It is a choice most of us only make a few times in our life, and it is usually when we have a life-change like graduating from school, starting a family, relocating, or downsizing.
It is a big decision, but it can also be a big opportunity to change your financial future. If you can find a way to significantly lower your total monthly housing costs, that will have a much bigger effect on your choices in life than things like canceling Netflix or obsessing over credit card points!
Imagine this scenario …
Robert has just graduated from college, and decides to share an apartment with a friend. He does this from age 22 to age 30, and it saves him about $550 per month which he invests. At age 30 when he gets married, his investment fund now has $76,000 in it that he can put towards wedding expenses and a down payment on a house.
Or how about this …
Tanya is 35 and buying her first home. She has narrowed it down to two choices, one of which has a total monthly cost (price, taxes, HOA fees, etc.) that is $600 per month less than the other. It doesn’t have granite countertops or a “bonus room” but she’s okay with that. She uses the savings to put $300 a month in a vacation fund and invests the other $300. At age 65 when she is ready to retire, she has gone on some fantastic vacations, and has half a million dollars in her investment account.
A final scenario …
Faye and Dereck are both in their late 50s and thinking about retirement, but don’t have as much saved as they would like. They are still making payments on their home, but they have $500,000 in equity. They decide to sell the house and use half the money to buy a condo and add the other half to their retirement account. Suddenly they have no more mortgage payment, are spending less each month on home maintenance and utilities, and have added a big sum to their retirement account. Early retirement and traveling now becomes a real possibility.
Reducing your housing cost, no matter if it is a rent payment or a mortgage payment, gives you more options for every other thing in your life, whether that is retirement savings, saving for your children’s education, reducing your work hours, or even just going on more vacations.
Of course, you want to have a home that you feel comfortable in and that you can be happy living in – but think carefully about what you really need for that to be true.
The next time you are making that big decision about where to live, here are some things to consider that can make a difference whether you are renting or buying:
- Think out-of-the-box on locations. You may have a certain neighborhood or city in mind, but check other locations, even if you are not sure if you will like them. Home prices and rents can vary wildly depending on location, and if you find an area with lower prices – don’t discount it because of a negative stereotype. Check it out for yourself – you might end up changing your opinion of the location and end up with a good deal.
- Choose something smaller. Homes today in general tend to be much bigger than they were in the past, so think about how much space you really need – there is no point in paying for rooms you don’t even go into. Smaller homes also need less furniture, have less maintenance costs, and lower utilities. The first condo I bought was a studio which was plenty for me. I probably wouldn’t be retired right now if I had decided I “had to” have a one bedroom.
- Choose something bigger and have a roommate or renter. With an additional bedroom, or a basement apartment, could the rent you get cover some or even all of your payment? You may not like the idea of living with a stranger, but maybe a friend or family member is looking for a place to live. You might be able to work out an arrangement that is beneficial for both of you.
- Cheap neighborhoods can mean an overall lower cost of living. In the book “The Millionaire Next Door” (see my book review here), they talk about how most millionaires do not actually live in wealthy neighborhoods – a low cost of living is part of how they were able to accumulate wealth. It is not just the mortgage payment or rent that goes down when you live in a lower cost neighborhood. Stores, restaurants, and entertainment options also tend to cost less, and there is less pressure to keep up with your neighbors’ expensive lifestyles.
- Think about lifestyle impacts. Would a new neighborhood allow you to get rid of a car? Have a less expensive childcare option? Work out at a park instead of the gym? Get free entertainment by volunteering at a local theater? Try to think about all the potential impacts to your budget.
- Do the math. You can’t truly compare options without getting all the details and adding everything up. When making your comparison, make sure to include all of the costs of each option, consider the equity you will be building up if you are buying, and think about potential lifestyle impacts.
If you are buying:
- Don’t go by what the bank says you can afford. Banks will approve people for huge mortgages – but this doesn’t mean that is the budget for your house! Ideally your housing cost, including property tax, home insurance, and HOA fees, should be 25% or less of your take home pay. But ultimately, YOU are the one who decides what you can afford, not the bank, your friends and family, your co-workers, or anyone else. Don’t be pressured to buy more than what fits into your overall plan.
- Interest matters. On a $200,000 mortgage, a difference of 1% can mean an extra $45,000 in interest over the life of the loan, so you definitely want to compare offers from different lenders to get the best rate. A good credit score can also help you get a lower interest rate. If your credit score is less than stellar, you may want to postpone your search until you can repair it. We are in a period of relatively high interest right now, so that might be another reason to postpone things. But it is good to remember that interest rates will come down, and you will probably be able to refinance at a lower rate when that happens.
- Don’t get stuck on the down payment. There are many programs out there, especially for first time home buyers, where you can get a loan with little or no down payment. A 20% down payment does reduce your mortgage payment, but so does buying a home that is 20% cheaper to start with. If you have family members who are in a position to help out, now might be the time to go to them.
- Two words of warning: 1) if you have less than 20% down you will probably need to pay PMI, a.k.a. mortgage insurance, so factor this into your calculations, and 2) closing costs are typically 2% to 7% of the purchase price, so in addition to a down payment you will need the money to cover this. This was a shock to me when I bought my first home!
- Consider the overall market. You might be ready to buy, but if we are at the top of a housing bubble, it might be better to postpone things. Or, if there is a sudden drop in housing prices, maybe you want to accelerate things. Be prepared to adjust your timeline based on what is happening overall in the housing market.
Wondering how your housing costs could be impacting your future, and if there are other options you should consider? Helping people weigh these kinds of options is a part of what I do in coaching. Schedule a free, 30-minute introductory session and we can look together at your whole financial picture, and the role that this important part of your budget can play in helping you achieve your financial goals.
