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I\u2019ve said it once and I\u2019ll say it again: While I\u2019m thrilled this blog has a shot at helping others, I am \u2013 at heart \u2013 a selfish creature. Writing these articles mostly serves as a way for me to publish my own thought experiments and, consequently, force my own hand at figuring out how these types of major life decisions will impact my own <\/em>financial independence calculations.<\/p>\n So while one could perceive that as a shortcoming of this blog, I invite you to see it as the opposite: I\u2019m looking out for #1, and therefore really<\/em> putting my back into the research and methodology here (since it directly impacts me). <\/p>\n Feel better? Great. Let\u2019s get into it. <\/p>\n For the purposes of today\u2019s post, we\u2019re talking about:<\/p>\n A \u201ctypical\u201d home-buying experience: Buying a house you can afford that\u2019s already \u201clivable,\u201d so to speak, and not intended to function as a rental. In other words, you aren\u2019t going to \u201cforce\u201d appreciation by buying a fixer-upper, and you\u2019re not using it to generate passive income via renters. <\/p>\n<\/blockquote>\n While you totally can (and should!) do those things, I don\u2019t think that\u2019s how most Americans buy homes, so I want to look at the \u201cbaseline\u201d experience, if you will \u2013 from there, we can always build on later and look at how those two approaches outlined above could shift the narrative.<\/p>\n As I think through factoring a mortgage into a FI calculation, there are a few things that come to mind immediately:<\/p>\n Using a chunk of your net worth for the initial down payment, thereby lowering your net worth in the short-term<\/p>\n<\/li>\n The opportunity cost of that chunk of your net worth (in other words, what your down payment would\u2019ve turned into had it stayed invested)<\/p>\n<\/li>\n The ongoing cost of your monthly payment over the next 15 or 30 years, depending on the length of your mortgage (but theoretically, afterward you\u2019d be home-free \u2013 literally)<\/p>\n<\/li>\n<\/ol>\n Two things jumped out at me immediately:<\/p>\n Because we know home ownership has a shit ton of other hidden costs<\/strong> associated with it that are typically proportional to the value of the home (property taxes, insurance, maintenance, repairs, renovations, building a skateboard ramp in the backyard for your snot-nosed kid), buying a home has the potential to really throw a wrench in your financial plan. After all, when we\u2019re calculating our FI number, we\u2019re using our annual spend to determine how much we need to invest to be #free. If property taxes in my town are 2%, the difference between a $300,000 house and a $600,000 house is $6,000 or $12,000 in property taxes \u2013 a $6,000 per year annual difference means my FI number has to be ($6,000 * 25) $150,000 more in order to for me to be work optional, since I\u2019d need $150,000 invested to throw off that $6,000 difference each year in annual returns. The TL;DR: <\/strong>Spending as little as possible to be happy in your home is a baseline principle here. We ain\u2019t swinging for the fences. <\/p>\n<\/li>\n I feel like half my life on personal finance Instagram is #respectfully arguing with people in my DMs about why your primary residence isn\u2019t an investment in the traditional sense. I\u2019ve written about this ad nauseam. But we all need a place to live \u2013 and it\u2019s worth noting throughout this exercise that, while your home is an asset that will hopefully, likely appreciate, it\u2019s a bit of a phantom presence in your net worth. In order to actually realize any of the gain or value, you\u2019d have to sell it and \u2013 that\u2019s right \u2013 not live in it anymore. The TL;DR:<\/strong> It\u2019s not liquid in the same way that your investment accounts are liquid, so treating your home equity like it\u2019s money in the bank isn\u2019t really accurate for the purposes of financial independence.<\/p>\n<\/li>\n<\/ol>\n The last thing I\u2019ll tack on here is closing costs. Closing costs can be thousands upon thousands of dollars, and they don\u2019t go toward the value of the home \u2013 they\u2019re just the cost of doing business. Buying a home you don\u2019t intend to stay in very long can rack up more in closing costs than it\u2019s worth.<\/p>\n I\u2019ll be the first to admit that I basically paid engineering students to do my calculus homework for me in college because my brain doesn\u2019t work well in the theoretical, mathematical realm. When it comes to personal finance, I can scrape by (because the stakes are so high!), but it helps me a lot to use hypothetical examples to make these types of scenarios more tangible.<\/p>\n Let\u2019s apply some basic best practices to a hypothetical situation. <\/p>\n Best practice: Not spending more than 30% of your total net worth on the down payment<\/p>\n Frankly, I hate espousing \u201claws\u201d of personal finance with no basis in anything other than, \u201cWell, that\u2019s just the rule of thumb!\u201d, but to me, this is a starting point. <\/p>\n The idea here is that we don\u2019t want more than a third of our net worth being tied up in our home equity, because (as we already noted) it\u2019s illiquid. <\/p>\n Really, the key here is to use as little of our net worth as possible to hit the \u201c20% down\u201d mark and avoid PMI (that\u2019s insurance a lender will charge you on top of regular insurance if you put down less than 20%; while I know there are certain groups that can avoid it like doctors and military members or first-time home buyers, for the purposes of today, we\u2019re going to pretend PMI is a thing). <\/p>\n If our hypothetical couple has $350,000 between them, 30% of that net worth is $105,000.<\/p>\n The couple shouldn\u2019t spend more than $105,000 on a down payment. $105,000 is 20% of $525,000, so $525,000 is theoretically the most they\u2019d be able to \u201cafford.\u201d<\/p>\n But remember, we aren\u2019t really trying to max out our budgets here. Let\u2019s dial it back a little and shoot for, say, 20% of our total net worth as the down payment: $70,000, or a 20% down payment on a $350,000 home. <\/p>\n What happens next?<\/p>\n Well, a few things:<\/p>\n We\u2019ve put $70,000 down, so our (liquid) net worth drops down from $350,000 to $280,000. <\/p>\n Of course, we\u2019re building equity in a home. <\/p>\n Using national averages and a Zillow mortgage calculator, I\u2019ve learned that my hypothetical couple\u2019s monthly payment on this home would be $1,595, broken down like this:<\/p>\n $1,180 toward mortgage principal & interest<\/p>\n<\/li>\n $292 in taxes<\/p>\n<\/li>\n $123 in insurance<\/p>\n<\/li>\n<\/ul>\n But for all intents and purposes today, it doesn\u2019t really matter how it breaks down: All that matters is that we have to spend about $1,600 per month on our housing, or $19,200 per year. <\/p>\n Quick tip: <\/strong>To see how something affects a financial independence number, just multiply the annual cost by 25. That\u2019s how much needs to be invested to produce enough in investment returns to pay for it. $19,200 * 25 = $480,000, in this case.<\/p>\n Now, the kicker here is that it\u2019s likely that couple would be paying at least $1,600 in rent anyway \u2013 this isn\u2019t a new or novel<\/em> cost, per se. It\u2019s just money that would\u2019ve been spent on rent that\u2019s instead being spent on a mortgage and the associated costs, so it\u2019s not like we\u2019re adding $480,000 to an existing FI number. <\/p>\n It\u2019s possible they were spending more or less on rent before, but remember: The house is going to introduce ownership costs that are<\/em> new and novel, so even if their monthly payment is lower, it\u2019s still worth budgeting in extra for repairs, etc.<\/p>\n So what does this tell us?<\/p>\n A \u201cfuture value\u201d calculator becomes our best friend here. <\/p>\n For the sake of simplicity (though you could plug in your own real numbers for an accurate depiction), let\u2019s pretend our couple was spending $1,600 on rent anyway. In other words, their monthly costs <\/em>didn\u2019t change because they bought a home, they just lowered their net worth. <\/p>\n So let\u2019s say this couple needed $480,000 in their FI number to produce their $1,600 per month in \u201cincome\u201d for their housing, and maybe they spend another $3,000 on other stuff, bringing their monthly \u201cspend\u201d to $4,600 total. <\/p>\n That means their FI number is $4,600 * 12 * 25 = $1.38M. <\/p>\n This is where you\u2019ll have to just go with the flow of the example<\/p>\n For the sake of fleshing this out, let\u2019s pretend this couple can afford to invest an additional $60,000 per year.<\/p>\n In order for this to be accurate, that would mean they\u2019d need to (combined) make about $115,000 after tax, since they\u2019re spending $55,200 per year. That means their average salaries (between them) would probably be roughly $70,000 each, for level-setting.<\/p>\n In the example where they buy the house and drop from $350,000 to $280,000 in net worth <\/strong><\/p>\n They could hit FI ($1.38M) in 10 years, assuming an average rate of return of 7%. <\/p>\n In the example where they don\u2019t buy the house and just rent, but their net worth stays at $350,000<\/strong><\/p>\n They could hit FI ($1.38M) in 9 years, assuming an average rate of return of 7%.<\/p>\n Record scratch: It\u2019s just a year difference?<\/p>\n Let\u2019s break this down. This couple only spent 20%<\/strong> of their total net worth on their home, thereby only shaving off a fifth<\/strong> of their invested assets to pour into the home. The other crucial thing here is that they bought a home with a monthly payment of around $1,600 total, and in our example, we assumed the couple that didn\u2019t<\/em> buy was renting for an identical amount (thereby giving the two scenarios the same \u201cFI\u201d number to strive for).<\/p>\n So you may look at that and think, \u201cWell, shit, might as well buy the house, right?\u201d I mean, that\u2019s what I thought at first glance, too.<\/p>\n But here\u2019s what I always come back to: When you flesh these two scenarios out to #completion, the not-super-realistic-but-still-ideal outcome is that you\u2019d end up owning the house outright and living in financial independence with basically no housing payment, therefore cutting back on your monthly costs by a sizable chunk, where the couple who was renting would have to keep renting indefinitely. One couple would lower their housing costs significantly after 30 years, and the other wouldn\u2019t. <\/p>\n In this example, the couple with the house would likely still need to pay their $282 in taxes and $123 in insurance every month indefinitely, but they\u2019d recoup about $1,200 of their monthly payment after paying off their 30-year mortgage. <\/p>\n Do you see the writing on the wall here?<\/p>\n Most people don\u2019t stay in the same house long enough to own it outright<\/p>\n And if I\u2019m just buying homes and then selling them before I own them outright, I don\u2019t see how it\u2019s any different from renting \u2013 sure, I may make a little on the appreciation even after I pay the bank back (or a lot, if I time it correctly), but remember those phantom costs? It\u2019s hard to quantify how much of that appreciation is truly<\/em> profit after you consider all the money you have to sink into a home over the years. That\u2019s not a knock on home ownership, it\u2019s just reality. <\/p>\n Side note: We\u2019re living through a truly unique time period right now with an extraordinarily hot market because of a housing shortage. While some will certainly get lucky selling their homes right now at inflated values, it\u2019s not something you\u2019d want to bank on down the line because it\u2019s admittedly a bit of a fluke (and the obvious caveat to selling your house in a hot market is that you then have to <\/em>buy<\/em><\/strong> in that same hot market since you, you know, need a place to live, which eats into your gains and locks you into <\/em>another<\/em><\/strong> mortgage that\u2019s inflated thanks to the aforementioned hot market). <\/em><\/p>\n The shitty thing is that it often doesn\u2019t even make sense to pay off a mortgage any faster, because your interest rate is likely lower than the average stock market return and \u2013 as a result \u2013 your extra #fundz will go further in the stock market anyway. <\/p>\n I suppose if I ever found myself in a position where I lived somewhere that I could buy a home I\u2019d actually want to live in with numbers that worked out like the above, I\u2019d be interested. <\/p>\n The hard thing is, I\u2019ve never lived in a city where I could get anything remotely attractive for $350,000. The \u201cZestimate\u201d for the home we\u2019re renting in Colorado right now is $895,000. The ramshackle huts down the street from our apartment in Dallas were $500,000+. <\/p>\n To find something at $350,000, we\u2019d have to move far away from the types of areas we like to live in at this point in our life, and that\u2019s not necessarily a compromise I\u2019m willing to make yet<\/strong>. That said, it\u2019s also worth divulging (in transparency) that our rent right now is $3,000 per month; nearly double that of the example rent in this scenario. It\u2019s certainly not the most \u201cFI\u201d choice. <\/p>\n (And to be clear, I\u2019m not suggesting anyone compromise on housing if they don\u2019t want to \u2013 I\u2019ll be the first to admit that it\u2019s $3,000 very well-spent for the quality of life it provides.)<\/p>\n I\u2019ve always found that renting enables you to live in homes much nicer than those you could actually afford to purchase outright; the breakdown for the house we\u2019re living in now would\u2019ve been $178,000 down and a monthly payment of $3,700. Instead, we get to live in it with no money down, $3,000 per month flat, and no obligation to pay for the landscaping, a future broken hot water heater, roof repairs, or other [insert miscellaneous repair costs here]. <\/p>\n This is why real estate is a hyper-regional choice. In cities where the cost of real estate is only 80% as high as the national average, you can get a palace for $350,000 and it may truly make sense (the counterpoint is that you could also probably rent extremely cheaply, too, but again \u2013 the headline here is that running the numbers is worth 20 minutes of your time). <\/p>\n The important thing: Buying a home you can truly afford won\u2019t really<\/em> slow your progress to FI, but it probably won\u2019t end up helping it, either<\/p>\n I mean, come on: 9 years vs. 10 years? Who cares? Because our hypothetical couple chose a property that was technically worth the same as their total net worth, it didn\u2019t really make a difference in their investing timeline (assuming their rent was the same or more than their monthly payment for the house, as in the example we saw today).<\/p>\n And if you\u2019re in a rare circumstance where you intend to stay in a house for the next 30 years to the point that you own it outright and don\u2019t have a housing payment anymore, you could find yourself in quite the sweet position. My parents lived in the home I grew up in for 26 years before they sold it, so they almost owned it outright \u2013 but it didn\u2019t appreciate by very much in that time, so they mostly broke even. <\/p>\n But I suppose \u2013 in practice \u2013 I\u2019ve always found renting a more realistic option with practically zero phantom costs or impact to your net worth. You can predict with perfect precision what your rental costs will be: Rent * 12. No roof repairs, broken garbage disposals, or broken pipes to speak of. That\u2019s someone else\u2019s problem. <\/p>\n (Although, your rent will likely go up every year, which is a fair complaint that people have \u2013 to that, I say, if you\u2019re down to move, you can always find a cheaper place elsewhere. That\u2019s where the \u201cconvenience\u201d vs. \u201cmoney\u201d starts to come in, and you have to make choices that align with your income and goals. For the last five years, I\u2019d move or negotiate any time they tried to raise rent and kept my housing costs about the same every year. This year, I decided I made enough money to justify the better place.)<\/p>\n They own it, you make payments, and you hope that when you sell it, you make enough on the sale to recoup your initial down payment and then some. That has always felt risky to me, but I suppose I\u2019ve never been truly incentivized to buy. <\/p>\n That\u2019s the thing about the \u201cappreciation\u201d conversation I\u2019ve never really understood:<\/p>\n Even if you make $100,000 on the sale of your home, you probably put $50,000 down (at least), and you have to go find somewhere else to live now<\/em>. That money just shuffles to the next place. It feels like you\u2019re just moving around the same pile of money from property to property, not actually pocketing the difference and benefiting from it. But what do I know? I\u2019ve never owned a home.<\/p>\n Man, when I set out to write this, I promised myself it wouldn\u2019t become another Renter\u2019s Manifesto. Another one bites the dust.<\/p>\n Oh, and the last piece to close us out: opportunity cost. <\/p>\n Our couple who didn\u2019t buy? Their original $70,000 down payment, left in the stock market to compound over a few decades at a 7% average rate of return, would turn into $568,000<\/strong> after that 30-year mortgage period is up. I think that appreciation is pretty hard to beat. *winks<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":" I\u2019ve said it once and I\u2019ll say it again: While I\u2019m thrilled this blog has a shot at helping others, I am \u2013 at heart \u2013 a selfish creature. Writing these articles mostly serves as a way for me to publish my own thought experiments and, consequently, force my own hand at figuring out how these […]<\/p>\n","protected":false},"author":178814,"featured_media":2421,"comment_status":"closed","ping_status":"open","sticky":false,"template":"si-template-single-post-big-purchases-cars-and-houses.php","format":"standard","meta":{"footnotes":""},"categories":[37,35],"tags":[43,58,41,62],"class_list":["post-193","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-independence","category-investing-and-taxes","tag-big-purchases-cars-and-houses","tag-popular-big-purchases-cars-and-houses","tag-relationships-and-family","tag-popular-relationships-and-family"],"yoast_head":"\n\n
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Jumping into an example<\/h3>\n
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Key takeaways<\/h3>\n
If you\u2019re always going to have a mortgage payment because you plan to buy but never plan to own a property outright, you\u2019re really just renting your home from the bank<\/h2>\n
Concluding with a reminder about opportunity cost<\/h3>\n