Derk's question is up next. He says, "My income is variable, so how do I make the decision of what my 25% of housing should be?" Because we say housing expenses shouldn't be more than 25% of your gross income. For some context, he said in 2020 he made $200k, in 2021 $300K, and in 2022 $400k. But he's not confident that the income will be as good this year based on how things are going. How should he think about this?
This one is really tough, Brian, because here's how we see this manifest with clients a lot too. We'll have a client who says, "Hey, I work for a tech company and I make $100,000 to $150,000 a year, but because I have RSUs that were granted to me a number of years ago, the annual income I show on my tax return is way different than my salary. I might have $150,000 of RSUs that vest every year. So when I think about my household income, do I actually make $150,000 or do I make $300,000?" The thought around saving is pretty easy there; it's easy for me to think about how to get to 25% savings. But some of these other rules, like housing, what guidance and counsel would you give Derk to make sure that he does stay inside those lines?
Yeah, I mean, I think we're hitting on the same things. I want to know how much of your pay is fixed and how much is variable. Because that, go ahead and stratify those two things. Then, I would focus on the fixed part, which is likely to show up monthly, whereas variable pays often only pay out once or twice a year, whether it's short-term incentives or long-term incentives. A lot of times, there are also Deferred Comp options on those that you ought to consider for the 25%. All that needs to be coordinated. I would lean heavily on the fixed part, and if you want a nudge, I would average your variable comp over the last three to five years to account for variations.
Far too often, I see people plan on trajectory, but circumstances change. So when it comes to housing, consider the replacement value of your skill set if your current job were to disappear. How secure is your ability to find a similar job with the same income? Use that as a metric to normalize your pay. Then, consider what you can do with the large flows of variable income to adjust your down payment or monthly payments.
Lenders can be aggressive, but don't overextend. Keep in mind that interest rates can change, and it's essential to moderate your housing goals. Set a realistic goal for your dream house, so you don't keep moving the goalposts. Bigger houses mean more problems and higher costs. A 10,000 sq ft house might not be worth the resources unless TLC is showing up to give you a documentary. More house means more expenses, so keep yourself grounded. You don't need a 10,000 sq ft house unless you have 26 kids or something. For more information, check out our free resources