For many years the mantra, when buying a home, was you should buy the biggest home you could afford. This may have made sense years ago when homes were a better long-term investment. Nowadays that mantra may just be self-serving advice from real-estate agents and mortgage brokers. The more you spend the more they make. They don’t care whether you’ll be struggling to make your mortgage payment in a year or two. They’ve already been paid.
There are endless articles about how home size has ballooned over the decades while family size has decreased. At the same time there are endless articles about how people find it difficult to save any money. I think there’s a correlation there. What the pundits and financial websites should be saying is: “One of the top ways to save money and build wealth is to live in a home that is well below what you can afford.”
Are you house poor?
If all your cash is going to pay for and maintain your home and you have no money left at the end of the month to save for an emergency or retirement or anything else then most likely your home is too large. This is a classic case of being “house poor.” You may make a decent living but after paying for your house you are “poor” and possibly living paycheck-to-paycheck. If you moved and your monthly housing expenses dropped by $500 a month or more how would that improve your financial situation?
The one-asset portfolio
If you are spending every last dollar on your home you will end up with is a lopsided portfolio where all your wealth is tied up in an illiquid and possibly low-return asset. No one needs to be reminded of how disastrous that was for some people since 2008, where their only asset plummeted in value and has yet to return to its prior value.
What we all should be striving for is a diversified portfolio of assets that include our homes, regular savings and retirement savings. The only way to achieve this is to spend less money on our homes and divert that money into savings. If you moved and your monthly housing expenses dropped by $500 a month how much money would you have after 10 years, assuming you are earning 5%? Answer $79,241. Try it here.
What does it really cost to own a home?
When you buy a home that is larger than you need (or can afford) keep in mind that every extra square foot not only costs you a principal and interest payment, real estate taxes and homeowners insurance, but also heating and air conditioning, water, furniture and interior cleaning supplies and time spent cleaning. On the exterior there are more windows and gutters to clean and more yard to mow and snow to shovel and so on. So if your home is 30% bigger than you need you may actually be spending 40% or more to pay for all the extra square footage. Are you really using all that extra space? Is it worth it work all those hours to pay for unused or underutilized space?
Not all home affordability calculators are created equal.
There are dozens of calculators that will tell you “How much house you can afford.” However, most of them are overly generous if not downright dangerous.
The general consensus is that you should not spend more than 28% of your income on principal, interest, taxes and insurance. What does that mean exactly? Where did that 28% number come from? Who knows? What it doesn’t take into account is that your real estate taxes, insurance, utilities and other housing-related expenses are going to increase every year. It doesn’t take into account that you may have expensive home repairs in the future and no savings. Worse, some calculators use parameters that tell you that you can “afford” to spend up to 36% of your gross income on your home. Many of those same calculators don’t show that they’re using 36%; you have to go back and calculate that yourself.
You should not rely on these calculators. They will make you house poor. Instead use a calculator, like this one, that allows you to control the percentage of your gross income you can afford to spend for your home. Depending on your income level, in order to be able to save money, you should never spend more than 20% (moderate income) or 25% (high income) of your gross income on your home, including utilities and maintenance and upkeep (not just your mortgage payment, real estate taxes and insurance).
If you already own go back and calculate what your house is costing you currently. Even if you started at 28% it may have crept up to 30% or more. Can you really afford it?
Obviously there are costs associated with selling your home and moving so you have to do the math. If you were planning on moving in the next few years then maybe no action is needed at this time. If you were planning on staying longer you need to really crunch the numbers and take a hard look at your situation. It may be time to downsize.
- Don’t feel pressured to stay in or buy a home that you can’t afford. “Friends” or relatives who are pressuring you to do this are most likely broke. And don’t listen to the “experts” about “investing” in a large home. They are wrong.
- Every month, after you pay your housing expenses, if you have no money left to save your home is too large.
- If you haven’t bought yet be wary of housing calculators. Some of them are downright dangerous. Never exceed 20% to 25% of your gross income for all housing-related expenses. If you already own go back and calculate what you’re spending now.
- Freeing up cash by reducing your housing costs will enable you to build wealth in a diversified portfolio.
- By lowering your housing expenses you will be able to enjoy your life rather than being a slave to paying for a home you can’t afford.
Bonus: Most of the time when someone I know is having financial problems it’s because they’re living in a condo or house they can’t afford. When I suggest that the answer to their problems is to downsize I’ve heard unbelievable excuses for why they can’t do that. Here are some of the most amusing (or tragic):
- I have to live in a house that’s bigger than the one I grew up in. My parents worked so hard so I could get here. The parents, of course, still live in the small house.
- I have to have a large kitchen to store all my kitchen equipment. Or I need all the closets and storage space for my things.
- I need a place for a hobby I plan to take up some day, like knitting or painting.
- I can’t get rid of my deceased family members’ things (even though they’ve been dead for decades).
- My dead husband wouldn’t want me living in something so small.
- What if I get married again?
- I might need money later so I need an extra room for a roommate.
- My kids may move back home someday.
- I would be claustrophobic if I lived in a one-bedroom condo.
- My dog needs a big yard.
If you already have a house that’s making you poor and don’t know what to do, next month we’ll talk about downsizing with advice from a downsizing expert.
Here are some other housing-related articles:
- How to buy your first home
- How to buy a house with no down payment
- Is the tiny house movement for you?
- How to get the best deal on a mortgage
- 12 tech tools to help sell your home