A Home Mortgage Means You Pay Double – Limited Income and Wise Spending

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Home mortgage and home ownership

I came out strong enough against home mortgage in last weeks renting vs. mortgage article that I errantly gave some the impression I was opposed to home ownership; that could not be farther from the truth.  What I am opposed to is the home mortgage.  This is because a home mortgage will cost the average homeowner more than twice the asking price of their home over the life of the mortgage.  Some feel this is no big deal – as long as the monthly payment is manageable – and that quality of life issues outweigh concerns of being in debt.  My biggest concern is how much a home mortgage will steal from your future standard of living; which is true of most forms of debt although mortgages deserve special attention since they tend to be our largest debts.

Cash flow and earning potential

Most people think in terms of monthly cash flow because they pay their bills monthly – nothing wrong with that.  However, something many people fail to consider is the limit to how much money they can make in their lifetime.  This is especially true of young people – for whom retirement and cessation of work is a far off – who like to think they will make more money “some day” but may never actually see the growth they might first imagine.

For the most part what we choose to do for a living decides our wages and we can usually estimate those wage with some variation for job experience and cost of living.  Our earnings scale will be similar with others who share our occupation so using current wages and demographic data we can estimate what our income will be each year from now until we retire.

Annual income example

Let’s use me as an example.  I made about $50,000 this year.  I am on a pay scale that starts at about $40,000 but with hard work can quickly jump to about $80,000 over the next 5 years.  Then that is it.  In good years I might receive a cost of living adjustment (1.7% this year) and if I want more, I either have to have the aptitude for competitive management positions, or try to work as much overtime as I can (which has limits.)  If I wanted to make a heavy six figures, I probably should have done something else.  🙂  My little side hustle writing for DFA is nice, but it is not about to bump me over the $100,000 mark.  Even investing, as wonderful a tool as it is for preserving savings against inflation is not going to skyrocket me to new financial heights.

Future wealth example

Using my salary and an example closer to the national average salary, I created a simple spreadsheet that shows projected salary with some cost of living adjustments after 30 years of work for me and average Joe.  Before taxes, I stand to earn around $3.3 million, and Joe will earn about $1.4 million.  That looks like a lot.  After some rough adjustments for taxes however, (and who knows what those will do in the future) I am left with $2.4 million, and Joe still has about $1.1 million.  More staggering, an average inflation rate of 3%/yr results in 100% inflation every 18 years (that’s a 50% loss.)  That means after 36 years I would have just under $620,000 and Joe $298,000 of today’s dollars.  These calculations include salary increases that outpace inflation, and have not yet factored in spending any money.

Consider income limitation with home mortgage

This analysis is far from exact.  There are many variables, and it is difficult to precisely value currency, investments, and income across time.  What I wanted to demonstrate is that none of us have unlimited supplies of money, and are therefore limited in the number of things we can buy in a lifetime.

Before entering into a home mortgage make sure you roughly consider how much money you stand to earn over the course of your life.

Because most of us cannot make significant changes to our income, we can better affect our future wealth and standard of living by limiting how much we buy and spend.   The more informed we are about our earning potential, the more apt we are to use our money wisely.  These considerations are especially important when making a large purchase such as a home.  With all the other things we do to save money and get good deals, it does not make sense to turn around and spend double the price tag on a house by using a home mortgage.  I mean, does it really make sense to rate chase for savings accounts only to end up spending twice the purchase price for our homes?  No, it doesn’t.  It makes mathematical sense to parlay our wants by saving for a few years… and paying cash – if at all possible.

Financial decisions always catch up with us

Whenever we overspend, at some point in time we will have to give something up to pay for it, even if that time doesn’t come for decades… it will come nonetheless.  Consider this a plea to take greater care when making purchases.  We work very hard to earn what we have so let’s make sure we spend as wisely as possible!

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1 George

I don’t disagree with anything you say, but one has to remember that a mortgage, done properly, will lock in against the effects of inflation. A mortgage is for a home purchase priced at a particular point in time – the payment on that mortgage won’t change unless you have an adjustable rate, refinance, or move. If you sign up for a fixed-rate mortgage amortized over a reasonably-short period of time (say, 15 years or less), then a house with a mortgage can make sense.

I take your point, though – many homeowners buy far more house than they can afford and then refinance or move every 5-7 years. Effectively these people are paying rent to their lender and building no equity.

I’m proud to say that my wife and I will have our mortgage fully paid off within the next two years, which will be before we turn 35, and less than ten years after purchasing our home. For us, buying a home was truly a blessing and a great place to grow our family, but the reason that’s the case is that we bought a modest home and then increased our payments as our income went up.

2 Kevin@OutOfYourRut

George – your inflation point is well taken, however the exact opposite happens with deflation, which is what many homeowners are now experiencing. It’s not so much that there’s a general deflation in the economy, but there most definately is in regard to housing. So a person buys a house for $200,000 with a $160,000 mortgage, and three years later the house is worth only $150,000. I think that could happen even if there was a substantial inflation economy wide because of the impact inflation would cause on mortgage rates.

Robert – you’re giving solid advice pointing out the limits of income growth. Young people often make spending choices based on nothing more than a hope for unlimited future income, only to find themselves trapped by reality at some future date.

3 Ann

When we bought our house 15+ years ago and showed the amortization table to my father, his eyes just about popped out of his head. At the time and with the rate we got (we have since refinanced to a much lower rate) we would be paying back more than double (we only put 5% down, minimum payments, etc.; if we only knew then what we know now!). When my father bought his house (in mid 1960s) it was 11,000.00, 10% down and over the course of a 20 year mortgage he paid back the principal and approximately 7,000.00 in interest.

Up until the past year or so (when we started learning more about how to manage our personal finances) we always looked at “can we afford the monthly payment.” We did this when we bought our house & didn’t looked at what the actual cost would be over the life of the loan. Looking at the long-term cost, It’s been an eyeopener in other parts of our finances as well (namely CC debt, which we continue to work on).

4 JoeTaxpayer

Nice article, although small correction. Rule of 72. at 3% inflation, it takes 24 year to lose half your purchasing power, as a 3% per yr cost increase makes an item double in cost after 24 years. 4% = 18 years.

5 Joseph

Your math is right- In most cases if you pay just the monthly mortgage payments you pay mre than double the initial cost of the home.

But realistically speaking, how many avarage people with one average income would be able to save enough money to buy their home cash?

6 George

@Joseph: If you’re an average person with one income, why do you think you should be buying a home, let alone buying one with cash?

Realistically, two (substantial) incomes are required to realistically buy a home outright with no mortgage, combined with several years of savings. If you only have one average income, renting is probably your only reasonable option.

7 Matt Jabs

Great point George… you saved me the trouble of saying the same thing.

@Joseph: It’s true… not everyone should be buying houses – that is a modern personal finance fable.

8 Jenn

Are people who earn $13 an hour any less deserving of home ownership? We work as many, if not more hours at jobs that are probably more dangerous. Just because the economy or society places less value in our work do we not have the same rights to property? Should we always be indebted to a landlord or mortgagee? We the people are exactly the ones who should own homes outright because we cannot afford to pay rent forever or interest on a home. I am not saying anyone deserves a brand new stainless steel appliance-granite counter top kitchen with a thee car garage home. I’m talking about a modestly sized two or three bedroom house (for a family!) with a large lot for all the things a family would need (veggie garden, chickens, fruit and nut trees, play and space, etc).
This property would take a minimum of 8 years for our family to save enough cash to buy outright (living in a one bedroom apartment with two kids-assuming no surprises com along).
Even if we bought with a mortgage it would take a minimum of 2 years to save the 20% down payment THEN 15 years to pay the rest. And not for very much house either. It is just over a 1000 sq. ft. on just over 0.25 acres and has no garage (in New Hampshire, mind you). This towns largest employer is a factory with $15 to $17 and hour being top rate. The second largest employer is a small grocery store with most workers earning $9 an hour and no benefits.
Honestly how much should home prices increase? I know it takes money to keep up a home but COME ON a house should not be an income making endeavor. It is a PLACE TO LIVE. Everyone needs a place to live. Why are there not options for everyone’s price range?
What is this elitist type thinking that says all of us “poor” folks should stay forever poor? It makes me sick.

9 Matt Jabs

Hi Jenn, if you want to buy a home then go buy a home – no judgement being passed here. God bless.

10 mUK

The problem isn’t house pricing, it’s the banks
seriously, do they HAVE to charge more than DOUBLE the loan amount in interest?

I was looking at cheap houses ($30k range) Most banks won’t even loan you 30k because $34k isn’t enough profit?

11 FinancialBondage.org

Buying a home with cash is what Dave Ramsey suggests doing. Sounds great, but few people can save enough money to do it. Id like to see Dave try it making $13/hour. Not gonna happen. Most of the people I know can’t even scrape together the 20% down payment that Dave also suggests.

12 George

@FinancialBondage That’s exactly why people who earn $13/hr shouldn’t be buying houses. A 20% down payment is not unreasonable – 20 years ago it was the norm, and a prerequisite to getting a mortgage.

13 JoeTaxpayer

George, there’s a flip side to (nearly) every issue.
Someone making $13/hr may very well be able to afford a $100K mortgage, even within conservative underwriting guidelines. That same hypothetical guy can save the downpayment by living with friends, parents, etc.
The median homeprice in the mid-west is about $140K. It’s not too great a stretch to expect there to be many homes in the $100-$120K range.

14 Robert Espe

The real question that comes to my mind is, what would people do if they couldn’t get a loan? They would rent and save if there was no other option. To me that says that people are getting mortgages either because of a lack of patience, because of the notion that anything else is impossible, or because they think it doesn’t make a big difference. My goal was to show that people have something tangible to lose by taking the impatient route to what they want. I’ve tried to demonstrate before that it is possible. I’m having a go at it myself. I make around $23/hr, but I’m single income. I’m thinking about 4 years. I believe it can be done, and that people would be better off in the long run. But like anything good in life, some sacrifice is required.

15 Theseus Ocean

Using your math, imagine paying rent for the rest of your life. Average rent in the mid-west is around $600 a month. That’s $216,000 over a 30 year period. Finding a more conservative apartment at $300 would not only be limited in quality, but still only cut the cost in half. There are plenty of homes in the mid-west in the $60,000 – $90,000 dollar range. I think purchasing a house is still a more economically sound idea. Why pay someone else’s mortgage?

16 George

@Theseus Ocean: Whether the house is “economically sound” involves more than a comparison of the cost of rent versus a mortgage. It involves looking at the total cost of home ownership: mortgage, property tax, repairs, insurance, utilities, more repairs, etc. All of these items cost far less (or aren’t your problem) if you’re renting. You also have to look at your income, projected future income, and ability to carry the mortgage in the event of unexpected circumstances.

For example, if you and your spouse both have incomes, could you still pay your housing costs if one of you lost your job? Do you have enough of an emergency fund to cover a few major expenses at a time (say, your furnace or AC dies at the same time that your car breaks down)?

Paying rent can be a very wise move, since it avoids a number of the risks that go with home ownership. It also makes you considerably more mobile if you need to change jobs and move to another location.

17 Matt Jabs

@George: Again… thank you for this response, it is exactly what I would have said.

@Theseus: Presumption of income for 30 years is terribly risky.

18 Fred @ One Project Closer

George, On average, the cost of renting must always exceed the cost of home ownership in order for it to be a profitable business for the landlord… You make a good point with the risk side of the equation; however, most large systemic risks are manageable with homeowner’s insurance. Other risks (such as property losing value, needing to move in a hurry) are unavoidable, but generally homeowner’s are well compensated for these risks by not paying profits to the Landlord.

19 Fred @ One Project Closer

I can’t help but weigh in on this one. Kim and I spend a lot of time thinking about our mortgage and home. Here’s a few things I think:

1) A home is not a financial investment. At least, not in the traditional sense of the word. It’s really an expense…. Your home doesn’t really ‘make money’ for you. On average, home values must approximate the pace of wage inflation in an economy. At best, they are a better way to pay for a housing expense than renting because they offer capital accumulation and, over the long haul, cost less than renting.

2) Taking a mortgage is a wise investment if you view it as a positive alternative to making a rent payment and you do all the math to justify it. Mortgages are tax deductible if you itemize and make the necessary deduction floors to make it worth it. That said, no one should get a mortgage “just to shield income” or something like that…

3) Rules of frugality still apply in housing. Buy only what you need. Don’t splurge unless you want to be ‘house poor’. Better to take the extra cash and invest it. Then, once you have a larger capital base, by the larger house with cash. Or better yet, stay in your current house and have the option to start your own business.

20 Neil

To buy a house without a mortgage, you must spend years saving up for that house while renting a place. Over the course of that time, your rent will continue to increase with inflation, as will the cost to buy a house (over the long term, both rents and house prices do a pretty good job of tracking inflation). In order for renting until you can buy outright to be a better deal than buying a home the following equation must be true:
rent paid + cumulative inflation off house price – investment income on savings < interest on mortgage

I've run some simulations in a spreadsheet, and come out that it's better to rent only if inflation remains low and investment returns are more than 8% – a combination that you'd need some luck to end up with. This calculation did not incorporate the mortgage tax credit which would result in only very unrealistic scenarios tipping in favour of renting. So the only realistic scenario where I'd recommend renting to someone is if they expect to move, or have such bad credit that they can't get a favourable interest rate.

21 George

@Neil: You’re quite right that the cost of homes, over longer periods of time, does track inflation. Problem is, that only really applies for timeframes of greater than 20 years. In the past five years, for example, housing prices have experienced deflation – severe deflation in some markets. Before that housing prices increased at a rate far greater than inflation.

If housing prices have outpaced inflation (as they did from 2002-2007), then it can make sense to keep renting until a price correction reverts the prices to the long-term averages. There are plenty of people out there who purchased homes in 2006 and 2007 and now own an asset that’s worth considerably less than the price they paid for it. I’m sure many of those people wish they were renters.

22 Forest

What an excellent article. I owned a flat in London and the mortgage was crushing. I sold as I wanted to move out of country but it taught me that I did not want a mortgage ever again…. Now I live in Egypt and am on the slow road to start savings. However I really think I can buy a house in cash one day and save the mortgage woes.



23 Spedie

I really liked this article! I think it is dead on. Why you may ask?

I am going through an event in my life right now that many people in the United States are going through. My daughter, who’ve I’ve raised her whole life, and is now 17 years old has decided to go live with her father.

I am about to become a non-custodial, paying through the arse, parent. Paying the child support has almost nothing to do with the actual support of the child and the expenses. Most of the child support goes to support the financial situation of the custodial parent. I am about to pay about $1900 per month, under state law, to my ex hubby, for this one child.

With the high divorce rate in this country, I can’t help but think I am not alone in this situation.

I bought my home a few years back and it is well within my means at $50 an hour to make the payments on a 15 year, 5.5% mortgage.

I am now going to have to sell it to meet the child support obligation. No worries, as I’d rather pay the child support than have my house.

Know what I am going to do? I am going to sell that house, sell just about everything in it, find a walk out basement to live in for 3 years after the child support obligation ends (that will be in just over a year), and bank all the savings of not having this “chain around my neck” called a mortgage around my neck any longer.

My husband makes about $18 an hour.

We figure, by renting out a walk out basement, that we can save $6000 per MONTH for 3 years, and then pay for a home with CASH.

Having a mortgage puts you at RISK. Having that mortgage and now this situation with my kid, knocked out my huge income and put me in danger of child support default – which would put me in jail.

No matter what would happen if I got laid off, got real sick, got in a car wreck, etc.

I refuse to have any more debt in the future – and that includes a mortgage. I am not playing this game any longer.

24 Ryan

@everyone on this comments section…Learn your economics or don’t speak…there are two main forces that control house prices: demand & inflation. While inflation will help increase the purchase price of housing, little to no demand can pull down the prices of housing. In 2002 to 2006, the annual rate of inflation grew at 2-5%, and at the same time, demand for housing was extremely high due to easy borrowing options and a good jobs market. Today, inflation is higher, yet prices are low (I read someone say deflation…lmfao). Its not deflation, (the value of your dollar has not increased). The problem is DEMAND is low, in fact demand is so low, that it more than offsets the inflationary affect in housing. Thus, once DEMAND increases (a result of banks lending more and job markets growing), then prices will go up again. Also, you buying a home is an ASSET to the bank, NOT you, it is a LIABILITY to you. The only reason one should even consider buying a home is if they plan on that house holding value or appreciating in value in the future (in which case they can Refinance, or sell). Additionally, you should only purchase a home to become a landlord renting out your property. Tax-write offs can be nice as well, if you know what your doing.

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