Housing is often cited as one of life’s biggest costs. When you make the decision to buy a home, there’s lots of advice that will come your way. Some cliche house advice that you may hear is:
- buy a house you can grow into
- design and build your own house
- buy your forever home
- buy a fixer upper
- your house is an asset
This post is about our decision process for buying our first home and the lessons we learned. The cost of your house and the debt you take on will determine your FI trajectory.
Lesson # 1- Borrow less than the bank will give you
We went looking for a mortgage at my local credit union that I had banked with since I was 10. My wife and I needed approval for a mortgage before we could seriously put an offer on a home. At the time, we only had temporary employment so we weren’t sure if we would get approved for much or even at all. To our surprise, they approved us for over $400 000 and this was in 2013. The number made us uncomfortable.
This mortgage would need both of us to cover the costs for the next 25 years. That seemed risky and was pressure for both of us to have to work full time for that long, especially since we planned on starting a family. In the end, we decided on buying a house that we could comfortably afford on one salary, which was $55 000 at the time. The cost of our home was $272 000 and we put $30 000 down. Everything in the house was original from the 1950s. We had a lot of work to do but we could sleep at night knowing we weren’t house poor. It’s never a bad idea to borrow less money than the bank will give you.
Lesson # 2 – Beware the Diderot Effect
The Diderot Effect occurs when one purchase leads to many others. For example, buying a hot tub isn’t just one purchase. You have to pay for additional electricity, water, chemicals, maintenance, etc for the life of the hot tub. When it comes to purchasing a house, the more expensive your home, the greater the Diderot Effect.
The mortgage costs are only part of your overall housing costs. There’s also property tax, home insurance, utilities, and maintenance costs. While the mortgage will eventually end…..hopefully. The property tax, home insurance, utilities, and maintenance costs need to be paid forever. Pricier homes come with higher lifetime costs. These costs are a drag on your journey to FI.
A common rule of thumb thrown out by mortgage specialists is that the sum of these housing costs (mortgage, property tax, insurance, maintenance) shouldn’t take up more than 32% of your gross income. This is horrible advice because you pay for your housing costs in after tax dollars. When you calculate your housing costs and divide them by your net monthly salary, that percentage could be near 50%.
When we bought our home, our housing costs were exactly 32% of my gross salary. Which was $60 000 at the time. Fortunately, if we were both working, the payments were easy to make. Another positive is that we were both starting our careers as teachers and our salaries would continue to rise for the next 10 years while our housing costs would remain relatively flat. Today, our housing costs are 10% of our combined gross income.
32% of gross income at 30 years old is different than 40 years old. If you spend this percentage on housing costs, it will take 40 years to reach FI. Unfortunately, as people make more money, life style creep happens and they upgrade their housing costs.
Lesson # 3 Location matters if it adds value to your life
Thankfully, we both agreed that we should look for a house that we could comfortably afford on only one salary. My wife and I are both teachers so our salaries are similar. We bought our house in 2013 and opted for a 5 year fixed mortgage rate at 3.09%. I thought fixed was the way to go because the guaranteed payments felt like a safe play.
We wanted to live in an older area in the city close to amenities. It was a fixer upper to say the least. But we LOVED the location. The location brings so much value to our lives. It’s near parks, running trails, the library, a grocery store, a liquor store, and now a pot store. I don’t partake but it’s nice to know that if I wanted to, I could walk there. My kids are also able to walk to school and meet their friends at the park down the street.
Lesson # 4 Your primary residence is a money pit
Your house will never put money in your pocket unless you rent out your basement. That sounds like a nightmare. It’s already stressful trying to manage life with two working parents and two school aged children without throwing in a stranger to listen to our domestic disputes. This was a big take away from Rich Dad Poor Dad.
Your primary residence is not an asset. It is a liability that only takes money out of your pocket. If you have ever owned a home before, you know this is true. The only way I plan on seeing money from my home is when my kids force me to sell the house and put me in a nursing home. Hopefully, I’ll be senile by then.
Homeownership can be a wonderful thing. We derive a lot of value and joy from owning our home. It fits with our lifestyle and we love living in the community. In the end, you need to buy a home that fits in with your values. Take everyone’s advice with a grain of salt (including mine). But if you want to achieve FI, following conventional advice and trying to keep up with Jones’ will take you longer to get there.