Buying a House: Do Traditional Rules of Thumb Still Apply?

Rules of thumb exist to simplify complicated decisions. And the homebuying process is chock full of them. But times change, and sometimes faster than rules of thumb can keep up. Today we take a look at three of the classics related to buying a home – the 20% down payment, what makes for a sufficient credit score, and the max percentage of income to spend on housing – to see how they hold up in today’s housing market.

A Wild Ride in Housing

In 2000, the median home price was $137,000. It has since more than tripled, increasing to $423,000 in July 2024. (For context, median household income has grown by roughly 15% during the same time period.) A big driver of housing costs is inventory – that is, the number of homes for sale. That peaked at more than 4 million in July 2007. And after the housing market crashed in 2007, inventory withered, landing at around 1.3 million homes in July 2024. (If you want to learn more about how the cost of housing became so crushing, we recommend this podcast from the New York Times.)

Interest rates have further complicated things. In the COVID era, the Federal Reserve slashed its key interest rate to support the struggling economy. That caused mortgage rates to fall to their lowest point since 1971. After the Fed began jacking up rates to fight breakaway inflation, mortgage rates whiplashed back up, reaching a high of 7.79% in October 2023.

How Times – and Prices – Have Changed the Rules of Thumb

That’s quite a wild ride. And plugging some numbers into the SoFi mortgage calculator puts things into even realer terms. Buying a median price home in January 2000 would have cost $137,000. Making a 20% down payment would’ve required $27,400. And landing an average mortgage rate for the time, around 7%, would have resulted in a $729 monthly mortgage payment, including principal and interest.

Fast forward to May 2024: A 20% down payment on the median price home, $423,000, would require $84,600. And with a mortgage interest rate around 7%, the average this spring, your monthly payment would be roughly $2,250. Ouch.

With that, let’s step back and reevaluate some rules of thumb for today’s market:

Rule of thumb: The 20% down payment

There are plenty of good reasons to make a 20% down payment. The most compelling of them is that it frees you from having to pay for private mortgage insurance, which can cost 0.5% to 1.5% of your loan amount. A 20% down payment may also net you a lower interest rate. And both of those can translate into a lower monthly payment.

Does it still apply? Though some people still put down 20%, it’s less of a hard and fast rule today, given the massive increase in home prices. It’s also worth noting that buyers who are eligible for a loan from the Federal Housing Administration can put down as little as 3.5%. And other government agencies, including the Department of Veterans Affairs and the Department of Housing and Urban Development, offer 0% down mortgages to qualified buyers.

Rule of thumb: You need a high credit score to buy a home

A better credit score makes you more likely to qualify for a more competitive mortgage rate. The standard FICO credit score ranges from 300 to 850. Generally, the higher your score, the better your loan terms.

Does it still apply? Yes. Since the housing meltdown that brought about the Great Recession, mortgage lending standards have become more strict. Lenders want to know you’ll be able to pay your mortgage every month and a good credit score remains a primary consideration. Paying your bills on time and managing your credit responsibly will lead to a higher score.

Rule of thumb: Don’t spend more than 30% of your income on housing

This is more of a budgeting rule, but the conventional wisdom is that you shouldn’t spend more than 30% of your monthly pre-tax income on housing. For homeowners, that includes mortgage principal and interest, property taxes, insurance premiums, and homeowner association fees.

Does it still apply? No. Keeping housing costs below 30% of your income is ideal – but not realistic for everyone in 2024. Making a larger down payment or buying a less expensive home can help reduce monthly housing costs. And, ultimately, you’ll need to weigh all of the financial benefits of owning a home – a topic we’ll revisit soon – against the stress it will put on your monthly budget.

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