Posted by Tim Stobbs on May 6, 2010
I suppose one of the harder questions people face in the red hot housing market is: when do I know I’m paying too much for a house? To be sure, it is a difficult question to answer, so I’m going to toss out an idea. Take your proposed house value times by 4%, divide the result by 12. That should be around a monthly payment, without property taxes, that you feel you can afford.
So where the hell did this 4% number comes from? Well in retirement planning the safe withdrawal rate is about 4% for the typical retirement. Meaning you can take about 4% of your assets out each year adjusted for inflation and likely not run out of money before you die. Therefore extending the idea a bit assume your house has to meet the same standard. By paying off your home you should get a monthly savings of 4% of your house value. Of course if you get a cheaper house and pay it off faster you could beat this, but lets put the 4% rule as the floor.
So if you use the 4% idea and then assume 1% of house value for property taxes and $100/month heating you can create a table based on 32% of your gross income for housing and can determine the most house you can afford for your income. See below for details.
So as you can see from the table below you likely shouldn’t buy a house worth over$600,000 unless you make over $100,000/year as a family. Then when you consider the median household income in Canada is about $53,000, that implies that most people should be in the low $300,000 or cheaper range.
So what do you think of the 4% rule for housing? Good idea or am I out to lunch?