Establishing Your Housing Budget

"What percent of my income should I spend on my mortgage payment? How do I establish a housing budget that takes all of my other expenses into account? How much of a house can I afford to buy?"

Every week, we receive questions like these from our readers. So I thought it was time to address this topic in a comprehensive way. In this video lesson, you'll learn how to create a housing budget the right way. You'll find a full transcript of this video below.

Video transcript: Today we will talk about the importance of using a housing budget, and how you can easily create one before buying a home. The purpose of this exercise is to answer the question: How much house can I afford to buy?

The first thing we are going to look at is your net monthly income. This is the money you make each month after taxes. For this hypothetical scenario, let's say I make \$6,000 per month. This is my take-home pay after taxes.

The next thing I need for my housing budget is a list of monthly expense.

• Let's say I have a student loan with a monthly payment of \$250.
• My car payment is \$550 per month.
• My credit card payment is \$250 per month.
• I add up my groceries, what I spend at the grocery store on a monthly basis, and it comes out to \$600 per month.
• The lifestyle or entertainment category includes the things I like to do for fun, things I don't want to sacrifice. Let's say I spend about \$200 a month on dinners, movies, etc. Remember, you don't want to give up your lifestyle just to buy a home.
• Savings. It's always good to put money toward your savings or retirement account every month. Let's say I contribute \$500 to savings each month.
• Rent. I can leave this item off the list, because my rent payment will go away when I buy a house.
• Utilities. Average utilities for water and electrical come out to around \$150. You might pay more or less than this, based on where you live and other factors. But \$150 is a good average number for our purposes.

Now it's time to add these items up. I've done the math for you. It comes out to \$2,500. This is the amount I spend each month on my various debts and lifestyle expenses. That means I have \$3,500 left over each month (\$6,000 - \$2,500).

Now my housing budget is shaping up. I don't want to spend any more than \$3,500 on a mortgage payment. In fact, going less than this would be ideal because it would give me some breathing room. But this is the absolute most I can spend on my combined housing costs.

A General Rule for Housing Budgets

I think it's foolish to spend half of your income on a mortgage payment. That's a good way to become "house poor." In this scenario, spending \$3,000 per month on monthly payments would equal 50 percent of my net income. That's too much, in my opinion.

As a general rule, I recommend keeping your housing costs below one-third of your net income (like a \$2,000 mortgage payment with \$6,000 net income).

When I talk about your combined housing costs, I'm talking about everything you pay to be a homeowner. This includes your mortgage payment (which will probably include homeowners insurance and property taxes), home maintenance and repairs, HOA fees, etc. All of these things cost money, and they're all part of your total housing costs.

So, I should not spend more than \$3,500 for my monthly housing costs -- and ideally a lot less. If I get approved for a loan, and the monthly payment comes out to be \$3,700, a red flag should go off in my mind. I'm being approved for a loan that's probably too big for me.

This kind of thing happens all the time. It's possible to get approved for a mortgage that exceeds your comfort level. That's why you need to establish a housing budget before you apply for a loan.

So I want to stick with \$3,500 as an absolute maximum. The further I go below this number, the more of a buffer I have for emergencies. I don't want to wipe out my paycheck each month between my mortgage payment and other debts. That would leave me nothing to cover unforeseen events. What if my car breaks down? What if I run into some hospital bills I didn't plan for?

Conclusion and Summary

So that's how you come up with a housing budget for mortgage purposes. Look at what you're bringing in each month -- your take-home pay. Add up all of the things you spend money on each month. Add up your car payment, your credit card payments, groceries, etc. Don't worry about your rent because that item will go away.

Subtract your monthly expenses from your income, and that will give you your maximum housing budget. I recommend reducing it even more, so you can allow for any emergencies that might come up. I recommend using no more than 33 percent of your net income to cover your housing costs -- less is better.

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I hope you've enjoyed this lesson in housing costs. If you would like to learn more about this topic, you can use the search box at the top of this page. There are more than 1,000 lessons and tutorials on this website. So you're bound to find what you need. Good luck with your home buying process.