When it comes to financial advice, there are few people as well-known and respected in the money management world as Dave Ramsey. Millions of people have read his books or listened to his radio show and have seen their personal finances improve after taking his advice. One of the most popular pieces of advice he gives is to limit your monthly mortgage payment to no more than 25% of your take-home pay. Here's why he recommends this amount specifically.
Limit your monthly mortgage payments
Dave Ramsey's rule for mortgage payments is based on the idea that you need to allocate enough funds each month to cover all your other expenses while still making sure you can make your mortgage payment on time each month. He suggests that no more than 25% of your monthly take-home pay should go toward a housing payment. It is important to understand that your take-home pay is what's left over after you pay your taxes, benefits, any contributions to your 401(k), etc.
So if you make $50,000, that means you can afford to pay a monthly mortgage of $1,041, right? Not exactly. If you make $50,000 and live in California, then your take-home pay is $39,758 after you pay your state and federal taxes. This amounts to $3,313 per month. Using Ramsey's rule of thumb, you can allocate about $830 a month toward your mortgage. The total cost of home ownership also includes homeowners insurance, property taxes, any homeowners association fees, and if you make less than a 20% down payment, private mortgage insurance (PMI). So the actual amount dedicated to the price of a home is much less.
Why does Ramsey suggest 25%?
Capping the total cost of homeownership to 25% of your income ensures you'll have enough money available each month to cover all your expenses without having to dip into your emergency fund or put yourself in debt due to late payments. According to Ramsey, this guideline will determine how much house you can afford without stretching your budget.
In addition, by limiting your mortgage payment amount, it allows you the opportunity to save for long-term financial goals, such as retirement. Having enough saved for retirement is important because it ensures you won't have to rely solely on Social Security or other government programs during your golden years.
There are many other rules for determining housing costs. Some say to limit your monthly mortgage payment to 28% of your gross income, while others use the 35%/45% model. This rule states you should limit your mortgage payment to 35% of your pre-tax income or 45% of your after-tax income.
These rules allow for a higher amount to be used for your mortgage, but there is less money left that you can put toward food, clothing, savings, and other essential bills. Ramsey's 25% rule is more conservative and may be best if you have other debt such as credit card debt or loans you need to pay off. You may have less money to spend on a home, but your finances won't be overstretched, especially if something unexpected occurs.
Dave Ramsey's rule for mortgage payments is sound advice that should be taken seriously by anyone looking to purchase a home or refinance their current loan. By following this rule, you'll be able to ensure that all necessary bills are paid each month and also leave money for emergency savings and retirement planning. Not only will this give you peace of mind, but also provide financial stability in case anything unexpected happens in your life.
