Less House, More Savings (And Wealth)

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So, you’re considering buying a house?  Your Dad has been telling you for years that you need to buy a house.  He said you’re throwing your money away renting.  He said you’re making some landlord rich instead of pocketing the cash yourself.  He said you should buy the largest house you can because it is a great investment.  Is he right?

Homeownership Builds Wealth

Many Americans choose to develop their net worth through homeownership.  It is a proven wealth builder.  The average American homeowners net worth ($195,000) is 36 times that of the average renter ($5,000).

For most Americans, their home is by far the most significant wealth they possess.  The median net worth of all Americans is $94,670.  The median net worth excluding home equity is $29,410—which means home equity is 69% of the average American’s total net worth.

Homeownership Erodes Wealth

A well-maintained home in a desirable location should appreciate over time.  But according to WENLI LI AND FANG YANG, the actual rate of return on US real estate (when considering inflation, taxes, and mortgage interest rates) from 1975–2009 was actually below zero:

“Assuming an annual depreciation rate of 2.5 percent, a property tax rate of 1.5 percent, a mortgage interest rate of 7 percent, and a marginal income tax rate of 25 percent for a typical taxpayer, the adjusted real rate of return on housing actually falls below zero (-0.575 percent, to be exact).  The stock market, on the other hand, averaged 3.375 percent annual returns for this period, after taxes and inflation.”

Perils of Buying Too Much House

Many people see housing as a status symbol but don’t really think about how it may impact their over-all financial situation.  According to Business Insider, Americans spend approximately 37% of their take home pay on housing.  Buying a home can easily lead to being house poor if you don’t do enough research on the total cost of home ownership.

House Poor: A situation that describes a person who spends a large proportion of his or her total income on home ownership, including mortgage payments, property taxes, maintenance and utilities. House poor individuals are short of cash for discretionary items and tend to have trouble meeting other financial obligations.

Just because you can pay the monthly house payment doesn’t mean that you can afford everything else that goes with it. There are ongoing costs when buying a house, which is something that many homebuyers forget about.

In fact, according to Zillow:

  • S. homeowners, on average, spend more than $9,000 per year in hidden homeownership costs and maintenance expenses.
  • S. homeowners pay an average of $6,042 per year in unavoidable hidden costs: homeowners insurance, property taxes and utilities.
  • S. homeowners pay an average of $3,435 per year in annual optional costs, including house cleaning, yard care, gutter cleaning, carpet cleaning, and pressure washing.

Buy Less House and Save the Rest

Small homes cost less.  Think about what it costs to heat and cool a 2,800-square foot home. Home improvement projects like repainting the exterior, replacing the roof, or changing the flooring also cost more because of the size of these homes. You will also spend more money to furnish and decorate the extra rooms. It all adds up.

Small homes, on the other hand, reduce expenses because of their size. They have smaller rooms to heat and cool, less square footage on the outside to paint, and a smaller roof. Monthly utility bills cost less, and you’ll spend less on home maintenance. You also save money on property taxes, since you have less square footage.

What if You Bought a Home for $50,000 less?

If your bank approved you for a $300,000 home, and you purchased for $250,000 instead, you’d save about $238 per month ($2,800 per year) on your mortgage payments.

Here’s a look at some things you could do with that savings:

  • If you purchased the home when your child was a year old, you could have more than $87,000 saved for college by age 18.
  • You could put the difference each month back into your mortgage. The home would be paid off in 22 years instead of 30, and you’d save nearly $54,000 in interest payments. That $50,000 savings is now over $100,000.
  • You could invest in a low-cost index mutual fund for the next 30 years.  If the stock market returned a modest 7% annual return, you could have over $264,000 in your retirement savings.

Bottom-Line: How Much House Do You WANT to Afford?

A bank may tell you that you can spend up to $300,000 on a new home.  But how much home can you afford and still achieve your other financial goals?  If most of your money goes towards home-related expenses, this means you have less money for other things in your life.  This will prevent you from doing the things you want, like saving for retirement or your children’s college education. Buying less house, to save more could be a better investment option.

If you’re not in the market for a home right now, it’s the time to get your finances in order.  Saving up a substantial down payment of 10 to 20% will make your monthly mortgage payment more affordable.  Paying down your unsecured debts before applying for your mortgage could build your credit and save you thousands of dollars in interest payments.  Consider creating a Personalized Financial Plan  to equip yourself with the necessary tools to reach your financial goal(s) like, to buy less house to save, and set a true path to wealth creation.

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