“If we command our wealth, we shall be rich and free. If our wealth commands us, we are poor indeed.” —Edmund Burke
I remember watching an episode of Property Brothers and they were telling this couple that you do not want to spend too much or overspend on a home and end up being house rich and cash poor.
They instead wanted the couple to buy a fixer-upper, do some sweat equity, renovate the home, and put that money into their pockets.
Basically, when you buy a turn-key home, the work has already been done and you are paying the homeowners for the money they put into the home on renovations.
However, then you buy the house at a markup.
This is due to the fact that they may pay $20,000 for renovations and then the property may increase in value by $40,000 or double what they paid. Thus, allowing them to increase the purchase price of the property, ergo you pay them to renovate.
That’s pretty steep for move-in-ready.
If you do the work yourself, you get to keep the value that the home increases by.
This means buying a fixer-upper for $300,000 and putting in $20,000 for renovations will push the home value to $340,000 and let you keep the $20k in equity for yourself instead of putting it in someone else’s pocket.
If you read my last post, Save $10,000 by Avoiding PMI, then you know I am all about saving that paper.
So, let me show you how not to be cash poor, but house rich.
WHAT DOES HOUSE RICH, CASH POOR MEAN?
According to Investopedia, “house poor is a situation that describes a person who spends a large proportion of his or her total income on home ownership, including mortgage payments, property taxes, maintenance and utilities.”
Basically, you are paying more for your home than you can afford or simply buying too much home.
If you have to pay more than 40% of your income for your dwelling, then you will become cash poor.
Matter of fact, if the value of your home decreases, you can be both house and cash poor.
'House-rich, cash-poor' explained in real numbers. https://t.co/TpgTsfy8Jm
— Realtor.com (@realtordotcom) October 12, 2018
When you are house rich that means all your money or wealth is tied up in your home. The home equity may be something like $150,000, but you only have $1,500 in the bank. That is not even enough to cover one month’s mortgage payment!
https://twitter.com/AP_Lifestyles/status/1051911392704499713
In order to shift this, you would want $40,000 in the bank, and to owe less than $150k on your home. That $40k would be enough to pay one year’s worth of expenses including mortgage payments ($1,600 x 12 = $19,200).
You would need a fixed rate mortgage to help you do this.
STAY AWAY FROM VARIABLE RATE LOANS
The ARM, or “adjustable rate mortgage” loan is too dangerous. Any loan product that can change at the drop of a hat and without a moment’s notice is too risky.
Let’s think about this for a second. Why is anything at a drop of a hat so bad? Well, did you ever see the movie Tombstone?
The idiom is likely to have come from the Old West, when duels would begin with a signal consisting of a man grabbing his hat and thrusting it toward the ground, before weapons are drawn.
Is this any way you want any part of your life to be lived?! Absolutely, not.
Entertaining in the movies sure, but not for real life.
This type of trickery should be left out of the equation.
First, lenders approve you for wayyy too much. Second, they tell you it’s okay to only pay the interest when it’s really not. As you cannot get out of debt, without paying off the principal of a loan.
And going for the trifecta of trickery, the third thing lenders do, and this is the hat trick, your mortgage payments jump so high Bryce Harper couldn’t catch it!
Your mortgage payments spikes upward too sharply for most folks to keep up.
A reasonable $1,600 mortgage payment could reset and go up to $2,400 in a single month!
That’s no joke.
I had a conversation with someone this actually happened to. Shocks like this are hard for most people to fathom and continue to live comfortably.
A fixed rate loan allows you to plan the monthly budget in advance.
When you how much you monthly nut has to cover, you are just better off.
HOW TO BE CASH RICH
Buying a home for less than you can afford is a start.
If you are approved for $400,000, then slash this amount by 25%. This equals $400k x 0.25 = $100,000!
You heard me. Then bank says $400k, and then you say: I’ll go $300k.
In one fell swoop, you both cut the amount of home you buy and monthly payment by 25%
You then take that $100,000 and over the course of the 15, 20, or 30 years you are paying your mortgage, you put this same amount into mutual funds.
You could do the S&P 500 index. Do whatever you want.
The goals are to simultaneously invest that money and pay down your mortgage.
For instance, that $100k over 30 years translates to investing $277 per month for 360 months. That would allow you to save anywhere from $500,000 to over $1 million depending on your rate of return through compound interest.
That means over a 30 year time period you have paid off a worth an estimated $300,000 or possibly more as home value may increase during this time and have an additional $800,000 in investments.
You would have a net worth of $1.1 million and would put you in the top 10% of wealthy households in America. See my post; Join the top 10% club for more on this.
WORDS OF WISDOM
A few words of wisdom to follow:
- Buy less home than you can afford
- Spend no more than 25% of your income on the housing payment
- Invest the difference of the savings you received from not paying the full amount approved for
- Stick to a housing budget
- Have a god size emergency fund of 8 months or more
It sounds so simple, but most folks are actually living beyond their means and buying my house than they can afford. I have actually seen people in their 50s signing up for 30 year mortgages! Holy crap! The odds of paying off this home are slim at that age.
If you can follow the advice I give above, you could find yourself at the top of the economic pyramid.
Don’t believe me? Read my post Join the top 5% club and find out!