Buying a home is part of the American Dream. It gives you the privacy that many rental spaces cannot offer, and allows you to lay down roots in the community that you have decided to live in. Plus, making monthly payments toward the mortgage balance builds equity in the property that you can take advantage of in the future.
The problem with homes is that they are very expensive, probably the largest investment you will ever make. While you can search for a smaller, more modest home to save money, sometimes it’s worth splurging on your dream home if you can afford it.
In this article, we’ll explain different personal finance rules people use to determine the home purchase price they can afford, using the example of someone who wants to buy a 1.5 million-dollar home — only slightly more than the median price in San Francisco.
Necessary Annual Salary to Afford a 1.5 Million-Dollar Home
Your annual income plays an important role in deciding what type of home to buy.
Let’s say you want to purchase a 1.5 million-dollar home by putting the recommended 20% down on a thirty-year mortgage, which is the most common mortgage term. Assuming your interest rate, property taxes, and homeowners insurance are comparable to national rates, your monthly payment would be over $10,000, for an annual total of $120,000.
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The Gross Income Rule
The rule of thumb is that you can afford a home that is 2 to 2.5 times your gross household income. In that case, your annual income should be between $400,000 and $750,000 to comfortably pay your monthly housing costs, which can also include homeowners association fees.
However, there are plenty of factors to consider outside of this basic calculation, especially if you have additional debt and want to maintain your long-term financial goals.
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The 28/36 Rule
The most popular rule for home affordability is the 28/36 rule. The first number is the recommended percentage of gross annual income that should go toward your mortgage.
If these payments are more than 28% of your gross income, a home that is this expensive is a high-risk purchase. With the 28% rule, assuming your total mortgage for the year is $120,000, the recommended annual salary should be about $430,000.
The second number is the maximum percentage for all your debts combined. If your total debts, including car loans, student loans, or credit card debt, account for more than 36% of your total income when added to your mortgage, you cannot comfortably afford a 1.5 million-dollar home.
For example, if your salary is $500,000 per year, you wouldn’t want to exceed total debt payments of $180,000 yearly.
Which Factors Determine How Much You Can Afford
The salary requirement is not the only factor that comes into play — other factors iclude your living expenses and debts, the size of your down payment, and the types of loan programs you qualify for. Let’s take a look at essential elements that affect the price of the home you can afford, whether you want to buy a modest house or a million-dollar home.
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Debt-to-Income Ratio (DTI)
The debt-to-income ratio, or DTI, refers to the relationship between all the monthly debt payments you owe and the money you make.
Many mortgage lenders will assess your risk as a borrower based on your DTI rate to see if you have sufficient income to afford a home. The lower this percentage is, the better your chances of being approved for a jumbo loan to buy an expensive home.
A DTI calculation includes debts like auto loans, child support, alimony, credit card payments, and other factors. A mortgage lender typically wants to see a DTI of 43% at most, but for more expensive homes, the requirement could be as low as 36%.
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Down Payment
The down payment is also a very important number when buying a house. A lower down payment means you will have higher monthly mortgage payments to cover the total price of the home and the interest payment. The more money you put down upfront, the lower those ongoing costs will be. The standard recommendation for a down payment is 20%.
For a 1.5 million-dollar home, that would mean $300,000, leaving the remaining balance at $1,200,000.
You should be able to afford pretty large down payments if you are interested in buying million-dollar homes, so pay attention to your savings account balance or any gift funds available to you. Lenders may have even higher down payment requirements to protect themselves from risk.
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Loan-to-Value Ratio
A loan-to-value ratio, or LTV, is used by lenders to assess the risk of a specific property. It is a simple calculation of the mortgage amount divided by the property’s appraised value. For example, if you were looking at a home that cost $1.5 million and you planned to put $200,000 down, the LTV is 1,300,000/1,500,000, which is roughly 87%.
For a property this large, the lender may prefer an LTV of 80% or lower, so it might be hard to get approved with that small of a down payment.
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Credit Score
A borrower’s credit score has a big impact on their housing costs. A credit score is a reflection of how reliably that person pays back their debts. The higher the score, the better their history of making payments. Taking out a loan to afford a million-dollar home involves a lot of money, so the lender will need reassurance that you can pay that money back.
A jumbo mortgage may require a credit score of at least 720 to be approved depending on the lending firm you choose. Additionally, a stronger credit score gives you access to a better mortgage rate. Lower interest rates significantly reduce the total cost of paying back your mortgage over time.
Loan Options for a 1.5 Million-Dollar Home
Unless you have this much cash lying around, you will need to take out a loan to buy your dream home. The limit set by Fannie Mae and Freddie Mac for conforming loans is $766,550, which means any loan amount above that number is much riskier for lenders (depending on the housing market you are buying in).
That means you will likely need a jumbo loan to afford a higher home purchase price, with a reasonable mortgage interest rate. If you’re looking for competitive rates, our jumbo loans are a great tool to help you buy the home of your dreams.
Mortgage Requirements
The requirements for a jumbo mortgage will vary from lender to lender. F5 Mortgage has very attainable requirements for the jumbo loan program.
The minimum credit score requirement is only 680, which is considered good and can help you access lower mortgage rates. For the down payment, you must be able to pay at least 10% of the purchase price of the home upfront.
Your DTI must be lower than 45%, which includes debts like car payments and student loans. You should be able to afford an additional 3-6% of the price to cover closing costs. The income required to achieve this depends on how these numbers play out. You can use our mortgage calculator to play around with the numbers.
Additional Costs of Owning a 1.5 Million-Dollar Home
A mortgage is not the only expense related to owning a home. Before you commit to buying a 1.5 million-dollar house, you need to consider all these expenses along with the mortgage itself.
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Property Taxes and Homeowner’s Insurance
Property taxes are paid by owners to the local government. These taxes are used to pay for public services such as road maintenance, schools, parks, and more. If you use an Escrow for your mortgage, property taxes are usually part of your monthly payment and will get automatically paid to the government when they are due.
The property tax rate for a home of this size could be about 19,650 based on the median tax rate of the country of 1.31%, though this will vary depending on your market. Homeowners insurance is another expense to consider, and it could cost about $560 a month to insure this home adequately.
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Maintenance and Miscellaneous Expenses
One of the hidden costs of owning a home is maintenance. A home is a complex system of plumbing, electrical components, appliances, HVAC systems, structural materials, and more. These elements all need to be maintained to keep the home safe and comfortable.
The general rule is that maintenance for a home could cost about 1% of its value each year. As the owner of a home that costs 1.5 million dollars, expect to pay $15,000 on average every year to maintain it. There could also be unexpected costs such as a furnace replacement, repairs, possible HOA fees, or home improvement projects.
Summary
Buying a million-dollar house is not easy. There are very high salary requirements to afford the mortgage payment each month, and there are additional expenses like utilities, maintenance, and HOA fees that can add up quickly.
Having the right lender can make it easier to afford your dream home, and F5 Mortgage can help you choose the perfect loan program for your needs. Give us a call at 888-459-0483 to get a free quote or fill out our online form.
FAQs
Can I afford a 1.5 million-dollar home with a 300k salary?
The answer could be different from person to person, but you typically can afford this house price with a $300,000 salary. However, you will need to budget well and have a lot of money saved up for the down payment.
A large enough down payment can significantly reduce the ongoing costs and make a $300,000 salary enough for a 1.5 million-dollar home. Otherwise, you might be going over some of those recommended limits, such as the 28/36 rule.
Every buyer is different, so as long as you understand the total cost of the mortgage, property taxes, homeowners insurance, and closing costs, and your monthly income can comfortably cover everything, then you should be fine.
What is a good down payment for a 1.5 million-dollar house?
20% is usually the recommended amount for a down payment. The reason for this rule is most lenders will not require private mortgage insurance from the borrower if they can afford a 20% down payment.
However, this is also a good number to aim for at any purchase price, including $1.5 million. Usually, the more you can pay upfront, the better because it will greatly reduce the total cost of the home because of a lower interest rate.
Is now a good time to buy a 1.5 million-dollar home?
It might seem like now is a bad time to buy a large home because of the higher costs and interest rates. However, these circumstances have led to less competition among home buyers, especially for more expensive homes.
Purchasing a bigger home now could pay serious dividends when rates equalize and pent-up demand for homes suddenly skyrockets. Additionally, the lack of competition that currently exists may make it easier to negotiate with a seller who is struggling to sell their expensive home.
How much of your gross monthly income should you spend on a monthly mortgage payment?
Your estimated monthly mortgage payment is one of the easiest ways to assess how much house you can afford. Going by the 28/36 rule, the monthly mortgage payment should not exceed 28% of your gross monthly income. However, if you have budgeted well to buy your multi-million dollar home, then you can easily afford a higher percentage.
Whatever number you use, make sure you include property taxes, homeowners insurance, and interest rates in your calculation.
