This Underrated Rule of Thumb Will Tell You How Much House You Actually Can Afford

Buying a new home is a significant financial decision that requires careful consideration and planning before you can get the keys. That's why it's essential to determine how much house you can afford before embarking on the home-buying journey. There are tons of rules and formulas for determining what you can afford, but one rule of thumb, in particular, stands out -- the 8.71% rule.

What is the 8.71% rule?

The 8.71% rule takes into account the additional cost of homeownership, including property tax, maintenance costs, and cost of capital. The cost of capital is the opportunity cost of the down payment. Essentially, this refers to the cost of not putting your down payment money into other investments, like the stock market.

These three expenses make up the bulk of the cost of homeownership, and taking them into account is crucial in determining how much you can afford to pay for a home on a monthly basis.

The average rates for these three expenses add up to 8.71%.

• Property tax (1.1%) + maintenance costs (1.00%) + cost of capital (6.60%) = 8.71%

This rule can also help you determine if it is better to rent or buy based on the costs.

How to apply the 8.71% rule to determine your home-buying budget

So, let's break down the rule -- if you want to figure out the total cost of owning a home on a monthly basis, you need to take the home price, multiply it by 8.71%, and divide it by 12.

For instance, if you have your eye on a $500,000 home, you can calculate the annual cost of homeownership by multiplying $500,000 by 8.71% (which gives you $43,550 per year).

Now, divide that annual cost by 12, and that gives you your monthly cost of homeownership: $3,629.17 per month.

So, what does this mean? If you want to make owning a $500,000 home financially feasible, you need $3,629.17 in disposable income per month in addition to your mortgage payment to afford a home. If you cannot afford to pay this extra amount, you might need to reconsider whether or not that house is within your budget.

Factors to consider when using the 8.71% rule

The 8.71% rule is a simple rule of thumb that can help you determine the maximum amount of money you can spend on your home's monthly mortgage payment. It's a quick and easy way to get an idea of what you can afford.

Additionally, the rule can help you save time and effort when you shop for homes within your budget, helping you avoid the disappointment of falling in love with a home that's beyond your reach financially.

This rule can also help you determine if it is better to rent or own. If renting will cost you less than this amount, then it may make better financial sense to rent a home than to buy.

While the 8.71% rule can help you determine the maximum mortgage payment you can afford, it's essential to consider other factors. This can be interest rates, tax benefits, capital appreciation, and your personal finances.

Buying a house is a significant financial investment that requires careful planning and consideration. The 8.71% rule is an underrated but useful tool to help you determine how much house you can realistically afford. By taking into account the hidden costs of homeownership, this rule can give you a realistic idea of what to expect from your monthly budget. It can also help you decide if it is better to rent or buy. Keep in mind, this rule is just a guideline, and your unique financial situation and preferences ultimately determine what you can afford. By following this rule or considering it a starting point, you can make informed decisions about your future homeownership plans.