Please note this article is for educational purposes only, and your financial advisor should be consulted before purchasing a home.

How much home can you afford?

In this article, we’re diving into how much house you can afford. At first, I will outline, according to financial advisor Dave Ramsey, and then offer my opinion on how it can apply to our community. Dave is a big advocate for a debt-free lifestyle, but he’s okay with taking on a mortgage—as long as it’s the only debt you carry and you work to pay it off as quickly as possible.

Step 1: Be Debt-Free First

Dave Ramsey’s first rule of thumb is to be debt-free before considering buying a home. This means eliminating all credit card debt, student loans, car loans, personal loans—anything and everything that puts you in the red. This can be challenging for many, but it’s the foundation of Ramsey’s advice. Being debt-free sets you up for success and ensures you’re not stretching yourself too thin financially.

Step 2: Opt for a 15-Year Mortgage

Dave strongly recommends a 15-year mortgage over the more common 30-year option. Why? Because it saves you a ton of money in the long run. You’ll pay less interest over a shorter period, amounting to tens of thousands of savings. If you can swing the higher monthly payment, a 15-year mortgage is a smart move.

Step 3: Stick to 25% of Your Take-Home Pay

Now, how much house can you afford? Ramsey suggests your mortgage payment should be no more than 25% of your take-home pay. For example, if you and your spouse bring home a combined $4,000 monthly after taxes, your mortgage payment should be no more than $1,000. 

Step 4: Aim for a 20% Down Payment

Another piece of advice from Dave is to put at least 20% down on your home. This reduces your mortgage amount and eliminates the need for private mortgage insurance (PMI), an added cost that doesn’t benefit you. If you can’t quite manage 20%, he suggests that 10% is the minimum you should consider.

Example Scenario

Let’s break this down with some numbers. If you have a monthly take-home pay of $4,000, 25% is $1,000. Based on a 4% interest rate on a 15-year fixed mortgage, you could afford a house priced around $150,000 with 10% down or closer to $170,000 with 20% down.

Is this realistic?

The answer is not really, but it’s a good understanding of what you should aim for. Most young families still pay off car loans when outgrowing their tiny apartments. Waiting until all loans are paid off may be too late. Additionally, home prices keep increasing, and waiting until you are debt-free may result in homes being a lot more expensive and unaffordable at that point.

Opting for a 15-year mortgage is a good idea. Still, it’s also not very reasonable because amortizing a mortgage over 15 years, even with the lower interest rate of a 15-year mortgage over a 30-year mortgage, will result in a much higher monthly payment. For example, a $500,000 loan at a 6.5% interest rate would lead to a monthly mortgage of $3160. A 15-year mortgage at 6% will be $4219 (taxes and insurance not included). 

Sticking to 25% of your take-home money is also not very possible. In Ocean County, NJ, the median household income is $81,101, which is pre-tax. Assuming a post-tax household income of $60,825.75, a quarter of that would allow you to spend $1267 a month, which is lower than what most people pay for rent. It is highly recommended that your monthly mortgage payment should not be more than a third of your take-home income.

Aiming for a 20% down payment is a great idea, and I highly recommend it, especially when interest rates are higher. 

In conclusion, buying a home is a big decision and should not be made simply out of peer pressure. It should be well calculated, and a solid plan should be figured out to afford the payments comfortably.

Renting is also viable if you can’t figure out how to comfortably make a mortgage payment yet. It’s not “wasting money, but rather “buying patience,” giving you time to save and prepare for a home purchase that aligns with these principles. Alternatively, you may consider living in an out-of-town community where the homes sell at a cheaper price.