The 30-30-3 Rule Explained: How to Buy a House in 2023

While it’s always encouraged in this blog to take on the least amount of debt as possible, sometimes there is just no way of getting around debt due to life stages and situations. But we can always be smart about how we take on debt, specifically mortgage debt. The 30-30-3 rule exists just for that purpose: to provide a guideline on how much of a house to buy and how to assess if it is too expensive for you. These guidelines do not have to be met with 100% accuracy, but the further you get away from them, the more pinch you will feel in your budget:

30% of Monthly Income

Your monthly mortgage payment, including principal, interest, property taxes, and homeowner’s insurance (often abbreviated as PITI), should not exceed 30% of your monthly gross income. This helps ensure you have enough money left over to cover your other monthly expenses and maintain a comfortable lifestyle.

Obviously, if you have a spouse this factors in combined incomes. This metric gives a bit more wiggle room than the classic “25% of your take home pay” that Dave Ramsey suggests. Many times it’s just not possible to meet those metrics, especially in HCOL areas.

30% Down Payment

Aim to make a down payment of at least 30% of the home’s purchase price. A larger down payment reduces your monthly mortgage payment, lowers your loan-to-value (LTV) ratio, and can potentially help you secure a lower interest rate. It also reduces the risk of owing more on your mortgage than your home is worth if property values decline.

This will likely be the most difficult part of the rule. 30% of a $300,000 home is around $100,000, so no small potatoes at all. It’s wise to take the time and save up the money to make a massive down payment. You’ll be avoiding PMI (private mortgage insurance) if you pay over 20%, and your monthly payment will feel way better. It’s also suggested to have a small chunk of savings aside outside of your down payment to cover moving expenses, repairs, and any other miscellaneous things that you may incur during the purchase.

3 Times Annual Income

The total cost of the home should not exceed three times your annual gross income. This helps ensure you don’t purchase a house that is too expensive for your financial situation, reducing the risk of potential financial strain or foreclosure.

Chances are if you meet the first two requirements, you’ll meet this one. This just serves as a sniff test to see if the two other rules tie together.

Understandably, it can be very difficult to find deals like this that fit within your budget if you live in areas like LA, SF, or NYC. To that end, I would suggest maybe trying to move out to a cheaper suburb, or relocate to a completely different state. If that’s not an option, nobody ever said you NEEDED to own a house. Many have become wealthy by simply investing steadily and buying other assets.

You never know, you may end up buying a house in cash one day.

Example

Let’s say you have an annual gross income of $60,000. We’ll apply the 30-30-3 rule to determine if a potential home purchase is financially feasible for you:

1. 30% of monthly income: First, calculate your monthly gross income by dividing your annual income by 12: $60,000 / 12 = $5,000

Next, find 30% of your monthly income: $5,000 x 0.30 = $1,500

According to the rule, your monthly mortgage payment (including principal, interest, property taxes, and homeowner’s insurance) should not exceed $1,500.

2. 30% down payment: To determine the maximum home price based on the down payment rule, divide the amount you have saved for a down payment by 0.30. For example, if you have $54,000 saved for a down payment:

$54,000 / 0.30 = $180,000

In this case, the maximum home price you should consider is $180,000.

3. 3 times annual income: To determine the maximum home price based on your income, multiply your annual income by 3:

$60,000 x 3 = $180,000

According to the rule, the total cost of the home should not exceed $180,000.

In this example, the 30-30-3 rule suggests that you should look for a home priced at or below $180,000, with a monthly mortgage payment not exceeding $1,500, and have at least $54,000 saved for a down payment. Keep in mind that these numbers serve as a guideline, and your specific situation may vary. Consult with a financial advisor or mortgage professional to develop a personalized plan for purchasing a home.

Wrapping Up

The 30-30-3 rule serves as a valuable guideline for prospective homebuyers looking to make a financially sound decision when purchasing a property. By adhering to this rule, you can avoid becoming overextended financially and ensure that your home is a source of comfort and stability, rather than a burden. However, it’s essential to remember that this rule is a general guideline, and individual circumstances may vary. To make the best decision for your unique situation, consider consulting with a financial advisor or mortgage professional who can help you evaluate your financial health, assess your homeownership readiness, and develop a tailored plan to achieve your dream of owning a home. By taking a thoughtful and well-informed approach to homeownership, you’ll be better prepared to enjoy the benefits and rewards that come with owning your own piece of real estate.