# What Should You Pay For A House?

I suppose one of the harder questions people face in the red hot housing market is: when do I know I’m paying too much for a house?  To be sure, it is a difficult question to answer, so I’m going to toss out an idea.  Take your proposed house value times by 4%, divide the result by 12.  That should be around a monthly payment, without property taxes, that you feel you can afford.

So where the hell did this 4% number comes from?  Well in retirement planning the safe withdrawal rate is about 4% for the typical retirement.  Meaning you can take about 4% of your assets out each year adjusted for inflation and likely not run out of money before you die.  Therefore extending the idea a bit assume your house has to meet the same standard.  By paying off your home you should get a monthly savings of 4% of your house value.  Of course if you get a cheaper house and pay it off faster you could beat this, but lets put the 4% rule as the floor.

So if you use the 4% idea and then assume 1% of house value for property taxes and \$100/month heating you can create a table based on 32% of your gross income for housing and can determine the most house you can afford for your income.  See below for details.

So as you can see from the table below you likely shouldn’t buy a house worth over\$600,000 unless you make over \$100,000/year as a family.  Then when you consider the median household income in Canada is about \$53,000, that implies that most people should be in the low \$300,000 or cheaper range.

So what do you think of the 4% rule for housing?  Good idea or am I out to lunch?

## 15 thoughts on “What Should You Pay For A House?”

1. Doesn’t look too bad but you are ignoring the down payment.

For first time home buyers the down payment might not be all that much but for everyone else – it could be huge.

2. Traciatim says:

Wow, I’m incredibly glad I didn’t subscribe to this thinking when I was shopping for a house. Our annual income at the time was something like 45K or 50K, which would have put the home in the high 200’s. We spent a smidgen over 100K on our house, and I’m still feeling it.

I thought the rule of thumb was Mortgage = 2-3 times incomes?

3. ldk says:

I have to agree with Traciatim on this…our family income is in the \$150k+ range and I can’t even conceive of living in a \$900k house!!(ours is currently worth about \$450k) The operating costs on a property like that would drown us.

4. You really don’t have to worry that much because the bank won’t give you a mortgage unless your debt expenses (mortgage + LOC + car loans + etc.) are less than a certain percentage, and I believe that number is in the low to mid 30’s.

The other important thing to remember is that just because you can get a house for that much, doesn’t mean you should.

Gotta love the reality tv shows where they want the person to go up to the maximum amount the bank will give them for a home….

5. Kat says:

I ran the numbers, and it gave me just over half of what our monthly payment is, and we had a good downpayment… so not sure how this works? We have a 25 year mortgage.

6. John the Contractor says:

House prices are driven by a number of factors; what the city charges the developer for land, contractor wages, and the costs of raw materials. Based on current figures, it would be increasingly difficult to build a house for less than 200 dollars per square foot. This allows the developer to operate at about a 25 point margin. Of course you be amazed at the range of extras customers now want and I’ve been installing; marble multi-head showers, a dog wash in the garage, custom cherrywood built ins, and the list goes on and on. How much you pay for a house is directly related to what people expect in a ‘base’ model.

7. It depends on whether I’m buying a property that I plan to live in or rent.

As a landlord, I want my net return (gross rent less 5% minus taxes and insurance) to be twice what I can get in a diversified portfolio of preferred shares/bonds. Since I can get 6-7% these days from fixed income, I want real estate to be somewhere in the 12-14% range. That way I get wiggle room in case a renter damages the place/doesn’t pay.

As for buying something for myself, I would never go beyond 3 times my income. I’ve read that in a normal market, house prices are 3-4 times median salaries. Anything above that is overvalued, anything below is undervalued. I can’t control house prices obviously, but I can control not getting in over my head. That’s where the 3x rule comes into play.

@FP,

Good point to include.

@Traciatim,

Oh, those numbers are the maximum that you could go with the 4%, if you did less than that you are doing better. A ratio of 2 to 3 times your income equal your mortgage is also not a bad guide. Ideally you would like to keep it under 2.

@Matt,

Total debt is actually 40%, while max house is 32%. Hence the above numbers are the maximum you want to go. The reality is less is better.

@Kat,

A large down payment throws the numbers out so that could explain why you are at half. Otherwise you might have too much house for your income.

Financial Uproar,

Good rules of thumb. Thanks.

Tim

9. George says:

You based the monthly payment on fixed 30-yr mortgage. Why not 15-yr mortgage?

You definitely need to include room for down payment and the contingency fund. Even if you make a low down payment, banks like to see that you still have some cash available to deal with upkeep, such as roof repair.

And if it’s a place to live in, then what you pay is irrelevant unless you really are looking for ROI.

10. George says:

Oh, wait, nix that bit about mortgage terms. I see I was out to lunch 🙂

11. JMK says:

Don’t know where the \$100/mth for heating would work but not in my area. Here it’s several hundred in the winter and perhaps that for your electicity only in the summer if you don’t go crazy on AC. It’s also a good rule of thumb to assume 3%/yr for maintenance. Take that off your available cash flow.

Sorry, but using those numbers is going to get you waaaay in over your head.

JMK,

\$100/month is right out of thin air. It’s about my equalized heating bill. I also didn’t use AC last summer so not much there either. Interesting idea with 3%, but what is that suppose to include? It seems like a lot of money.

The numbers are just the MAX you would want to go. Obviously lower would be better.

Tim

13. Honestly, I prefer to use the ING converter on their website 😉 you can convert your rental monthly payment to a mortgage total value. I haven’t found something like that elsewere yet.

14. Living in the lower mainland of BC, I think it is funny saying that these numbers put you way over your head. I have a two bedroom condo in one of the cheaper areas in the lower mainland. Two small for a family and it is worth 200,000 now. So if you want a home you are looking at a much larger number.

I would love to move, but it is difficult for many reasons. First, divorce is expensive, second it is hard to move away from family, and third my wife’s job is based on experience in this area only. Somewhere else and the seniority is useless.

So those numbers work out perfectly here I think. I would love to do less, but it is not really an option.

One correction I think you need though is that should be mortgage value and not house value. After all if I have paid off a 500,000 home and want a 600,000 home. Looking at the chart would show the 600,000 home is out of our budget, when really it would only be a 100,000 mortgage.