How much should you spend on your house?

Don’t feel pressured to buy the biggest house possible

How much should you spend on your house?

How much should you spend on your house?

Those who know me know I’m a big believer in real estate. I’ve bought and sold tons of real estate over the years, including single family houses, rental property and I even wound up doing a sort of flip once (wasn’t planned that way, but that’s what it turned into).

At this point, I’ve pretty much seen everything from sewer backups, lunatic renters, mold, leaky pipes, you name it. So I feel qualified to spray my opinion all over the internet about most real estate topics.

The latest thing that’s gotten under my craw is the nonstop drive by the real estate and lending institutions to push buyers into purchasing as much house as they can possibly afford. The most visible way we see this is in online calculators helpfully offering advice on how much home the user can afford.

These calculators all have one thing in common: the first thing they ask you for is your yearly salary. They then typically will use a simple computation to determine your debt-to-income ratio. That’s usually somewhere around 35%. In their defense, that is largely how the lending industry will look at things. And unless you have something weird on your credit report or a relatively high amount of consumer debt, you’ll probably get that loan.

But look at the calculator on CNN Money, for example. I put in a fairly typical upper income salary of $100,000 each for a couple with 20% down with no consumer debt (if you have ANY consumer debt, you should be getting rid of that right now instead of reading this). Using that input, it tells me I can buy a house of over a million dollars!

Mmmm, milliiiiiooooon doooolllllaaaaaaaaaaaaaar hoooouuuusssssseeeee… (Drool, drool, drool.) My head is filled with visions of waterfront homes, decks with hot tubs, space far from my neighbors, condos with sweeping views of harbors, kitchens with islands and built-in wine coolers, separate rooms for every possible human activity. It’s almost irresistible!

Almost.

My problem with this way of looking at house shopping, is that it’s asking the wrong question. The question isn’t “How much house can I AFFORD?’ The right question is “How much house do I NEED?”. And, really, no one “needs” a million-dollar house. It's a Trap!

It’s easy to get starry-eyed about real estate. I’ve done it myself. I did buy too much house when I moved into my current home. (Not because I was buying as much as I could, however. According to these calculators, I could have afforded much, much more. I was just confused about what I really needed, a good topic for a later post.) Beautiful real estate is one of the most engaging forms of art. I could spend ALL DAY just looking at pictures on Houzz. And like any consumerist temptation, I feel the pull to make my house look like those lovely models.

That’s when I have to work hard to slap myself back to reality. Because there is no bigger hole to flush your pretirement money down than the real estate hole. I could have shaved several working years off my career had I not bought so aggressively. That’s true for so many people. Let’s say you purchased a $600,000 home when a $400,000 home would have sufficed (which is what I did). That would be an extra $100,000 each toward your pretirement funds. That could be a third of what you each needed! In addition, there is more house to maintain. A larger house will have a larger roof, more bathrooms, more windows, more expensive furnace, etc. Plus higher insurance and property taxes. More yard to mow, bigger electric bills, the list goes on.

But we haven’t even talked about the biggest problem: your gigantic mortgage. If you really bought that $1,000,000 home that CNN Money was saying you could buy, you’d be paying a mortgage of nearly $4,000/month before tax and insurance! Now if you’re both making $100,000/year, that may not sound too bad, really. It’s, by definition, around 35% of your monthly income. You have plenty of money leftover each month. You could even afford a car payment if you wanted. What’s the big deal?

Here’s the big deal: Unless you have a way to talk to Future You 25 years from now, you don’t know how much you’re going to hate your job by then. And if you really love your job at that point, but haven’t purchased an unnecessarily expensive home, you’ll be able to buy that million dollar home then with cash! You’ll be much better off buying the cheapest house that will work for you instead of the most house you can get.

Pretirement is about gaining your own freedom. As quickly as possible, you want to build up your investment fund so your monthly bills are covered. This doesn’t happen overnight, but it WILL happen if you can resist the urge to bury yourself in debt.

With all that in mind, here are my rules for buying personal real estate. This only applies to the home you’ll live in, I’ll have different rules for investment property.

  • Buy quality, not a project
    We’ve all heard the old saying about buying the worst house in the best neighborhood. And, that saying is actually true! However, don’t let that convince you to buy any project houses. First time homeowners have no idea how much these projects will cost and once you’ve begun there is no turning back. The best way to make money in real estate is to not spend any money on property AT ALL and let the market appreciate for you. And, first time homeowners ALWAYS over-improve their first homes. I did it, you’ll do it. We all do it. By buying something that’s already in good shape, you’ll usually come out way ahead.
  • If something bothers you about the house, don’t overlook it
    My wife and I once bought a house that had more than 20 steps from the street to the front door. It was an old tudor with tons of charm and we lost our heads (it was a major project house). We overlooked the steps as long as we could and finally realized it was such an unchangeable feature that we knew we had to get out. We barely escaped the real estate collapse, closing the deal right before all hell broke loose. Had we not been able to sell, we would have been stuck living with those horrible stairs. Do yourself a favor: If something bugs you, keep looking, you’ll thank yourself later.
  • Buy what you need — don’t believe the “more is more” crowd
    With real estate, it’s very easy to move up the cost ladder by inching your way a little at a time. “Well, this one is only $5,000 more, I guess we could come up a little.” If you do that more than a few times, you’re soon in expensive home territory. It’s OK to adjust your budget to match reality, but make sure you’re clear about what you really need. If you’ve decided a three-bedroom is right for you, why are you being tempted by a four-bedroom for $10,000 more?
  • If you can’t afford the 10-year loan payment, you’re buying too much house
    The best way (right now — this could change with an increase in interest rates) to determine how much house to buy is to use a 10-year loan as a guideline. Take a look at your expected monthly bills. Add in a bit extra for breathing room. Now, can you afford the payment if you do a 10-year loan? Congrats, you’ve just found your budget! It may not make sense for everyone to structure their loan as a 10-year loan, but as a guideline to figure out your maximum budget it makes a lot of sense.
  • Buy it because you love it, not as an investment
    Real estate can be a great investment and a very lucrative one. But it can also be a harsh mistress. Make sure it’s the right home for you before pulling the trigger. Focusing too much on the investment side can leave you stuck somewhere you don’t want to be.
  • Make sure it fits your practical needs, not just emotional needs
    Now that you love it, also make sure it fits all your objective criteria. Layout, number of bedrooms and bathrooms, privacy, proximity to work and school. These are all critical and must not be overlooked just because the home has loads of style.
  • Don’t “drive until you buy”
    These days the highest priced real estate is largely found in city centers. Moving in concentric circles outward the prices drop as distance from work increases. Home buyers often will simply explore outward from the city center until they find what they can afford. This is often called the “drive until you buy” strategy. They then live miserable lives in their cars, driving to work, errands and soccer games, frantically five minutes late to everything. Instead, either buy less house (hey, earlier generations had even more kids than families today so it’s possible, right?) or rent right in town.
  • Always put at least 20% down
    Fortunately it’s harder to get a loan without a decent down payment these days. That keeps a lot of people who aren’t ready to buy off the market. But there are still a lot of purchases happening with 10% or less down. If you don’t have the 20% yet, just hang in there. It’ll be worth it in lower payments, built-in equity and no mortgage insurance.
  • Don’t rush it
    Don’t be tricked into buying, thinking you have to get in before it’s too late. It’s never too late. Stick to your strategy and don’t be rushed by anyone. There’s always another house and another great time to buy.
  • There is no shame in renting
    Renting has its annoyances but it has a lot of upsides, too. You can keep maximum dollars flowing to your pretirement fund, you don’t have to fix anything and you can move whenever you want. If anyone gives you crap for renting, just chuckle to yourself, knowing you’ll be completely pretired while they’re still schlepping to work every day.

I’ll add in any others that occur to me, but following those guidelines should keep you on a healthy path to pretirement. Once you’re well under way, you can check out my tips for paying off your mortgage early and really speed the process along.

What are your best tips for keeping real estate costs under control as you pursue pretirement?

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36 Thoughts on “How much should you spend on your house?

  1. I think that most people have more house than they need (in the U.S. at least). We bought our current house before we had kids….and I thought I would need a ton of room. Now that we have two kids, I realize that we don’t need much room at all. I hope to downsize in the next 5 years or so.
    Holly@ClubThrifty recently posted…Benefits of Juicing (Plus Tips & Tricks)My Profile

  2. Pretired Nick on April 30, 2013 at 12:06 pm said:

    Same. We finally realized we use maybe 1/2 of our house. Better to realize it now at least! We’ll probably downsize in the next 2-3 years. Hopefully that’ll free up another $200,000 or so for our pretirements!

  3. What a timely post. We signed a contract to sell our home today. Similar to what you say in your comment, we are downsizing. We just don’t need that much space.

    “The latest thing that’s gotten under my craw is the nonstop drive by the real estate and lending institutions to push buyers into purchasing as much house as they can possibly afford. The most visible way we see this is in online calculators helpfully offering advice on how much home the user can afford.”

    Ha, we’ve dealt with this before and it annoys the crap out of me. Real estate agents get very confused when they see you’re looking for a home that is half as much as you can afford.
    Mr. 1500 recently posted…The Tale of Bad Car BillMy Profile

    • Pretired Nick on April 30, 2013 at 3:26 pm said:

      Good for you, Mr. 1500! We’d downsize today, but we think we’re better off rising with the market a bit longer. Good point about the realtors. They cannot break out of the cliche “starter home> larger home> dream home” pattern.

  4. I like your – If you can’t afford the 10-year loan payment Rule. It’s a good rule of thumb for the working stiffs.
    We got a bigger house than we needed when we first started too. It was 2,000 sq ft and we didn’t need all that space. We should have purchased a duplex instead. That’s what I’m telling my younger brother now.

    Can you add a tweet button so it will be easy to share your posts?
    Joe recently posted…The Pros And Cons Of Living In A Smaller HomeMy Profile

    • Pretired Nick on May 1, 2013 at 7:01 am said:

      Thanks, Joe! I hope that rule does help some folks determine the right buying level. I also advise younger folks to look for a multiplex of some sort as their first purchase. I wish I could go back in time and do that.
      Will do on the Tweet button. That’s one of the features I’ve been meaning to add to the site.

  5. This is a great point. I wrote an article a little while back covering this exact same topic. It’s crazy how much you can be pre-approved for if you have no consumer debt. The problem is that most people take their pre-approved amount as their budget. The amount you are pre-approved for should have nothing to do with how much you can afford (besides giving you the absolute max you could spend). I really like your 10 year payment as max rule. This gives you a bit of flexibility.
    Jake Erickson recently posted…Check Your Retirement Accounts QuarterlyMy Profile

    • Pretired Nick on May 1, 2013 at 8:29 am said:

      Thanks, Jake! I think a lot of people don’t even consider 10 year loans. The 30 year loan has just become automatic.

  6. We decided to wait to buy until next year. We honestly can’t find anything that we like where we live, and still love the current house that we own. We don’t want to rush the next home purchase!
    Michelle recently posted…$7,859 in April Extra Income and GoalsMy Profile

  7. Brian on May 1, 2013 at 9:44 am said:

    We went old school with out house purchase and bought my grandmother’s house. It is in a very good location and is built for the long haul. When we had an inspector go through it, he kept saying “man they don’t build them like this anymore.” We know the history of the house and know it was built using quality. We are now raising the 4th generation of our family in this house! I know people move away from where they were born for a number of reasons, but sometimes I just don’t understand why more American’s don’t want to just purchase their parent’s/grandparent’s house.

    While this house is more space than we need (1900+ sq/ft with a full basement) the price, neighborhood and history (we are the only family to have ever lived in this house) were too good for us to pass up.

    • Pretired Nick on May 1, 2013 at 10:21 am said:

      Wow, that is wonderful, Brian. I think keeping something like that in the family would be worth the extra cost. Never let that place go!

  8. We’re not buying anytime soon but since we live in 270 sq ft (not a typo!) I think just about any house will feel amazing and spacious to us!

  9. This post made me smile. Not so long ago, I also went on CNN Money to use their Affordable Home calculator and was so surprised that we could apparently afford a house with a 7-digit price tag! I adjusted it by putting in under the “Monthly Debt” field the monthly amount we set aside for our savings and investment accounts. After that, I got a more reasonable result. They really should automatically deduct a certain percentage of your income for savings or at least have a field for it.

    • Pretired Nick on May 2, 2013 at 9:09 pm said:

      That’s a good call, Mrs. Bookworm. The math behind this calculator is so simplistic, it’s silly. Of course the important thing to figure out is how much house and with what features does your family need and where does it need to be located. Something all the calculators ignore. Glad you enjoyed!

  10. I was always confused by the folks who advised people “buy as much house as you can afford”. Sure, they didn’t see the recession coming, but what do Americans really need to be comfortable. It’s sure as hell not a mcmansion.

    Also, any housing post that references A New Hope is golden in my book, haha.
    CashRebel recently posted…Should You Live Next To Rich People?My Profile

    • Pretired Nick on May 3, 2013 at 6:03 am said:

      LOL, thanks, Reb! It is crazy how often you hear the advise to buy as much as you can afford. They sell it like it’s a secret to instant wealth or something.

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  12. What would you advise for people living in high cost of living areas? I live in NYC and it would be extremely difficult to have a 10 year payment plan and 20% downpayment. I’ve been renting which I think is good now, but do have the urge to eventually own.
    Andrew@LivingRichCheaply recently posted…How to Save Money on GroceriesMy Profile

    • Pretired Nick on May 13, 2013 at 10:23 am said:

      Renting is your best plan in a high real estate cost area. So you’re already there. In areas that are high-income but high cost-of-living areas, you should rent (get roommates if you have to) and keep your personal costs down while you rake in the sweet, sweet, high salaries. One option for someone in your situation is to buy a property in the area where you might like to settle down once you’re pretired. Rent it in the meantime while you’re still building up your pretirement fund. By the time you’re ready to leave corporate work, hopefully that eventual home is all paid off and waiting for you!

  13. We are going to buy a house soon, and I have worked the numbers already. We are not going to buy too much house, because I want to have it paid off by the time we are 30. We live in Texas, and I’ve calculated we buy a house for a max of $150,000. We will put 20% down.
    Savvy Financial Latina recently posted…Carnival Cruise on the Western CaribbeanMy Profile

    • Pretired Nick on May 24, 2013 at 5:37 pm said:

      That’s great! I wish there was a house around $150,000 out this way. Starter homes here go for twice that! Definitely think about the 10 year loans. I think they’re a great deal right now.

  14. By the way, I love your writing style!
    Savvy Financial Latina recently posted…Carnival Cruise on the Western CaribbeanMy Profile

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  16. I love it when people tell me they’re buying a house because they’re tired of “throwing money away.” There are many, many times when buying a house is throwing money away!
    Joe Saul-Sehy recently posted…Barf Bags, Hard Rock Glasses and Beatles’ Records – Investing in CollectiblesMy Profile

    • Pretired Nick on June 18, 2013 at 6:19 am said:

      Yeah, and on top of that, they throw even more away fixing them up. It can be an awesome thing to do and it’s also a terrible mistake sometimes.

      • Hi, I am wondering if you can think of a way to explain this to my husband. He is currently in the “sick of throwing money away” stage of renting (he says that exact phrase weekly), and he simply “cannot wait” to move out of an apartment and buy a house. A little background is that we owned a house for 6 years, made the expensive “over-improve their first homes” mistake you mentioned above, then moved across the country and have been renting for 6 months. We have decided to live in this new area long term, so it is time to start looking around, and we are also considering having children in the near future.

        • Hi Susan,
          Thanks for your question. It’s an interesting one. He’s not necessarily wrong. But he’s not necessarily right, either. Buying a house can be a really smart decision, but you have to be careful.
          My recommendation would be to work together to develop an OBJECTIVE criteria for buying before moving ahead. The criteria would be based upon your shared goals, of course. If you both would like to stop working in , say, 10 years, then use that to determine whether and how much house to buy.
          Just deciding to buy for emotional reasons is a one-way trip to a very long working career.
          So what would an objective criteria for buying look like? Maybe something like this:
          – You can easily afford the payment on a 10-year loan
          – You plan to stay there indefinitely
          – The house is close to your work
          – You already have the 20% payment saved up

          You get the idea. I like your question. Perhaps I’ll try to turn it into a full post in a few days.
          Hope that helps!

          • Wow, thanks for the great (and timely) advice! I will work to develop something with your guidance. You are awesome! :)

            In response to a different post you wrote, I think it is great to incorporate ads on your website, which it appears you have done in the far right column. You should be making a buck off of your time and knowledge!! Thanks again!

  17. Where I live, it’s impossible to find even a modest house in a relatively nice location for less than $450k (which is a stretch for me). I could come up with the down payment, and have enough income to be approved on a 30 yr loan to buy such a house. But I’d be paying about 30% of my income in mortgage and property taxes for a long time, into retirement. Renting here is not a good alternative, because there’s very little available and rents are also very high (I’m renting now, and it’s outrageous). I have children, so anything other than a three bedroom is not viable. The only other option is to move far away (“drive until you buy”), which is not desirable, as you say. So what to do?

    • Pretired Nick on July 10, 2013 at 1:24 pm said:

      Hi Mary! Glad you stopped by!
      It’s impossible to answer your question completely without knowing more details (feel free to shoot me more info through the contact form if you like!), but here are a few thoughts:
      – Definitely do what you’ve already done, which is to avoid falling for the “American Dream” nonsense that tricks people into buying homes when they don’t need to yet.
      – Renting apparently IS an alternative for you since that’s what you’re doing. But, I get it, it’s not always ideal.
      – You’ll need to be open-minded about your options and make the best choice based on your ultimate objective, not on what feels right or comfortable at the time.
      – One really good option to think about is buying a fourplex and living in one of the units. I’m sure it’d be hard to find one with three-bedrooms, but I think it’d be worth it even in a smaller space. Depending on the exact numbers for the place you buy, you could be living with NO housing costs at all or at least very low costs. All of that extra money could be then channeled into building up your pretirement fund. The fact that rents are high makes this a pretty good opportunity for you.
      – And not knowing where you live, this may or may not apply to you, but it may be time to think about moving to another part of the country.
      If you’re not succeeding while operating under the current situation, change your situation.
      Bottom line do NOT buy a home if you can’t afford to do a 10-year loan and don’t crush your monthly cashflow with giant house payments.
      Hope that helps!

  18. Thanks for the advice. It really makes a lot of sense. Continue to rent is indeed an option but not a good one, I’m paying more in rent than I would be paying for a mortgage. What I’d use for a down payment is invested and probably making more than I would on equity, so I’ve been fine with this arrangement so far. I’m basically just tired of renting and want to have my own place, so there’s more to it than just finances, but definitely don’t want to go crazy in debt just to be able to buy. I’ve considered the duplex option (or fourplex!), but as you say it’s hard to find something with three bedrooms. I’m in Massachusetts, and in a relatively affluent area, which is why prices are so high. Can’t relocate for some years due to my job situation, but eventually will. Anyway, you’ve given me lots to think about. I’m glad I found your blog!

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