One of the biggest myths about money is that if you rent, you’re a loser, and buying a house is the best investment. The propaganda around real estate can be extremely harmful and can lead you to buy for the wrong reasons.
Even worse, it can cause you to get a mortgage you can’t afford. But this doesn’t just happen because of societal pressure. It’s also because most people don’t know how to run the numbers, what they can afford, and how to save properly for a house.
Buying a house is one of the biggest purchases of your life. When done the right way, it can be extremely rewarding! So I want to walk you through how to do it. By the end of this guide, you’ll be able to answer all of these questions:
Will I live here 10+ years
Is my total housing cost lower than 28%?
Have I saved 20% for a down payment?
Am I ok if the value of my house goes down?
Am I excited about buying?
Step 1: Be aware of the myths & propaganda
Buying a house is often not a carefully measured purchase. Instead, it’s a decision based on propaganda and myths.
The reasons we’re starting here is because myths around buying a house are so heavily seeped into our culture that almost everyone believes they’re true. This has caused so many people to buy a home when they’re not ready or when it’s not the right choice for them.
If you’re considering buying a house, the first thing to do is unlearn these myths.
MYTH: Renting a house means you’re just paying your landlord’s mortgage
Almost everyone thinks being a landlord works like this: a landlord owns a place that costs them about $1,000 a month, they add on 10% — and laugh all the way to the bank:
This is untrue.
Your landlord can only charge you what the market will bear. That means sometimes the rent you pay is more than their expenses, and many times, it’s not.
This myth has led to so many people rushing into buying a house because they think someone else is getting the better end of the stick.
MYTH: If you’re paying rent, you’re throwing money away
I posted these questions on Twitter. What do you notice?
Virtually everyone agreed that when I paid for dinner, it was worth it. But when I said I rented an apartment, suddenly many more people thought I “threw money away on rent.”
But when I pay rent, I have a roof over my head, a great view, and a home to lay my head.
When you pay rent, you’re paying for value. When you spend money at a restaurant, you’re paying for value. The same concept applies when you pay for essentially anything. It’s as simple as that. You’re not throwing money away if you rent.
MYTH: Housing prices will keep going up
It’s a common belief during times of mania that rising prices will sustain themselves forever.
It happened during ‘99, during ‘06 and ‘07, and again during 2020, ‘21, and ‘22 where people say, “Oh my god, housing is going to be this expensive forever. Crypto is going to go up 10,000% forever.”
That almost never happens. It mathematically cannot sustain itself.
(By the way, the same goes for rent! Rent doesn’t just go up—it also goes down. Again: landlords can’t just charge what their costs are. They can only charge what the market will bear. Sometimes this means lowering rent.)
You should always have a financial plan that tells you how much money you need to save and invest and how you’re using your money to create a Rich Life. And you also should be aware of what’s going on in the world.
If you’re thinking of buying a house when prices are high, I’d wait for housing prices to drop and then make a decision based on whether or not you can afford it.
MYTH: Buying a house is always a great financial investment
Buying a house doesn’t always equal building wealth. The pricing of your house might not go up. If it does, then great!
But it often takes YEARS to build any meaningful equity. And maybe, once you factor in Phantom Housing costs (down payment, maintenance, taxes, etc.), you could’ve gotten a much better return in a simple S&P index fund.
Buying a house isn’t guaranteed to be a great investment. That’s why I always say, if you choose to buy, you should also be OK if the value of your house goes down.
Step 2: Figure out if buying a house is part of your Rich Life
Now that you’re aware of the myths and propaganda, you’re in a much better place to make your own decision. Instead of listening to what everyone around you is parroting, you can decide what YOU want and what makes sense for YOU.
I encourage you to really take some time to decide if buying a house is right for your current season of life and is part of your Rich Life.
What is your Rich Life?
A Rich Life is your ideal life — one where you look at your personal relationships, your finances, and your ordinary days and say, “Wow, I love this!”
Your Rich Life is YOURS. Not your parents’, not your friends’. Not even mine. Yours.
It’s a life that is full. A life lived intentionally, proactively, and abundantly.
Let’s go more into detail about what a Rich Life can be:
Is buying a house part of your Rich Life? And is it part of your Rich Life in your CURRENT life season?
Buying a house is a financial decision AND a lifestyle decision. It might not be the right choice for you NOW — but maybe it will be right for you in another season of your life (or once you’ve saved enough to afford it).
Here are some good reasons to buy a house:
- You have kids and you want to stay in your area, school district, and build memories in the same house for at least 10 years
- Your parents are moving in with you
- You want to design a house together with your spouse
- You love repairing and tinkering with a house and making it your own
- You just want to!
Notice what’s not on the list: “You need the price of the house to go up.”
I’ll repeat myself again: buying a house doesn’t always mean building wealth. So this should not be part of your decision process. Buy for the right reasons.
Step 3: Run the numbers
If you want to know whether or not you’re ready to buy a house now, run the numbers.
Very few people do this the right way (or at all). Many people make this common mistake:
- 2-bedroom house for $2,000 rent
- 2-bedroom house for $2,000 mortgage
“Same price? I should build equity!”
They forget to add ~30% – 50% for Phantom Costs (interest, taxes, closing costs, and maintenance, etc.) to the monthly mortgage. They don’t realize true expenses until it’s too late.
Rent is the MAXIMUM you will pay, but a mortgage is the MINIMUM you will pay.
To figure out exactly what your expenses would be and whether or not you can afford a house, there are a couple of numbers to figure out first. Let’s dig into it.
QUESTION #1: Can you afford it based on your income and debt?
Your total housing costs should be less than 28% of your gross monthly income (your front-end ratio), and total household debt shouldn’t exceed more than 36% of your gross monthly income (your back-end ratio). This is the 28/36 rule.
When housing costs exceed 28%, you run the risk of being overwhelmed with expenses if something goes wrong (e.g., an unexpected repair, job loss, etc). And if your total household debt exceeds more than 36% of your gross monthly income, you might have more difficulty getting a mortgage from lenders.
To see if you can afford it based on your income and debt, let’s break it down.
First, add up your household monthly costs.
Below is a guideline for the numbers that will make up your total household costs. The list includes Phantom Housing Costs — like maintenance and insurance — which most people forget about:
- Principle. This is the part of the payment that goes towards paying down the amount you would borrow to purchase the house.
- Closing costs. Buyers can expect to pay between 2% and 5% of the purchase price on closing fees.
- Interest. This is the rate creditors charge for lending you the principal.
- Taxes. This is your property tax.
- Insurance. This is your homeowner’s insurance.
- Maintenance. This is the cost to maintain your home and the utilities in it, like the roof repair 7 years for now. A simple guideline is 1% of your purchase price every year.
- Any additional fees related to the specific place you’re buying. HOA fees, condo fees, etc.
Calculate the monthly cost of each of the above items, and add it up to get your total monthly housing costs.
Now, calculate your monthly housing costs.
Figure out if your total monthly housing costs would be lower than 28% of your gross monthly income.
Here’s how to calculate it:
Total housing costs ÷ Dollar amount of your gross monthly income = your monthly housing costs
Multiply this number by 100 to get your percentage.
It should be lower than 28%.
Here’s an example:
Say your total housing costs are $1,120 / month, and you make $4,000:
$1,120 ÷ $4,000 = .28
.28 x 100 = 28%
In this case, you’re exactly at 28%. Ideally, you’d be lower than this (though, in high cost-of-living areas like NYC and LA, most people are above this).
Next, calculate your 28/36 number.
See if your total monthly housing costs plus your total debt load would be lower than 36% of your gross monthly income.
This number compares your income to your debt. Creditors look at this number to determine how risky it is to lend to you.
The riskier it is to lend to you, the smaller chance you have of attaining a home loan — or at least a home loan with a good interest rate.
Here’s how to calculate it:
Dollar amount of monthly debt you owe ÷ Dollar amount of your gross monthly income = Debt-to-income ratio
Multiply this number by 100 to get your percentage.
The lower the number is, the better. The 28/36 rule of thumb says that you should ideally have no more than 36% for your debt-to-income ratio.
Here’s an example:
Say you owe about $1,000 in debt month-to-month and make $75,000 a year ($6,250/month):
$1,000 ÷ $6,250 = .16
.16 x 100 = 16%
In this case, you’d be in great shape because your 28/36 number is 16%, which is much lower than the 36% maximum.
Exceptions to the 28/36 rule
- If you live in a HCOL (high cost-of-living) area like NYC or Los Angeles, many people stretch the 28% number to 35% or even 40%.
- If you have no debt (e.g., no car payment, student loans, or credit card debt), you might stretch the numbers a little. I’d consider going to around 33%, but I’m conservative with my finances.
- If your income is reasonably expected to go up soon, such as a job promotion, you may stretch the numbers a little. Again, I’d conservatively consider going to 33%.
Lastly, determine if you’d still be able to save and invest.
At the same time, you should also be able to save 5 to 10% of your take home pay, and invest roughly 10% of your take home pay.
QUESTION #2: Have you saved a 20% down payment?
If you haven’t saved a 20% down payment, you’re not ready to buy a house.
Why? It’s not just because of PMI, which is an additional fee you’ll often pay when you get a mortgage without 20% down.
The real reason to save 20% before buying is counterintuitive: Building the habit of saving is critical before you buy and have unexpected housing expenses such as a broken water heater, roof, or unexpected taxes.
I frequently get frustrated comments about how “impractical” this rule is. “How am I supposed to save 20%? That will take years!”
Yes, it will. Which is exactly why you should save now. Saving is a habit, which is better practiced before your mortgage is at risk.
Note: I don’t mean that you have to put 20% down. In some cases, such as low interest rates, many people intentionally choose to put a small amount down. But you should be able to put 20% down regardless.
Not yet ready financially?
If you want to buy, but you’re not yet ready financially, I recommend the CEO method: cut costs, earn more, and optimize spending. Here’s how it works:
- Cut Costs
Identify areas where you can cut spending, whether that’s in your fixed costs category or your guilt-free spending. Use my Conscious Spending Plan to get an understanding of your income, spending, investing, and saving. You can reallocate some of your money towards your goal of buying a house.
If you want to create a full system for your finances to achieve ALL of your Rich Life goals (like buying a house or taking your dream vacation), I walk you through every step to do it in my program, Money Coaching with Ramit Sethi.
- Earn More
There’s a limit to how much you can cut, but no limit to how much you can earn. One option is finding a new job that pays better (which my Find Your Dream Job program shows you how to do).
Another is to start a side business (which my Earnable program shows you how to do). This will expedite your ability to buy a house, because you’ll be able to put more away towards your housing costs and down payment.
- Optimize Spending
You can do this in 2 ways. 1) Negotiate your bills — like your car insurance or phone bill. 2) Try the A La Carte Method, which means cancelling all of your subscriptions and only adding them back as you use them. This forces you to be conscious of your spending. I show you how to take control of your spending in my program, Money Coaching with Ramit Sethi and in my book, I Will Teach You to Be Rich.