In today’s episode the guys are discussing the big question… how much house can you afford? They’re crunching the numbers to calculate how much mortgage one can sustain. Join Josh and Austin as they dive into the 28/36 rule, investing the difference, and some tips for modest living. Listen now!
Main Talking Points
[2:22] – How Lenders Look at Your Affordability
[3:43] – The 28/36 Rule
[4:36] – Private Mortgage Insurance (PMI)
[9:16] – Dad Joke of the Week
[10:10] – House Rich and Cash Poor
[11:50] – Modest Living
[12:52] – Investing the Difference
[13:32] – Don’t Feel Pressured to Keep Up with the Joneses
[14:46] – Short Term vs Long Term Goals
[16:24] – Should You Buy a House?
[17:34] – Don’t Forego Safety Measures
Links & Resources
052: Understanding Your Credit Score – The Invested Dads
Invest With Us – The Invested Dads
Free Guide: 8 Timeless Principles of Investing
Social Media
Full Transcript
Intro:
Welcome to The Invested Dads podcast, simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments. Here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right. Hey. Hey. Hey, welcome back to Invested Dads Podcast, a podcast where we take you on a journey to better your financial future. Today, we are going to be discussing the big question. How much house can I afford?
Josh Robb:
I hope you could afford the whole house, because that would just be weird. If you just showed up with half a house. This is all I can afford, sorry. A roof’s missing, but here we are. Hopefully it doesn’t rain.
Austin Wilson:
I bought a three bedroom house, but I only paid for two.
Josh Robb:
Yes. It’s on consignment.
Austin Wilson:
So yeah, not quite, but that’s in the same ballpark of what we’re talking about, of houses. So we’re talking about really the numbers and the nitty gritty and some thoughts behind how much in terms of dollars, I guess we don’t really get into size.
Josh Robb:
Yeah. It’s not how much size of house can you afford, but that’s the end result is because you’re saying how much mortgage can I sustain? And the mortgage will then dictate what type of house you can get.
Austin Wilson:
Absotively.
Josh Robb:
But most people look at it from the house standpoint.
Austin Wilson:
So yes, how can I get much house can I afford, in terms of what size mortgage can I have? Because it’s a different question, if you say how much house can I afford, but I’m not using a mortgage. That’s like how much cash do you have? But that’s pretty rare-
Josh Robb:
How many dollars are in your piggy bank?
Austin Wilson:
That is pretty too rare. So Josh hit us-
Josh Robb:
I got a stat for you.
Austin Wilson:
…with some stats. Yep.
Josh Robb:
In 2019. And this is when they did this last research, 86% of home buyers used a mortgage to close the deal on their house.
Austin Wilson:
See? Only 14% have that cash just on hand or they’re buying it with Bitcoin.
Josh Robb:
Yeah. Who knows what they’re doing?
Austin Wilson:
Who knows what they’re doing? That number isn’t that surprising to me-
Josh Robb:
I actually thought it would be higher.
Austin Wilson:
…and especially with the low interest rates that we had in 2019, we’ve had in 2020 and we have in 21. Interest rates are so low that it makes borrowing for a house really easy, even if you have the cash on hand, it’s almost lucrative to borrow for it.
[2:22] – How Lenders Look at Your Affordability
Josh Robb:
Yep, definitely. So how do you do this? So the question always is, well, okay, how do I know how much I can afford in a mortgage without it hurting everything else? And so we’re going to talk first about how lenders look at things. Cause they’ll be the ones approving your mortgage. So how do they look at your affordability or sustainability? Now, they come from one perspective, right? They want to make sure that if they’re lending the money, they have a high chance of getting paid back.
Austin Wilson:
So low risk on their part.
Josh Robb:
So low risk, but they also want to make sure that more money they lend you, they’re going to collect more interest. So it’s this balance between how much can I lend out with still keeping that security or the higher probability of payback. So that’s their approach, right? They don’t care what your budget looks like. They don’t care how tight things are on your spending. They just are going to run these numbers and say, from our standpoint of getting repayment here’s as much the max we’re willing to give you.
Austin Wilson:
Absolutely.
Josh Robb:
So what they use is what’s called the 28/36 Rule.
Austin Wilson:
Wow. That is very weird-
Josh Robb:
It’s not normal numbers.
Austin Wilson:
…numbers.
Josh Robb:
And in our industries, there’s a lot of rule thumbs, there’s the Rule of 72, which Austin-
Austin Wilson:
We love the Rule of 72. So that’s, if you take the return or the growth rate or any percent percentage divided by 72, you get the years it takes to double, I guess essentially at that point is what we use it for.
Josh Robb:
So, if you have a 10% return, 72 divided by 10-
Austin Wilson:
7.2%.
Josh Robb:
…is 7.2 years.
Austin Wilson:
Or 7.2 years, yeah.
[3:43] – The 28/36 Rule
Josh Robb:
So that’s in 7.2 years, if you average 10%, you’re going to double your money. So that’s a cool rule. This is another one. So this rule 28/36. Why those numbers? Because again, the banks have found that if you have 28% of your pre-tax income, so your gross income-
Austin Wilson:
And this is interesting to me because the pre-tax side of it is a very different story than the post-tax side of it. But they’re using pre-tax figures, that’s why they ask for your pay statements or whatever. Not your bank statements that have to take home.
Josh Robb:
Because there could be a lot of things withheld that are deceitful on your beginning and ending of your pay stub, right? You could have other things withheld out of there and they want to know your gross so they can start with there and then go back from there. But they’re looking at your gross income, so your pre-tax income, 28% of that can go towards your total housing expenses. Now I meant in the same mortgage, it goes to your total housing expenses, which include-
Austin Wilson:
It’s a bucket.
[4:34] – Private Mortgage Insurance (PMI)
Josh Robb:
Yes. Your mortgage, your principal and interest, that’s all that in your mortgage, property tax and insurance. Those are your housing things together. And PMI, we’ll get in that in a minute. But private mortgage insurance is another safety feature banks put on. If you don’t have enough down payment, you don’t get that 20%
Austin Wilson:
Typically less than 20. Yeah.
Josh Robb:
20%’s kind of their threshold. So down payment. So let’s say you’re buying house for a $100,000s, okay. If you take a full loan, a $100,000s, there’s no equity on the house. You owe the same amount that it’s worth.
Austin Wilson:
Correct. Very risky.
Josh Robb:
The bank is taking a lot of risk in that if you default and they have to sell the house, they’re not going to really make anything off of that. And if the value goes down, they aren’t going to recoup your full amount. So what they like to see is you have a down payment, or in other words, you reduce the mortgage versus what the home is worth.
Austin Wilson:
So you have some skin in the game, you own part of the house.
Josh Robb:
Yep. So using my examples, the $100,000 house, 20% down, you have an $80,000 mortgage. This $80,000, so if the housing market has some trouble, they have a 20% cushion that the market could drop before they’re equal to what they’ve given out.
Austin Wilson:
Right. So typically when you’re thinking about banks, if you have decent credit, now everyone’s credit’s different. And check out, we have a whole episode on your credit score. But if you have decent credit, banks will usually offer to do a mortgage for all the way down to 5%. 5%’s the low end of most mortgages. 5% down is what most banks will lend to. And so you’ll get-
Josh Robb:
And some might be eight, and some special loans. You can go even down like three and a half, but-
Austin Wilson:
Now the less down payment you have, the higher your interest rate is. And the more you have PMI on top of that.
Josh Robb:
And all that is, is they’re adding on interest to your mortgage, that you’re paying them as insurance for not having enough of a down payment. And so that just increases your cost.
Austin Wilson:
Now that does typically fall off when you hit the 20% equity threshold-
Josh Robb:
Just to cover that gap.
Austin Wilson:
But if you get to that 20% equity threshold and you don’t see it automatically fall off call because they’ll drop it.
Josh Robb:
Yes, they need to do that. So 28% is the total housing expenses. That’s their threshold. So, that’s the starting point. That 36, so there’s 28/36. So what’s another one? They also look at, because you may have other debts, and so they want to make sure that adding this new debt doesn’t overburden you. So 36% of your total, again, pre-tax gross income should be your debt. So-
Austin Wilson:
Including housing.
Josh Robb:
Yes. So in other words, if you already owe 20% of your pre-tax income to other debt, you can’t get the full 20% mortgage rate. They’re going to use that as a stop point, you can only get 16 in there. So, those two work together. So what are those other debt? It could be credit cards, car loans, personal loans, student loans are usually what you see a lot of times, as a piece of that. So they look at all your monthly debts and say, okay, we know you have those obligations. So we can’t tack on another 28%. We got to make sure the cap is 36.
Austin Wilson:
Now what they’re looking at though is not the outstanding balances, it’s the payment amounts. And the payment amounts would be on credit cards or whatever. It’d be the minimum is what they will use as in their calculation. But even though, hopefully don’t be the person who pays a minimum.
Josh Robb:
Just carry credit card debt. That’s a big rule. So here’s an example. All right, 28/36 Rule says, let’s say I make $5,000 gross a month. Then $1,400 is my housing cost every month. Now this also works for renters by the way, if you’re not getting mortgage out, but if you want to know how much can I spend on my rent. You can use a 28/36 rule and apply that. So your rent shouldn’t be more than $1,400 a month as well. So, that’s just a little sidebar there. We’re not talking about renting today.
Austin Wilson:
Yeah. So I guess extrapolate that out. That is a pre-tax income of $60,000, can afford based on that rule, $1,400 per month on housing. Now that includes the mortgage and taxes and insurance, as you’ve talked about.
Josh Robb:
Yes. It’s not just my mortgage. And a lot of times when you get a mortgage from a bank, they’re going to put the property tax in there as well. And some, I mean, I don’t know most don’t do insurance, but that union factor that in and they can run those numbers.
Austin Wilson:
Most do.
Josh Robb:
They want that in there as well?
Austin Wilson:
If you give them your insurance policy, they will accrue just like they do with property taxes.
Josh Robb:
That’s right. They put it off side, you’re right. They accrued in-
Austin Wilson:
In the accrual account.
Josh Robb:
…their own little account and they pay it for you.
Austin Wilson:
Which you should be doing on your own.
Josh Robb:
Either way.
Austin Wilson:
If you’re not having the bank take care of your taxes and insurance, you should set that money aside automatically every month.
Josh Robb:
If you don’t pay monthly, if you pay annually.
Austin Wilson:
If you don’t pay monthly.
Josh Robb:
And usually paying annually, you save money too.
Austin Wilson:
That’s exactly true.
Josh Robb:
All right. So high level, that’s how a bank looks at your affordability. 28/36.
Austin Wilson:
28/36.
Josh Robb:
All right.
Austin Wilson:
Perfectly round even numbers that everyone can remember.
Josh Robb:
Should stick right in your brain all the time.
[9:16] – Dad Joke of the Week
Austin Wilson:
So Josh, I got a dad joke of the week for you.
Josh Robb:
You got a good one for me?
Austin Wilson:
It’s a good one. What-
Josh Robb:
Because you laughed when you read it.
Austin Wilson:
When I read it from?
Josh Robb:
Reddit.
Austin Wilson:
Read it on Reddit.
Josh Robb:
Reddit, Reddit.
Austin Wilson:
What did the stamp say to the letter?
Josh Robb:
Ooh, I don’t know.
Austin Wilson:
Stick with me and you’ll go places.
Josh Robb:
Wow. I like it. I like it. I saw a thing that said car keys, technically trap travel farther than the car ever does. And that stuck with me.
Austin Wilson:
Think about that, yeah.
Josh Robb:
Because they’re always in the car when it travels. So, that’s equal.
Austin Wilson:
Then they’re in a pocket.
Josh Robb:
But it leaves the car and goes other places in your pocket. So-
Austin Wilson:
Oh, the places they’ve been.
Josh Robb:
This blew my mind.
Austin Wilson:
That should be a kid’s book.
Josh Robb:
All right. So, that’s what a bank does. We don’t necessarily say at maxing out that 28%, 36% that’s ideal for everybody because-
Austin Wilson:
Especially the 36.
Josh Robb:
Yes. That’s a lot. Well, you shouldn’t. Try to eliminate as much debt as you can-
Austin Wilson:
Exactly.
[10:10] – House Rich and Cash Poor
Josh Robb:
…is the key. But what we’re want to talk about next is the more intangible piece from a financial perspective from us saying, okay, the banks are telling how much you can max, but maxing isn’t always the key. The key here is we don’t want to be house rich and cash poor.
Austin Wilson:
Ooh. I think you’re going to explain this.
Josh Robb:
Yes. And so-
Austin Wilson:
What do you mean by that?
Josh Robb:
…what does that mean? So you could have a lot of net worth, meaning value, but because of cash constraints, you don’t have a lot of cash flow. So if you own a lot property and have debt to it, even if the debt to equity have a lot of value, your monthly cash flow may be tight where you don’t have much to spend elsewhere.
Austin Wilson:
Or vacations.
Josh Robb:
Or if an emergency comes up, you can’t sell a piece of your house. It’s all or nothing. And so you may not have access to a lot of that equity you show on paper.
Austin Wilson:
Now we’re not including home equity loans. that’s a real thing.
Josh Robb:
That’s a whole nother thing. Yeah.
Austin Wilson:
But yes, house rich and cash is a reality for a lot of people, the bigger and more extravagant and elaborate your houses is. The more expenses you’re going to have to a, for property insurance and taxes. That’s going to be higher. So, that’ll drain your cash flow. But also just the upkeep on bigger houses is more expensive. There are more things to go wrong.
Josh Robb:
Yeah. If you have a vaulted ceiling, you got to change that light bulb. So you got to get an extension ladder and oh man, just keep that ceiling close.
[11:50] – Modest Living
Austin Wilson:
Exactly. So yeah, we do not want people to be house rich and cash poor, where they can’t fund their needs for one, if they have to have them or where they don’t have discretionary income on top of their housing and stuff to do things that they want to do, or to save for retirement or those sort of things. Yeah. My next thought is, just because you can afford, so say that example, you make $60,000 here-
Josh Robb:
$1400.
Austin Wilson:
The $1,400 is your limit that the bank will give you per month. And they extrapolate that out to a home price or whatever for you. Just because you can afford that much doesn’t necessarily mean that you should buy that much house. In fact, my thinking is, and this is kind of the way that I’ve done things in my life is, if you can live in a more modest house and have a lower mortgage and invest the difference. Now I’m not going to say guaranteed because we can’t make guarantees the future, but you’re likely going to come out way ahead, over time. And this is because the stock market has historically done way better than home prices over long periods of time. Now it’s a lot more volatile and over shorter terms, very different returns, but over long periods of time.
Josh Robb:
This year houses have done really well.
Austin Wilson:
Exactly. So has the stock market. I mean, it’s crazy. So anyway, that’s kind of my thought, don’t buy the biggest house you are authorized to buy.
[12:52] – Investing the Difference
Josh Robb:
And you mentioned investing the difference. Not just investing the difference, but making sure that adjusting or upgrading your house, whatever you want to look at it, if that makes you reduce what you are saving, that could be a problem, make sure you talk to your financial advisor about those changes. If I was saving $500 a month, but now I’m going to increase my mortgage by $300 and now I’m only saving $200, that net difference may impact you long term more than you realize. And so you’re right. Don’t ever let it impact your other savings goals by increasing that debt payment, to the point where it’s causing you to draw money out of other buckets or other strategies or other purposes.
[13:32] – Don’t Feel Pressured to Keep Up with the Joneses
Austin Wilson:
Absolutely. And another thought I had is, and Dave, this is Dave Ramsey, but don’t and try and keep up with the Joneses. If all your friends and family are upgrading and buying bigger and better, and bigger and better houses every couple years, that’s great. They can do whatever they want. They don’t have the finances you do. And because you’re listening to this podcast and they’re probably not, they should for one should. And you know a secret, and that is to not do that. Don’t try and feel pressure to keep up with the Joneses. Find contentment where you live, if the house fits your needs and all of that. Find contentment with where you’re at and stay there as long as you can, because it’s going to go up in value over time. But your payment won’t, you bought it at a certain point in time.
Now, unless we’re not talking about adjustable rate mortgages. That’s different too. But you have the option to make your house what you want. If your house has the bones of what you want in a house, if it has the size and the rooms and all this stuff, you don’t have to buy one that’s completely done for you already. You could buy something that checks the boxes, but maybe isn’t up to date and then just slowly improve it and renovate it and improve it and renovate it over time. And you’re going to come head because you bought a house way cheaper. And if you want one and bought one that was already done. So, that’s kind of one of my thoughts on there.
[14:46] – Short Term vs Long Term Goals
Josh Robb:
The other piece there, and we mentioned it, is short term versus long term goals. And if your priorities are, I’m a family person, I want my kids, I want this house to be a spot that everybody congregates to. Then maybe that makes sense, but understand which other goals will be impacted. If you are having two competing goals, you’re going to have to decide which one’s more important. And I can’t sit here and tell each person which one the answer is until you know, right. It’s not one answer for everybody. There are some who say, you know what? I would rather invest more in my house than I would in X, Y, or Z. That’s fine if that’s their priorities. You always just need to understand the trade offs. And so when we’re talking through this, it’s not to say, no don’t go buy a new house or don’t upgrade. No, it’s just understand the ramifications. There may be other ways to get there. There may be a different house that you can put some equity into your own sweat equity-
Austin Wilson:
Sweat equity.
Josh Robb:
…and get just as good a house with less burden on you financially, who knows?
Austin Wilson:
Absolutely.
Josh Robb:
So just don’t make rash decisions. Think through it, make sure you run the numbers, talk to your advisor if you have one, because that’s very important. They can help you through those decisions.
Austin Wilson:
And it’s probably also just really important to not think of the home and the home purchase process as a silo in your financial picture because it impacts everything. So it really should be taken into consideration with your entire financial plan and how you are investing your money and how you’re saving your money and how you’re spending your money. In other ways, it all needs to be looking in at the same place. So that’s why it’s good to work with an advisor because they can kind of look at the entire picture there. Right?
Josh Robb:
I like that.
[16:24] – Should You Buy a House?
Austin Wilson:
I know you would like that Josh. Josh, here’s the question. Should you buy a house?
Josh Robb:
Yes.
Austin Wilson:
Okay. That’s it.
Josh Robb:
Again, we talked about renting versus owning a home and the answer was, it depends on your situation. This is the same thing. If you already own a home, should you upgrade or move? Maybe. Did you buy a house with two bedrooms? And now you have six kids? Maybe it’s time. I don’t know. But yeah, it really just depends. And that’s really the answer is everybody has unique situation and you got to think through those choices. People ask so too, right now housing prices are up, right. We’ve had a strong thing. It’s like, well, I could sell my house before, but I’m going to buy it. So don’t-
Austin Wilson:
You’re even coming out ahead. Yeah.
[17:34] – Don’t Forego Safety Measures
Josh Robb:
…don’t look at that. And I always say, it’s the same as like the stock market. It’s not what’s happening now. It’s, does this make financial sense for me? So it’s the same as the stock market’s up. Well, I should probably wait for it to drop before I invest. Well, who knows? Because it could keep going up. And then you say, well, I wish I would’ve bought then. The same issue with houses, yes they’re up in price now. But if you could sell your house for high and buy it for high, as long as it’s affordable, then doesn’t really matter if you got what you needed for that situation and you’re comfortable for what you paid for it. And that’s really the answer. What I did see is I saw an article during this research that because of the housing market being so hot right now, people are foregoing all the safety measures put in place like inspections and all the-
Austin Wilson:
Buying also site unseen.
Josh Robb:
Do not rush through the process just to get it done. There is a lot of things that people will do. And that’s what happened 809 too, is they were paying unreasonable prices with the expectation that it would continue. Make your assumptions on, can I afford what I’m getting into? Not if it goes up, I can sell it for a profit, but where I’m at, is it affordable for me? And so that’s the answer to this whole thing.
Austin Wilson:
Absolutely. So that was a really big tangent on me finding a way to creatively ask Josh how he can say it depends or in moderation.
Josh Robb:
In moderation.
Austin Wilson:
Yeah. Those are the things.
Josh Robb:
You should have moderate house all the time.
Austin Wilson:
But it depends.
Josh Robb:
It depends if you have a moderate house.
Austin Wilson:
Exactly. So thank you for being here this week, two quick reminders and there’s not that many weeks left of our stock draft, which I’m winning.
Josh Robb:
You’re kicking butt.
Austin Wilson:
That’s right. Go Bitcoin. It’s not too late though to enter it. And hopefully this episode comes out before the end of the year, which it will.
Josh Robb:
It will.
Austin Wilson:
In that case, you have a couple weeks probably to start with a fresh hundred grand, try and beat me. So, that’s number one. Number two, as always check out our for gift you a brief list of Eight Principles of Timeless Investing, overarching investment themes meant to keep you on track to meet your long term goals, a house and all of that is part of your financial picture. So think about that. When you’re looking at it, check it out. It’s free on our website. Josh, how can people help us grow this podcast?
Josh Robb:
Yeah. Make sure you subscribe that way, every Thursday you get our most recent episode sent directly to you. Leave a review on Apple Podcast. It’s always great, helps us rank higher are so more people find us when they’re searching. And then if you have any thoughts, questions, have questions about the housing market. Send us an email at hello@theinvesteddads.com. We love hearing from you love your ideas for episodes. We always take those and try to record those as soon as possible because if that’s what you want to hear, we’d love to talk about us.
Austin Wilson:
That’s right.
Josh Robb:
And then if you know somebody who’s talking about houses or think about buying, shoot them this episode, hopefully will help them.
Austin Wilson:
All right. Well until next Thursday, have a great week.
Josh Robb:
Yep. Talk to you later.
Austin Wilson:
Bye.
Outro:
Thank you for listening to The Invested Dads Podcast. This episode has ended, but your journey towards a better financial future doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review. Click subscribe and don’t miss the next episode.
Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All Opinions expressed by Josh, Austin or any podcast guest are solely their own opinions, and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions or forecast provided here in will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.
