A Tale of Two Home Buyers. Why Waiting Matters.

In the last post I advocated saving a 20% down-payment and putting no more than 25% of your take-home pay towards your mortgage.  I also advocated using a 15 year fixed loan to reduce your interest rate and be able to pay off the house before your kids start college.   Some readers took exception to limiting the mortgage payment to 25 % of your take-home pay.  After all, the standard mortgage has been 30 years, and even in these low-interest rate times 30-year mortgages are more common than 15-year mortgages.  Raising a 20% down-payment, which is needed to avoid paying mortgage insurance each month, is also no longer the norm.  Individuals instead typically take out two mortgages (one which provides the 20% down-payment, and then a second that pays for the rest of the house), put almost nothing down, and go ahead and pay mortgage insurance.  This allows individuals who cannot come up with a down-payment to get into a house right away and start “living the dream.”

A couple of generations ago people started out in small homes or even rented an apartment for a long time before buying a home.  Many couples today, however, are looking for their first house to have everything that the home they grew up in had.  A large backyard.  Three or four bedrooms.  A bonus room.  An office.  They therefore want to jump right into a $200,000 mortgage, but certainly don’t want to wait until they can save up $40,000 for a down-payment.  Loan agencies that qualify individuals for huge loan limits certainly don’t help.

Despite this advice being out-of-the-norm, I still advocate for a 20% down payment and a mortgage no bigger than 25% of your take-home pay. The reason for this is that unless you limit your expenses you will not have money to save and invest.  To illustrate this, take the tale of two guys.  Both guys are 21 and make $50,000 per year and put away 15% for retirement.  After funding their 401K’s and paying taxes they have take-home pay of about $32,500.

The first one, Joe Average, buys a home with a mortgage of 35% of his take-home pay.  He takes out a 30-year mortgage on a $204,700 home.  His payment is $948 per month on a 3.75% fixed rate loan.  He is very normal in his choice of home but abnormal in that he does not take any equity out of his home – he just pays his payments until he pays it off at age 51.  After that, he invests his mortgage payment, getting an average return of 12%.

The second guy, Crazy Fred, opts for a home with a mortgage of no more than 25% of his take-home pay.  He therefore finds a first home for $94,700 and a mortgage payment of $677 per month on a 15-year fixed loan.  Because of the shorter term, his interest rate is 3.5%.  (Note that he could have also opted for paying rent for the first ten years and little would have changed financially, which might have been the thing to do if none of the homes for under $100,000 were in safe neighborhoods.)  He saves the extra 10% and invests, earning a return of 12% on his investments.  After ten years he takes the money he has built up through investing, sells the home he has, and uses the home equity he has built up ($57,486) and the money he has saved through investments ($95,926) and uses the money for the down-payment on a bigger home.  Not wanting to increase his mortgage payment, he takes out another 15-year loan for the same amount ($94,700), meaning that his new home is worth $248,000.  In other words, he puts $153,300 down on this new $248,000 home.

Here are the amounts Joe Average and Crazy Fred will have in investments and in home equity during their lives:

Joe Average Crazy Fred
Age Home Equity Investments Home Equity Investments
21 $0.00 $0.00 $0.00 $0.00
31 $44,805.00 $0.00 $57,486.00 $95,926.00
41 $109,959.00 $0.00 $210,898.00 $95,926.00
51 $204,700.00 $0.00 $248,000.00 $412,519.00
61 $204,700.00 $218,076.00 $248,000.00 $1,457,400.00
71 $204,700.00 $937,815.00 $248,000.00 $4,905,910.00

So, at 51 years old, when Average Joe is just paying off his $204,700 home, he only has the equity in his home.  Crazy Fred, on-the-other-hand, is paid off his $248,000 home four years earlier and has built up more than $412,000 in investments. 

In ten more years at age 61, Average Joe has built up a respectable amount in investments since he has been contributing what he used to contribute to his mortgage to investments (meaning he is not sending kids through college or anything).  Crazy Fred, however, now has more than a million and a half-dollar net worth, including $1.4 million in liquid assets that he can use to generate about a $60,000 per year income easily.  This is in addition to his retirement savings and his job.  Note that Crazy Fred continued to contribute only 10% of his pay to investments when he paid off his home, so he also had his $677 per month that he was paying for his mortgage to spend as he wanted.

By the time they reach 71 years of age, Average Joe has finally become a millionaire, but just barely (not counting his retirement savings, which also would have been a few million dollars since he was putting away 15% per year).  Crazy Fred, however, has more than $5 M just from the money he made from investing rather than buying a big house to start.

But wait, Average Joe made more in equity because he had a larger loan, right?  Assuming that the price of the two homes went up 5% per year, Average Joe would have made $2,143,377 in appreciation on the home value.  Crazy Fred would have made about $1.5 million between his two homes. So yes, Average Joe would have made more on home appreciation, but only $600,000 more.  This is nowhere near enough to make up for the $4 M difference from investments.

So, is it normal to buy a $94,000 house instead of a $200,000 house?  No.  Are there plenty of excuses to buy the larger house to start?  Of course.  But this is why most people don’t become wealthy.  Two individuals can have radically different outcomes given the same middle class incomes.  The difference is that those who become wealthy don’t settle for the excuses and do what is needed to save and invest.  Everyone else doesn’t.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.


  1. Not to mention the differences in quality of life between the two. Crazy Fred could retire at 51 when his home is paid off and live off his personal investment’s interest until he is able to withdraw from his 401k and/or collect SS. If he was ever laid off, he would have much more security with his private investments as well. Also if he got married with a spouse who also makes an income or if he got a raise his goals would be met much sooner.

    Naturally getting a sub 100k home isn’t very appealing to a lot of people, neither is driving a used car when they want the BMW. However, if you’re making 50k thats exactly what you need to do if you want to be wealthy. Within a few years he is able to comfortably upgrade beyond what Joe Average did anyway.

    Regarding 30 vs 15 yr mortgages, my opinion is that if you can do 25% of your income on a 30 year, that is great as well. You can always make an extra principal payment to cut the term of your loan down if it doesn’t have a prepayment penalty.

    Both of these examples will be fine in retirement, I wont do the math but they will have at least a million or 2 in their 401ks when they are 60-65.

    • Another thing to notice is that Fred has $100,000 more than Joe Average after 10 years and $200,000 more after 20 years. This is because Joe Average is paying a lot of interest during the first ten years even though his interest rate is only 3.75%. By using a 15 year instead of a 30 year mortgage, Fred is building a lot more equity. Plus he is making 12% on his investments instead of paying interest on a loan. Instead of buying a $100,000 house, he could have also rented an apartment for $400 per month, say, and invested the rest.

  2. Since I was one of the people who took exception to your previous post, you have multiple MAJOR problems with your argument here. The assumption here is that you can find a house most places for $95,000. Just not the case. You’d be living in a trailer in most cities, and I am sorry, while this may be financially smart, you can’t start a family in a trailer – and most people want to start families before 31. And to be honest, family is so much more important than being a millionaire in retirement.

    But, let’s examine. You fairly state that if that is not feasible or that price point would put you in a dangerous neighborhood, you could rent instead for $677/month. Let’s be honest, for this amount, you’d be renting, not buying, in most of the country. Now, there’s absolutely nothing wrong with renting, and I am also one for living simply, so I also have nothing wrong with buying a house for under $100,000 if you can find one, but let’s look at the results of renting since it would probably be what most would have to do for those first ten years with only being able to spend $677 on housing. If you rent you build zero equity. So, at the ten year mark (31 years old) crazy Fred doesn’t have $57,000 in equity like you list. He has nothing in equity because he’s been renting. He also hasn’t had the tax benefits of paying mortgage interest and property tax, but we’ll ignore that because it makes the math really complicated (but realistically, this decreases Average Joe’s tax burden significantly which gives him more money to invest than the zero you suppose for those first 30 years). So, without that equity, he actually has $96,000 for that second down payment. Still very respectable, to be sure. But now he wants the same $677 payment that he was making on rent. So, he can now buy a house whose mortgage will be 15 years for the $95,000 you list, plus a down payment of $96,000, or a total of $191,000 (NOT $248,000!!!). Realistically, ten years later, this is a house that would have cost around $180,000 at the time that Average Joe bought his $205,000 house. BUT, he actually has zero liquid money because he put it all toward this house. He has $96,000 equity in his new home which is better than Joe’s $45,000 for sure. And he will pay this house off at 46 instead of 51 like Joe. But his house will still be worth only 88% of what Joe’s is (maybe less because Joe bought in a better neighborhood to start with). So, he may be SLIGHTLY better off than Joe because he can now invest, but not nearly what you make it out to be.

    Second problem, most of the country doesn’t make $50,000 at age 21. This is national average household income for the entire working class. If you have to wait to buy a $95,000 home until you’re bringing in $50k/year, you’re probably not even starting down Crazy Fred’s road until more like 31. In turn, you’re not having a family until 41. Yikes! No thank you. I don’t want to be over 60 by the time my nest is empty.

    Third problem, you stated nothing about insurance or property taxes for either guy. I thought 25% was supposed to be the limit for housing expenses. If you include those, Crazy Fred can now only afford an $80,000 house, not $95,000. Just gets better and better.

    Lastly… With your advice to essentially invest 25% (15% 401k, and 10% take home), the math for these two guys assumes they take home $32,500. Even if they keep their home payments to 25% and invest 10% liquid, their monthly expenses better be less than $1760 or they’re under water (probably more like $1600 once you realistically include the property taxes and insurance which you didn’t above). Again, this isn’t gonna cut it for a guy with a wife and 2 kids even if you’re eating Ramen every night. And, realistically, they’re both house pour, which especially sucks when your house is a complete dump like Fred’s.

    Ultimately, my biggest problem with your arguments is how extreme they are. I don’t need to have $5 million in liquid assets when I am 71. I also definitely want to have more than $1 million. This is why I am an advocate for the middle road that I included in my last comment. Let’s be realistic here and not kill ourselves over money. If you’re making $50,000 like these two, buy a reasonable house, say $150,000, but don’t jump off a bridge in either direction. See if a 20-year mortgage might be reasonable (probably would be on that size mortgage). I am in 100% agreement with one thing – have 20% down payment before buying anything which would bring that house down to a $120,000 mortgage and probably only $700/month payments. Again, the 20% is not gonna happen for ANY 21 year old, so the clock is starting much later for Fred than you suppose above. Put 8% in your 401 k and 5% in liquid savings, as opposed to nothing like Joe.

    While your advice seems awesome on paper, no one can actually legitimately do it. So rather than offer impractical advice, why don’t you give us something we can actually accomplish.

    • Andrew,

      First of all, thank you for reading and for the comments. I believe that an honest discussion is healthy and leads to discovery. I certainly welcome disenting opinions.

      I do think that you can find a livable home for a single or a couple for under $100,000 in 98% of the communities in the US. (If you live in New York City and want to tell me that there is nothing for less than $500,000 where you won’t get shot, I’d say get out of New York City.) It may be a two bedroom condo, it may be on the outskirts of town, it may be 1200 square feet, and in some cases yes, it may be a trailer. I even saw a one bedroom condo in a nice building in the SF Bay Area of California – one of the more expensive areas in the country – for $92,000. If you can find that there, I’m sure you could find a lot of places in Denver, Albuquerque, Oklahoma City, Dallas, Phoenix, Las Vegas, and most other cities and small towns as well. Browse through Zillow.com before you summarily dismiss the idea – you may be surprised.

      The point is that if you want to “live like no one else,” as Dave Ramsey likes to say, you need to find a way. Everyone has excuses. There are always reasons you can come up with to spend a lot more and live like everyone else does. The point is that is you want something more a little sacrifice like staying in a condo for a few years and having your infants share a bedroom for a while can make a huge difference in your life.

      Now on other points. I’ve never said 25% of take-home pay for all of your housing expenses. I said 25% for the mortgage on a 15 year fixed loan. Doing that will also mean your property taxes will be lower, as will your upkeep. It will also make your life a lot better since you’ll actually have money to invest and save. You’ll also not be living so close to the financial cliff. Yes, you might lose some mortgage interest deduction, but most people don’t itemize anyway and you’re trading $100 bills for $25 off on taxes. if you really want your deduction, give the money you are saving on interest to charity – it will have the same effect. Or send me a check and I’ll send you the money to pay the taxes on it!

      On Crazy Fred’s rent, he wouldn’t spend the whole $677 on rent. He would spend like $400 on a two bedroom apartment and invest the rest. He would therefore build up “equity” and actaully do it faster than he would with a home loan. The 12% he was making on equities would make up for the leverage he lost,

      Finally, I’m sure many people can’t follow the path I describe to the letter, either because they simply can’t or they don’t want to be “extreme” enough to do so. I could also say that it would be best to exercise an hour a day, bike to work, and get ten servings of vegetables each day and I would be right. Just because most people would not reach the ideal doesn’t mean it can inspire them to work out a few mornings a week and pack an apple with their lunch. Do what you can. Maybe you’ll only have $2 million at retirement instead of five. It beats having $100,000 in the bank, a $200,000 mortgage remaining, $30,000 in credit card debt and a student loan when you retire. My point is to show what can be and tell people how to get there.

      • I understand your goal. My biggest problem is that you make liberal assumptions to make your argument. When those assumptions are invalidated, the resulting conclusions don’t mean much anymore.

        Redo the math assuming both make $36,000 at age 21 straight out of college (much more realistic). Neither have any savings because they wisely worked their way through college and put every dime toward their education to make sure they wouldn’t leave school with debt. All of the above falls apart really quickly because neither can afford a home (especially because neither has any downpayment or credit) and they can only get an apartment for about $440 (I live in a very moderate market and wouldn’t advise anyone to live in the parts of town that that will fetch). 10% means you’re saving $175/month and it takes you 9 years just to save a $20,000 downpayment. Sure raises come, but those probably serve to build up a safety net account which you’re not gonna touch to make a downpayment, and you probably had to buy a car at some point in those 9 years because the junker from your parents finally died (even a 4 year-old used car is gonna run around $15,000). So you’re realistically looking at age 30 just to get that first $95,000 house (assuming Fred has advanced to a $50,000 salary by this point). NOW start the clock above, and Fred’s 41 before he moves into that $248,000 house and he’s not paying it off until age 55. His family life is also wildly different because he didn’t have kids till 32 cause due to his $1200/month cash flow after paying rent and saving 10%, so he couldn’t afford to support any sort of family until that point.

        Anyway, I could go on. I just want to emphasize that all these things sound great, but they probably aren’t all realistic right off the bat. That is all. It’s just a pet peeve when people put these things out there as if they’re realistic and then everyone who truly is living very frugally sees them and thinks they’re doing something wrong because they aren’t following all of them (or maybe any of them). Instead, I find it more beneficial to give achievable goals. To use your analogy, don’t tell an obese person to start getting healthy by running 10 miles per day. Ain’t gonna happen! Realistic goals are challenging but achievable. Crazy goals area ones that send the unhealthy guy back to the couch because he feels so discouraged at the impossibility of living up to them.

Comments appreciated! What are your thoughts? Questions?

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