I was looking at these average house price numbers in various neighborhoods, and the house price/income ratio seems awfully high. For instance, there were some places where the average home price was $800,000 and median income was like $85k. If you go to Beverly Hills or similar places, the average house costs $2 million but the median income is below $200k. Understandably, the “average” home price might be skewed upwards, but still looks like people are spending an unreasonable amount on housing - at least from my perspective.
So, my questions are: 1) is it really normal to have such expensive homes with such modest income? and 2) What sort of “capital buffer” do you use when buying a house? For instance, I would probably not buy a $1 million house if I did not already have $1 million in cash or liquid investments (I am quite conservative with spending though).
Presumably, some people here own homes and have mortgages. What is your personal experience?
Yes*. Those high-end neighborhoods have a large amount of old people that don’t claim a lot of current income, but have considerable wealth.
That’s up to you, but most reasonable people buy homes that are 3-4 times their gross annual income.
*Obviously this thread will probably devolve into a discussion about the housing crisis, and how those people in million dollar homes never should have been there to begin with. That’s also true.
3-4 times your gross income is just a rule of thumb. I say “reasonable” because you’ll always have assholes that try to stretch for a home they can’t afford for whatever insecurity they’re battling. And, you’ll always have folks that buy homes well under their financial capacity because they simply don’t need the extra space or whatever.
Yeah, I guess defining “reasonable” with percentiles doesn’t really work. Whether 1% or 99% of other people are unreasonable shouldn’t affect your decision making.
Wouldn’t this depend more on your monthly mortgage payments as opposed to house price/annual income? I’ve heard of the figure 30% of your monthly income after taxes should be spent on your mortgage.
I agree rule of thumb is don’t go over 4X income BUT a major factor is also the type of rate you are getting. See, in Canada we can’t get long mortgages so there should be some cushion when considering buying a house.(funny thing though, this is where we experience nose bleeding housing prices). If you go for a fixed rate for your mortage you can be on the higher end of the income multiplier.
And it makes sense, according to other ‘rules of thumb’ (see CFA Sac)… if you go 4X gross income at 4% interest rate that is 16% of your gross income, so over 20% to your net pay - consider the part of the principal you need to pay back each year and you are getting close to the 30% of net pay ( so 4X or even above is ok given a low, fixed interest mortgage)
It gets you to the same place. For example, assume a $350,000 house with 20% down. Your $280k mortgage will cost you approximately $1,750 once you include taxes and insurance. Using your rule you’d need an after-tax annual income of 12*$5,834 = $70,000. From there you can ballpark gross to the neighborhood of $100,000. That puts you right in the middle of 3-4x gross annual range.
How would you define your income? Shouldn’t you build in some growth/shrinkage possibility, or the possibility that you might lose your job? It seems weird to say you are making $100k now and therefore, you will make $100k for 30 years.
I would go much more conservative than what most have listed (3-4x), principally because I don’t want to be house poor. With a household income of about $195k at the time I bought a house for $260k…plenty of cushion.
You shoud have a safety net in cash to buy you 6 - 9 months with no income. If you can’t get a new job in that timeframe you sell the house. Houses can be very liquid at the right price.
Well, you should obviously normalize for that - if you had a crazy good year and your income is volatile, need to adjust for that. You would take into account possibility of losing your job by having a year’s worth of mortgage payments in the bank, not by adjusting down the house price.
Also if you make way more than average people you should go conservative on the rules of thumb, after all they are mostly rules for average people not for outliers
You have to be very careful building in future pay raises. What if they don’t come? What if they come but are less than expected? I think the best rule of thumb is pretty simple: Can you make the payments TODAY without creating a lot stress on your monthly budget and without resorting to a “creative” loan structure? If the answer is no, then the house is too expensive for you.
That’s sort of my motivation behind the large “capital buffer” - that is, money that I already have in the bank. So, if I utterly fail in my career, I can still pay off the house and work as an ice cream man or something.
I think for that sort of planning, it would be better to use the current income to judge feasibility, and upgrade houses when you or your income outgrow it.
This is a pretty subjective question and I reckon the answer is different for everyone. Personally, I am about to buy a house and have made my decision based on the following:
My current salary + bonus - Current rental yields - A personal belief that central banks will continue to devalue our currency and thus hopefully my mortgage I went for a mortgage about 3x my annual income, which results in a monthly payment of 35% earnings (pre bonus). The monthly payments will be slightly less than rent would be.
I know it doesnt answer your question but these are some of the things that went through my head in deciding. Im still not quite sure if I am making a wise decision trading in a diversified and liquid portfolio to stake everything on the housing market though.
I’m going through the loan approval process right now. There are a couple of ways to look at it. The traditional method, as mentioned above several times, is the 3x gross income multiplier. During the housing bubble this ratio approached 4 and easily exceeded it in some areas. Most banks back into the equation and look at it from an expense/income ratio. Generally, a house is “affordable” if the total mortgage payments (mortgage, pmi, property tax escrow, hsa, insurance, etc…) do not exceed 30% of your gross income. This is the general calculation that your mortage rate is tied to in conjunction with your credit information.