With today’s crazy real estate market, inflation, and talks of recession it’s difficult to find an affordably priced home. How do you determine if you can “afford” a home? Factor in the worst-case scenario that could jeopardize making your 15 or 30 year mortgage payment.
Say you have a $150k/year salary job as an employee and you’re single. You’re fairly confident in the near term you’ll be employed, but there’s a chance you could be laid off during a recession. Ask yourself, what’s your earning potential during a recession? $100K? $80K? $75K?
Let’s say you believe it’s 100k, but worst case you know for certain you can find a job doing X for at least $75K/Year. Your worst-case scenario is a 50% pay cut. That’s a pretty big deal, considering almost all of your expenses will stay the same, or increase due to inflation.
Ask yourself, if I make $75k/yr, what are my other expenses? Will 37.5K/yr cover those expenses? If so, your housing expense should be 25% of your Gross Salary a year so when your income drops in half, you’ll be able to cover your other expenses. $150k*.25= $37.5K / $3,125/mo
It’s important to understand what your expenses outside of housing are. If you’re forced to cut expenses to just afford housing, your quality of life and happiness can suffer immensely. So much so, you may consider selling a house you just purchased.
The above example is using Gross Salary, but we all know we pay our mortgage using after-tax dollars. This is incredibly important for Self-Employed Individuals to understand at $150k/yr = ~$23K in SS/Medicare Tax + ~$30K in Federal Tax + ~$12k State Taxes (in Iowa)
That $150k for a Self-Employed individual after-tax turns into $85,000 Net or $21k/Yr. The $150k for an employee, is about $96,500 which is $24k/yr as their employer pays one-half of their SS/Medicare Tax (up to $147,000 for 2022). Considering the above there’s a logical argument to make that 25% of Net Income, will be the least risk averse stance to take since we pay our mortgage with after-tax dollars, and in our example, there’s a probability of a 50% drop in income during an economic downturn.
That means a person making $150k hedging their risk during a downturn will still have 50% of their income for other expenses.
So what should this person’s housing cost be equal to?
As someone who is an employee making $150k a year that would mean housing should cost no more than $2,000/mo
As someone who is Self-Employed making $150k a year that would mean housing should cost no more than $1,750/mo
After the price increases, for some it’s nearly impossible to meet these metrics. However, the beauty of this analysis is to give you a better understanding of your personal financial situation, and think of ways you can deal with a layoff, a personal downturn or inflation.
If you need any help regarding these issues Corridor Consulting would love to help, please schedule an individual consultation here. We’re looking forward to opening many more doors for you!
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This article is not professional tax or legal advice for your specific circumstances. Consult with your professional adviser to better understand how these items may impact you, or how they’ve changed
