In today’s article we’ll review strategy #2 in your path to obtaining MAD Wealth!
Ah home! There’s no place else like it on earth. It’s your own little piece of heaven on this place we call earth. You can decorate, have parties, relax in it, and create wonderful memories lasting a lifetime. The idea of home brings thoughts of joy, wonderment, and the yearning to always be there. Even Dorothy said “There’s no place like home.” But is your home really that nice to you?
What if your home was actually a bloodsucking, evil, nefarious place turning you into it’s servant for life? Imagine instead of lovely flowers on the tables, and custom window treatments, it actually represented your tin cup with prison bars over the windows. That’s what your house is really doing for you. How could that possibly be? Well if people have learned anything from the last recession is that a home can become a financial morass wiping out years of your hard earned savings in a heartbeat. Leaving you cold on the street with none of the comforts it previously provided.
How could this pillar of American society be a source of our actual financial destruction? Well there’s a lot of reasons, and they don’t stem from the recent recession. If anything that’s helped change societal views of our home. For the majority of people the basic home buying checklist is as follows
- Watch HGTV and proclaim you must have everything you see other people buying.
- Find a real estate agent and browse MLS listings.
- Get mortgage pre-approval.
- Look at 5 homes because they look at just 3 on TV, and who really wants to spend time doing more than that!?
- Buy the spacious, updated, expensive home at the top end of your price range because everyone said you can afford it!
- Decorate the shit out of it with Restoration Hardware and Crate & Barrel furnishings.
- Handcuff yourself for the next 30 years to pay for it all.
If this doesn’t seem like a logical sequence then congratulate yourself for seeing the insanity! Major things I see wrong is why the heck you’re doing #1 instead of putting more effort into #4? This is how the list should start.
- Carefully consider exactly how much space you really NEED, not WANT.
- Analyze rent-vs-buy in your targeted neighborhood to find out which you should be doing. Make sure it’s close to where you plan to work. If not refer back to how driving is a huge cost.
- Get mortgage pre-approval and compare loan costs from two separate places. Understand borrowing means you actually can’t afford your home without someone else’s money. Also never borrow the maximum amount. Think about how you will pay for it all if you end up with a job paying less money, or your spouse works less in order to raise children. My rule of thumb is your total mortgage, insurance, and tax payments should not exceed 20% of your annual income. Most banks will approve you for a loan that comes out to 30% of your annual income. Remember that they make money by collecting more interest so there is an incentive for them to nudge you towards the max.
- Find a smart and trustworthy real estate agent if you decide to use one. Remember you can even buy a home without an agent if you desire through the for sale by owner market.
- Look at lots of homes before you even really consider buying one. Trust me, another one will be put up for sale everyday so you won’t miss out on the “opportunity of a lifetime.” It usually takes 30 minutes to walk through a property. I bet most people spend more time trying on pairs of shoes before they purchase new ones. Does spending the same amount of time on a $70 and $250,000 purchase sound like a wise idea? I didn’t think so. Make sure you spend lots of time checking out your potentially new abode & always get an inspection.
- Consider buying ANY home if the price is good, and structure is sound within your target market. Even if it needs updates this is likely where deals can be had. Also you can renovate it yourself (very rewarding), or use a reputable construction company for custom updating.
- Vow to never watch glorified home buying television shows again & enjoy the luxury of not being financially handcuffed to your home!
When I bought my first piece of real estate I ended up looking at over 200 condos, single-family homes, and multi-family buildings. It ended up being a great lesson. At the end of it I realized in the beginning I had no idea of what I was looking at in a house, and no particular way to judge the quality and value of a property. Unfortunately for me I also had a real estate agent that was not analysis savvy. So as the process wore on I fired up the old spreadsheet. I ended up developing my own proprietary analysis techniques to gauge the viability of a property which I now share with my clients for a reasonable price. With a lot of analysis, time, solid negotiation, and bit of luck I ended up with an undervalued multi-family property that will pay for itself many times over in the long run.
But back to the real issues of how your house is impeding you from Getting MAD Wealth. If you follow the standard American way you end up buying a home that is 2,600 square feet. If you’re not sure how big that is let me tell you, IT’S HUGE! It’s bigger than my first aforementioned multi-unit property I bought which comfortably holds 2 families leading extraordinarily happy lives.
So let’s look at some purchasing, decorating & operating costs to bring this full circle with Homebuyer A & Homebuyer B.
| Homebuyer A | Homebuyer B | Difference in Housing Costs | |
| House Size Sq/Ft | 2,600 | 1,700 | |
| Price/Sq Ft | $105 | $105 | |
| Purchase Price | $272,900 | $178,434 | $94,466 |
If the average cost of heating a home with natural gas is $0.55sq/ft then your 2,600 square foot home will cost you $1,430 a year*. I won’t go into AC systems for brevity’s sake, but it’s well documented a bigger home costs more to cool in the summer. Meanwhile if you had bought a smaller, still nicely sized 1,700 square foot home you would spend $935/yr. Might not seem like much, but we haven’t even started looking at other areas yet. Also don’t forget other utility/municipal services such as water, sewage, waste removal, and taxes which can add significant yearly costs.
How about the cost to decorate your home? We all want our home to look like pictures in magazines for good reason. They look beautiful, it impresses your family & friends, and it can provide a sense of happiness which I don’t mean to discount. Some quick google searches will show a lot of interior decorators stating you will spend 25% of the value of your home furnishing it. Let’s take a little off the top and assume it’s actually 22.5% since interior decorators are motivated to have you spend a lot of money. So nothing scientific in our 2.5% reduction. If your average 2,600sq/ft home costs $272,900 then you’re looking at spending(272,900*22.5%) $61,402 to decorate. Now obviously most people will do rooms one at a time spaced out over a couple years. We can now estimate a cost per square foot to decorate your home($61,402/2600) at $23.61sq/ft. If you had purchased a 1,700sq/ft home you’d instead be looking at paying only $40,137 to furnish your home. Below we’ll take a look at how big of an impact saving $21,265 will have. But the preliminary lesson should be don’t make Pottery Barn & Pier 1 wealthy, make yourself wealthy!
So we have some basic numbers from Homebuyer A & Homebuyer B. Overall Person B has initially saved $116,226 with their smaller home purchase. Only 10 years later earning an 8% monthly compounded return this person has a significant nest egg stored up. How much exactly?
| Homebuyer A | Homebuyer B | Difference in Housing Costs | |
| House Size Sq/Ft | 2,600 | 1,700 | |
| Price/Sq Ft | $105 | $105 | |
| Purchase Price | $272,900 | $178,434 | $94,466 |
| Yearly Heating Cost $0.55 sq/ft | $1,430 | $935 | $495 |
| Decorating Cost $23.61 sq/ft | $61,402 | $40,137 | $21,265 |
| Total Saved | $116,226 |
It turns out buying the smaller home after just 10 years nets you $257,979. That’s nearly enough money to buy the larger home. A prudent person would use our proprietary real estate model to find an awesome rental property providing passive income streams for life! Or you can of course enjoy the savings and treat yourself to a country cottage! Either is fine depending on your goals and situation.
So now we see how just a few changes to our decisions early on can have huge life long lasting impacts later. A bigger house may seem nice, especially if you plan on having a large family. But always ask yourself if it’s worth the sacrifice, and extra stress. Besides wouldn’t we all love having more time to spend with family instead of working to pay for a house?
*Calculated using 80% efficiency natural gas furnace(2200 sqft/$1215=$0.55 cost per sq/ft) from www.energysvc.com. Adjust your numbers accordingly if you have a different heat source or more efficient furnace.
