How Much House Can You Really Afford?

Jaime from Eventual Millionaire interviewed me. Check out the interview (you can even download the podcast) here!



I have two house-related rules of thumb:

1. never have more than 20% of your Net Worth tied up as equity in your house (i.e. borrow the rest)

2. Don’t let your mortgage payments be more than 25% of your Net Income (i.e. after tax)

Ryan questions the first of these:

Regarding the first tip, I”m assuming you are referring to not using more than 20% of your net worth as a down payment, correct? Because as time goes by, your equity should grow, and it wouldn’t make sense for most people to withdraw equity from their home value.

As I explained to Ryan, I think it makes great sense for “most people” to withdraw equity from their homes … but, only for the purposes of investing ;)

My overarching rule of thumb is to always have 75% of your net worth in investments.

The remaining 25% can typically be:

20% in your house

2.5% in your car

2.5% in your other possessions

[AJC: by “in” your house/car/possessions, I mean “in the current value of the equity that you hold”; so it’s a good idea to reevaluate yearly e.g. using tools like Zillow or an MLS search tool to check the current value of your house and Kelly’s Blue Book to check the current value of your car and a finger in the wind – or eBay / Craig’s List – for your possessions, etc.]

Since you can only buy a shoebox (literally) for 20% of Net Worth, if you’re a typical person just entering the workforce … don’t sweat it: just apply these rules AFTER you have bought your first house/car/TV/etc.

Then, if you abide by these simple rules, they will stop you from buying more too soon AND from over-investing your hard-come-by Net Worth in ‘stuff’ 🙂

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11 thoughts on “How Much House Can You Really Afford?

  1. I agree with not putting too much equity into your own home. I am also comfortable with drawing down on equity to fund investments which are expected to provide greater returns than the cost of the debt (and I did just that in 2009). A home mortgage is (typically) cheap and non-callable.

    Whether it is a good idea to buy your own home at all is another question entirely – and one that produces wide spread disagreement.

  2. @ Bill – Nope.

    @ traineeinvestor – Despite the rational ‘for/against’ debate, I encourage it as a first step … because some may never make the second 😉

  3. Great article, and I agree with you mostly. My wife and I were able to recently buy our condo with a VA loan, literally nothing down! Pretty much the only way that you can do it these days, but I still would like to have a little more equity than zero from the start. Regardless, we are happy with our purchase, and we can use the money/time it would have taken us to save for a down payment on other things. Keep up the great posts!

  4. This is hard advice to swallow. Maybe it’s because I’m not fully convinced that the American ideal of “you are what you owe” is correct. Most of the world lives under the motto “You are what you own” and postponing owning something outright goes against that.

  5. @ Luis – Don’t owe … just live in something v. small and you will still fit in within these two rules – which are maximums, not recommendations 😉

  6. I’ve seen plenty of arguments both for and against withdrawing equity from a home as it accrues, and maybe I’m missing something. Simply put, if the intent is to keep only a limited equity balance in a home, why own a home at all? Wouldn’t you be better served to rent a property in perpetuity so that you don’t have to deal with the expense, paperwork, and somewhat arbitrary timing of refinancing each time that you seek to withdraw equity?

    For my part, I have never viewed a home as an investment since all of the costs associated with ownership and upkeep outweigh the rate at which equity accrues. Second, the equity is not as liquid as it seems – I can’t refinance at a whim whenever and as often as I choose. That being said, my long-term goal is to eliminate a substantial portion of the cost of sheltering my family, which is to say that I will ultimately satisfy the mortgage and stop making payments to the bank. If I were to forego this in place of investing a greater share of my assets immediately, it seems that I’d be hunting for a low-cost alternative to home ownership, i.e. renting an apartment.

    I welcome any comments or corrections.


  7. @ TECHNOmancer – technically speaking [pun intended] you are correct: renting is usually better use of your assets than buying.

    BUT, for many people, owning their own first home – and, the enforced savings practice that this puts in place combined with the usual increase in home equity prices over a long enough (bust) or short enough (bubble) period – is the WAY that they accumulate their seed capital for business and/or investment purposes. It’s a human nature thing …

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