What is the 30/30/3 Rule for Buying a Home in Uncertain Times?

Blog posted On September 30, 2020

Buying a home is always a significant investment, but during uncertain economic times, buyers should be especially careful to not overstretch their finances.  Unlike the stock market, real estate is often considered a more stable investment since it tends to appreciate over time.  However, if you lose your job or suffer an income reduction, you want still to be able to cover the cost of your mortgage, at least temporarily, so you do not fall behind on payments, or worse, go through a foreclosure. 

Record low mortgage rates have many prospective home buyers considering a home purchase, but recent economic uncertainty brought on by the pandemic has some reconsidering.  If you’re on the fence about buying a home, but not sure if it’s the best financial choice for you, consider the more conservative “30/30/3” home-buying rule.

Spend less than 30% of your gross household income on your monthly mortgage payment.

Your gross income includes all of your household’s pre-tax income from all sources including your job or other investments.  This is a good rule to follow whether you are buying during a strong or slow economy. 

When mortgage rates are low, you may consider allocating more of your monthly income toward your mortgage payment, because you know you will be paying less in interest over time.  If you are spending more of your income on your mortgage payment, you will have less to save or invest, and then you will have less of a cushion if someone in your household loses their job or gets a pay cut.

Save 30% of the home’s value before making your purchase.

A 20% down payment is not required to buy a home but putting down 20% on a conventional mortgage means you will not have to pay mortgage insurance.  Although there are low down payment alternatives, if you put down less than 20% you will have to pay mortgage insurance until you’ve built up enough equity in your home.  If you’re close to your down payment goal, you may want to consider our down payment gifting program HomeFundIt™ to get all the way to 20%. 

The extra 10% will be your cash buffer.  If you lose your job or get a pay cut, you will have a financial cushion while you find a new job or a way to supplement your income.  If your home requires an emergency repair or maintenance, you will be able to cover some or all of the cost without taking on an additional loan or racking up credit card debt.  When you own a home, the maintenance is your responsibility – you no longer have a landlord to call if the air conditioning breaks or the sink starts leaking!

The price of your home should not exceed 3x your annual gross household income.

If you haven’t set your budget yet, this is a good place to start.  For example, if your annual gross household income is $150,000, you should only look at homes that are $450,000 or less. 

Your good credit score and low debt-to-income ratio might mean that you could qualify for a higher loan amount, but real estate professionals advise against taking out the maximum loan for which you qualify.  It’s also important to consider the long-term costs of a more expensive home. The more expensive the home, the more expensive the property taxes and ongoing home maintenance. 

Historically low mortgage rates might have you thinking about buying a home, but pandemic-related uncertainty might make you think about waiting.  Still, when it’s time to move, it’s time to move.  If you have any questions about buying a home in the coming months, let us know.   

Sources: CNBC, The Financial Samurai