Episode 62: What Does it Mean to be Able to Afford a House?
‘The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.”
Henry David Thoreau, Walden
From time to time I see snarky comments floating around the internet with folks commenting about how they’ve been paying rent for 10 years without missing a payment, but the banks won’t qualify that person for a house. I absolutely understand the frustration but it comes from a partial understanding of the trust cost of owning a home.
Home ownership has become one of the defining features of the American Dream and it can be quite devastating and difficult for people who see this dream as a part of life and also forever out of reach. The insane housing market now coupled with high rents is making this feel worse. I’ll tackle renting vs. Owning another time. Today, as part of a series I want to do on financial literacy, I’d like to dive into what it means to be able to “afford” a thing and in this case specifically a house.
Before I start, I’m not giving any specific financial advice, just broad observations from my personal experience as a homeowner and a former financial planner for the previous 27 years.
Ok with that out of the way, let’s dive into what I mean.
First, banks do want to lend money and to as many people as possible who can pay them back with interest. Lenders are customers. The reality is, sadly, that a huge number of people who did “qualify” to buy a house, can’t really afford it, or at least that house, and it has a profound impact on their lives.
When you “qualify” for a loan they banks look at your credit score to see what kind of risk you might be from your history, your loan to value ratio, and your debt-to-income ratio. The rule of thumb I was taught in my training as a financial planner was the 30% rule. That is, spending 30% of your income on housing is a good place to start.
Problems:
Real time depreciation is rarely budgeted for accurately, if at all. If you buy an investment property, the government acknowledges the fact that you have to keep investing in the asset to keep it up and gives you a tax break to help pay for it, this isn’t recognized the same way for you as a home owner. According to investopedia, the depreciation for rental homes is 27.5 years, or 3.63%. A quick google search shows that the average home price in the US is over $400,000. To use that as an example, a homeowner should budget $14,520 per year to account for entropy. That is, repairs and maintenance.
Then, if you are buying an older house, you’re often buying decades of deferred maintenance and projects. Sometimes those can be extremely expensive like if you have to replace a roof, especially if it has a slate or tile. Or maybe has asbestos shingles, lead pipes, lead paint, or old dangerous wiring you have to replace. (I wrote quite a bit about my old house adventures in AfterLIFE, Waking Up from My American Dream.)
On top of this are all the things you Want to do to the house. Decorating, landscaping and more!
You have to fill the house with all of your stuff, every bit of which is also depreciating or even completely disposable.
Often, to pay for all these projects you Have to do and the ones you Want to do, homeowners keep refinancing their homes to pull out equity. Sometimes people will live in a home for decades and still have decades left on their mortgage that’s as high as or higher than where they started.
Oh! And don’t forget you have to also pay for homeowner’s insurance, real estate taxes and utilities.
Often, couples buy a house with the intention of starting a family. After the new baby/babies arrive expenses go up and often income can go down if on parent stops earning income partially or entirely.
Then, after all these considerations people need to use the rest of their money to pay down other debt (often cars required to get to job to earn money to pay for all the stuff we are talking about), health insurance, save for their futures, and try to have a little fun along the way.
Rarely do people account for the real and opportunity cost of all the time they have to spend thinking about and working on their homes. Time and money that could have been used towards other goals.
Often people keep upgrading and moving which resets the clock to pay off the home and often with a higher mortgage plus all the moving costs and costs to buy and sell a home.
Going back to our example to buy the average priced home and only spend 30% on housing a person would have to earn over $100,000 just to pay the mortgage, insurance, taxes. To properly budget for repairs a much higher income would be needed.
Starting from the beginning and what Thoreau said, what is the true cost of the homeownership? How much of your life will you have to sacrifice for this home? If you could truly afford to pay for all this maintenance, repairs, budgeting, is that wha will help you achieve your goals in life? If you want to be financially free, that house will likely eat your freedom.
“How much of your life will you have to sacrifice for this home?”
Knowing you dreams, having them clearly defined, and building an action plan to map out your future is and absolutely key step in knowing how much you can really afford to spend on your housing, or how much you need to make in order to buy what you need and want.
In addition to renting vs buying there are so many other options one could look at to reduce housing costs especially for those who can work remotely. I’ll explore more of that in the future as well in my personal life and here with you all.
Until then, please share ideas you have or things that have worked for you! Maybe you rent out a room to a roommate or guests. Maybe you have a duplex or bigger with other tenants? Maybe you don’t have a home at all and are renting or doing the van life adventure now!
PS, This is a big topic and our homes carry so much personal meaning to ourselves and identities. The changes I’ve made and the way I look at houses and other things has evovled from the experiences I’ve lived through and through witnessing the life and energy I’ve seen robbed from so many people in my work as a financial planner in my former career. If something I said doesn’t make sense or you have ideas on how I might clarify or expand on a concept let me know!
Best,
Carlo