The Road to Financial Hell Is Paved with Beautiful Houses

Show me how much you spend on housing, and I’ll tell you your financial future.

If you want to be successful with money, you need to make a thoughtful choice about where you live. Housing costs account for 37% of after-tax household income in America. That means 37 cents of every dollar the average person makes goes to housing costs.

That means that someone who clears $3,000 per month; they only have $1,890 left to cover all other expenses and try and save a few bucks. Remember, that's the average, which means a lot of people are spending 50% or more of their take-home pay on housing.

Spending that much on a single expense makes it virtually impossible to achieve a high savings rate and build financial security.

Not only is housing our biggest expense, but it’s also one of our fastest-growing expenses too.

Indeed, the road to financial hell is paved with big, beautiful houses. Let’s discuss why and how to avoid becoming house-poor.

Real estate has never been less affordable

To the surprise of many, housing prices in rich countries have exploded during the pandemic.

• U.S housing prices were up 12.2% year over year in March.
• U.K housing prices were up 10.9% year over year in May
• Canadian prices were up 24.4% year over year in May.

I live in Waterloo, Ontario, which was once viewed as a relatively affordable place to live. After an exceptionally hot housing market, the average cost of a detached house is now $900,000.

The price of a house where I live is more than 13 times the median after-tax household income of $67,500.

Let’s break down the numbers to quickly show how quickly buying a house in my city can be a one-way ticket to financial hell.

• The average family brings in $5,625 per month after tax.
• The mortgage on an average $900,000 house with a 10% down payment would be about $3,600 per month.
• Property taxes would be about $750 per month.
• That would mean the average family would spend 77% of their take-home pay on housing costs.

That leaves 23% of your income to cover all other living expenses and try and save a few bucks.

Of course, these numbers will change depending on the average income and average home price in a particular city, but the story is the same across most major real estate markets;

An average family can’t afford to buy an average house.

Except, many people I know still are trying to buy a home. They are willing to put off every other financial goal and go nearly $1 million into debt just to buy a house.

Now, the extra depressing part is that the numbers above only include the mortgage and property taxes, which are only the tip of the iceberg costs when it comes to the cost of housing.

Don’t buy a home you aren’t prepared to live in for at least 10 years

It’s stupidly expensive to buy and sell a house.

It costs $3,000-$7,500 in transaction costs to buy a home.

In addition to your down payment, you have to pay legal fees, transfer taxes, pay for a home inspector, title insurance fees, mortgage insurance premiums.

The list of closing costs goes on and on.

According to a report from Zillow, the average closing costs to buy a home are between $3,000 and $7,500.

It costs $26,608-$36,192 to sell a home.

The biggest expense in selling a home is often the realtor fee, which is as high as 6% of the value of the home. You’ll also need to put some money into home improvements to get the home ready for market, pay a lawyer and be prepared to pay taxes and cover various other costs.

According to a separate report from Zillow, the average closing costs to sell a home are between $26,608 and $36,192.

On average, the total combine costs of buying and selling a home are $29,608-$43,692.

The less time you spend in a home, the more likely you are to lose money. That’s why I would never buy a home unless I was prepared to live in it for at least 10-years.

Like with all investing, a buy-and-hold strategy is the smart way to go.

The 1% rule of thumb; property taxes and maintenance

Once you’ve bought a home, you need to pay the ongoing costs required to live in that home. The mortgage is just the tip of the iceberg. There are obvious and less obvious annual costs to owning a home.

Two obvious costs are;

1. Property taxes.
2. Maintenance.

How much you need to spend on each of these will vary widely depending on where you live and how big and old your house is.

A common rule of thumb is to budget 1% of the cost of the home to both property taxes and home maintenance each year.

Earlier, I cited a statistic showing the average cost of a house in the city I live in is $900,000. That would mean you could expect to pay up to $9,000 per year for property taxes and another $9,000 per year for home maintenance.

Home renovations are a terrible “investment”

In 2020, the average homeowner in the U.S spent $8,305 on non-essential home improvement, according to a report from HomeAdvisor. This is not money spent on leaky rooves or new furnaces; this is money spent on redoing the kitchen and other “upgrades.”

We all know people who have justified an expensive home renovation as an investment. I hate to break it to you, but spending money on a home renovation is one of the worst investments you’ll ever make. You’re almost guaranteed to lose money.

On average, nearly every type of home renovation project loses money. If you are going to spend money on home upgrades, I would think function over flash. Projects like adding a back deck or replacing windows are more likely to recoup more of its costs than remodeling your basement or adding a second story to your house.

Here is an important reality to keep in mind:

It’s not the value of your house that increases in value, it’s the value of the land it’s sitting on that increases.

Big houses keep us from financial freedom

I have a very simple definition of financial freedom; If you can do work you love, without worrying about how you’ll pay the bills, you’re financially free.

I’ve summarized what it takes to achieve financial freedom in what I like to call “the financial freedom equation.”

Financial Freedom= (Passive income + income from work you love) > Your living expenses

There are three variables you need to consider.

1. Passive income: aka income from investments.
2. Income from work you love: pretty self explainatory, money you make from pursuing your passions.
3. Living expenses: of which housing is by far our biggest expense.

Here’s the thing about generating passive income; it’s hard. It takes most people decades to build up enough passive income to cover their living expenses.

Making money doing work that you love is no picnic either. It’s taken me three years to build my passion project (writing) to a point where it can cover my basic living expenses. Building up my side hustle that quickly makes me one of the lucky ones.

The only variable in the financial freedom equation we can control is our living expenses.

High living expenses and, more specifically, high housing costs are what keep most people trapped in jobs they hate. The higher your housing costs, the further away financial freedom becomes.

Think about the hypothetical “average” family in my city that I mentioned spends 77% of their take-home pay on housing costs. Unless they are already doing work that they love, they are on track to never reach financial freedom.

If I were buying my first home today

One of the luckiest breaks in my financial life was buying my home in 2016 at 40 cents on the dollar compared to what I could sell it for today.

If I were buying a home in this crazy real estate environment, I would look into doing a house hack, which is a new age term for buying a home with rental income.

A common example is buying a house with a basement apartment or a duplex and living in one unit while renting out the other. A well-executed house hack can go a long way to reducing net housing costs and make achieving financial freedom more realistic.

Going back to the example of the average family in my city spending $4,350 per month on housing. If, instead, they decided to buy a house with a basement apartment that generated $1,500 per month in income, they could reduce their net housing costs by 35%.

My simple advice on spending money on housing

If, like me, one of your long-term goals is to achieve financial freedom, then let me leave you with some simple advice.

Buy or rent the smallest home you are comfortable living in, learn to become happy with what you have, and put down roots.

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.