How Costly A House Should You Buy & How Much EMI Is Best? The 5-20-3-40 Formula Will Guide You

For most people, the dream of buying a house goes hand in hand with the fear of overwhelming debt. Home loans may have made ownership easier, but many buyers still struggle with questions of affordability: How expensive should the house be? How much down payment is enough? How big should the loan be? To answer this, financial experts point to a simple but effective calculation: the 5-20-3-40 formula. (News18 Hindi)

This four-part rule lays out the balance between income, down payment, loan amount, and monthly installments in clear terms. It begins with the 5 percent cushion, which suggests that a buyer should always keep at least five percent of the property’s value in cash. On a Rs 50 lakh house, that comes to Rs 2.5 lakh readily available to manage initial costs or emergencies. (News18 Hindi)

The second component is the 20 percent principle, which emphasises that a buyer should ideally cover one-fifth of the home’s cost upfront, keeping the loan capped at 80 percent of the property’s price. Financial planners say this step is crucial because it reduces the interest burden and shortens the repayment period. (News18 Hindi)

The third measure, known as the 3X rule, links the value of the house to the buyer’s income. The advice is straightforward: never buy a house priced at more than three times your annual earnings. So, someone making Rs 15 lakh a year would be safe purchasing a home worth Rs 45 lakh, but stretching beyond that amount risks straining long-term finances. (News18 Hindi)

Finally comes the 40 percent ceiling, which applies to EMIs. The formula warns against committing more than 40 percent of monthly income to loan repayment. For a buyer earning Rs 1 lakh a month, the EMI should not exceed Rs 40,000. Staying within this limit ensures there is still room to manage daily expenses, savings, and unexpected costs. (News18 Hindi)

Taken together, the formula provides a realistic picture of what a person can afford. Consider an example: a professional earning Rs 15 lakh annually wishes to buy a house worth Rs 45 lakh. According to the formula, they should have Rs 2.25 lakh in cash for the initial cushion, make a down payment of Rs 9 lakh, borrow no more than Rs 36 lakh, and limit their EMI to around Rs 30,000 a month. In this case, the purchase falls comfortably within all the recommended limits, leaving the buyer financially secure while pursuing home ownership. (News18 Hindi)

Experts stress, however, that while the 5-20-3-40 formula offers a valuable framework, it should not be treated as an unbreakable law. Each household has its own financial realities, whether that includes children’s education, health care needs, or investment goals. The formula is best used as a guide, a way to set boundaries that prevent overextension, while still allowing flexibility depending on individual circumstances. (News18 Hindi)