• Philip Stratton

LESSON 10: The BIG 4 - #1 Housing

There are numerous studies on how Americans spend their income as a percentage of their pay. A common claim is that households spend approximately 75% of their income in only 4 areas: Housing, Transportation, Food, and Clothing. The following chart which shows spending by category over the 73-year period of 1941-2014 does show how these categories, especially the first three, are far greater than the others. In more recent years, healthcare and entertainment spending has exceeded clothing.

Housing is by far the greatest amount spent each year. Housing isn't simply the rent or mortgage payment. It also includes insurance, maintenance, taxes, utilities, and upgrade projects. Experts recommend keeping your rent/mortgage payment to less than 30% of your pay.

Should I buy or rent a place to live? The answer to this question greatly depends on your personal situation and preferences. Renting provides a lot of flexibility in terms of living in different locations. Maintenance costs are not your responsibility, nor are the taxes related to the property. However, the amount you pay in rent will include the real and potential costs of these expenses which may give the appearance that rent is more expensive than a mortgage. Renting could limit your decorating options and you may be forced to move before you were planning if your lease is not renewed by the owner. Home ownership provides the ability to express your individuality, assuming you are not required to join a Home Owners Association that levies strict rules. It also provides stability peace-of-mind to those that own their home outright. Most financial advisors will try to dispel the myth about your house being an investment. Although it is (usually) an item that increases in value when properly maintained, your primary residence is not an investment instrument. The PBS series Two Cents explores the topic of home ownership in their video "Should I Buy A House?"

Assuming your analysis leads to a "yes" answer regarding buying a house, there are more things to consider.

  • Should you put 20% down towards the purchase in order to avoid the additional PMI fees?

  • Should you take out a 30-year mortgage with a lower monthly payment, or a 15-year mortgage in order to build equity in your home faster and pay less interest on the overall loan?

  • If you have the money available, should you pay off the mortgage early or invest that money in a retirement or other investment instruments?

  • Are there options available to purchase a larger or better quality home such as "house hacking" where a portion of the home is made available for rent to cover some of the housing expense?

There are advantages and disadvantages associated with each of these questions and no one-size-fits-all answer. Understanding the costs and benefits to decisions like these is important when considering your home costs. Use a financial calculator to explore how altering the variables will impact your financial situation. If you're already in your home or rented location, you can still evaluate your housing costs and formulate a plan to address them if they are higher than you are comfortable with. Maybe it is time to look into relocating or downsizing, refinancing/renegotiating your payments, renting space in your home to help lower your costs, etc.

Lowering your costs to below 30% of your income, better yet below 25%, is a major step towards having the money available to invest towards retirement or other goals.

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