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Can You Afford to Buy a Home—and Should You?

October 2010

Picking Stocks

The US has a home-ownership bias. For decades, government policy has favored home ownership over renting, but the credit crisis has shown that not everyone should buy a home. Here are some rules of thumb if you are debating whether to buy or rent.

1. Be realistic about your financial prospects. The rule of thumb (and rules of thumb are notoriously inaccurate but a good place to start) is that a mortgage should be between two and three times your gross annual salary. So, for a $500,000 home with 10 percent down, the mortgage would be $450,000. Your annual salary should be between $150,000 and $225,000 for you to comfortably afford this home. But this is just the start of the calculation.

2. Another rule of thumb that advisors use is that no more than 28 percent of your gross (pretax) income should go for a housing payments (including principal, interest, taxes and insurance). Real estate taxes are a wild card in this equation and can vary tremendously depending on where you live. In addition, you should look at how much total debt you have. No more than 36 percent of your gross income should go toward all debt service including (but not limited to) mortgage, car loans, student loans, personal loans, credit card minimums, etc.

3. Next you should ask yourself whether owing a home really fits your life right now or in the near future. If you are young and just starting your career, being able to easily pick up and move across the country or around the world is a huge advantage. If your life or job is super-stressful or you are going through big changes (new career, new city, a marriage or divorce) it’s probably not a great time to add the hassle of buying a house— wait until life settles down a bit before you commit. If you are in or approaching retirement you need to ask yourself whether you could stay in your home or your current neighborhood if you could no longer drive or if you needed a walker or wheelchair to get around.

4. Finally, you need to ask yourself how long you intend to stay in one place. As with stocks, housing prices can fluctuate wildly over five-year time horizons, and it is not unusual for housing prices to stay stable or even drift down for as long as ten years. Even if the neighborhood you live in has been experiencing solid real estate price growth, a sudden spike in mortgage rates or tougher lending standards can make it harder to sell your home when you need to. So be sure that you’ll be staying at least five or more years and that you have enough of a cash and income cushion so that you can carry two homes for a while if you do need to move.

To help you analyze the rent-versus-buy decision, check out this terrific calculator from The New York Times.

Financial Coaching can help you sort out the daydreams and the realities of your family finances. Coaching can also help you get motivated and stay on track when you need to make life changes. To learn more about how financial coaching can help you, schedule a free initial consultation.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Past results are not indicative of future performance. Outside sources used in this article are believed but not guaranteed to be accurate. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.