How much do you really need to buy?

Here is a related article by Millard Fuller, President and Founder of Habitat for Humanity International. I know it really made me think.

Since I wrote this calculator I thought I should also add my opinions on the "How Much" issue. Even though a lender might think you can afford to buy a certain house, you must always consider the ramifications and decide what you really can and want to afford yourself.

Buying More is not always Better

Here in the United States the bottom line is usually "the more, the better". Buy as much as you can for yourself; you deserve it. But in many cases you may really want to buy less, or at least not push your finances so much that you really have to strain to afford that house some Web based calculator says you can afford.

Let's say you have an income of $50,000 and my web calculator says you can afford a $160,000 house. What that really means is a lender will give you a loan large enough so that you can purchase that $160,000 house. If you are someone who regularly barely keeps your checking account above the minimum you really will not be able to afford the house. The only way you may be able to keep up with the payments is to throw more and more on your credit cards. And then you will curse me and my silly calculator.

It definitely depends on the housing market in your area. In some places a $300,000 house is a luxury home, in other places that is barely a starter home. People who live in the more affordable areas have the most options. They are the ones who must decide not only "how much can I afford?" but "do I really need all that I can afford?".

Bigger Houses cost More

Another factor people often forget is that the bigger a house you have, the more it costs to own it. If you move from a 900 square foot apartment to a 2500 square foot house, you are going to have a whole ton of floor space you are going to want to fill with furniture. You have a lot more space to heat and cool, lots more to clean (or you hire out the cleaning as an additional expense.) Then there is the yard and maintenance issues you never had to deal with in a rental unit. Don't think that the monthly payment is the vast majority of your house costs, there are plenty more costs to worry about. By buying a home that is 20% smaller than the one you can afford from the lenders' points of view, you can also save on utilities, furnishings, maintenance, property tax and insurance. Everything is relative.

Another factor is property appreciation. In more expensive neighborhoods the number of people who can afford to buy them decreases substantially as prices increase, since incomes have not been increasing as quickly as property values. So the amount of headroom for appreciation in more expensive areas is much more limited than in more moderately priced areas. During the huge real estate run up in the last few years, many of the already overpriced regions have seen their properties rise not as quickly as many more affordable areas.

The Neighborhood Factor

Then there is the neighborhood issues. If you live in an expensive house in an "exclusive" area, the costs definitely do not end with your house payments. For example, if you live in a more expensive area, the homeowners there will also tend to drive fancier cars, are more apt to join private organizations and send their children to private schools. After living there a while you learn to accept that this is the norm and that becomes the typical standard of living in your (and your family's) eyes.

Much of this is discussed in the book The Millionaire Next Door by Stanley and Danko. People who live in expensive neighborhoods are not necessarily the ones who own the most assets, just the ones who spend the most money. Their environments give them a model of how much money should be spent. That's just natural due to day to day exposure. And every persons actions affect others in a specific environment. If just one neighbor buys a new Mercedes that is no big deal. But then if after looking at it a while his neighbor decides maybe he needs a new car, so he gets a Lexus. Then another neighbor thinks "well, if they can afford new cars, I don't see why I can't", so she goes out and gets herself a BMW. Soon people who drive home in that neighborhood in a 3 year old Accord will think there is something wrong with themselves. However several blocks away in a less affluent area that 3 year old Accord looks pretty darn nice...

You might find yourself perfectly happy in a less expensive neighborhood in a less expensive house. If your housing costs then end up only being 10 to 15% of you earnings, think of all the extra money you will have. Plus the "neighborhood" factor changes. Personally I have found that middle of the road neighborhoods are more friendly and comfortable than more affluent ones. You also want to consider who you want your children to think of as normal peers and a "typical" lifestyle. ("But, Dad, everybody flies to Europe for Spring Break!").

"But I'm doing it for the kids for better schools"

Many people use the "better schools" argument as their reasoning for buying an overpriced home in an overpriced neighborhood. In less expensive parts of the country like the midwest, it may well make sense to spend an extra $20,000 or even up to $50,000 for a home in a better district since that may only cost you a few thousand more per year than living in a less desirable school district. But in more expensive regions of the country (e.g. the West and East Coasts), when you start paying $100,000, $200,000 or $300,000 more for a home solely because it is in a "better district" you could easily take the savings by living in a cheaper district and spend that amount on a premiere private school. In a less desirable area, the same size and quality home will be substantially cheaper, so you can live better, in a less "exclusive" (i.e. "snooty") area, and send your kids to good schools for less or the same amount of money.

So what is Hugh Getting At?

My bottom line is don't think the best thing to do is always to buy the most house that you can afford (or at least how much the lenders think you can afford). There are many other issues you have to think about when deciding where to live. The most expensive places are not necessarily the best places for you and your family. That is a choice only you can make yourself.

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Hugh Chou