Why You Should Consider Downsizing Property and Carry Less Debt
When I first started purchasing real estate at age 20, I took out a $13,000 loan. I partnered with my Dad to purchase a $30,000 house that would be fixed up and turned into a cash flowing rental property yielding a high annual return on investment. After $7,000 in initial repairs to fix the place up, our all in cost was $37,000 or so split equally between the two of us.
I put down $5,000 at the time of purchase and after repairs I was responsible for $18,500 share of the expenses, so I took out a $13,000 loan and made another $600 payment to cover the remaining gap from repairs plus a little extra for future repairs.
This was a great first experience being in debt but controllable debt as I had more than enough money in the bank and stock investment accounts to pay it off.
I took on debt though because of the principle of using other people’s money when investing and at a 5% interest rate on the loan, I could keep my other money invested at a higher rate of return.
This was a great strategy for growing my net worth while my rental property paid down my loan, property taxes, and property insurance plus left cash flow to be deposited into my rental property bank account each month.
While I don’t have personal experience taking out larger mortgages, I pose the question to you of whether or not you could be happy living off just a $100,000 mortgage as opposed to someone taking out a $200,000 or $300,000 mortgage.
How Big of a House Would Make You Happy
In other words, could you be happy sacrificing an expensive home for a less expensive home?
The average person gets a job and we will assume they are making the average wage in the U.S. of $55,000. Let’s say they’re also married so now they have two incomes totaling $110,000.
When it comes to buying a house, financial advisers and banks will usually say you can afford a house payment that is 28% of your income.
A family of two making $110,000 would be able to afford an annual housing payment of $30,800, which would be equal to monthly payments of about $2,567.
Now that we know the monthly payment this family could afford, let’s see how much house that would buy. Using a housing affordability calculator, this family would be able to take out a loan for $478,000. We can assume this is 80% of the purchase price of the home because we will assume the couple put down 20% in cash. This would mean they could afford a $597,000 house.
This family would have a nice sized house (if not a mansion) in most parts of the U.S. unless they are living in San Francisco or New York City. $30,800 of their income would be going towards their housing payment each year and remember a large portion of this would be interest (money they would never get back).
Let’s pose the question again: What if they only took out a $100,000 mortgage for a $125,000 house? They could move to a cheaper city where cost of living is lower and thus their $125,000 could go a long way. For example, my rental property was over 1,500 square feet and had a basement, ground floor level, and an upstairs. It had 4 bedrooms and two bathrooms. It was a decent sized house for only $37,000. I think $125,000 could get this couple a similar sized home with 3 bedrooms and 2 bathrooms and nicer finishing on the interior.
What’s the financial impact of making the decision to purchase a less expensive home?
For starters, their annual loan payment on a $100,000 loan with a 30 year mortgage at 5% interest would be just $6,444! Their monthly payment would be just $537! Talk about a massive saving of $24,356 each year for 30 years: $30,800 vs $6,444.
This extra $24,356 could be invested in a low cost index fund that returns on average 7% over the 30 years that it would have been spent on a mortgage. The results?
Their investment account would reach $2,374,000 tax deferred at the end of year 30! Your mind is blown too right? You sacrifice on the house and now instead of paying $924,000 to the bank over 30 years on a $478,000 mortgage, you invest the difference saved each year and end up with a tax deferred retirement account of $2.37 million since you elected to go with the $100,000 mortgage.
This is the difference between someone who has to work 40 years of their life and someone who becomes a millionaire at a young age and retires early to live off of passive investment income.
Other advantages of living on a $100,000 mortgage?
Since you usually would be paying $30,800 per year if you did the traditional spend 28% of your income on housing, you could still pay this same amount towards your $100,000 mortgage and have it paid off in just 4 years. Now you’re mortgage free and can invest the full $30,800 for the next 26 years while the average person is paying off a mortgage plus interest.
You also have a less expensive home so you’ll be paying less in property taxes and insurance and likely utilities as well.
What would you do? Comment below in the comment section.
Overall, you see the impact on your wealth if you elect the cheaper housing option. Housing is a huge life expense and if you want to be a U30 Wealther who achieves financial freedom in 7-10 years from now you have to make sacrifices. I would argue you’ll be happier. You’ll have no debt if you pay off your small mortgage in 4-5 years. You’ll have more money to invest and build your net worth faster. You’ll be able to retire early in life and since you’re debt free you will have little stress in your life, which means you’ll be healthier and happier emotionally.
Can you taste the freedom?
You have to decide what’s more important to you. Buying a super nice house you can afford with 28% of your income or buying a cheap home, traveling the world, and living an early retirement lifestyle most will never experience.
The average millionaire saves over 50% of their take home income. The secret to retiring in 7-10 years? Saving 75% or more of your income and keeping your cost of living low without sacrificing happiness. You can find happiness living a minimal and simple lifestyle. The average person thinks they need to buy a brand new car and a large expensive home to feel happy and feel like they are living the American Dream.
You’re a U30 Wealther and you’ve seen inside access to the way money works and how you can benefit from smart financial decisions that the average person doesn’t consider. Be happy you found this article today and please feel free to share it to your social media to save a life or two (:
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