By definition, a “rule of thumb” is meant to be a greatly simplified estimate for a complicated matter. So let’s see what happens when I search for “rule of thumb” + “how much house can I afford” on the internet:
Northwest Community Credit Union says 1.5 times your gross annual income:
If you and your spouse have a total income of $50,000 the general rule would be that you shouldn?t borrow more than $75,000 for your home.
CNN Money says 2.5 times:
The rule of thumb here is to aim for a home that costs about two-and-a-half times your gross annual salary.
Washington Mutual Bank suggests anywhere from 3 to 5 times:
As a broad generalization, most people can afford to purchase a house worth about three times their total (gross) annual income, assuming a 20% down payment and a moderate amount of other long-term debts, such as car or student loan payments. With no other debts, you can probably afford a house worth up to four or even five times your annual income.
Hmm… So far, with an annual income of $50,000, I’ve been told I can buy a house for anywhere from $75,000 to $250,000! Instead, I decided to run some numbers for myself using values I think are reasonable with current interest rates.
Figuring My Own Rule of Thumb
Let’s take $50,000 in gross annual income. Let’s spend 30% of that income on housing. This is within most lending ratios including the government’s Fannie Mae. 30% of $50,000/12 = $4167 is $1,250 per month. Housing costs include insurance and taxes, so let’s back out $200. That leaves us with $1,050.
For a 30-year fixed mortgage with a rate of 6.25%, a monthly payment of $1,050 roughly equates to a loan amount of $170,000. If you had a 20% downpayment, that would be a $212,500 total house value. So with these numbers, that’s about 3.4-4.25 times gross annual income. Taking a very rough estimate of this to get a rule o’ thumb, you get 4 times your gross annual income.
In reality, these days it’s really not that hard to find a lender to give you a loan for 5 times your annual income. Theoretically, this means that they think that you can “afford” such an amount. Now you and I just have to decide whether we want to take it!
By Jonathan Ping | Real Estate | 1/2/07, 6:08am