Use the 25% Rule to Decide How Much Home You Can Afford
When it comes to buying a home , one of the biggest challenges is determining exactly how much home you can afford. After all, you don’t want to end up “poor” by paying so much for your mortgage that you have little left over for other expenses and savings. This is where the “25% rule” can come in handy.
What is the 25% rule of thumb?
The “25% Rule” states that your total monthly housing expenses (including mortgage payments, property taxes, homeowners insurance and any homeowners association fees) should not exceed 25% of your net monthly income. In other words, if your monthly salary (after taxes) is $6,000, your total monthly housing expenses should not exceed $1,500.
Why does the 25% rule make sense?
This rule can be useful for several key reasons:
1. It helps ensure your housing costs are reasonable in relation to your overall income. Keeping housing at or below 25% of your income leaves room in your budget for other important expenses, such as food, transportation, healthcare and savings for the future.
2. It provides a simple and straightforward way to estimate the maximum purchase price of a home. Once you know your net monthly income, you can quickly calculate the maximum monthly payment you should aim for and then use that to determine the price of the home you can afford.
3. It complies with the general rules of mortgage lending. Most lenders use a debt-to-income ratio of around 36% as a benchmark for approving mortgage applications, so the 25% rule can help you stay within those parameters.
When can you break this rule?
Of course, the 25% rule is just a general guideline, and there may be times when it makes sense to deviate from it. Here are a few situations in which you can break this “rule”:
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If you have a reliable secondary source of income that is not included in the 25% calculation. This may allow you to comfortably spend a little more on housing.
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If you have minimal other debt, such as a car loan or student loan. The lower your overall debt load, the more housing costs you’ll be able to cover.
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If you live in an area with a particularly high cost of living. In these cases, following the 25% rule can make it very difficult to find an acceptable home, so you may have to spend a little more.
The key is to look at your entire financial picture—income, other debts, expenses, savings goals—and determine what housing expenses you can actually afford, even if in some cases that means going over the 25% limit. Like most personal finance advice, the 25% rule is a useful starting point, but ultimately your unique circumstances should determine your home-buying decisions .