When we think of how much house we can afford, we often look to our lenders for advice. Unfortunately, lenders are all too happy to lend to us at the maximum of what is affordable, disregarding the rest of our personal finances.

The maximum of what is affordable means what is affordable for the bank, not you. The bank wants to know whether it will be paid. It doesn't care if you want to save additional money, pay for your kid's school, take a nice vacation, or dine out frequently. The bank doesn't account for what makes up your most fulfilled life. All the bank wants to know is how much principal and interest you can pay given your income.

In my practice, I talk a lot about keeping all housing costs (mortgage, taxes, homeowners insurance, HOA fees, utilities, maintenance) under 20% of pretax income. This is significantly below the lender's 36% pretax income metric, which can move upwards toward 44% of income depending on type of mortgage and the lender. Additionally, lenders do not include home maintenance, 1-3% of your home's total value per year depending on the home's condition, or utilities in their calculations.

Here is the math behind the 20% housing spend:

Note: 25% is the average American tax rate including FICA. Your rate may be higher if you are self employed or living in a state with high income taxes. Your tax rate will be lower with income below $150k if single. 20% savings rate is my recommended amount to ensure retirement and ability to fund other important life goals.

Generally, spending more than 20% of income on housing also means increased spending on everything else. This means a person spending 36% of income on housing is not likely to save 20% of their income, but rather live paycheck to paycheck with minimal savings.

Let's look at an example using real numbers:

A couple with two children makes $300k and only spends 20% or less on housing

Taxes: $75k
Savings: $60k
Housing and associated expenses: $60k
Cars and associated expenses: $15k
Everything else: $90k

Here's the list of "everything else":

Nanny: $18,800
Kids' activities: $3,500
Travel: $12,000
Groceries: $16,600
Life Insurance: $2,000
Medical Insurance: $6,600
Dining Out: $6,240
House cleaner: $6,500
Gym and Fitness: $2,200
Medical out of pocket: $1,200
Amazon (or other favorite superstore): $3,500
Clothing: $2,360
Gifts: $2,000
Family recreation: $1,500
Charity: $2,000
Unexpected expenses: $3,000

Total: $90,000

If this family were to spend $108,000 on housing, like the bank would lend them, rather than $60k, they would need to make significant cuts to their lifestyle or they would only be saving $12k per year instead of $60k.

The easiest way to manage expenses is to keep the big fixed ones low so you can enjoy the rest of your life without penny pinching.

What if this is not possible to do in the region you live? Great question! Either you need to watch other expenses to afford housing and still save, or it is time to move. You get to decide!

The Math Behind Keeping Housing Costs Reasonable