A solid article, but it should have commented on single family home prices. If you use the 3x salary rule, a $120k a year techie couldn't afford the median home price in America ($374k). A software engineer in San Francisco would have to make $526k a year in cold hard cash to reasonably afford the median single family home ($1.58 million).
Talking about six figure salaries as if they are unquestionably upper-middle class should take housing prices into account.
Median household incomes to home price ratios have risen to ~8x across the US as a whole , not just crazy house price areas like SF/NYC. Canada and Australia are far worse again, pushing 15x in some cities.
3x, if it ever was a rule, has been dead for a long long time.
Just crunched the numbers, and an 8x mortgage would exceed my monthly take home.
I felt pretty uncomfortable at 2.5x. I feel a lot of people are probably extending out to 4 or even 5, but 8 would be irresponsible and I doubt you could even find a lender for that.
Damn, I completely misunderstood what you were saying, sorry!
For some reason I was reading the comment that the average homebuyer is paying 8x their salary for a house. What you've been comparing are median incomes to sales prices. A useful indicator, but not capturing what people are actually paying - it is entirely possible the 'medians' are priced out, especially with such constrained supply.
That makes me feel way less crazy now... apologies again.
Even though as you said it's "not capturing what people are actually paying" it's related, and still horrifying to me, as a measure of overall housing affordability. Esp when you look at places like vancouver, sydney, melbourne.... At 10x I cant understand how the market keeps going - how do home ownership rates stay so high? how are people affording these multiples? It just doesnt make sense to me how it can keep going. To your point this measure includes the people who cant afford to buy at all , but theres still enough ownership % overall that it doesnt add up to me.
A 5x mortgage over gross pay should be just over 30% of monthly gross take home. Maybe too much for some, but not absolutely irresponsible - especially if you choose to stay in a stable housing market.
2.5x is completely ridiculous to expect - that’s going to be far below rental payments in most places that anybody would want to live. Its definitely not the norm. It’s obtainable in some areas of the northeast like Pittsburgh and the Midwest. But usually the catch is property taxes are outrageous.
It's really hard to compare because of how rates doubled in a period of 2 months.
At today's rates, which I'll enter at 5.2%,
A person making 200k at 8x is buying a house worth 1.6 million dollars.
Assuming a 320k down payment(ha), 20k in taxes, and 5k in insurance, the monthly payment comes out to over 9000 a month. I don't think anyone in CA at 200k is taking home that much monthly, but maybe my math is off.
I think 2.5x is also probably not the norm, but I'm extremely conservative with money and what I went with.
4 or 5 I can believe, but in today's market with today's rates, I can't see how 8x is even possible.
> 2.5x is completely ridiculous to expect - that’s going to be far below rental payments in most places that anybody would want to live. Its definitely not the norm. It’s obtainable in some areas of the northeast like Pittsburgh and the Midwest. But usually the catch is property taxes are outrageous.
The funny thing is: you just explained why property taxes are basically 'free'. (They are basically the best tax. Tweaking them to include only the value of the land, and not the house makes them even better.)
Basically, supply and demand in the housing market determine the sum of property taxes plus mortgage payments. If property taxes fall, real estate prices increase until the sum is the same as before.
If property taxes increase, real estate prices decrease accordingly.
Of course, existing property owners will feel the changes in price. But for someone young or from outside the area, who doesn't already own property, areas with high and low property taxes cost the same amount to live in.
The area with high property taxes can either spend more on public infrastructure or lower other taxes.
In the long run, all of society is made up of people who don't live yet today.
In the short run, votes are mostly cast by people alive now, many of them owning property.
That is not true. Property taxes are based on relative property values within a region such as a county or school district. Here in NY, appraisals are done at the county level and then that determines the amount you pay to the school district, town, county, etc. If budgets don’t increase, then your property tax stays the same even if your house is worth more. There are towns in my area with 1 million dollar houses that pay half the tax of a 500k house the next town over, because the town/school district tax gets spilt among the very valuable houses in that district. Whereas the poorer folks next door have to shoulder their tax burden among their less valuable homes.
Oh, that's weird. I assumed property tax was set at a fixed percentage of home value per year?
Thanks for explaining!
Though to be clear, most of what I explained still applies: if you are looking to buy real estate, the expected burden of property taxes will already be baked into the market price. Almost no matter how the taxes are set.
Yes it is true. Basically the formula for your taxes are (appraised home value / total appraised value of all houses in the town) * budget of the town. The market does absolutely take it in effect, like I said, towns with lower taxes sometimes become wealthy enclaves were people will drop 2 mil on a house and then have basically no taxes. My only issue with the system is it winds up being regressive sometimes because the wealthier an area is the lower the taxes tend to be.
but total cost of home ownership is supposed to be 33% of take home. how do you pay electric, gas, internet, trash, water, sewer, umbrella insurance, AND routine maintenance on just 3%?
Utilities normally wouldn’t be included in the 33% of take home rule - the 33% rule applies to renting an apartment too, where most of the items you listed except trash are also separate costs not included in the 33%. (Also the 1/3 rule is of gross income not take home.)
I'm not saying it makes up for the difference in the arguments, but please note that people seem to be talking past each other in this thread by talking about home price to income ratios and mortgage to income ratios without making a distinction.
I'm at 2.8x and no sir, I don't like it. At least I got 2.75% on my mortgage. Though I have a feeling we're heading back to 2008ish levels of job insecurity so maybe I'll end up homeless after all.
Prior to a recent promotion I was at ~6.7x. I still had some frivolous spending on going out and such, but I’m a bachelor. This was also before the recent inflation rise. Now I’m at 5x. Do I feel comfortable? Mostly… I work for the government so I’m not worried about losing my job, but rising inflation has eroded away the safety buffer I hoped to have with the increased salary. I’m concerned about how an expensive emergency situation could affect me.
Take, like 30 cash-rich buyers chasing 25 available homes in a given year. That sets the value of hundreds of thousands of homes in the metro area. All those homeowners now have a ton of equity that they throw around in their subsequent purchases.
That doesn't mean "everyone" is spending huge multiples of their salary in cash, it just means a handful of people did. The rest rode the wave of equity.
My gut reaction was also “what kind of outdated rule is this?” until I realized that I accidentally followed the 3x rule almost to the dollar in buying my house. And I have to say, I feel extremely comfortable with the results, so I would recommend it.
A price to salary ratio doesn't make a lot of sense because it ignores interest rates.
At today's interest rates, which are still historically low even though they increased last year, 3x is unusually conservative.
The better rule of thumb is to keep housing expenses under a certain percentage of gross income. 28% and 30% are common number that get mentioned in that context.
Why gross income and not net income? Because two people with the same gross income might have very different tax situations and their net income could be very different. So, of course you also need to consider what percent of your net income your housing costs represent -- these are all just rules of thumb.
Funny enough my first and only house was actually very close to 3x income at the time I bought it 10ish years ago and everything real estate seems crazy to me now...
Now that value delivered is disconnected from location, live somewhere inexpensive and push for your actual value. The only real requirement is US friendly timezones and 10+Mbps up speed internet. I'm sure there are 100s of cities in America that meet this expectation and would make you "rich" in that locale with a $200k TC .
Choosing to live somewhere for the "lifestyle" is in itself a form of expenditure for which your employer should neither be subsidizing nor penalizing.
I hope that is what happens. So far only a few companies are giving up fully on pay being linked to COL. Even so, flexible work (1-2 days in office a week) is currently revitalizing parts of New York as people move twice as far from the office, drastically reducing housing payments, while keeping the same pay and same total commute time.
Why would a single person need to buy a 3 bedroom home (the median American home size)? A household with two $120k earners can very comfortably afford a $1 million home at current mortgage rates.
Mortgages are leverage, but unlike traditional financial leverage not subject to margin calls. Normally high leverage is risky in trading, because small perturbations in price can force liquidations.
However with a traditional mortgage, as long as you keep making payments you cannot be forced to sell. (In fact it's even better, you can always re-finance when rates improve, whereas the bank cannot raise rates on you when they worsen.) Therefore all you care about is the return to the asset over the long-run. And absent maybe a once-in-a-century depression, there's no way a single family home will decline in price over 20+ years.
Mortgages are not just leverage. They also lock in your cost of housing.
For example, people who rent in major cities have seen their rents increase by 30% or more over the past few years. Housing prices have also gone up by that much.
On the other hand, someone who bought a home a few years ago has not seen their monthly payment change -- and it will not change for 30 years if they got a fixed-rate mortgage! In the next few decades, their mortgage payment will be increasingly smaller in real terms due to inflation and will eventually be substantially lower than the rent for a similar home.
2 people earning $120k each have a monthly pre-tax income of $20k. They can easily afford a million-dollar home, and the property tax (~11-12k per year), in the San Francisco area. The problem is, a home that cost a million dollars 2 years ago now costs $1.3 million.
It still sounds insane to me, I've made an assumption anyone with a $1M home (or above) is either carrying much less via down payment or is in the $4-500k / yr range.
Most responses on an assumption that, inflation adjusted, housing prices only rise. For many areas this is not true, the bay might not be one of them, it is probably even more localized for the areas that are more protected from downturns.
From your example, a house would be around $5.5k/month before maintenance / capital costs on take home of ?12-14k?. Seems rough, especially if one of those salaries is lost or degrades.
It is all perspective though, we're used to lots of space and size. My normal is other people's insane.
I'm single and bought a $350k 3 bedroom when I was making around $130k. I bought the home because the city I lived in at the time (Austin) had banned townhouses/duplexes/etc so my only option was to rent in a midrise, rent a home, or buy. I wanted a townhouse downtown, not a SFH in the suburbs.
Unfortunately I sold said home at the beginning of 2019 and have watched it essentially double in value over the last two years.
1. A single person likes to have guests stay over and wants to offer them a room and also have a home office for working from home
2. There are no "starter" homes available in their area. This is what my spouse and I hit in Los Angeles. We tried a condo and ended up suing the person who sold it to us because it was so noisy as to be unlivable. (And it turns out most of the condos in the area are like that.) But there were no small homes available on the market to purchase. When one did show up, they were usually purchased immediately for cash for more than asking price, torn down, and a new home built lot-line to lot-line put in its place and sold for 3x the cost. Eventually, I got some bonuses that allowed us to purchase a larger home so we did that. Now we have a guest room and an office which has worked out great during the pandemic. I'm really glad we did it.
3x rule is not a rule but a guideline. It applies more to the average person.
If you give someone 100 dollars a day they have to buy food, clothes, rent, education, transportation. You give them 1000 dollars a day they still have to buy the same things. They can then use this leftover to buy nicer food or nicer house. This is why values of homes can get so high in areas. For the people getting 1000 they chose where ti spend this extra money. For people with 100 a day they don’t have extras to reallocate towards rent.
5.25 joint salary, though, so that could be as high as 11.5 times one person's salary for one house if you're buying together (they may have a slightly different calculation when combining salary).
And indeed my house, but not the mortgage, was well over 10 times my salary when I bought it. The mortgage was around 8 times my (entry level UK) salary, but about half that if you counted both of us.
Which is one route to how people end up in serious trouble: get a mortgage as newlyweds with 8 times one person's salary, then one person stops working for The standard post-marriage activity: kids, and now you have a house you could never have passed the affordability checks for, as well as a very expensive baby. Then interest rates rise. Game over. Luckily for lots of people, interest rates have been miniscule for a while, but I get the feeling that there's a lot of people on the edge.
Technically, but that's moot as there's two incomes so not really what we're discussing. And the only way that happened is because your partner earns the same as you.
People used to be be able to easily afford houses on a single income. My old boss, for example, bought a house alone when he was 25 and rented out a room. And that was back when tech salaries were low, especially in the UK where it was viewed as a perfectly normal job and no better paid than, say, a teacher.
That's just not really possible these days, a 25-year old teacher could never buy a half decent 3 bed house alone.
That what I mean. The "borrow 3-5ish times your household salary" hasn't changed that drastically (especially considering interest rates have been fairly low). What has changed is that the baseline is borrowing that multiple of two salaries to buy the same house.
In UK you always get a fixed rate for X number of years, then it automatically move to variable(but at that point you'd just remortgage again). Like we're on a 1.29% 5-year fixed mortgage, but the whole thing is 20 years long. But after 5 years we'll just remortgage again on new terms.
We also could have had 1.12% I think, if we increased our LVT to like 60%, but I didn't have the cash to do that at the time. It was in September 2021, so basically the historically lowest interest rates time in UK, ever - we were quite lucky to be remortgaging at that point. My sister is just getting a mortgage herself now and the lowest she can find is about 3% for 5-year fixed mortgage.
Where it goes wrong is when you remortgage in a higher rate regime, and the bank won't give you a new fixed mortgage to cover your remaining capital. Now you're stuck on the "punishment" variable rate you get when you don't remortgage.
you don't "always". The mortgage industry has a long history of different optimal strategies given different scenarios. For example, overpayment and payment holidays without incurring penalties used to be features only available on tracker mortgages. Discounted (yet still fluctuating) rates used to be effective.
Fixed rate mortgages are popular with people that don't want to take on the risk of payment fluctuation as well as in economic environments such as today.
In the UK even fixed rate mortgages are only fixed for the first couple of years, which wasn't so bad as rates were decreasing, but obviously things might change in the next couple of years.
My partner and I earn dissimilar amounts (I earn more than double what she does) so we are borrowing only what can be covered on her wages which is about a third of what the bank will actually lend us (a frankly eye watering amount).
We don't want to be in a situation where I have to earn what I do now forever to cover the mortgage and doing the above would allow me to take a 50% paycut and still comfortably pay all the bills.
The houses we are looking at decent size in a nice area with good sized gardens, what the hell more do we need, there are only 3 of us, a 3 or 4 bed is just fine.
We are effectively borrowing about x2 our household income not the 5.whatever the bank would lend.
> It's a rule of thumb that your total debt should not exceed 1/3 of your income.
Unless tax deductions work very different in the US than they do in Denmark, that is pretty bad advice.
Here, sitting on a 60% mortgage loan that is many times higher than your annual income is genuinely a good idea for most people because of tax law. It’s not until you have assets that are worth more than your house that it becomes a good idea to pay off the entire loan.
Meanwhile having even a small “quickloan” that is 0.1% of your annual income is a very stupid idea.
I mean, if you don’t know finance at all then maybe it’s a good rule of thumb as you’ll never bury yourself in debt, but loans aren’t just loans.
I've never heard total debt should be 1/3 of income. Having a mortgage completely blows that up. Nevermind student loans, a car, or getting a credit card.
I've heard that monthly housing shouldn't be more than 1/3 monthly take home. Is that what you're thinking?
> I've never heard total debt should be 1/3 of income. Having a mortgage completely blows that up. Nevermind student loans, a car, or getting a credit card.
I think you mean 3x of your income, not 1/3 of your income. If it was 1/3, then someone making 100k would only be able to get a mortgage loan of 33k...
Or are you saying payments on debt (mortgage payments)?
When I've heard this before it was about mortgage payments. The general idea being the money you make is broken up into thirds with the gov getting a third in taxes, the mortgage payment getting a third, and living/saving from the final third.
It used to be that the average monthly payment on housing would go up to around 25% of your spendable income, at least that was what the government used as a guideline. These days you need over 40% to even get anywhere and even that is unlikely to be enough. I've also noted around here the required income went from about 3-3.5 to around 5 times the rent rate despite that meaning you need a 6+ figure income for even the most basic apartments (which is rare here) which is just risk reduction for the owner.
Also checkout the "rule of 72" if this stuff tickles you. It is also a rough estimate that gets used in place of more complex formulas. (Actually closer to 69/70 but 72 makes things cleaner)
The 72 is optimised, it seems to me, for annual compounding with percentages from 5% to 10% (as ln(2)/ln(1.08)*8 = 72.051746736), while, as you point out correctly, ln(2) = 0.69314718, so for continuous compounding 69 would be better indeed.
Talking about six figure salaries as if they are unquestionably upper-middle class should take housing prices into account.