Is Dave Ramsey Right About How Much House You Can Afford?

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Key Takeaways

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• Dave Ramsey has a number of “rules of thumb” for managing your finances.

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This content is for educational purposes only and does not constitute financial advice, advisory, or brokerage services. We may earn compensation from some links on this page. Learn more.

Dave Ramsey has a number of “rules of thumb” for managing your finances. Arguably, his most key rule answers the following question: “How much house can I afford?”

We spend a significant portion of our income on housing, so it’s key to answer this question correctly.

A recent Federal Reserve study found that the cities that suffered the most severe impacts from the 2008 financial crisis were those with the highest average personal debt-to-income ratios. And one common trait shared by residents of those areas was that they bought too much house.

With almost half of U.S. households carrying credit card debt, it’s simple to make the argument that the majority of home buyers purchased more house than they can afford. After all, mortgages are one expense that has to get paid , even if that means building up credit card debt.

Table of Contents

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• How Much House Can You Afford?
• How Much House Can You Responsibly Afford?
• Dave Ramsey Housing Guidelines vs. 28/36 Mortgage Rule
• Dave Ramsey Mortgage Rule vs. 50/30/20 Budget
• How Much Down Payment Do You Need to Save?
• Dave Ramsey Mortgage Rule vs. My Own Thoughts

How Much House Can You Afford?

Dave Ramsey’s advice for buying a new home is to limit your monthly mortgage payment (including homeowners insurance, homeowners association fees and property taxes) to 25% or less of your monthly take-home pay on a 15-year fixed-rate loan.

This housing rule of thumb is quite different from the recommendations you’ll find elsewhere. Using the affordability calculator on DaveRamsey.com, you can calculate the maximum monthly house payment you can afford under these guidelines, which is all based on the simple question, “What is your monthly take-home pay?”

Ramsey has the simplest affordability calculator you’ll find.

According to Ramsey, your monthly housing expenses should never be higher than 25% of your monthly after-tax income. So, if you take home $5,000 a month after taxes, you can afford a $1,250 total monthly housing payment.

Therefore, you hardly need to use the calculator to follow this rule. To find out your monthly maximum mortgage payment, just take your monthly-after-tax income and divide it by four. 

Monthly Net IncomeMax Mortgage Payment$4,000$1,000$5,000$1,250$6,000$1,500$7,000$1,750$8,000$2,000$9,000$2,250$10,000$2,500

Ramsey advises using your monthly take-home pay (also known as net income or after-tax monthly income) rather than your gross monthly income.

Gross income is the amount you make before taxes and other deductions, while net income is the amount you make after taxes and other expenses are taken out. To get this number, simply look at your recent paychecks.

How Much House Can You Responsibly Afford?

Dave Ramsey’s rule allows you to purchase much less house than most mortgage lenders and real estate agents want to sell you , not to mention, much less house than other calculators will say you can afford.

Ramsey’s affordability calculator also gives you an estimate of how much house you can afford based on your monthly take-home pay: 

Notice that you can afford more house based on the more money you save for a down payment.

In contrast, here’s what Realtor.com’s affordability calculator says you could afford based on the numbers shown in the example above. 

For the sake of this exercise, we’ll base our comparison on the 20% down-payment calculation, as follows: 

• $5,000 monthly income ($60,000 annually).
• $42,248 down payment, which represents a 20% down payment in Ramsey’s example.
• $0 Monthly debt. (Ramsey’s Baby Steps framework says you should be out of debt and have a fully-funded emergency fund before buying a home.) 

Perhaps unsurprisingly, Realtor.com’s calculator suggests you can afford to purchase more house than Ramsey’s.

Keep in mind, Realtor.com is showing you what you can afford on a 30-year fixed-rate mortgage. Ramsey, on the other hand, suggests a 15-year fixed-rate mortgage. Yet Realtor.com shows a mortgage payment that’s $579 higher than what Ramsey suggests. 

Why such a difference? To understand that, it’s key to understand the guidelines used by mortgage providers.

Dave Ramsey Housing Guidelines vs. 28/36 Mortgage Rule

The standard debt-to-income ratio used in the mortgage industry is called the 28/36 rule. What this says is that your total monthly debt payments should not exceed 36% of your pre-tax income, with a maximum of 28% going towards housing.

Taking a closer look at this ratio, I recently wrote the following for a separate article:

The first thing you need to know about the 28/36 rule is that it’s not a rule used in financial planning. Instead, it’s the rule mortgage lenders use to determine your home loan.

The rule states that you shouldn’t spend more than 28% of your monthly gross income on housing (this includes principal, interest, taxes, and insurance). Then, total loan payments (housing plus all other debt) should not exceed 36% of your gross income.

It’s key to look at this ratio from both a lender’s perspective and a consumer’s perspective. For lenders, the purpose of the 28/36 rule is to determine the largest amount of debt a person can have.

In other words, this is the largest amount of debt banks have found you can take on and still have a reasonable chance of paying back. Loaning you as much money as possible maximizes the bank’s bottom line, not your finances.

The big takeaway here is that Ramsey’s guidelines are optimized to help you build wealth. With a lower mortgage payment, the idea is you’ll be able to avoid credit card debt and invest more over time. Not only will you have a lower monthly payment but also 15 fewer years of making payments. 

The mortgage industry’s guidelines, on the other hand, are optimized to maximize their profits.

Dave Ramsey Mortgage Rule vs. 50/30/20 Budget

One of my favorite budgeting methods is the 50/30/20 budget, which states that you should spend 50% of your income on needs, 30% on wants, and 20% on savings.

Where I find this budget strategy most useful is in helping people make big financial decisions by creating a hypothetical budget for their future.

Housing costs, which include home maintenance, fall within the 50% of your budget allocated to “

Final Thoughts

The bottom line: a little research on dave ramsey right about goes a long way. Compare your options, watch for seasonal offers, and never pay full price when a better deal is one click away.

Originally published at thewaystowealth.com.