During planning sessions, especially those at the start of a new wealth planning engagement, I’ll often ask the potential client, “Tell me what it is you want to accomplish financially. What is your real goal?” They usually respond with something along the following;
- I want to be debt free and achieve financial freedom
- I want to retire comfortably
- I want to be able to quit my job that I don’t like and eventually do what I want
- I want to be able to control my time
These are all perfectly reasonable goals and objectives. But when I undoubtedly start digging into the financial details of their lives, I usually discover a very common situation. Their stated and verbal goals describe financial security, but their actions and behaviors tell me that their real top priority is to constantly live in the most expensive home that they could justify to themselves.
Americans have a love affair with expensive homes.
I don’t really see this trend changing at all based on observations right now. Homes that are too expensive based upon real household earnings are also the top reason why people don’t have enough to accomplish what they say they really want to accomplish (debt free and financially secure).
The fact is, we fool ourselves on the long-term ramifications of housing costs on our wealth plans.
- A house isn’t an “investment” like most people believe. Many of us say, “A home is a great investment.” It depends on what your definition of an investment is. For wealthy people, an “investment” is something that pays them money. A bond is an investment. A dividend paying stock is an investment. A REIT is an investment. A business is an investment. These things pay you while you own them. When you own a home, it isn’t paying you to live in it. You are paying a constant stream of cash outflow to own it. The more cash you deploy to live in your house, the less cash you have to buy “real investments” that will lead to your eventual financial freedom. Wealthy people ensure that they are setting enough capital aside each month to reach their long-term wealth objectives.
- The housing budget includes far more than just principal and interest. When average people buy homes, they ask themselves if they could afford the monthly principal and interest payment. If they love a house that is a stretch, then they change the loan terms to a longer loan length, or interest only loan. Also, do not think your real estate agent has your best financial interest in mind. How many times do you see agents showing clients homes way outside their budget? How often do you see people fall in love with that home that is way outside of their budget? They rarely account for all the actual costs of home ownership which includes taxes, insurance, maintenance, repair projects, decorating, furnishing, landscaping, appliances, roofs, air conditioners and a fence to keep Fifi the labradoodle in the backyard. Wealthy people create an entire budget for home ownership expenses that is realistic and all encompassing.
- Taking on too much debt with too long of a loan length. Debt, debt, debt. Americans love that debt (so does your government). Average people keep themselves in debt their entire lives. Wealthy people break off from the financial slavery that debt creates. There may not be anything wrong with a 30 year mortgage if you want to be debt free at 60 and you are 30 years old. But if you are 52 and want to be debt free at 65, why in God’s name are you taking out a 30 year mortgage??? Wealthy people that crave financial security eliminate their debt and achieve financial freedom.
- Changing homes too often. When you move, you create damage to your long term wealth plan. Each time you sell your home, you incur sales costs. Each time you move you spend money to get your home ready to market. Each time you move, you have to start decorating and furnishing all over again. Most Americans use 30 year mortgages. Most of your mortgage payment during the first 10 years goes towards interest, not principal. So you never really build equity year over year. You just keep having perpetual cash outflow. Each time you move you have moving expenses. It’s an endless treadmill which results in many Americans never ever owning their homes. Wealthy people move less often and only move when they have the funds to upgrade to something that works within their overall wealth plan. How often do people move into older homes only to find that it becomes a money pit for repairs?
- People spend more to keep up with their direct neighbors. When people upgrade their housing, they usually upgrade spending on other areas of their lives as well. If all of your new neighbors are driving new cars, you are more likely to drive a new car. If the neighbors are sending the kids to private school, then you are more likely to send the kids to private school. If the neighbors are going to Tahiti on vacation, you probably aren’t camping at the KOA Campground in a tent. In America, everybody is trying to keep up with the Jones’ and what they don’t realize is that the Jones’ are a bunch of financially irresponsible people that are nowhere near on track to achieve financial security. Wealthy people are only competing against themselves. They don’t get sucked into the gutter just because their neighbor can’t save a dollar and is up to their eyeballs in debt.
So, what is the solution to this housing madness?
- Never take on a mortgage that is greater than two times your annual household income. For example, if you household income is $150,000 your initial mortgage should never exceed $300,000.
- If you are already in a home that is wrecking your financial security then downsize to a home you can afford and get on the road to financial security before it is too late.
Most people want to be happy in life and they believe that being wealthy would increase their happiness (it usually does). They also think that living in an expensive home will make them happy only to discover that constantly being stressed about keeping their head above water makes them unhappy. They are never able to escape from the treadmill of life which makes them very unhappy and stressed.
You can lead a happier life by living your life based around proven principles of success.