Recommended Percentage of Income for Housing

Budget carefully for a new home.

When determining how much housing you can afford, there are many factors to consider -- location, savings, other debts, your personal preferences, and most importantly, your income. The maximum monthly housing allocation should be 25-30 percent of your net income. Your home is your largest single investment and considering the current high foreclosure rates, you want to put yourself on a solid financial foundation.

Less Risk

While you can qualify for a higher housing-to-income ratio, there are many benefits that make a conservative percentage of 25 percent worthwhile. The biggest benefit is that there's considerably less risk involved. Most households require two incomes to meet monthly expenditures, with housing being the largest expense. In the event of a job loss or illness, the financial strain is substantially minimized if only a quarter of your income is allocated for your largest expense.

Your Total Debt Picture

As financial counselor Dave Ramsey recommends, the ideal circumstance is to be debt-free and have three to six months of expenses saved, in addition to your downpayment. If you're not at that point -- and most Americans aren't -- work toward it. Allocating 25 percent of your income towards housing only has a marginal benefit if you're saddled with credit card, car or student loan debt. If the house bug has bitten too hard, spend a few months reducing your debt, while saving for a downpayment. Reducing your debt in the short term increases your cash flow in the long run, so that you can manage your budget better.

What to Include

Include the following in any calculation of your housing costs: mortgage principal and interest; insurance; and property taxes. Keep in mind, insurance and property taxes are separate costs that are usually paid to an escrow account on a monthly basis, before being paid out at the end of the year. All of these costs are to be included, as they're ongoing for the life of the loan -- and in the case of insurance and taxes, beyond the life of the loan.

Do the Math

Divide your annual household take-home pay by 12, to calculate your monthly take-home pay. Then multiply your monthly take-home pay by 0.25 and 0.30. The resulting numbers represent your ideal monthly housing costs. For example, say your monthly household take-home pay is $4,000 -- you should allocate between $1,000 and $1,200 for housing.

References

• Dave Ramsey: How Much House Can You Afford?
• CNN Money: How Much House Can You Afford?

Resources

• Dave Ramsey: Mortgage Calculator
• Bankrate: Mortgage Calculator