Last week a retirement plan participant had a question: Where best to redeploy a monthly expense the size of a car payment that was going away? Her house was on track to be paid off, and she didn't have any big spending needs. After a discussion she settled on a heftier travel fund to visit kids and grandkids and an increase in retirement savings for the option to retire in her early 60s.
I want to quickly observe the tenor of a meeting like that. There is a good deal of smiling. You could maybe call it boring since there are no crises or fires to put out.
While there are always a number of reasons for why finances are strong, I can usually point to one pivotal decision that stands out from the rest. And that is the home. In her case, her modest home was well within our affordability principal with a payment less than 14% of her gross monthly pay.
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But this is usually not the story. I have had many people plead a case to buy a home that is not affordable. The home could be $250,000, $500,000 or even $2 million. After hearing the case, I emotionally agree. Life is not livable without two offices, three bedrooms, within driving distance of work, or in a certain school district. Those homes they are finding would add tremendous value to their lives.
But at what cost?
Money is subject to the laws of, thankfully, easy math. Just subtraction and division. Sure, multiplication if we are talking about compound interest. All this to say I find it curious to hear people talk of "stretching" into a new home payment. The notion maybe is that if you want something badly enough, that the same dollar everyone else is using will somehow produce more for you. A dollar can't be stretched. It can be spent, saved or ripped. But not stretched.
No, with spending there is only substitution.
Let's take a more common conversation. A young man is living in an apartment. He is struggling to pay off lingering credit card debt. It's two steps forward. One step back. He is saving 5% and needs to get to 10% but isn't sure how. Then he decides to buy a house. The payment will be more than the rent, but he feels it's a good investment. Sound familiar?
Sometimes I am lucky at talking folks out of a home purchase in a stage of life like this, but more often I am not. I will admit that the enthusiasm of the buyer and excitement of the home purchase can sweep me away, maybe even to the point that I start to question my advice or my, uh, math. But the story plays out the same. They are always six months away, or one disappearing car payment, or one pay raise from getting ahead. Sure that credit card debt has jumped again, but there were legitimate repairs or improvements necessary for the house. It's just temporary.
The pay raise might go to a new car payment. The tax refund to a new couch.
The story here is deeper than one purchase. I find that a home purchase is a trajectory decision. I had one such trajectory decision. Out of grad school I took on a rent payment that was one-third of what would be considered "affordable." It was a small, one-bedroom apartment with a loud and rickety window unit. And every single time I drive by I secretly thank that sweet apartment. See, during those years I got on my first trajectory as a saver. My savings decision led to better ones and better ones after that. The reward was not even imaginable, but ultimately the freedom to walk away from a salaried job to start my own business.
Buying too much house, whether renting an apartment or buying a home, poses a number of chain-reaction problems that accumulate over time.
So how can you be confident that a home will not set you on the wrong trajectory? The first step is to make sure your finances are in order:
• Are you saving 10% or an amount that will allow you to retire in your 60s?
• Do you have a fully funded emergency fund?
• Do you have a car fund for repairs and buying your next one?
• Have you funded, or are you on track for saving enough for your kids' college education(s)?
• Do you have enough for a 20% down payment on the house you want to buy?
The next step is the affordability test. Take the payment of the home you want to buy, add in a home repair reserve (1% of the value of the home divided by 12) and then factor in any upgrades or remodels, especially if it is a fixer-upper.
Practice the payment. Let's say the all-in payment/monthly repair reserve savings comes to $1,400 per month, and you are currently paying $800 per month. Have $600 auto-drafted into a home savings account. This will conveniently go toward moving costs or new home furnishing or painting that inevitably come up when buying a new home.
If the following things cross your mind in a six-month period, then abort mission, save for a larger down payment to get the monthly house payment lower, or reduce how much house you want to buy:
• Do you raid the home savings, say for a vacation?
• Do you end up with a credit card balance one month that you can't pay in full?
• Do you have to say "sorry, can't go" to dinner with pals?
• Do you table a vacation you had been planning?
• Do you find yourself perusing the HR handbook to find out how you can reduce your retirement savings for temporary relief?
Folks, these are the things that happen when you buy too much house. But because the house is more of a commitment, instead of recognizing that the house is the problem, you might find yourself in that mind bender convincing yourself that this is a temporary problem from x, y or z.
And that pay raise? Folks, pay raises have way more awesome uses than relief from a mortgage too big. Think about it. "Oh goodie, I just got a promotion with a pay raise. Guess I can afford my mortgage now!" Um, no. Pay raises in my experience are opportunities to take nicer and bolder vacations, to save for bigger financial goals like starting a business or having a kid. "So excited for the pay raise I have already spent," said no one ever.
More important, watch closely how your life feels when you "stretch" into that payment. You might find that instead of stretching you are bending. And no one wants to go through life that way. If your experiment ends less than stellar, then change your trajectory, stand tall, and find the home that's right for your life and for your paycheck.
Sarah Catherine Gutierrez is founder, partner and CEO of Aptus Financial in Little Rock. She is also author of the book "But First, Save 10: The One Simple Money Move That Will Change Your Life," published by Et Alia Press. Contact her at sc@aptusfinancial.com.