WRITTEN BY: Gideon Drucker, CFP® AIF® ECA
I wanted to discuss one of the most important planning decisions that you will ever make: buying a new house.
My thoughts below are just about buying a new PRIMARY home (whether for the first time or you’re thinking about moving) and not about rental properties. (You can find my thoughts about buying rental properties here and here .)
Many of us have had these conversations as it applies to your specific circumstances & we’ll continue to…but sometimes an idea grabs you when you’re reading on your own, so I wanted to make sure I distilled these concepts in writing!
1. Spend less on your house - You may (will!) be happier.
Admittedly, this first note is anecdotal & not scientific. The rest of this piece will provide numbers, ratios, and facts. But before we discuss this intellectually, I think I’d be doing a disservice by not breaking down the decision to buy a home based on my experience and my gut.
Because that’s what buying a home is: an emotional, all-encompassing gut decision….& I can only tell you what I know to be true from our team’s experience of working with clients for over 100 YEARS collectively.
Keeping up with the jones is a real thing…feeling like you have to buy a certain level of home because that’s what friends/colleagues/neighbors have done has unfortunately become ingrained in our DNA. The number of times I’ve heard clients say, well, I can’t find anything below $1.5mm or $2m or (insert number here) so that’s my starting number.”
Well, maybe you can’t buy a home that checks all 10 of your boxes for anything less than $2mm (for example), but you can find one that satisfies your 4 deal breakers for $1.5mm. Financial decision making is always about prioritizing what’s most important to you in each of a number of different areas (housing, travel, family, retirement, charity etc.) and being uncompromising in what’s most important so you can achieve your version of success across the board.
As you all know, Team Drucker takes pride in being “brutally honest”. Housing is probably the conversation around which this comes MOST into play.
Because this I know to be true: buying a home out of your price range is the single biggest reason that clients have found themselves thrown off track towards their long term goals. That one decision, more than any other, is what can lead to financial uncertainty & anxiety.
Doing it right...can also lead to financial freedom.
As most of you know, my dad is my role model in how he approaches life, family, and business. His personal finances are no different. He is financially independent at this stage of his life: he can do what he wants, when he wants, with who he wants. He bought his current home 25 years ago (the house my sister and I grew up in.) It’s a fine HOUSE…but it was an amazing HOME. It was a wonderful place to grow up. But it was a house that fit comfortably in my dad’s budget 25 YEARS AGO and has only become even better over time (as his income and net worth grew.)
He could have bought a bigger or nicer home over the years (just ask my mom) and they could have dumped hundreds of thousands of dollars into it over the years…he never saw the point. The house was a place to live and raise a family. It was nothing more. He didn’t derive validation from how big his house was or how “new” the kitchen was or whether it was the nicest home on the block. He just didn’t care. (My house was also THE house that all our friends around the neighborhood grew up in, in part because it wasn’t a museum…it was lived in. While not directly, I think this is somehow relevant here.)
I can confidently say that my parents house was substantially “less” than what they could afford….and has been for over two decades. In the years since they bought it, It would have been easy, quite frankly, for them to spend a lot more….with nary an effect on their finances. But, when I bring this up to my dad every now and then and ask if he ever thought about buying bigger, he would answer “to what end?” The fact that the house NEVER felt like a financial albatross around my parents’ neck gave them peace of mind financially when they were just starting out and raising a young family….They never had that feeling of swimming upstream or needing their income to chase their lifestyle. They ALWAYS felt in control.
Buying a home is the single “biggest” thing you will ever buy/own. My parents “acing” this big decision also allowed them to spend money on the family in other ways: family trips, summer camps, tennis and basketball lessons, a full gym in the basement etc. that they found immensely more valuable. They did so without guilt, debate, or doubt.
What should you take away from my dad’s story? Don’t buy a home with the reasoning that your income will go up over 20+ years & therefore you’ll have more breathing room than you do now. Imagine your income stays at this rate until you retire….would you still feel comfortable buying that home? Imagine your living expenses go up 5-10% with each additional child? Or that you’re planning on traveling more as you get older….imagine you increase your travel budget from $10k annually to $25k? Would the home costs start to feel tight around your neck? Give yourself some breathing room. Buy a home that doesn’t require every other financial decision you make to go perfectly….because as we all know, they probably won’t.
Your future self will thank you.
2. What you can get approved for isn’t what you should spend
An approval for a mortgage amount is not a suggestion….it is an upper limit. It is literally the most you are allowed to borrow to buy a home but it should have absolutely no bearing on what you actually spend.
It doesn’t consider your fixed expenses, variable expenses, future schooling costs, level of liquidity, whether you need to play catch up towards retirement, whether you have plans of going from a two-income household to one, whether you plan on having more kids, changing careers, starting your own business from the ground floor etc. All of these numbers, goals, and future decisions should really be looked at together (holistically) to allow you truly understand the impact that your housing purchase will have on the bigger picture.
As a rule of thumb, we maintain that your all-in housing costs (mortgage, interest, property taxes, HOA, condo fees etc.) should equate to less than 20% of your household gross income. (If you make $500k household, your total housing costs should come out to less than $100k.)
Of course, this is just a way to start/open the conversation around housing ranges that make sense for you rather than a definitive answer. Sometimes you can accomplish this ratio and still be left in a vulnerable position.
For example, maybe the house you’re looking to buy would only cost you 17% of your current gross income each year, which is great by itself, but because your current housing costs only come out to 8% of income presently, you’ve effectively turned a strength of your plan (having low housing costs) into more of a push. If you already had a vulnerable savings rate (percentage of your total gross income that gets saved each year), well, this increase very well might push your spending past it’s breaking point and damage the long term viability of your plan. And this all happened even though the housing costs by themselves don’t break the bank!
We’ve also clients that do have a fantastic savings rate (saving/investing at least 25% of their gross income annually) chiefly because their housing costs were so low relative to your income. They think this savings rate means that they’re untouchable and so ask us to run the plan with MUCH larger housing costs. Doubling or tripling your housing costs (estimates we’ve seen) by buying the bigger home might (and with higher interest rates unfortunately) might turn that 25% savings rate that the plan is counting on into the single digits. Again, because housing will most likely be both your single largest annual expense & your longest-running annual expense, it’s effect (whether positive or negative) on the plan is usually exponential.
3. Total Purchase Price is what matters
I’ve had dozens of conversations with clients discussing a home that they really like but that might be a bit out of their price range based on the rest of their financial program. Naturally, part of my role, is letting them know how/why it might be problematic, to what degree etc.. I’ve had quite a few of these clients follow up this conversation by asking if they could increase the amount they put as a down payment (over and above the 20% we discussed) in order to lower their monthly costs.
Now, figuring out the right balance between down payment and mortgage balance is an important conversation to have…assuming you can afford the purchase price. But, moving around the costs in this way (more up front versus higher monthly costs) most likely won’t do much to change the calculus of whether you can afford the home in the first place. Lowering your monthly costs may help you to feel better about your purchase because you don’t have to see these higher monthly costs bump up against your paychecks EVERY SINGLE MONTH, but if you’re just taking more out of our liquid net worth (in the form of a larger down payment) to get to that result, it can have the same effect!
If you’re buying a $1.5mm place and instead of putting down $300k (20%) you want to put down $500k (30%) to lower your monthlies, you are pulling out an ADDITIONAL $200k from your savings/investments. While it might feel better to only have to rip the band aid off at the start like this, think about what that money could be doing for you if it stayed available to you long term. That money could have been invested, set aside in tax-efficient retirement accounts, earmarked for other goals down the road etc. Quite simply, there’s a huge opportunity cost for putting down that “extra” money up front.
Erasing years of cash accumulation & investment savings in one fell swoop like this ultimately can have the same net effect of having such high monthly expenses that you’re depleting your accounts slowly over time (or just not saving enough to reach retirement). And while seeking to lower your monthlys might absolutely “feel” better (and I absolutely understand that impulse) in either case, you’re limiting the growth of your other capital by extending yourself on the house’s purchase price…however you choose to pay for it.
To be clear, deciding whether to put more or less into your home depending on interest rates, investment opportunity cost etc. is a worthwhile separate conversation around asset placement….my only point here is that you should be aware of what rationalizing this thought process might do as you consider buying a home that may be outside your price range. At the end of the day, total purchase price is what matters when determining if you can afford a home, not the way that you may choose to pay for it. In running our calculations, I like using a 20% down payment amount when calculating your income-to-housing ratio as it forces us to compare apples to apples and prevents us from stretching prices too far.
4. Your home is a place to live.
Every now and then a client will rationalize a home purchase price (or the renovation costs that will follow) being higher than they wanted to spend by saying, “well, it’s an investment!” Well, maybe, but historically not a very good one! Real estate prices have gone up approx. 3-4% over time. The S and P 500 (representing the stock market as a whole) has averaged a 10% annualized rate of return. And that’s to say nothing of the property taxes, maintenance costs, insurance costs etc. that you pay along the way that doesn’t factor into the sales price. 
And taking it one step further, in our experience at least, most of the time when you ultimately do sell your home….you’ll be using the proceeds from the sale to buy your next home, so any gains that you do receive at the point of sale aren’t necessarily going back into your liquid net worth to live off, they’re going to help you pay for your next place to live. And that’s really the way I’d recommend thinking of your primary residence: it’s a place to live (and you are always going to need a place to live.)
Of course, gang, there are exceptions. You buy in a hot neighborhood and the purchase price goes up dramatically over 3 years and you have an opportunity to sell…of course, this happens! But buying a home with the assumption of wild appreciation is just historically not home prices move.
Think about it like this: you buy a home for $750k twenty years ago…and it can sell for $1.5mm today….and you think, “wow, I made $750k on that house, I doubled my investment etc.! Well, sure, but it happened over 20 years!! That’s about a 3.5% rate of return….Would you be happy with any investment portfolio that earned 3.5% over 20 years? (I wouldn’t!) I think the fact that homes involve such large dollar mounts over such long periods of time exaggerate the actual capital appreciation that is happening here and blinds us to the opportunity cost of how that money have could elsewhere. Now, my point is NOT that you shouldn’t have bought and lived in that house over the last 20 years….that’s ridiculous…you need to live somewhere!! The house served you wonderfully over that time. The point is exactly that….it’s a place to live….and shouldn’t be thought of (or relied upon) as an investment that serves a financial growth purpose.
5. There’s no rush to buy…do so on your timeline!
This point is geared towards our clients that are thinking about buying their FIRST primary residence. A lot of times when I ask clients why they want to buy a home and what their timeline for doing so is, I hear “well, I just want to start building equity…I feel ridiculous paying all this rent!” And I can understand this thought process! It’s one that seems to be a core part of the American ethos….buying a home ASAP was seemingly a clear sign that “you’re on track.”
But that’s not ALWAYS the case.
Let’s start by understanding how much “equity” you’re actually building when you buy a home. On average, only 25% of your annual housing costs goes towards your mortgage principal (IE: building equity.)   The rest goes towards mortgage interest, property taxes, insurance, maintenance etc. So, most of the money you will outlay when you buy your home has the same practical effect of money that you would have paid towards rent: you are not getting it back.
By way of example, at current mortgage rates, a $600,000 home with 20% down will cost you $1,125,412 over 30 years (just based on the mortgage and interest!)  
Over the first 4 years of owning this home, you will have paid $119,725 in interest but only built $21,000 in equity (pre any appreciation.) (Of course, interest rates are higher than they’ve been in a long time so these numbers are worse than if we ran this exercise 10 years ago…but this is our reality for the foreseeable future. And this will speak to a later point, but in this type of interest rate environment, make sure you want to buy and then live there for a while!) 
Now, of course, if you could pay $5k per month in all-in housing costs for a place you own or a place you rent, all else being equal, you’d rather own it (and yes there is the mortgage interest deduction to benefit from as well!) Of course, building some equity slowly is better than none at all! But these costs are generally not the same. As most of you know, it usually costs more to buy a home (all extra costs included) than it would to rent that same home/apartment on an annual basis because it’s short term in nature.
Sometimes renting makes more sense for practical/lifestyle reasons. Renting affords you flexibility. To be able to pick up in 12 months and say, I’m out of here, I want to go live in a different part of town. Or, I might be leaving my job in 2 years and I want to find a remote opportunity so I can move back closer to family. Renting allows you to change course on a dime.
Personally, that’s why I rent in NYC. I don’t know where I’m going to find myself in 5-7 years…  I know my family talks about moving to other parts of the country, I know for sure that I don’t want to live in NYC long term even though it’s where I want to be right now, and so I have absolutely no intention of buying a home anytime soon. Financially speaking, I could buy in NYC tomorrow and “build equity” but the future optionality that renting provides me is worth substantially more peace of mind than that equity is worth. (and of course, the price I’m paying to rent my apartment on a year-by-year basis is way more than I’d be comfortable paying (and locking myself into) for the long term.)
By the way, I mention a 5–7-year plan because typically that is the break-even point of when it makes sense to buy. If you don’t see yourself living in the home for at least 6-7 years (and I do not see myself living in NYC for the next 5-7 years), a lot of times the costs of buying (closing costs, broker fees, moving costs, furniture etc.) mean that renting might make more sense over that shorter time period.
Not to belabor the obvious, but renting also doesn’t require a down payment. So while I’m “figuring out” my long term plan over these handful of years, and not locking up any “down payment” capital, I’m able to save 30% of my income every single month into my long term investments & retirement accounts….I’m building my net worth through saving & investing so that when I am ready to buy, the down payment I ultimately make won’t capsize my liquidity.
My point here is not to push off buying indefinitely. For some of you, as we’ve broken down, it is ABSOLUTELY the right time to buy. More than anything, I’m just saying that you shouldn’t feel “pressured” just because it “seems” like the right thing to do. That’s not always the case….There are a lot of ways to get there!
6. Do not forget about Property Taxes…they don’t go away!
My sister Gabby and I grew up in a great area in North New Jersey with excellent schools….My town was wonderful; I’d recommend it to anyone. There is a part of my town called “the hill’ that for some ungodly reason have property taxes double what my dad pays. My dad, just last week, ran into someone from town who lives in that part of town and they got to talking about the area and the guy asked my dad what his property taxes were. My dad cautioned him that he didn’t want to know…it would get him too worked up!
As I don’t think he’s a reader, I’ll lay it out: My dad pays $14k in property taxes, this guy (lets call him Greg) pays upwards of $50k. That’s $50k per year that HE WILL NEVER GET BACK. For some reason people get more worked up about having to pay income taxes than they do property taxes but imagine if your tax bill each year resulted in an extra $50k liability each April….you’d be livid. As my dad is fond of saying, our family and Greg’s family went to the same school system, the garbage got picked up the same day, the police & fire department worked the same way, and we all knew the same people.
Property taxes don’t go away when you pay off your mortgage either. It’s with you for life. Underestimate their effect at your own peril.
7. Expect Maintenance Costs.
When mapping out a potential home purchase for a client, we always want to make sure we are accounting accurately for maintenance costs. Obviously, we have no idea what exactly this will come to but 1-2% of the total home value on an annual basis is a good rule of thumb. So, if your home is worth $1mm, than we would want to figure in $10k-$20k in maintenance costs each year. Of course, just like investment returns, the average doesn’t mean it’s this exact same amount each year but rather an average over time. Some years, you maybe fixing up the kitchen or the washing machine or have a leak etc. and other years, the maintenance costs may be more minimal/run-of-the-mill. This is a good planning assumption though.
I’ll also caution here that this is when buying a “bigger” “more expensive’ home has a negative compounding effect. The more expensive your home, typically, the more expensive it is to fix/clean/maintain it. Lawncare becomes more expensive. Utilities are more expensive. Heat & air conditioning. Plumbing. Cleaning Services. Upkeep. Literally everything becomes a bigger deal. So that home you thought you were just barely extending yourself for becomes a lot more expensive 5 years in when all of these “other” costs start to compound and spiral. And these costs typically only go up with time. Simply put, annual housing costs are NEVER what you’re paying just in mortgage & property taxes.
Ok, team, probably the longest piece I've written...so we'll leave it there!
As always, let us know if this got you thinking at all & if you want to discuss any of these ideas one-on-one... It’s why the Drucker Wealth team is here!! Schedule your 15 minute "Right Fit" call here
 https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html - The opinions expressed and material provided are for general information, and should not be relied upon as financial, tax or legal advice.