How Much House Can You Actually Afford? (5 Tests)

How much house can you afford? If you ask a lender, the number is probably a lot higher than what you should actually spend. In the example below, the bank would approve a couple for about $2.25 million, while my numbers put their budget closer to $1.4 million, on the same income.

This article covers why the lender's number differs from yours, the five tests I use with clients, and two special cases: a large portfolio, and wealth tied up in illiquid stock.

Why the bank's approval is not your budget

The Parkers are a made up couple earning $360,000 a year, or $30,000 a month before taxes, with about $1,500 a month in other debt payments and 20% saved for a down payment.

A lender mostly cares about debt to income: all monthly debt payments, including the new mortgage, divided by gross monthly income. Fannie Mae's system will let that go as high as 50%, which allows the Parkers a housing payment of up to $13,500 a month. At a 6% rate, used as a round number since rates move around, that supports a house of about $2.25 million. The lender is only asking whether you will pay them back, not whether you can still save or take a vacation.

The 28% housing test and the 36% debt test

Take your total housing payment, meaning principal, interest, property taxes, and insurance, and divide it by gross monthly income. You want that around 28% or less. Add your other debt, like car payments and student loans, and the guideline is 36%.

For the Parkers, 28% of $30,000 is $8,400 a month. At 36%, after their other debt, they have $9,300. You go with the lower number, so $8,400 a month, which at 6% buys about $1.4 million of house. After taxes and retirement contributions, the Parkers probably take home around $18,000 a month, so even this is close to half their paycheck.

The cash test: what you need beyond the down payment

• Mortgage insurance. With less than 20% down, you will usually pay it until you build enough equity.
• Closing costs. Freddie Mac says these usually run 2% to 5% of the price.
• Reserves and maintenance. Something is going to break. Fannie Mae suggests budgeting 1% to 4% of the home's value every year for maintenance.

For the Parkers, 20% down is $280,000, and with closing costs and a cushion they really need well over $300,000 in cash. Even 1% a year on maintenance is $14,000, a little over $1,100 a month that is not in the mortgage payment.

The savings test: what you can still save after you buy

After the house and all of these costs, I generally want to see savings of 15% to 20% of gross income, including retirement contributions. If the house takes you well below that, it is probably too much house, even if the bank will lend on it.

The Parkers' payment plus maintenance is about $9,600 a month out of roughly $18,000 in take home pay. Maxing out both retirement plans gets them to about 14%. Reaching 20% means finding another $1,900 or so a month. It is tight, so for them $1.4 million is the top of the range rather than the target.

The plan test and the gut check

I like to run a client's 5 to 10 year plan with the house they want and with something cheaper, then compare whether the bigger house pushes back retirement, cuts into college savings, or makes a career change or sabbatical harder. Paying more for a school district or a shorter commute can be a fair call, as long as you know what you are giving up.

Buying a home with a large portfolio

Qualifying through asset depletion is rarely the issue. I think of a house as something you spend your portfolio on rather than add to it. Say a family has $8 million invested and spends about 3.5% a year, roughly $280,000. They buy a $3 million house in cash, and 3.5% of the remaining $5 million is about $175,000. Property taxes, insurance, and maintenance can easily add 2.5% a year, about $73,000. After housing, their spending drops from $280,000 to about $100,000. Mortgage versus cash is a separate question, which I cover in when to pay off your mortgage early.

When your wealth is in RSUs, private shares, or carried interest

This comes up a lot with the private equity professionals and executives I work with. Lenders are conservative here. Unvested stock generally does not count. Vested RSUs can, but Fannie Mae usually wants at least a year with your employer and averages the last two years. Private shares and carry often count for little.

I agree with the lenders. Size the house on cash pay you are confident you will keep getting, and if the equity pays off, use it to pay the mortgage down faster. Two other things to watch:

• Taxes on selling appreciated stock. With a very low basis, 23.8% federal, and say 5% state, you would need to sell around $700,000 of stock to net $500,000.
• Borrowing against the stock. Those loans can be called, and FINRA points out you typically get 2 or 3 days to add collateral if the stock drops.

Start with whichever test gives the lowest number, and if you go above it, do it deliberately.

Common questions

How much house can I afford on a $360,000 income?

In this example, a lender would approve about $2.25 million at 6%, but the 28% housing test puts the couple closer to $1.4 million, which I would treat as the top of their range.

What is the 28/36 rule for buying a house?

Your housing payment, including principal, interest, property taxes, and insurance, should be around 28% or less of gross monthly income, and housing plus other debt around 36% or less. Use whichever gives the lower payment.

Do lenders count RSUs as income for a mortgage?

Unvested RSUs generally do not count. Vested RSUs can, with at least a year of history at your employer usually required.

VDB Wealth is a registered investment adviser. Information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not indicative of future performance.

If you ask a lender how much house you can buy, the number they give you is probably a lot higher than what you should actually spend. In the example I am going to use today, the bank would approve a couple for about two and a quarter million dollars. When I run their numbers the way I would with a client, the budget comes out closer to one point four million. That is almost nine hundred thousand dollars apart, on the same income.

So I want to walk through the five tests I use with clients to figure out a home budget. And if you have a big portfolio, or a lot of your wealth is tied up in company stock, stick around for the end, because the usual rules do not fit your situation very well.

Who I am and what we will cover

If you are new here, I am Andy VandenBerg. I run VDB Wealth, a boutique registered investment adviser, and I work with private equity professionals, founders, and executives on taxes, equity compensation, and the rest of their personal balance sheet. A home purchase comes up a lot with clients, and it ends up touching almost every other part of their plan.

We will start with why the lender's number is so different from yours, then go through the five tests, then the two special cases, and I will finish with a quick checklist.

Why the bank's number is not your number

I am going to use one example the whole way through. The Parkers are a made up couple who earn three hundred sixty thousand dollars a year, so thirty thousand a month before taxes. They have about fifteen hundred a month in car and student loan payments, and they have saved enough to put twenty percent down.

A lender mostly cares about debt to income. That is all of your monthly debt payments, including the new mortgage, divided by your gross monthly income. Fannie Mae's system will let that go as high as fifty percent. For the Parkers, that means a housing payment of up to thirteen thousand five hundred a month. I am using a six percent mortgage rate for all of these examples just as a round number, since rates move around. At six percent, that payment gets them to a house of about two and a quarter million.

But the lender is really only asking whether you will pay them back. They are not checking whether you can still save for retirement, pay for childcare, or take a vacation. That part falls on you.

Tests one and two: income and debt

The first test is the one most people have heard of. Take your total housing payment, so principal, interest, property taxes, and insurance, and divide it by your gross monthly income. You want that around twenty eight percent or less.

The second test adds in your other debt, like car payments and student loans. The guideline there is thirty six percent.

For the Parkers, twenty eight percent of thirty thousand is eight thousand four hundred a month. Thirty six percent, after their other debt, leaves nine thousand three hundred. You go with the lower one, so their budget is eight thousand four hundred a month, which at six percent buys a house of about one point four million.

So the bank is fine at two and a quarter million, and the guidelines say one point four. That gap is where I see a lot of people get stretched.

And keep in mind that twenty eight percent is of gross income. After taxes and retirement contributions, the Parkers probably take home around eighteen thousand a month, depending on their state. So even the conservative number is close to half of their actual paycheck.

Test three: the cash test

The third test is cash. Most people plan for the down payment and not much else, and that is where a lot of budgets fall apart.

If you put less than twenty percent down, you will usually pay mortgage insurance until you build up enough equity. Then there are closing costs, which Freddie Mac says usually run two to five percent of the price. And you want money left over after you close, because something is going to break. Fannie Mae suggests budgeting one to four percent of the home's value every year for maintenance.

For the Parkers, twenty percent down is two hundred eighty thousand dollars. With closing costs and a cushion, they really need well over three hundred thousand in cash. And even one percent a year on maintenance is fourteen thousand dollars, a little over eleven hundred a month, that is not in the mortgage payment at all.

Test four: the savings test

The fourth test is the one I spend the most time on with clients. After you buy the house and cover all of these costs, how much can you still save? I generally want to see fifteen to twenty percent of gross income, including retirement contributions. If the house takes you well below that, it is probably too much house, even if the bank will lend on it.

For the Parkers, the payment plus maintenance is about nine thousand six hundred a month, out of roughly eighteen thousand in take home pay. Maxing out both of their retirement plans gets them to about fourteen percent. Getting to twenty would mean finding another nineteen hundred or so a month, out of the money that also covers childcare, cars, groceries, and travel. They can probably make it work, but it is tight. So for them, one point four million is the top of the range, not the number I would aim for.

Test five: the plan test and the gut check

The fifth test is the bigger picture. I like to run a client's five to ten year plan with the house they want and with something cheaper, and compare. Does it push back retirement? Does it cut into college savings? Would it make a career change or a sabbatical harder?

And then there is the stuff numbers do not capture, like the school district, the commute, or a yard for the kids. Sometimes that is worth paying more for, and that is a fair call. I just want people to make it knowing what they are giving up.

If you have a large portfolio

Now the two special cases. The first is if you have a large investment portfolio. Lenders can count your assets through what is usually called asset depletion, so qualifying is rarely the issue.

But the more important thing is how you think about the purchase. I think of a house as something you spend your portfolio on, not something you add to it. Say a family has eight million dollars invested and spends about three and a half percent a year. That is roughly two hundred eighty thousand dollars. Now they buy a three million dollar house in cash. The portfolio drops to five million, and three and a half percent of that is about one hundred seventy five thousand. Then the house has its own costs. Property taxes, insurance, and maintenance can easily add up to two and a half percent a year, which is about seventy three thousand. So after housing, their spending goes from two hundred eighty thousand a year to about one hundred thousand.

That is the math I care about for families like this, more than what they can qualify for. Mortgage versus cash is a separate question, and I have a full video on that, which I will link here.

If your wealth is in illiquid stock

The second special case is when a lot of your net worth is in things you cannot easily sell. Unvested RSUs, private company shares, carried interest, or a big position in one stock. I see this a lot with the people I work with.

Lenders are conservative here. Unvested stock generally does not count. Vested RSUs can, but Fannie Mae usually wants at least a year of history with your employer and averages the last two years. Private shares and carry often count for very little.

I actually agree with the lenders on this. I would size the house on the cash pay you are confident you will keep getting. If the equity pays off, great, use it to pay the mortgage down faster. I just would not count on it to make the monthly payment work.

Two other things to watch. If you sell stock that has gone up a lot to fund the down payment, remember the tax bill. With a very low cost basis, twenty three point eight percent federal, and say five percent state, you would need to sell around seven hundred thousand dollars of stock to net five hundred thousand. And if you borrow against the stock instead, those loans can be called. FINRA points out you typically get two or three days to add collateral or pay it down if the stock drops. I would not want my house depending on one stock holding up.

The scorecard and next step

So to pull it all together, here is the checklist. I would start with whichever test gives you the lowest number, and if you go above it, do it deliberately.

If you are thinking about buying and want someone to look over the numbers with you, feel free to reach out. Leave a question in the comments or get in touch through vdbwealth.com. And if this was helpful, please subscribe.