Looking at the home mortgage products available today against your income, it’s important to consider what you can actually afford based on estimated household incomes. Now it’s easy to get caught up in what you qualify for from a bank or financial institution, not realizing that although you benefit from your ability to pay the mortgage, they also benefit from you signing onto a larger mortgage producing larger amounts of interest in their pockets.
With household incomes relatively stagnant, let’s look at three scenarios over the next few days based on a hypothetical income and what you should then be attributing to a home as a means of a percentage of that income.
Let’s say that you are a single 24-year-old college graduate in your first year of your career, making an income of $48,400 per year gross in a tax bracket of 22%, contributing a minimum of 3% toward a match for retirement with one exemption.
This gross income would put you at about $4,033 per month. Using a Smart Asset paycheck calculator depending, of course, on your specific situation, you can anticipate this being reduced by $552 for taxes, FICA and State Insurance Taxes of $309, pre-tax deductions of $121, and post-tax deductions of $500 for benefit contributions and retirement savings, leaving you with a net take-home salary of $2,552 per month.
This means that you will have $2,552 to put toward housing, additional retirement savings, giving, debt, and lifestyle otherwise. This is about 63% of your gross income that you actually get to keep.
Now the elephant in the room is the mortgage or rent costs, as they are typically the largest single expense within a household.
The advice for what this figure should be is all over the place. Business Insider referred to Americans spending nearly 37% on housing, but a percentage of 38% is typically the maximum amount a bank or lending institution will approve a loan for. There has been a rule of thumb of 30% of gross for many years. Some recommend 25% of gross and Dave Ramsey’s 25% post-tax approach.
Let’s look at 30% of your take-home pay sitting at $765.60 per month in this scenario. Woah, now that’s a sucker punch! At least in my area, I don’t know what neighborhood that would put you in for a purchase, much less a rental.
So if you are feeling the pinch of trying to be intentional with your finances but seeing scenarios where you almost always need to spend beyond the recommended parameters, then what do you do?
In this scenario with the recent grad, I recommend finding a solution to either house-hack where the initial percentage of income is higher but then reduced based on renting out rooms is ideal. If purchasing is just out of the question, then finding a place where you can split up the rent would be the next best option. If roommates are not an option, then I recommend working to increase your income, whether through promotion or a side hustle, to shorten the distance and purchase a property on your own.
Let’s jump ahead and look at what a purchase scenario with a house hack would look like. Assuming you have a standard three-bedroom, two-bath home that you purchased for $215k. For easy math, let’s assume you went with a conventional mortgage with 20% down. After principal, interest, estimated taxes, and homeowners insurance, the mortgage would be $963 per month.
Although this would stretch you some from the $765 amount, we looked at, if you rented out each additional room at, say, $500 each and split utilities, you would essentially live for free.
CTA:
My call to action is to look at this scenario and how it may relate to yours. Looking at your housing costs in relation to your take-home pay and what may need to change to ensure you don’t buy more house than you can afford.
Average college graduate first-year income of $48,400
(https://smartasset.com/taxes/paycheck-calculator#ZYS78jjKQh)
Average college graduate first-year income of $48,400 (https://www.cnbc.com/2019/02/15/college-grads-expect-to-earn-60000-in-their-first-job—-few-do.html)
- Assumptions
- 22% tax bracket, single and 24 years old (https://www.bankrate.com/finance/taxes/tax-brackets.aspx)
- Net $34,364
- Paid bi-weekly
- $1,321.69 per paycheck after taxes, FICA, Medicare, Benefit contributions, and the like
- Ok, so you have about $2.7-2.8k per month on average to spend
- The advice on housing costs is all over the map. Business Insider referred to Americans spending nearly 37% on housing, but banks will typically loan up to 38% on a mortgage. There has been a rule of thumb of 30% for many years. Some recommend 25% on housing before tax and Dave Ramsey’s 25% post-tax approach. (https://www.businessinsider.com/personal-finance/how-to-save-more-money-2017-8)
- For 2020, where you will spend the most; (https://smartasset.com/mortgage/housing-spending-2020)
- 10% donation/giving
- 15% retirement
- Debt
- Subscriptions
- Travel/Pleasure
- Insurance: auto, home/renters, disability, life insurance*
- Assumptions
- Exemptions @ 1
- 3% to retirement before match
