The Rule of 28 remains dead, and I feel even stronger about it than I did in April 2018 when I argued the point in an op-ed in the Arkansas Democrat Gazette.
You can read the op-ed here: arkansasonline.com/112rule28, but the rule of 28 is an erroneous measure of what the typical person can afford to pay in a monthly house payment (mortgage, insurance and taxes) based on a percentage of gross monthly pay. The rule dates back to the 1930s, a time that looks very different financially to us in the 21st century.
What should it be? The Rule of 14! This means that for many people, the upper limit on an affordable house payment is 14% of gross monthly pay. The calculation uses real people's budgets and the realities of day care, health care, college costs and cable/cellphone/technology costs that are mandatory luxuries these days.
If you are a homeowner, test it out. Take your house payment and divide it by your gross wages for the month. Is it less than 14%? If so, I'll wager that you take regular vacations, save into a retirement plan, and probably have the ability to save into college accounts for your kids. Is it more than 14%? Maybe you have a frugal lifestyle naturally and can still save. Or maybe, just maybe, you are like so many Americans -- living paycheck to paycheck. Maybe you bought somewhere around the rule of 28 or even modestly less and thought you were checking all the right and prudent boxes.
We call this being house poor. We have clients in high cost of living areas where a modest bungalow runs $2 million. Imagine the stress of working to pay a mortgage with little or no additional long-term savings or cushions to take vacations. Your only hope of retiring is to sell your home, leave behind friends and family, and move to a different city far away with less expensive homes. Lucky for us in Arkansas, it is reasonable to find houses in the rule of 14. And if you find yourself house poor, I beg you to explore alternatives. Homes don't bring joy. Experiences do. That outsized mortgage might be taxing your joy.
Oh, and speaking of taxes, it turns out that not a lot of people are enjoying the old trusty mortgage interest tax deduction any more, a very old and overblown reason to buy more house and even finance more of it rather than bother with a 20% down payment. The Tax Cuts and Jobs Act of 2018 increased the standard deduction, so only about 17 million households itemize their taxes versus about 46 million the year before. If you don't itemize, you don't get any benefit from the mortgage interest tax deduction.
Let's say you want to buy for the first time now, or you are about to upgrade your house because you need two home offices instead of one. You can use the rule of 14 and hope that it works out, or you can simulate that new payment before you buy and know that it will work out.
When I recommend this to people, they look at me like it's the most obvious idea, but I have still never met anyone who has done this before buying a house.
In theory, you calculate 14% of your gross pay to come up with your potentially affordable new house payment and then add an estimate for your cost of upkeep on that new house. Try putting the difference between this estimated house payment and your current one into a savings account every month. That's your simulation.
Let's say your gross salary is $84,000 per year or $7,000 per month. 14% of $7,000 is $980. There is your affordable payment for mortgage, insurance and taxes. That equates to a loan of $130,000, a far cry from the $260,000 many banks say is affordable. Let's say you want a bigger house than $130,000. Do you have to wait until you make more money? Not necessarily. You can save for a larger down payment, which would ideally be 20% of the cost of the home. In our ideal scenario, you would buy a $170,000 home and put $40,000 down, ending up with a $980 monthly house payment.
Where is that down payment going to come from? Wait for it. Your housing simulation! It's totally genius, right?
But wait, there's more. Lot's more. See, owning a house is more than making a payment. Things will break in that house, and while a lot of us are the prayin' kind, no amount of praying will unclog a drain or keep a roof from needing to be replaced every 20 years.
The answer is to build in an assumed home repair reserve for regular home upkeep. One common measure is to put 1% of the value of your home into a repair reserve savings account every year. In our example take the $170,000 home value, multiply by 1%, and divide by 12. That's about $140, or the amount you should put into a savings account each month to save for those things that we all know can and will happen over the course of owning your own home.
Now, back to the simulation. Take the estimated monthly house payment and repair reserve costs and put the difference between those and your current housing costs into a savings account every month for the next 6 months or more. If there is a month you can't swing it, or if there is a month you have to raid the account, then heed my advice; don't buy that house.
If you get to that 6 months or 1 year and find that you did not have to dip into that money and that you could save for retirement, take vacations and, shoot, have a little fun, then, congratulations, you know you can afford to buy that house.
Sarah Catherine Gutierrez is founder, partner and CEO of Aptus Financial in Little Rock. She is also author of the book "But First, Save 10: The One Simple Money Move That Will Change Your Life," published by Et Alia Press. Contact her at firstname.lastname@example.org.