How Much Should You Spend on a Home
Photo by Caleb George on Unsplash
Homes are great ways to accumulate wealth. They appreciate over time, provide you tax benefits, and act as a form of wealth that you can transfer to your children so give them a head start in life. However, allocating all of your money into your home is not the best option; just as a home can help you build generational wealth, buying a home that’s too expensive for your income can hurt your prospects of long-term wealth generation. In this post, we’ll take a look at how much of your income you should be spending on a home to maximize wealth accumulation while paying for your mortgage and other expenses.
Here’s how the article is broken down
- Method for Calculating Long Term Savings
- Results: Long Term Savings vs. Home Price
- Conclusions and Takeaways
Method for Calculating Long Term Savings
In order to figure out the effects of home price on our potential wealth generation we need to look at the following:
1. Household Income (Pre Tax): Your household income will determine how much you can spend on a home while saving to invest each month. The amount you can save or invest each month is determined by subtracting your monthly non-housing expenses (such as food, child care, utilities, etc.), taxes, and mortgage expenses from your monthly paycheck. For our calculations, we’re going to use a household income of $200,000 and an effective tax rate of 21% (this is considering California Tax rates and both you and your partner maxing out your 401ks).
2. Other Expenses – The more you spend on food, clothing, child care, travel, and other miscellaneous expenses, the less you can afford to spend on housing costs. In our calculations. We’ll use the following data for expenses as a percentage of monthly take-home pay. This breakdown represents the average Californian family budget.
| Food | 12% |
| Child Care | 20% |
| Transportation | 10% |
| Misc | 12% |
3. Other Assumptions – For our calculations we’ll use the following assumptions:
- Interest Rate – 3% 30-year Fixed Loan
- HOA (Homeowners Association Fees) – These are baked into the mortgage cost
- Long Term Investment Returns – 8% Long term investment returns
- Both our incomes and our expenses will grow with inflation such that our other expenses remain the same percentage of our monthly budget.
- Property Tax + Home Insurance is 1% of the home’s value.
- We have a 20% down payment on the home
Results: Long Term Savings vs. Home Price
Whatever savings we have after expenses (housing and other) and taxes will go into mutual funds or ETFs, here’s how much wealth we can accumulate in 30 years (the length of the home loan) based on a $200,000 household income, typical family expenses, and the assumptions we made above. I’ve used several different home prices.
| Home Price | PreTax Household Income | Home Price to Income Ratio | 30 Year Savings Total |
| $550,000 | $200,000 | 2.75:1 | $2,485,650.0 |
| $750,000 | $200,000 | 3.75:1 | $1,690,013 |
| $850,000 | $200,000 | 4.25:1 | $1,168,115 |
| $900,000 | $200,000 | 4.5:1 | $907,166 |
| $950,000 | $200,000 | 4.75:1 | $646,216 |
| $1,000,000 | $200,000 | 5:1 | $385,267 |
The ratio of the price of the home to our household pre-tax income is the simplest way to get the answer to the question “how much should I spend on a home?” The chart above shows that even for a 200k increase in the price of the home ($550,000 to $750,000), we take about an $800,000 hit in our potential long-term savings. However, depending on what your family needs, maybe you want more space, a nicer school district, or a shorter commute, it may be better to spend an additional 200k to buy a better home. As a personal recommendation, I think purchasing a home 3 – 3.75 times your pre-tax household income is a good target that will allow you to accumulate wealth and savings outside of your home equity. Any home that has a price tag higher than 4 times your combined household pre-tax income won’t leave you much to save, and you might end up too dependent on your home equity as a source of wealth.
| Home Price | Monthly Mortgage | Monthly Income | Percentage of Monthly Income | 30 Year Savings Total |
| $550,000 | $2,397 | $10,000 | 23.97% | $2,485,650.0 |
| $750,000 | $3,238 | $10,000 | 32.38% | $1,690,013 |
| $850,000 | $3,659 | $10,000 | 36.59% | $1,168,115 |
| $900,000 | $3,869 | $10,000 | 38.69% | $907,166 |
| $950,000 | $4,079 | $10,000 | 40.79% | $646,216 |
| $1,000,000 | $4,289 | $10,000 | 42.89% | $385,267 |
Another way to figure out how expensive a home you can afford is to calculate the mortgage cost as a percentage of your monthly post-tax income. Based on the rule of thumb of 3-3.75 times your combined household income, you should target your monthly housing expense, which includes the principal, interest, property tax, and HOA fees, to be no more than 36% of your family’s monthly take-home pay. This allows you to comfortably have room for other expenses (groceries, dining, family vacations, emergency events, or your children’s education savings plan) while having money left over at the end of the month to put into a savings or investment account.
Conclusions and Takeaways
The price of your home will depend on your combined household income and your other expenses. To account for our expenses changing as time progresses (i.e. having kids), you should plan that 45-55% of your monthly paycheck will go towards non-housing expenses. Given that, we should aim for spending no more than 36% of our monthly paycheck (post-tax) on housing costs (mortgage, property tax, HOA fees). In terms of your household income, aim for a house that’s 3 to 3.75 times your family’s combined pre-tax income.