Determining how much of your net worth to allocate to your home is an important personal finance decision. The amount you should spend on a home depends on your financial situation, goals, lifestyle needs and more. While there are guidelines, there is no one-size-fits-all rule. Carefully considering your unique circumstances is key.
Guidelines
As a general rule of thumb, it’s often recommended that your home purchase price be 2-3 times your gross annual household income. This range allows you to buy a reasonably priced home you can afford based on your income level. Some other common guidelines include:
- Spend no more than 28% of your gross monthly income on housing costs (including mortgage principal and interest, taxes and insurance). This keeps housing affordable and leaves room in your budget for other expenses.
- Allocate no more than 36% of your gross annual income towards your total mortgage debt. This includes your monthly principal and interest payments across all your properties.
- Limit your total debt payments (including your mortgage, credit cards, auto loans, student loans and other debt payments) to less than 43% of your gross monthly income.
These guidelines can provide a starting point. But you still need to consider your complete financial situation.
Factors to Consider
When deciding how much home you can afford and should buy, here are some key factors to take into account:
Your income and job stability
Consider your current income and your confidence in maintaining that level of income steadily into the future. If your income fluctuates or is uncertain, that should be accounted for.
Your other debts and expenses
Look at your full financial picture, including other debts like student loans and car loans. Factor in your average monthly expenses to determine how much room you have in your budget for a mortgage payment.
Your down payment amount
The size of your down payment will impact the size of the mortgage loan you need. A 20% down payment shows financial discipline and helps you avoid paying PMI.
Your savings and investments
Make sure you have enough liquid cash reserves for emergencies and other financial goals before committing funds to a house.
Local housing market conditions
Consider the trends in home prices and rents in your area. Buy based on value, not stretching to the limit of what lenders will approve.
Your retirement planning
Owning a home ties up a significant portion of your capital. Make sure you are still on track to meet your retirement savings targets.
Your lifestyle needs
Buy a home based on your needs and preferences, not for prestige. Don’t overspend on space you won’t use just because you can qualify for a larger loan.
Percentage of Net Worth Guidelines
Some financial experts advise limiting your home value to a certain percentage of your overall net worth. Here are some general guidelines:
| Home Value as Percentage of Net Worth | Assessment |
|---|---|
| Up to 50% | Conservative and likely affordable allocation |
| 50-75% | Moderate allocation, but may limit diversification |
| 75-100% | Aggressive allocation with higher risk |
| Over 100% | Highly risky with little diversification |
As a general guideline, trying to keep your home value at or below 50% of your total net worth is a conservative approach. As you get above 75%, you are putting a larger portion of your assets into one asset – your home. This can hinder your ability to diversify your investments.
The advantage of a lower percentage
Keeping your home value low relative to your net worth provides these benefits:
- Allows you to diversify your assets, such as investing more in stocks, bonds and other alternatives.
- Reduces your risk if the housing market declines.
- Gives you more flexibility to pivot your investments if needed.
- Potentially enables you to retire earlier since you have more invested.
When a higher percentage may be acceptable
There are scenarios where allocating more towards your home may be appropriate or necessary, such as:
- You live in a very high cost area with limited affordable options.
- You are an ultra-high net worth individual.
- You intend for your home to be a legacy asset.
- You attribute strong emotional/lifestyle value to your residence.
The higher your net worth, the more flexibility you have in your home allocation. Additionally, if you live in San Francisco or New York City, for example, even moderate homes may be a very high dollar value.
Additional Considerations
Beyond percentages, here are some other tips that can help guide your home buying decision:
Think long term
Consider both your current situation and your future financial needs and goals. Don’t buy the absolute max home you can barely afford today. Leave room to save and invest for retirement.
Seriously consider renting
Crunch the numbers on renting versus buying. In some markets, renting makes more financial sense. Be objective about the comparison.
Have a substantial emergency fund
Before buying, bulk up your emergency savings fund to 6-12 months of living expenses. Homeowners face expenses like repairs that renters don’t.
Buy when the time is right
Don’t rush into homeownership or let FOMO drive your decision. Buy when your finances are in order and you’ve saved a sufficient down payment amount.
Pick a reasonable loan term
To keep payments affordable, don’t stretch out your mortgage loan term longer than needed. Opt for a 15 or 20 year term if you can.
Account for other housing costs
Factor in property taxes, insurance, maintenance and utilities when budgeting. Owning costs more than just a mortgage.
Target Percentage Based on Age
As a very general guideline, here are some target home value percentages of net worth to consider based on your age bracket:
| Age Range | Target Home Value as Percentage of Net Worth |
|---|---|
| 20s | Up to 25% |
| 30s | 25-50% |
| 40s | 50% |
| 50s | 50-75% |
| 60s | 75% |
When you’re younger, you have more time to accumulate assets and investments so a lower home allocation allows you to diversify your holdings. As you age and your net worth grows, your home value can gradually increase as a percentage without necessarily hurting your overall diversification.
Risks of Overallocation
Having too much of your net worth tied up in your home carries several risks, such as:
- Lack of diversification – Overexposure to one asset (your home) leaves you vulnerable. Diversifying into stocks, bonds, etc. spreads out risk.
- Illiquidity – Home equity can’t quickly be accessed like cash or stocks if you have an emergency need.
- Interest rate risk – Rising rates increase mortgage costs and can limit cash flow.
- Property value declines – Local housing downturns can slash your net worth if overallocated.
- Missed investment returns – Money spent on an expensive house can’t be invested for retirement.
Balancing your home against your overall net worth and diversified assets is crucial.
Tips for New Home Buyers
For first-time home buyers, here are some tips for deciding on how much to spend:
- Get clear on your budget and how much you can realistically afford for a monthly mortgage payment and other housing expenses. Don’t max out your qualification.
- Bulk up your down payment savings to at least 10-20% of the purchase price.
- Crunch the numbers on renting versus buying. Don’t assume buying is always better.
- Be conservative. It’s better to start small and move up later than to overbuy now.
- Locate homes based on your needs and lifestyle, not stretching for prestige.
- Investigate prices per square foot to identify value. Newer or custom homes can skew value.
- Don’t drain all your savings on a down payment. Leave a robust emergency fund.
First-time buyers often benefit from starting small, learning about homeownership, and trading up later once their income and equity have grown.
Alternatives to Buying
Beyond the rent versus buy decision, here are some other options to consider if you’re unsure about purchasing a home:
Delay buying
Give yourself more time. Save more for a down payment and pay down other debts to improve your financial position.
Relocate
Research less expensive areas that still meet your needs. Expand your housing search radius.
Buy a multi unit
House hacking by buying a duplex or triplex can reduce your living costs while building equity.
Get a roommate
Sharing housing cuts costs substantially. Makes homebuying more feasible in pricier markets.
Rent out a room
Even if you buy, renting out a bedroom can help offset a chunk of housing costs.
Buy a fixer upper
Take on a home needing renovations to get more value. Sweat equity creates equity.
Key Takeaways
- Guidelines suggest limiting your home’s value to 50-75% of your net worth for adequate diversification.
- The younger you are, the lower your home percentage target allocation should likely be.
- Overallocating to your home increases risks from lack of diversification.
- Many factors like income, debts, retirement savings and more should influence your decision.
- First-time buyers should be conservative and buy based on needs, not maximum affordability.
Determining the right home purchase price involves carefully weighing many financial factors. Being strategic with your home allocation as part of your overall net worth can help you achieve your long-term financial goals.