How Much House?

by Gary Foreman

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Hi Gary,
Considering the cost of homes these days, what is a reasonable percentage of a person's salary that should be used for a mortgage payment? And does this percentage include everything needed to run that home (utilities, water, phone, etc.)?

Good question! And with the current median selling price of a house being over $185,000 it's an important question, too.

In recent years, people say that you can't buy too much house. Common thinking is to buy as much house as you can squeeze into today's budget. Expected increases in housing prices and your salary will make the deal fit better next year than it does today.

Yes, both housing prices and wages should go up over the long term. For instance, the Consumer Price Index shows that housing prices have increased about 43% over the last 10 years.

Unfortunately, the mortgage is due over the short term. Neighborhood housing prices can drop for a year or two. And not everyone gets a raise each year. In fact, some people lose their jobs. So you can get into a lot of trouble before the long-term increases bail you out.

OK, so if bigger isn't always better, how expensive a house can Margie afford? Let's start with what people actually do spend. The U.S. Statistical Abstract shows that of all the money we spend, about 33% goes to housing. That would include shelter, maintenance, heating and cooling.

So should she plan on spending 33%? Probably not. Maggie will need to consider her family situation. Looking for a new house because you're about to have a baby? Groceries, medical, college savings, daycare could all require a higher percentage of your money than before.

And past financial decisions will also affect what Maggie can reasonably afford. Alimony and child support are common issues. In fact, Tierney Foster, a long-time Realtor with Remax in Bradenton, FL won't give a client advice on affordability. She refers them to the lender who will consider their debt ratio and other factors that will affect the calculation.

Interest on any debt that you owe will lower the amount that you can safely spend on housing. In real rough terms (depending on your interest rates), for every $8,000 you have in credit card debt, you have $100 less to spend on housing each month. And that works out to a house that costs $16,000 less.

Remember that you can only spend 100% of your after-tax income without getting into trouble. And you really should be saving a portion of that for things like college education and retirement. If you spend 40% on a house, and another 30% on food and transportation, you won't have enough money to cover everything else.

Another problem that Maggie will run into is that housing expenses aren't easily adjusted. If you buy a house that's too expensive, there's not much that you can do to reduce the mortgage payment by 10%. And, if housing consumes too much of your money, it's hard to make it up in other areas. You'll never make up $200 each month by reducing your spending on entertainment! An over-expensive house often puts a family budget in serious jeopardy.

Which brings us back to the question of how much house can Margie afford. There are some broad guidelines that she can use. In most cases, if she's planning on spending less than 30 percent of her after-tax income on housing, she should be okay. On the high side, if she's approaching 40 percent, she'll need to be very careful.

She might want to check out calculators on the internet. has a good one. They provide financial information and aren't affiliated with anyone in the industry so their advice is neutral. She might also want to check with a mortgage banker or broker and ask their advice on what would be affordable.

There is one trick that Margie can use that might prove helpful. She can pretend that she already owns the house that she wants to buy. Estimate how much the new home would cost. Then set aside the difference between that amount and what they're currently spending on housing for a few months. In other words, pretend that she's already paying for the house. She'll pretty quickly find out whether they can comfortably handle the increase. If she finds that she's scrambling while playing pretend, she can expect to be in real trouble if she buys the house.

We hope that Margie finds a home that she can love and afford at the same time.

Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, and Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.

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