As we approach a new year, I have been reflecting a lot on how we can improve service for our existing clients. We have investing a significant amount of time honing our process, and thinking of what areas we can add the most value. Again in 2024, we saw that major purchase decisions continue to be a major pain point for clients. Far too often, people make emotional or rushed decisions on buying a new home, or a new car, only to regret the decision after they have had time to reflect on the financial ramifications. The crushing part as a financial planner, is we want our clients to enjoy these milestone moments, and we believe they can, as long as they remember just two numbers: 28 and 36. Let me explain.
28 is the percentage of your gross income that represents the maximum amount your should spend on putting a roof over your head. For simplicity, if a person makes $100,000 per year before taxes, they should aim to spend no more than $28,000 on a place to live. Dividing this number by 12 will give us our monthly spending budget of $2,333. Don't include utilities in this number, but do include property taxes and homeowner's or renter's insurance.
For renters, this calculation is pretty straightforward, and once you complete this first step, you can simply find an apartment or house to rent that costs less than $2,333. For buyers, we need to perform one extra step before shopping. We need to figure out how much you can afford to spend on a home and stay within that budget. A financial planner is trained at all of the nuance involved here, and enlisting the help of a Certified Financial Planner is a great idea when thinking of buying a home. However, if you want to try to get an estimate on your own, simply type the words "Mortgage Calculator" into a web search and you will find several free tools to help.
Once you know how much home you can comfortably afford, you have to put that figure in as a hard stop. If you exceed that purchase price, you are going to feel the pinch, especially if you have an unexpected repair the first year in the home, or if property taxes or insurance go up. In Missouri, both property taxes and insurance costs have been on the rise, and if your income doesn't increase at the same rate, you will be left feel financially stressed trying to make your monthly mortgage payment.
The second number that is important is 36. 36 is the percentage of your gross income that represents the maximum amount you should spend on both your home, which we have already calculated and should be less than 28%, plus all other debt service. This means the amount you spend on monthly credit card payments, car payments, student loans, and any other loans. The implication here is important to understand. If you spend all the way to the max on the house, you only have 8% of gross income left in the budget to pay off debt and have reliable vehicles to drive. Often younger families would do well to keep that first number lower than 28%, to give some breathing room to knock out student loans or credit card debt that is pretty typical for young families.
I really feel confident that if you stick to these two simple rules, your financial life becomes much easier to manage. That doesn't mean you want have challenges. All families do. It just means you will have the flexibility and financial wherewithal to meet these challenges head on. For example, we recommend clients build an emergency fund with three to six months of expenses, held in cash or cash equivalents. This is much easier to do when you are at or below the 28/36 figures. If you have exceeded them, you will be less likely to set money aside for a rainy day, creating unnecessary stress later on. It's nice to have nice things, but it's not worth your sanity. We don't control much in this life, but we do have complete control over our major purchase decisions. Take your time, get help planning if you need it, and you will feel much more in control of your finances.
Happy New Year from Five Key Capital Management