Every personal finance social media account loves to talk about cars and how the rich drive old, beat up cars. And while this may be partially true, you do not have to do this to become wealthy (although it sure does help to have less debt and lower fixed payments). This conversation leads to many wondering how much house and car they can reasonably afford? Let’s explore this topic some more!
The general rule of thumb is that your car should cost no more than 15% of your take home pay. Note that I said take home pay. If you take home $5,000 a month, that means your car loan, gas, maintenance, parking, etc. should be no more than $750 a month. A huge mistake I see millennials making is buying too much car too early on. They stretch themselves too thin with a payment closer to 20% or even more. And the more you spend here on fixed payments, the less you can spend elsewhere on travel, going out, etc. And even worst, it means you have less available dollars to invest for the future!
The general rule of thumb for your house is that you should not spend more than 28% of your gross income on it. This includes mortgage, utilities, taxes, insurance, lawn care, etc. If you make $150,000 a year combined in your household, that means you can afford around a $450,000 house assuming a $50,000 down payment and current interest rates of 7% (use this calculator to play around with the numbers and see what is affordable for you). Again, just because you can afford 28% does not mean you need to do it. The lower your housing payment, the more freedom you have outside of it. No one likes being house poor.
The 28/36 rule is used to help you best understand how much house and car you can own. The rule sates that you should spend a maximum of 28% of your gross income on total housing expenses and no more than 36% total to all the debt you have. This includes housing, cars, credit cards, student loans, etc. That means if someone makes $150,000, they should spend under $54,000 a year on all debt payments.
Why is this helpful? Let’s say you choose to buy a car that is close to 10% of your gross income and you have other debts that cost 5%. Now if you are in the market for a house, you can better understand how much you can reasonably afford from this. Since you already are spending 15% of your gross income, you should only get a house (with all its’ costs) that equates to 21% of your gross income.
Remember, these are just rules of thumb. Everyone’s situation is different and these numbers may need to be fine tuned for you and your life. Deciding how much house and car you can afford requires you to understand yourself and what you value. If you really value a house above all else, then spending more on that makes sense. If you don’t and really love to travel, then cutting to free up dollars to travel makes sense.
Use your money in a way that you value, that is key!
Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax , and financial team before making any changes to your financial plan.
Financial Advisor