Comments: Buy a House You Can Afford

I recently posted from the book The Millionaire Next Door saying that one of their rules to wealth-building was to buy a house work two times your annual income or less. I received a handful of comments on it, and here they are with my thoughts after each one:

We are in the third house that we bought. For our first 2 houses the mortgage were indeed less than twice the household income. But the current one is a little over. Why the difference? it depends on the circumstances. The book was written in the late 80's? I believe? Back then, interest rate was sky high because the fed wanted to fight inflation. What's assumed in the book was probably interest rate of at least 8 or 9 percent.

At what price point is suitable is a complicated subject. A better measurement is what is the percentage of the mortgage payment amounts to the monthly total after tax income. Cashflow analysis, my friend, is the key.

I think their actual point was that many people stretch themselves to the limit to buy a house, then have very little left over for wealth accumulation. The people that stayed within the rule had a better chance of having extra money left over each month.

Personally, I don't care a lot about taxes and the fact that mortgage interest is deductible. Yes, it's a nice financial exercise to calculate the "real" cost of the house once tax deductions are factored in, but in real life, very few people do this. I care more about no debt on my balance sheet. That's why we paid off our house early -- in seven years -- through a combination of buying a house worth less than two times our income then making extra payments, putting salary increases, bonuses, gift money -- anything we got -- against the mortgage. We paid off our mortgage when I was 34 years old and we haven't had a mortgage payment in seven years. As a result, our net worth has skyrocketed as we're able to sock away a good portion of income every month.

Here's the next comment:

One of the senses that I got when I read this book years ago, was that it is more about not trying to keep up with the neighbors, as opposed to living in a better, larger house. We live in one of the better neighborhoods and have seen very high gains on our equity. The trick for us is not trying to keep up with our debt laden neighbors. While we have nice things, we tend not to drive 45K cars etc.

Bingo! This is one of their other points. If you buy an expensive house, you're not only stretching your finances, but now you need to keep up with your neighbors who also have expensive houses. They also tend to drive luxury cars, have swimming pools in their back yards, belong to expensive clubs, take extravagant vacations, etc. As you try to keep up with them, you get deeper and deeper into debt.

Here's the final comment:

Is this rule of thumb even possible anymore? It isn't possible here in New York, that is for sure. When a raised ranch in a bad school district is selling for $300,000, then this just doesn't work.

Here's my advice to people who live in New York, California, Boston, Chicago, and other expensive locales: move. It's a big country out here and believe it or not, an $80,000 annual income is actually a lot for most people -- not a subsistence wage like you think it is.

I know, I know. There's "culture" there. There's lots to do. There's always something going on even at 4 am in the morning. Besides, your friends and family live there. My thoughts:

1. Culture is over-rated in most cases and is not exclusively found in big cities.

2. Who cares if there's always something to do. Do you have the time and money to always do it?

3. Most people sleep at 4 am. Don't you?

4. Get new friends.

5. Take your family with you.

Ok, so I'm being a bit sarcastic. But really, moving is an option that many people haven't considered but should.

Comments

[superdestroyer]

There are reasons why more people live in New York City instead of Fargo North Dakota and that is jobs. There are just not many jobs in Fargo and if you laid off or economic conditions change, then what are you do do in Fargo (starve, start working at Wal-Mart, or move?).

Also, in the world of two income families, it is much harder to do those small cheap towns instead of Chicago or Washington, DC.

[meaghan]

You know, there is a big financial bonus to living in New York over a small town (besides more job availability): Not having to own a car. Saves some major cash- not just on a car payment, but insurance, maintenance, and gas.

On the job availability issue: There are many fields (entertainment, namely, but I'm sure there are others) where you're just not going to find jobs outside of a large city.

I do agree with you that, even in NYC, $80,000 IS a lot of money, and is absolutely not a subsistence wage. A large number of people in NYC think they 'deserve' the lifestyle they see on TV- shopping at all the nice stores, lunch and dinner at nice restaurants, cocktails, cabs, an apartment in Manhattan. If you're willing to make some compromises, it's very possible to live on a quarter of that amount.

[Terri W.]

My husband and I went that route a few years ago before we got married. We were both working and doing well in the computer industry in Silicon Valley. But we knew that we wanted two things: to buy a house, and for me to be a stay at home mom with our kids. There, we could pick one.

So, we moved to Austin, TX. Now I'm home with our 1.5 kids, we're aggressively paying down our mortgage [20% down in 2 years] and put about 40% of our pre-tax income away in savings and live on the rest. Let me tell you, we would *not* be doing that in Palo Alto -- and it more than makes up for the fact that you can't get good sushi.

[RS1990]

I wasn't even talking about NYC when I made that comment. I live in Poughkeepsie, about an hour north of the city and we have that problem. Believe me, there is nothing going on here at 4 in the morning and there isn't even any culture. However, you were right about the family part. Unfortunately, my wife is not too keen on moving away from them. So, we are sort of stuck here.

-Rick

[Caitlin]

Another perspective...

It's not that I do not consider moving away from Boston, I think about it all the time now. I'm not here for the 4am partying (I gave that up long long ago) or even what most people think of when they think of "culture". I have been here for 15 years and my friends have become like family to me. We often borrow each others big ticket items rather than buy new, we have potlucks, and we spend wonderfully cheap evenings together having a grand old time. The library here has almost every book I'd think of buying. I can get inexpensive takeout when I'm feeling lazy ($3.50 for a vietnamese bahn mi, under $4.00 for two steak tacos etc). I am 4 hours from my parents, 1 hour from my sister, and 4 hours from my aunt, uncle and cousin...and I enjoy seeing them, it brings me joy and I dont have to buy an airline ticket to see them. And re: jobs...I'm in tech...there are always opportunities here.

It's a huge complicated decision and frankly its overwhelming to find a place among all the possibilities. I'm looking, but it's going to take a while to figure out if I stay and if I go...then where?

[mysticaltyger]

I sort of agree with your advice about moving. However, if you live in an expensive area it's not always so easy or cost effective to pick up and move, even if you have a fairly ordinary job. I work for a library here in Silicon Valley. If I lived anywhere else I'd get paid 1/2 to 2/3 of what I make here (and the benefits probably wouldn't be as good either). Sure, the rent would be lower, but there's no way I'd be able to save as much as I do here. And sure, I can retrain for something else, but that also takes time and money.

For me, the choice has come down to: 1. either max out my 401k type plan or 2. own a small condo because there's no way I can do both on my income. I've chosen option #1 and have a balance in my 401k type plan and IRAs that are now past the 100k mark, not bad for someone my age (36). However, I'm gay and therefore, not likely to ever have kids. If I wanted children I'd be outta here in a heartbeat.

However, I also have a friend who's a janitor and he knows he's going to lose his job in the next few months. He is not interested in going back to school to retrain. I told him he could be a janitor in Kansas City or (name the place...almost anywhere is cheaper than here) and probably make 80% of what he makes here and pay rent that's 1/2 of what he pays here. But I don't think he's going to go for it. He complains that he can't afford the lifestyle here, but, like a lot of people, he doesn't seem willing to make any changes to his life to make things better for himself (move somewhere cheaper, go back to school, etc)

So while I generally agree with your advice, it's true what others have said....it's sometimes hard to leave larger, more expensive metro areas for economic reasons.

[moneymonk]

I agree New York, California, Boston, Chicago are overated, and as for culture its nothing wrong with visiting !

I love NY, and Cali but I will never live there, I will only visit

I love ATL, that is my place decent income with nice culture

I know several people and family living in NY some 15 20 yrs living in a one bedroom apt. or 2+ bedrooms with roomates

Not my style of living

[Tim]

I work for the federal government, so moving away from DC just isn't an option if you're trying to build a career as I am. I've made the best of it by buying a place in an up-and-coming area in a suburb for much cheaper than buying a place in DC proper (which is insane). I also bought WAY more house than what I need-- I'm a single guy and I got a 3 bedroom, 2.5 bath townhouse-- and I rent out two of the rooms to roommates whose rent pays most of my mortgage. The remaining chunk of the mortgage that I have to pay is BY FAR less than what it would cost to rent a place by myself, and I'm still gaining equity in a super-nice house in an area with quickly-increasing real estate prices (despite the nation-wide decrease, DC housing prices will always go up for a number of factors I won't get into here).

The downsides, though, are plenty: the commute is long, and there's not a lot of stuff to do close by and not a lot of places that a single guy like me can meet women. Also, you have to live with strangers that you may or may not get along with (unless you have a friend willing to go along with it), and who may or may not perpetually steal your food (despite the clear "if you didn't buy it and it's not offered to you, don't eat it" rule), and who may or may not clean up after themselves. I've been lucky that I've never had a problem with people not paying their rent-- a strict roommate-screening process is important...

Other downsides: the loss of flexibility in location that comes with buying instead of renting, the worry of catastrophic events and having to fight with insurance companies to salvage your net worth, and the loss of privacy just to name a few. The financial upsides are vast, however, and are worth it all in my mind. Anyway, just my 2¢...

[Best Buy Finance]

I rely do not agree with it because there is big financial problem people those living in New York. I sort of agree with your advice about moving. However, if you live in an expensive area it's not always so easy or cost effective to pick up and move, even if you have a fairly ordinary job.So while I generally agree with your advice, it's true what others have said....it's sometimes hard to leave larger, more expensive metro areas for economic reasons.

Best Buy Finance

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Tamara