Follow the 30-30-3 Rule Before Buying a Home During Covid

Dated: December 28 2020

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As mortgage rates reach all-time lows due to the pandemic, demand for real estate has increased exponentially.  But that doesn’t necessarily mean you should buy a home right now.  Way too many homebuyers overextended themselves during the 2008 financial crisis.  As a result, most of us paid the price.  Having your neighbor conduct a short sale or foreclosure isn’t good for your wealth, even if you borrowed within your means.  To prevent buyers from the stress of owning a house they can’t afford, use the “30/30/3” home-buying rule.  The rule has three parts; ideally you want to follow all three, but if not, then at least follow one.

Rule No. 1:  Spend no more than 30% of your gross income on a monthly mortgage

Traditionally, the industry advises that your monthly mortgage should not exceed 30% of your gross income.  But as mortgage rates continue to decline, many people may be tempted to go beyond 30%.  When rates are lower, you can already spend more on a home if you keep your spending as a percentage of gross income fixed.  The real danger emerges when you break this rule to buy an even more expensive home.  For example, spending 40% of your monthly $50,000 gross income on a mortgage still leaves you with $30,000 in gross income.  Spending 40% of your monthly $5,000 income, however, leaves you with a much smaller cushion to take care of your basic needs.  The more income challenged your are, the safer it is to spend less. 

Rule No. 2:  Have 30% of the home value saved up in cash

Before buying a home, have at least 30% of the value of the home saved in cash or low-risk assets—20% for the down payment (to get the lowest mortgage rate and avoid private mortgage insurance) and 10% as a healthy cash buffer.  This might sound like a lot, especially since there are programs that allow you to do a smaller down payment.  But during time of high uncertainty, it is better to have a larger financial cushion.  Homeowners who got blown out the quickest during 2008 had minimal down payments, which increased the temptation to walk away from an underwater mortgage (those who did between 2008 and 2012 missed out on one of the largest real estate recoveries).  If you plan on buying within the next six months, keep at least the 20% down payment in cash.  It is unwise to invest your down-payment in stocks and other risk assets if your homebuying time horizon is so short. 

Rule No. 3:  The price of your home should be no more than 3x your annual gross income

This is a quick way to screen for homes in an affordable price range.  It also takes into consideration down payment percentages and prevents you from stretching too much, even with a high down payment.  If you earn $100,000 per year, then you can comfortably afford up to a $300,000 home.  Of if you have a top 1% household income of $500,000, you can afford up to $1,500,000.  Again, with mortgage rates collapsing, housing affordability has gone up.  Therefore, you could stretch this final rule and extend the home value by up to five times your annual household income.  Just keep in mind that a salary five times larger not only means more absolute debt, but also higher property taxes and maintenance expenses. 

Ways to get around the 30/30/3 rule:

Although this homebuying rule may seems stringent in such a low interest rate environment, just know that plenty of people pay all-cash for their homes, too.  This idea of taking on lots of debt to buy a property hasn’t always been the norm.  If you want to violate the 30/30/3 rule, then at least consider:  renting out a room or portion of your house, starting a side hustle to have a legitimate way to deduct a home office and expenses such as internet, putting yourself in line for a raise or secure a new job with a higher salary, building new passive income streams to help pay for homeownership expenses, being really good to your parents and rich relatives. 

Have discipline when buying a home: 

Despite all the benefits of investing in real estate, it’s best to avoid overextending your finances.  Remember, in addition to a mortgage, you’ll also have to pay for other things like homeowner’s insurance, property taxes and maintenance fees.  Buy a home for lifestyle first.  If it happens to appreciate in value, that’s wonderful.  If not, then it doesn’t really matter because you spent all those years creating great memories in your home. 

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John Lick

John Lick--brings his vast experience in contracts and negotiations to the Maurice & Lick team. Prior to becoming a full-time Realtor, he worked for a multi-billion dollar government agency and with ....

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