One of the most common financial rules of thumb is the “30 percent rule” for buying a home. Like many financial rules of thumb, though, the 30 percent rule is best taken with a grain of salt. In fact, rather than getting hung up on this rule of thumb, it makes more sense to examine your financial situation, and your individual needs, and get a mortgage that fits your circumstances.
What is the 30 Percent Rule?
The 30 percent rule boils down thus: You can “afford” a mortgage payment that amounts to 30 percent of your monthly income. Most people agree that the 30 percent rule applies to your take-home pay, and not your gross pay, although there are those who figure it based on the highest number they can.
You can see where the 30 percent rule might fail your financial situation, though. If you bring home $3,000 a month, that means that you can afford a mortgage payment of $900 a month.
What the 30 Percent Rule Doesn’t Consider
Unfortunately, the 30 percent rule doesn’t take into account other factors that might impact the true affordability of your mortgage payment. Here are some things that aren’t included in the 30 percent rule:
- Other debt payments, such as credit cards, student loans, and car loans, that impact your monthly cash flow.
- Maintenance, repairs, and utility costs that come with home ownership.
- Other bills and obligations, such as insurance, groceries, and expenses that impact your budget.
If your budget has other considerations, the 30 percent rule could lull you with the idea that you can “afford” your home — even though you actually can’t. Depending on your situation, one financial setback could result in an inability to afford your home, and lead to foreclosure or other problems.
Alternatives to the 30 Percent Rule
Instead of using the 30 percent rule to decide how much home you can afford, you can use it as a starting point. Some experts recommend that you lump all of your housing costs into the 30 percent rule. Make sure you figure in estimated property taxes, home insurance, utilities, maintenance, and repairs. In our example above, that might mean your mortgage payment can only be $650 a month, once you consider the other costs that bring monthly home ownership costs up to $900.
Another option is to figure the “affordability” of your home based on the 28/36 qualifying ratio. If you have other debt, this makes a little more sense. In order to get the best rate for your mortgage, you need to keep your mortgage payment (principal + interest and other included costs) to 28 percent of your monthly income, and your total debt payment — including the new mortgage — to 36 percent of your monthly income. This helps you see, realistically, whether or not you can afford to take on mortgage debt in addition to the other debt you have.
Finally, you should be honest about your budget. What are you truly comfortable with? What would you do if you had a setback? When you look at things in this light, it might make sense to keep your mortgage payment to 25 percent or even 20 percent of your monthly income.