Millionaire Graham Stephan: How Much House You Can Afford by Salary
Buying a home can be challenging for many people given today’s interest rates, record high prices and lender guidelines. Graham Stephen, a popular real estate expert and YouTuber discussed how much you need to make in order to buy a home as well as other important factors to consider when it comes to renting vs. buying.
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In his video, he points out several rules of thumb and tips to help you determine the home price you can truly afford.
Understand the Difference Between Buying and Renting
In his video, Stephen urges viewers to first understand the financial differences between renting and buying since you will need to rent first and budget for savings in order to buy a house.
Rent payments are fixed for the most part, but a general rule of thumb is that your rent should not exceed 30% of your gross income before taxes. So this means if you make:
$40,000, your rent should not exceed $1,000/month;
80,000, your rent should not exceed $2,000/month;.
$160,000, your rent should not exceed $4,000
With a mortgage, your payment includes principal, interest, property taxes, and insurance. Stephens says property taxes range from 0.4% to 2% to the property’s assessed value each year.
“It’s important to remember that this often readjusts each year as property values change and go up,” he stated in his video. “Because of this, the cost of owning a home is usually substantially higher than renting.”
Backwards Budgeting and Other Rules of Thumb
Stephens cautions that the 30% rule was created several decades ago before things like record student loan debt and $700 car payments. So there are other, more accurate guidelines to follow as well like the 50/30/20 budget.
With the 50/30/20 budgeting rule, you’ll spend no more than:
50% of take home pay on needs (housing, food, and transportation);
30% on wants (hobbies, clothing, travel);
20% on additional savings and debt repayment.
He also recommends something he calls ‘backwards budgeting’ to determine how much you can comfortably afford to spend on a home. This involves:
Calculating all your fixed non-negotiable costs like debt repayment, food insurance, transportation;
Allocating 15% – 20% as a buffer for savings;
Allocating 10% for miscellaneous spending;
Then, whatever is left over can be spent on rent or a mortgage payment.
“This puts you in the mindset of saving first, while spending second which will help you out in the long-term if you buy a home in the future,” Stephen says.
Another option is the 28% rule which states that your mortgage payment should be no more than 28% of your take-home pay.
To calculate this, multiple your monthly income by 0.28. Below is an example, with a $5,000 monthly income.
$5,000 x .28 = $1,400 per month or a $230,000 home.
Based on the 28% rule, this is the income you’d need to afford the following home prices assuming a 20% down payment.
$138,000/year – $500,000 home;
$212,000/year – $750,000 home;
$276,000/year – $1,000,000 home.
Lenders Have Their Own Rules
Knowing what lenders say you can afford is also important after running your own calculations,” Stephen says. “Lenders usually only care about income and debt.”
You’ll need to prove that your income is stable and your debt-to-income ratio should be below 45%.
This means if you make $8,000/month, up to 3,600 can go toward debt
So for example, if you have these monthly debt payments:
$500 student loan;
$700 car payment;
$100 credit cards;
There will be $2,300 left for a mortgage.
Even if you get approved for more, it may not be a good idea to buy a home that exceeds the amount you feel comfortable paying.
Final thoughts
Look at the overall cost of renting vs. buying and ask yourself “what makes more sense financially?”
Currently, renting is cheaper than buying in most metropolitan areas in the short-term;
Evaluate lenders to get a low interest rate, negotiate with the seller and don’t be afraid to some minor cosmetic work yourself;
Only make a purchase that you intend to keep long-term.
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“Yes, owning a home is incredibly expensive right now, but it is possible through diligent savings, patience, and research, especially if you know upfront how much it’s going to cost and how much you need to make to afford it,” Stephen noted.
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