Why you should buy spend less on a house than you can afford

It’s one of the most popular articles of all time on Money Under 30: How much house can you afford?

I originally wrote the article (and several spin-offs) about 10 years ago when Lauren and I began to consider buying our first home. Obviously, it struck a chord.

Your house will almost certainly be the largest purchase of your life. So you will, I hope, give ample consideration to how much you should spend on it.

Although the price of housing alone makes the home affordability question interesting, I think there’s more to it than that, especially here in the U.S.

Society tells us a more expensive house is indicative of success

American culture programs us to believe the things we buy must not only function, but also reflect our values and personalities. Few of us, if given the choice, would buy a stale, rectangular condo in a plain brick building filled with hundreds of similar condos. We want a home to be more than a place to live; we want it to be an extension of ourselves.

And then, there is the deeply-ingrained concept of the ‘American Dream’, in which homeownership is not only encouraged, it’s sold as a fundamental component of American success.

Older generations want us to believe homeownership is the only smart way to live

I’ve often written that renting is not “throwing money away” and that it’s always better to own your home. You wouldn’t think such a pedestrian topic would trigger passionate, even hateful replies, but, alas, it does—as consistently as politics.

I could explicitly describe a situation in which it would be financially reckless the own a home instead of renting, and some will still call me a dangerous fool for recommending anyone ever rent instead of buy.

I admit, there was a time, before I knew much of anything about money, when I, too, believed owning a home was the best way to build wealth. Why? Because I constantly overheard older, “successful” people talk about the importance of homeownership and how much their own homes had appreciated. They even talked about stretching to buy a home because, hey, it’s going to appreciate anyway, you can’t go wrong!

What I know now, interestingly enough, is that many of the same people I thought were successful because they were upgrading their homes or tapping equity to purchase toys, were actually not good with money at all. They had home equity, sure, but what savings did they have? What did their retirement accounts look like? And what would happen if the value of their precious home dropped by a third or more? Well, between 2005 and 2009, we found out.

It’s true that real estate usually appreciates, especially over several decades. In places where land is scarce, like Manhattan, it can appreciate very quickly and, sometimes, make owners wealthy. On average, however, real estate appreciation is a slow and volatile road. When you consider inflation, however, home appreciation is not very impressive. Here’s a rough example:

The Case-Schiller Home Price Index is a benchmark for average home prices in the U.S. Adjusted for inflation, it has risen from about 111 in 1980 to 197 in 2018. That’s an increase of 41%. Not bad. But now let’s look at the S&P 500 stock index. In 1980, it was at $111, or about $357 in 2018 dollars. Today, the index is around $2,700. That’s an increase of 656%! Suddenly, a home’s appreciation doesn’t look so impressive.

And we haven’t even begun to take into account a home’s carrying costs like insurance, property taxes and maintenance, never mind realtor commission. The more I write about it, the more I want to sell my house and rent!

Nevertheless, the chorus of voices signing in praise of homeownership is loud and persistent. Even in face of such sobering facts, it tempts us to believe we can’t go wrong owning a home, even if we have to stretch our finances to do so.

A house will be your home, and that’s pretty important

Cultural norms aside, let’s not discount the emotional pull of homeownership.

Not only will a house likely be the largest purchase of your life, it will be where you will spend most of your time. It will be your place of refuge from a world of work and stress. It may be a place where you will start and raise a family.

All these things add up!

As you approach buying a home as a financial decision, you see that you immediately have conflicting factors. As the largest purchase of your life, your instinct should be to spend as little as possible. If you’re a regular MU30 reader, you know that building wealth is all about spending less than you earn. So, all else being equal, why would you want to spend $3,000 a month on a mortgage if you could find a home for a $1,000 a month mortgage?

Well, for one, if you live in the Bay Area or NYC or Boston or the like, a $3,000 mortgage may be the best you can find. If, however, we consider a more typical housing market, then the other factors come into play. You’re going to live here for a long time, so you might as well get what you want. Prices are going to go up, so it’s OK to spend a bit more. You might plan to have kids, so you think you should choose a home in a good school district, even if it costs more.

Yes, these are all valid points. You should certainly consider all of them (and more) when you decide what to spend on a home. However, don’t let these factors lure you into spending more than you should.

Pregnant with our first daughter, Lauren and I bought our first home together in 2009. For me, it was a difficult time to buy a home because I had just finished paying off all of my other debt that same year. The last thing I wanted to do was take on a mortgage! But, those other factors came whispering. You may not understand it if you’ve not experienced it, but the nesting instinct that arises when a baby is on the way is real. We were living in a tiny city apartment. We could afford to move to the suburbs, so we did.

Being fresh out of debt, I approached buying our first home as conservatively as possible. Homes in desirable suburbs weren’t cheap, but we found a modest home in affordable neighborhood. We put 20% down and took out a fixed-rate mortgage over 20 years, not 30, to save on interest. Even with the larger monthly payment that came with the 20-year mortgage, our housing payment was less than 10% of our gross income.

But we suspected it would not be our home forever. It was a cozy and tidy little house, but it didn’t inspire us. We planned to stay for five years, which is, on average, about how long it takes to break even on owning a home.

Long story short, we only lasted three years in that house before we found something of a fixer upper in a desirable neighborhood and moved on. I’m no real estate expert, but I like to think we did right the second time around by buying the cheapest house in the nicest neighborhood. Time will tell. Due to market changes, we sold our first house for just $5k less than we paid for it, so when you add in closing costs and realtor commissions, we likely would’ve been better off renting. Then again, we didn’t think we’d move so fast.

Our current home was more expensive than our first. (Twice the price, in fact!) But it was still less than we could afford. In the interim, our careers had both taken off. Our mortgage was still less than 15% of our income, although we took out a 30-year loan this time. (We have since paid it off.)

Still, I had major reservations about spending so much on the house. Before we purchased this house, we had bid on another than was slightly more expensive still. We lost to another bidder because we wouldn’t budge, even $5k, from our best price. In hindsight, I’m so glad, because we ended up with a much better house for less money (though I didn’t realize it at the time).

Both times we bought a home, we bought less than a calculator (and certainly a realtor or a bank) would tell us we could afford. As a result, we’ve never lost sleep over our mortgage payments. Even better, we’ve been able to fund lots of other goals, from retirement to travel to, yes, home improvements. That’s all money that might’ve been spent on a more expensive house.

A note to readers living in superheated real estate markets

Before you get all testy and leave a nasty comment about how you can’t buy a dilapidated two-bedroom for less than $1 million in San Francisco/Manhattan/D.C. and how “nice” it must be to have such cheap real estate, let’s all agree that in those markets, the “rules” can be different.

It’s true, you may have to stretch from affordability guidelines to buy anything at all. You may have to wait longer to buy, settle for less of a house, or live with roommates indefinitely. Unfortunately, that’s the price of living in these places that are cool and loaded with desirable jobs. You want to live there despite the housing costs. Unfortunately, so do millions of others, and there aren’t enough homes.

You may have to adjust the affordability guidelines, but you can still follow the advice to spend less than you technically could.

Check out our partner Reali Loans to find a low-rate mortgage

When you Google how much house you can afford or play with MU30’s home affordability calculator, you’ll see lots of conflicting numbers. For one, there’s the total housing payment you can afford (including mortgage principal and interest, insurance, and property taxes) and also the total monthly debt you can afford (your housing payment combined with other debt payments, such as student loans, car loans, and credit cards). The more other debt you have, the less you should spend on a housing payment.

But even within these two figures, you’ll find conflicting information. One site will tell you can spend up to 30% of your gross (pre-tax) income on a mortgage, another will tell you to spend no more than 20% of your net (after-tax) income. That’s a huge difference, which we discuss here.

Always spend less than you could, you’ll rarely regret it

If you want more space or a new feature, you can renovate.

If you really don’t like your house or location, you can move, like we did.

But if you buy too much house and find you can’t afford your mortgage, you may not have any options. In the worst case, you could find yourself underwater in a bad housing market and not even be able to sell your house.

The less money you put into your monthly housing payment, the more money you have available for:

• Rainy day savings
• Funding retirement accounts
• Saving for other goals such as vacations, parties, or toys (cars, bikes, boats, etc.)
• Business opportunities or other investments (maybe rental real estate)
• Improving or renovating your house!

Always plan to use savings and investments to get you through emergencies, pay for a home improvement project, or fund your retirement. And, as long as you’re conservative in how much house you buy, you should have plenty of money left over to fund those accounts!

So you’ve resolved to spend less on your home purchase. Great! But where can you find those savings?

Set more realistic expectations

If the bank says you can afford a 4,000 square foot five bedroom with a pool but you know a 2,000 square foot three bedroom will suffice just fine, go with the cheaper option. Having too much space can cost money and you never end up using it anyway.

What do you really need in a home?

Obviously, schools and commute times will be a large factor. We chose an ugly duckling house in a town with great schools that’s super convenient to the city. The same money would buy a McMansion 40 minutes away from downtown in a town with so-so schools. And I know people who opted for that. To each their own. The key is to find your sweet spot.

Learn to live with imperfections

Our current house was on the market for two years before we finally bought it because it needed some major updating, especially in the kitchen and bathrooms. Most buyers saw the 50-year old kitchen as a deal-breaker, or something that would have to be renovated immediately at great cost. Although we did eventually renovate the kitchen, we lived with it for two years before doing so. It wasn’t fun, but accepting the house as-is got us into a location we wouldn’t have otherwise been willing to spend for. Keep in mind, however, that in our case, the deficiencies were cosmetic. Obviously, if a house needs a new roof or has major structural problems, buyer beware!

Don’t neglect the mortgage when factoring in your total cost. A 15- or 20-year mortgage increases the cost of your monthly payment but can save tens of thousands in interest. If you base your affordability on a 15-year mortgage instead of a 30-year loan, you’ll automatically start shopping for less expensive homes. Even if you decide to take out a 30-year loan, consider only shopping for homes that you could afford with a 15-year mortgage.

Put 20% down!

Finally, I do recommend putting 20% down whenever possible. Although the 20% down payment seems to be getting less and less popular, especially among first-time home buyers, I don’t think you can go wrong by waiting to buy a home until you can put a full 20% down.

It will save you money on private mortgage insurance and protect you from falling underwater on your house a declining market in the event you need to move quickly. More importantly, however, it’s a good gut check that you can afford the house. If you find yourself stretching for a house that requires you to reduce your down payment, you might be spending too much.

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When it comes to buying your first home, always try to buy less house than you can afford. Chances are, you really don’t need as much space as you think you do. Plus, buying less house means more savings for retirement, your emergency fund, and home improvements.