When I posted Stop Acting Rich Overview and Thoughts on Wealth, Habits, and Happiness I promised that I would follow up with some thoughts from Stop Acting Rich: …And Start Living Like A Real Millionaire on home ownership and how it impacts a person’s net worth.
This is the fulfillment of that promise. 🙂
There’s lots to share, so let’s get to it.
How an Expensive Home Can Impacts Wealth Negatively
We’ll begin with a general overview of how buying an expensive home can hinder wealth accumulation. Consider these four quotes:
What we don’t realize is that the true cost of living in certain homes and neighborhoods is unseen but truly devastating. I believe the greatest detriment to building wealth is our home/neighborhood environment. If you live in a pricey home and neighborhood, you will act and buy like your neighbors. In other words, human beings have an innate tendency to act and be like those around them — to fit in — and even compete. The type of home we live in and where we choose to live often takes the greatest toll on our financial wealth, and from it, all other perils flow.
The reason why so many homeowners today are having a difficult time making ends meet goes way beyond mortgage payments. When you trade up to a more expensive home, there is pressure for you to spend more on every conceivable product and service. Nothing has a greater impact on your wealth and your consumption than your choice of house and neighborhood. If you live in a pricey home in an exclusive community, you will spend more than you should and your ability to save and build wealth will be compromised.
The more expensive, the more affluent neighborhoods are a vortex of sociological forces. The more affluent the neighborhood, the more its residents spend on almost every conceivable product and service. From cars to haircuts, and from wine to watches, those living in “prestige estates” spend more. We take consumption cues from our neighbors. If many of our neighbors have a much higher level of income and wealth than we do, we will have set ourselves up to lose the war before we have even begun to battle.
My research has found that most people who live in million-dollar homes are not millionaires. They may be high-income producers but, by trying to emulate glittering rich millionaires, they are living a treadmill existence. In the United States, there are three times more millionaires living in homes that have a market value of under $300,000 than there are living in homes valued at $1 million or more.
Lots to unpack here and I’m sure I’ll miss something so you can help me out in the comments.
- Buying and expensive home in a pricey neighborhood is a net worth killer in and of itself. It violates the first two steps on my list of how to buy a home and pay it off in 10 years.
- As if that isn’t enough, buying that type of house then comes with a whole host of higher costs. First there are higher expenses associated with just keeping a pricey home (which is often larger) running: utilities, maintenance, lawn care, taxes, and on and on. Then there are the higher costs that stem from the location (i.e. the local grocery store is more expensive than the Costco across town). And finally there are the “keeping up with the Joneses” expenses like driving a luxury car, private schools for the kids, country club memberships, and so forth. Is it any wonder these people end up accumulating less wealth? The odds are stacked against them!
- The fact that most millionaires live in homes under $300k is both surprising (to the average American who thinks all wealthy people live in million dollar mansions) and not surprising (if you’ve read The Millionaire Next Door: The Surprising Secrets of America’s Wealthy or this blog).
- Depending on where you live, a home worth $300k is not exactly a shack. Yes, in NYC it probably is, but if you live in cities like we have, $300k actually gets you a pretty nice house.
- We never lived in a home worth more than $200k until a couple years ago (though we certainly could have afforded to). And yet our homes had 4-5 bedrooms and 3 bathrooms, were 10-15 years old when we got them, had 3k square feet, and were in decent neighborhoods. There was no need to buy an over-the-top house on a golf course. The homes we had were awesome. And they were quite affordable. This is a HUGE advantage of living in an affordable city.
- Buying homes at this price range allowed us to pay off our mortgage early and forego lots of interest costs through the years. Imagine the other costs we saved on as well! FYI, there was certainly no extra “Joneses” expenses in our neighborhoods — none of the neighbors were trying to impress each other, unless you count that time my next door neighbor got that smoking snow blower! That thing was awesome! But I had a teenage son that moved snow just as well. 🙂
Here’s a related but a bit different comment on why it’s hard for high-status individuals to build wealth:
Why are these high-status groups so bad at accumulating wealth? There are many reasons. Most live in or near high-cost-of-living metropolitan areas. They tend to live in expensive homes situated in or near exclusive neighborhoods. And so they spend accordingly, with little left over for saving and investing.
I wanted to highlight this quote separately because it really hits the cost-of-living of the city. I’ve talked about the facts that living in a low cost-of-living city can help you build your net worth and how where you live has a big impact on your net worth. Considering these I’ve suggested the dreaded idea of moving if you live in a high cost-of-living city. But most people won’t even consider that option.
How to Buy a House for Wealth Creation
Now let’s move to the book’s thoughts on how much someone should spend on a house if they want to grow their wealth:
The most productive accumulators of wealth spend far less than they can afford on homes, cars, clothing, taxes, vacations, food, beverages, and entertainment. As many millionaires see it, living in a pricey neighborhood is a bad idea. Why live in a million-dollar neighborhood when one filled with $300,000 and $400,000 homes will serve the purpose? Real and actual millionaires understand that when you live in a luxury house, you are also buying a luxury lifestyle. Included in this lifestyle are the social pressures to redecorate frequently, join the country club, and send your children to private schools. Your property taxes continue to skyrocket, along with the cost of utilities and insurance. Plus the prices of nearby services tend to be higher, from grocery stores to dry cleaners.
Contrary to popular belief, however, most of the self-made millionaires I have studied have one thing in common: They were able to build wealth precisely because they never lived in a home or neighborhood environment where their domestic overhead made it difficult for them to build wealth. In essence, they ran their households like a productive business. It is not only about how much you make. More important, it is how much you keep. And the “keep” component begins and ends at your home address.
If you want to become wealthy [the way other wealthy people have], live in a neighborhood where your household is among the top income generators. For example, what if your household’s total realized income is in, say, the high five figures? Then live in a neighborhood where the median market value of a home is less than $300,000. Do so, and the chances are that among your neighbors, your household will likely be in the top 20 percent along the income continuum. Then live and consume as though your household’s income was only 80 percent of what it actually generates. Save and invest the rest. Now you are on your way to becoming wealthy.
To enhance your chances of becoming financially independent, you should live in a home and neighborhood environment that has high wealth-building characteristics. You need to be surrounded by neighbors who have lower incomes than your household generates.
Here’s what I have to add:
- For the most part, the suggestion is “don’t buy a pricey home in a pricey neighborhood.” We kinda got it from the first set of quotes, but I wanted to include it again here as they said it in a more positive tone (what to do versus what not to do).
- The quote “they ran their households like a productive business” made me think of the “be your own CFO” e-book that J.D. Roth of Money Boss came up with. In addition, if you think of it, a net worth statement is basically a balance sheet and a cash flow plan/budget is basically an income statement, so why not treat your finances like a business?
- “Live in a neighborhood where your household is among the top income generators.” First of all, it’s difficult to say what the average income by household is in a neighborhood, isn’t it? Can you buy data that tells you this? Second, it’s “Get Wealthy 101” they’re preaching. They are saying to live in a neighborhood where you make more than most people but have the same housing costs. So your income is high but expenses are low. Makes sense, right?
- The example used cites an income near $100k and a house below $300k. So this seems to mean they are saying that you shouldn’t spend more than three times your salary on a home. This gets to our earlier discussion of how much you should spend on a home.
- Then you pile on and only live on 80% of what you make, saving and investing the rest. If you can save 20% of your income, you are well on your way to becoming wealthy. Though based on this early retirement calculator it will still take you 37 years to reach financial independence.
- Summary of this section: A “home and neighborhood environment” with “high wealth-building characteristics” is one where your “neighbors have lower incomes than your household generates”.
How Much Should You Spend on a House?
And now some general guidelines on how much house to buy to encourage wealth accumulation:
What is a good rule if you are determined to become wealthy? The market value of the home you purchase should be less than three times your household’s total annual realized income.
If you’re not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s annual realized income.
Some thoughts from me:
- So piece these two together and you should never buy a home that’s more than three times your annual income with a mortgage that’s twice your income. So this implies a 33% down payment at the highest (i.e. a home with a $300k value and taking out a $200k mortgage.) It could be a lot lower though (i.e. a home with a $250k value and a $200k mortgage).
- We discussed all this on my post titled How Much Should You Spend on a House? If you recall, our homes were always between the 0.93 to 1.38 times income valuation. The “experts” had 3.5 times as the high. Looks like 3.0 is the max to build wealth and, I assume, the lower, the better.
I don’t know about you but I found this information very interesting.
Anything you’d like to add or comment on?
photo credit: Renaud Camus Le Jour ni l’Heure 9491 : château de Voisins, 1820, Voisins-le-Bretonneux, Louveciennes, Yvelines, Île-de-France, mercredi 22 août 2012, 17:50:09 via photopin (license)
K D says
We have stayed in our smallish home that we paid off after ten years. It suits us, we like the location, we love how inexpensive it is to live in.
“The most productive accumulators of wealth spend far less than they can afford on homes, cars, clothing, taxes, vacations, food, beverages, and entertainment” fits us quite well. We just don’t see the point of chasing the latest and greatest, we are content (and happy) with what we have.
Ligaya Barlow says
I don’t know. We moved to the Philippines where we built a home worth $500,000-$1,000,000 in California for less than $30,000 here. See the sidebar article here telling you how to make 7% APR investing in Chinese contemporary art? I have over eighty friends I make personal loans with and bring in 6% a month, very low on the overhead.
You guys figure it out lol! Or as George Carlin put it: “They call it The American Dream because you have to be asleep to believe it.
The price of the house depends on the location and one has to look at the commuting distance for the work before taking the buying decision. However, considering today’s highly volatile job market, it’s not wise to buy a house with high mortgage during our early career. To my opinion, it’s good to stay on rent and buy the house when nearing retirement at the desired location.
I am a firm believer in “Just because you can doesn’t mean you should” Just because you can qualify for a higher mortgage doesn’t mean you should. This is a nice review of the basics and also a redefining of the rules of thumb but looking at the idea of looking at your net worth. The 33% down payment may be a little hard for first time buyers but definitely a 20% down payment is doable. Twice the salary of mortgage is also a good rule in that you do not want to be tied to a house but live.
This was similar to what we did when we bought our second house in that we had a 50% down and financed 50% for 15 years but paid off in 12. We could have qualified for twice the price house but we didn’t buy one and are very glad we didn’t. Now that we are almost empty nesters the house is the right size.
Mike H says
I had thought to keep the buying of a house to about 20% or less than your net worth. I also lucked out by buying the best unit in an old condominium so that we have more space and privacy but aren’t encouraged to consume more.
At the time of sale it will make this place harder to move and the price received will be lower than similar units in nicer buildings, but if we live here for a long time it should work out well for us. We are in a very central city location with excellent views and tons of space. That makes it a suitable place for us.
Laurie @thefrugalfarmer says
“Real and actual millionaires understand that when you live in a luxury house, you are also buying a luxury lifestyle.” We found this out first hand when we moved to our fancy house in the suburbs. There is indeed a whole entire lifestyle that is “expected” of you when you start to get into the spendier houses in certain areas. We lived there for over a decade and absolutely loved the house, but still shake our heads at the city and what it stands for and values. We weren’t able to see the subconscious obligations to keep up with the Joneses until we left suburbia for a house out on the country. We’ve now completely bucked the system and are dumping the debt and building wealth, and man, does it feel GOOD! 🙂
Excellent wisdom, ESI! One thought that stayed with me from ‘Millionaire Next Door’ was wealthy parents “helping” their children buy nicer homes than they otherwise could afford. It was a feather in the parents’ cap, to say their children lived in a great neighborhood. But the 40 year-old child, with a family and obligations, is now locked into the treadmill of Property Tax, maintenance, landscaping/remodeling, and lifestyle.
I’ve seen this actually used as a weapon by parents! The parents now have ‘access’ and ‘influence’ over the child and family. This can also be problematic with in-laws, where they use the ‘gift’ to keep their hooks in their grown child, at the expense of the unequal spouse. Watch out!:-)
Yes. And it doesn’t have to be a house for parents to keep hooks in grown child.. just the awareness that the parents have the money that will or will not go to them can also be controlling; if the grown child permits it. ☝️
Little House says
I’m curious as to what popular thoughts would be on a manufactured home. We recently purchased one in a very nice community in a suburb of Los Angeles. It’s what we could afford and it made more sense than continuing to rent. However, the house wasn’t inexpensive by any means and we are renting the land. With that said, the house is very modest and the community is very diverse, so I’m thinking we’ll just continue to build wealth over time. Especially if we can get this baby paid off in under 15 years.
Financial Panther says
Being one of the higher income households in a less fancy neighborhood is an interesting thought. It’s sort of the big fish in a small pond thing. A lot about how rich we feel is pretty relative. If you surround yourself with super spendy, rich looking people, you’ll always just feel broke, either because you’re trying to keep up or just because your stuff isn’t as nice. In contrast, be one of the higher income people in your own neighborhood and suddenly, you can live comfortably and still match everyone else who’s earning less. Definitely seems like a fast way to build wealth.
Jack Catchem says
I love every piece of this, but can’t emulate it. Based on where I work in California EVERYTHING is expensive. On the upside, my wife and I strive to keep things modest and comfortable. The big question is when I retire, do we continue to loiter in this area or take advantage of geo arbitrage and move to almost anywhere else and instantly super charge our savings by having the amount invested in real estate take a huge plunge for the same amount of square footage.
Time will tell, but in the meantime, thanks again for the insight!
Yes, it’s hard to do in CA. But you can still put some of the principles in place. For instance, you could buy a house worth “only” $600k versus one that’s $1MM.
Also, if you’ve lived in CA for any amount of time, you probably will be able to sell with a huge gain. Then you can move anywhere you like (as you note), buy a very nice place, and still pocket a ton of cash.
I’ll put in a plug for Colorado. Awesome place to live and very affordable! 🙂
Jack Catchem says
I love Colorado and eye it regularly!
When my wife was based in Wyoming we went down almost every weekend 🙂 it’s a fantastic place to live.
I am not sure what you do in CA but I was working with a lighting consultant that handled most of his work via, goto meeting, email, skype, etc. He would commute in from somewhere in the mountians near Sancremento (Vicaville?) once or twice a month ( more if needed) to San Fran to physically meet with his clients and they respected his schedule as he provided a quality product. Also in Michigan lawyers telecomute the same way from Traverse city to either Detroit or Chicago in the summer only traveling to there destinations when depositions need to be taken in person.
Jack Catchem says
Oooh telecommuting would be amazing! Sadly as a cop I am very much required to be there in person. To be truthful though, you can do amazing things with a compacted law enforcement schedule. When I worked a Big City in So Cal I lived in Vallejo in the Bay Area.
I commuted 6 hours down to Big City, slept at the station for my 3 12 hour days, and drove 6 hours back for my days off. On the upside I wasn’t too worried about gangsters following me home, they’d either get bored and give up or run out of gas!
It was worth the struggle as my wife and I are still together. Go team.
I didn’t know you were a police officer…
Thank you for your service! It is truly appreciated!!
Agree… thank you for your service in a very difficult job right now…
Jack Catchem says
Lol. Thank you both. It means a lot coming from Internet personalities I respect!
Those rules of thumb seems to be very US specific. I am living in europe, and with 2 times your income as limit for your mortgage and 3 times your income as limit for the home you just will get nothing. Just as an example I paid 1.260.000 € for a nice town house, nothing fancy. My household income is 200.000 €/year, my downpaymet was 400.000 €. So I have factor 6 for the home price and factor 4 for the mortgage. As I said those factost seem to be very situational. Anyhow I do not think that this must be a handicap to grow your networth. Interest is very low in europe (1,2 %, so a comparable rental solution roughly equals to the required interest and principal payment) and you can sell your home when the kids are big enough (hopefully) with a nice increase in price.
Was your purchase in a large city? That would make a big difference.
For instance, New York, LA, San Francisco, etc. would all have much higher housing values than St. Louis, Cincinnati, and Denver, and those would have much higher housing values than smaller markets.
Yes, it is in a big city.
What would you do if you live in a big city, move to another place even if you will get a hurting reduction in household income? Prefer a rental solution? Search for a job where you can work at home?
Even as I think that it will not be a handicap to my networth growth, I can still feel the missing liquidity, the downpayment was quite a chunk.
1. Move to a lower-cost area but keep your high pay. See this:
2. See if you can live elsewhere and either commute a day a week or work completely remotely (as suggested above).
3. Move to a lower cost area of the big city.
4. Look for creative ways to lessen the impact like getting a roommate or renting out part of the house.
Full Time Finance says
At least at the town level, though not the neighborhood, I’ve found searching places like Wikipedia reveals average income of the area. We bough into an area where we exceed the income and we bought a low priced house compared to the area, so we match the advice here. I might add one more recommendation. Don’t be afraid to buy and older remodeled home. Many of the homes here hat are new have a 100k markup for the same thing. And yet with a remodel I have no more or less issues. Even without the mark down I have a small enough house that maintenance costs are realitively benign, but it’s nice knowing the house I did buy is one of the cheapest in the area.
Financial Samurai says
Man, are you saying NO to my $5M dream house in Honolulu a block from the beach?!
The neighbors are already mega millions, and one billionaire founder of eBay!
Gotta live the dream baby!
I am 100% in favor of YOU buying a $5MM house!!! I’m looking forward to visiting!!!
Holy smoke, don’t agree…
I know dozens of people who own homes valued at over $3 MM. And they all either bought with cash initially, eventually paid off the house, bought before the home was worth $3 MM, or could pay off with cash anytime.
People at this level are very good with money, none of them are stretching…
There are always exceptions to any rule, but the book includes research/data, not just personal experiences…
I am fairly new to your site ESI but reading a bit of everything! This article captures my thoughts and views and give me a lot to think about as my income continues to increase. I can definitely afford a bigger home, already in a $1.7M home with an LTV of about 35%. I often think about a bigger nicer home but many who have gone down that path have shared the regret of going for that next house. Many peers look back on their homes and remember when life was a bit simpler and now they are trapped under significant debt even with very high incomes. I live in the Bay Area so its disturbing what $1.7M gets you, by national standards very small. In fact my best quote ever a colleague from Atlanta visited and literally said “so you are telling me this is a nice neighborhood, your guys are crazy for living here!”
I plan on retiring in 9 years at 52, (wonder why I was drawn to this site?). Our goal is to live in this home for the rest of our lives and possibly do a few upgrades here and there but cash only type stuff.
I am already in a neighborhood with a lot of pressure to keep up with the Jones’s and I think anything nicer would put me on a perilous path!
Thanks for this great bit of reinforcement.
The problem for me living here in Ft. Lauderdale, FL is that the affordable neighborhoods are in less desirable school districts and you may have three houses on a street that keep yards nice and then 3 in a row that are slobs. (embarassing) Pick a nicer (but more expensive neighborhood and that doesn’t happen) 🙁 so I am never sure how to handle this. (I rent now)
Ridley Fitzgerald says
I agree that the neighborhood is just as important as the home. We’re looking for a new home, and we haven’t put enough time into looking at the area. I’ll take your advice and look for a moderate home in a nice area.
While I think your point is quite solid in a general sense, it also ignores that the point of living isn’t just to acquire more wealth. It’s to live the best life possible. Anything $300K or under, in any city, isn’t going to suit my needs. Not even close. Our house now is twice that price and it’s pretty mediocre. It gets the job done, but it’s nothing special, and we own it virtually free and clear. I have no interest in “keeping up with the Joneses,” just living the best life that I can live. A house over $1M is about the sweet spot of getting the type of house that I want to be living in and enjoying my life. In an exclusive, gated neighborhood. I don’t have kids, and never will, and don’t care about joining a country club. But my home is where I spend virtually all of my time and is the greatest investment in my happiness, which is the biggest investment of all. Even with a $1.4M house, let’s say $400K mortgage, that would leave more than 90% of my net worth in income-generating assets, so it’s not exactly a hardship. Sure, I could stay in my current house and invest the extra cash in more income-producing assets, but ultimately would that make my life any better day to day? No. At a certain point, you need to enjoy the best things in life to live the happiest life you can. A beautiful, modern house, built to high quality standards in a great city with a great outdoor space to enjoy, is something that will help make every day better. What better investment is there than that?
Your points are good, especially about balancing wealth building v happiness. One thing that you mention is that you are male, single and childless – let me tell you, your choices are infinitely easier than one who has kids, as many of us do. You are not tied to school districts, the safety of neighborhoods, need to have access to certain amenities in a way a family does not. You can live in that rapidly gentrifying neighborhood with crap schools for the next 8 years, but it’s hard to choose that when one has kids. Most of my money spent after the basics ends up being on my kids – their clothes, their activities, their college savings. Significant amounts, even though I am a very frugal person. This makes me think: one important adage to all this advice – do as much as you can BEFORE having kids (if you plan to have any at all). Wealth building is much easier without having those little adorable but expensive people around.
Tom R. says
Much wisdom here. Buy a decent but not overpriced house in a good location. Don’t need the latest and greatest appliances, floors and counter-tops, etc. If the house is in good shape, and cleans up well and is functional, expenses are down and you can kiss financial stress good-bye. Location is the key. A great location can offer fantastic views and be close to all that you want and need to live.
The older you get the more you realize you don’t need or even have a desire for all that stuff. You want to declutter and get rid of it to simplify your life. A decent home in a peaceful neighborhood with less stuff to worry about is true wealth. No one told you that in your 20’s.
Adam Golightly says
Thanks for explaining about how the household’s annual realized income serve as the guideline that determines the market value of the home that they buy. My aunt has been thinking about buying a new home and she wants to make sure that she can get one that matches how she wants her wealth to grow. She would really like to buy a luxury home from a professional so that she can live a lot better and it will fit her style.