calculations.

a.                Calculate your after-tax income. You can use an online tax calculator or look at your W-2 forms from your employer. For example, $100,000 in Virginia turns into $70,000 after tax

b.                Take your after-tax income and multiply by 35%. $70,000 * 35% = $24,500 per year, or $2,042 per month

c.                Deduct monthly HOA fees, utilities, taxes, and other non-mortgage expenses. If you’re not sure exactly how much, I suggest 30% as a good starting point (10% for taxes, 10% for utilities, 10% for everything else). $2,042 * 70% = $1,429

d.                Use a mortgage calculator to see your maximum loan. You can use a financial calculator, but I suggest people hop on a search engine and look it up. Inputting $1,429 at 3.25% for a 30-year mortgage comes to a maximum loan of $328,350, or 4.7 times annual after-tax income

As you can see, this number fits squarely within the 4-5 times after-tax income rule of thumb. The benefit of doing the calculations yourself is to get a better sense of exactly how much you can afford.

What if the house is outside my budget?

Once you’ve answered “how much house can I afford” you might find a property that’s slightly outside of that range. And in my experience, it’s always SLIGHTLY.

So if you have a $500,000 budget, but the perfect $525,000 home comes along, should you take it?

As with most things involving personal finance, the answer is “it depends.” As always, I would suggest you consult an investment professional to make sure. There’s nothing worse than realizing you’re in over your head. To get you started though, here are my four pieces of actionable advice.

1. Wait until your income or savings covers it. Even among experienced homebuyers, there’s a temptation to rush buying a house. That’s because there’s often a fear that someone else will buy the house. But let me tell you now: other houses will come on the market. So instead, you should wait until you’ve built enough savings to cover the down payment. If a property is $25,000 outside your budget, save up another $25,000 and try again.

2. Reduce other expenses. If you follow a disciplined budget, you might find yourself with extra cash to spare. So instead of spending just 35% of your income on housing, you could spend 40% if you find discretionary expenses to cut.

3. Consider subletting or finding roommates. To start, it can pay to find roommates to help with mortgage expenses.

4. DO NOT cut into long-term savings. Let me be clear: no matter what you do, don’t liquidate your 401(k) to buy a house. That’s because not only will you have to pay income taxes on the withdrawn amount, but you’ll have an additional 10% penalty to pay for early withdrawal.

Nor should you divert the 15% of your saved income into paying mortgage payments. Your retirement is far more important than finding a house with that third bedroom or swimming pool. You’ll be able to afford those one day, but don’t do it until you’re financially ready.

Where to find more resources

If you’re looking for even more investment tips, you’ve come to the right place.

That’s because I’ve helped invest client money for over a decade in the same old-fashioned way. And that’s to seek out great investments that can you can buy at a discount to their fair value. Sounds too simple to be true? Give me a call today, and I’ll show you that it’s still possible after all these years.


Tom Yeung