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- [00:00]
Brian Preston
Here's an important money question. Is homeownership the best path to wealth?
- [00:12]
Bo Hanson
Brian, I am so excited to talk about this because we hear a lot of personal finance creatives and really the American populace in whole talk about homeownership like it is the end all be all to wealth creation and to being able to build wealth. In today's show, we want to put that to the test. Is that in fact true?
- [00:33]
Brian Preston
Well, I've often wondered, is it just because people don't save and invest money? Because a lot of people will buy house? Because that's just part of what you do as you go through life. But very few people actually let their money start doing the work for them. So this will be a great experiment to say, hey, let's actually separate the different behaviors you can do, whether it's renting and investing or whether it's buying or if it's one of these. Because there are debt crusaders that just go hog wild and try to pay it off as fast as possible. I can't wait to see the answers.
- [01:04]
Bo Hanson
Yeah, and truthfully, personal finance is personal. And so it may turn out that the right decision for one person might not be the perfect decision for another person. So we want to dive into that and see how making one small decision or really one large decision for most folks, the largest decision they'll ever make in terms of dollars and cents, how it can impact your financial life. But you know, what's another decision you can make that have a huge impact in your financial life?
- [01:31]
Brian Preston
I can't wait to hear this to.
- [01:33]
Bo Hanson
Subscribe right now to this channel so you can stay up to date on all the content that we put out there. So Brian, you've already set the table here. You said let's talk about the three different options that generally exist when it comes to housing. What are those three options?
- [01:47]
Brian Preston
Yeah, we got Nancy, who never bought a house and rents. But here's the good news because I know this is a lot of young people are struggling with the housing markets gotten a lot more expensive. Nancy's saving the down payment and she's investing all the difference between what she brings in and then she pays in rent. And then you've got John who bought a home and he pays it off in the traditional 30 years. We also assumed he bought the house with 3% down because we wanted to make this minimal. And then we moved to the third one, which is Earl. Earl bought a home, but he is a debt crusader and he's going to take up to 50% of his income to pay down that debt as fast as possible and get that mortgage wiped out.
- [02:28]
Bo Hanson
So let's walk through our assumptions for this case study. Let's assume that all three of our individuals have a household income of $120,000, their home. If they were one of the two that bought a home, they're going to have a mortgage payment equal to 25% of their gross income. So it's going to be $2,500. We're going to assume they put 3% down. We know right now the mortgage rate on a 30 year fixed mortgage is 6.79%. And so that means that they're going to be able to buy a home that's worth $374,198. And we're going to assume for Nancy, who decided not to buy a house, that she's going to pay the median rent in this country right now, which is $2,050 a month. So when we lay out these three individuals, Nancy rents for $2,050 and she invests 25% of her gross income plus the differential between the rent payment and what the mortgage payment would have been had she bought. So in total, Nancy is going to invest $2,950 every single month.
- [03:35]
Brian Preston
If I could whistle, I would.
- [03:38]
Bo Hanson
So now let's look at John. John is going to spend $2,500 on housing. That's the 25%. He's following the money guy rule. And with the other 25%, he is going to save and invest that. So John is just going to plan on paying the mortgage on its normal term over a 30 year cycle. And then we have Earl. Earl, you've already mentioned, is a debt crusader. He's going to put all $5,000, 50% of his monthly gross income toward his home. Then once it's paid off, he's going to begin investing all of that. He's going to invest all $5,000. So the question becomes which one of these ends up better? Who ends up in the better spot? Well, if we just look at the data, we just look at the raw numbers, we can see that after 30 years, Nancy does not have a paid for home. She has been renting the whole time and will continue to do so. But because she's been saving and investing, she has actually been able to accumulate a portfolio worth over four and a half million dollars. So certainly attaining a high level of wealth was possible even though Nancy was renting.
- [04:47]
Brian Preston
Now I think it is. We need to notate. She did put down $11,226 as a house down. I mean, not as a house down payment. But she didn't do that. She didn't have to come up with a house down payment. And then we also used a moderate 8% rate of return on growing the assets. We, of course, could have gone higher, but we wanted to keep everything equal. So we kept it at 8% because that's pretty reasonable.
- [05:11]
Bo Hanson
So then we have John. John decided that he was gonna pay the house off over the normal 30 year period and invest the whole time. Well, not only does John's house grow in value, remember he paid something like $330,000 for it. And assuming the house just increases, the.
- [05:30]
Brian Preston
Actual original value was $374,000.
- [05:33]
Bo Hanson
$370,000. And the house grows with inflation. It's now worth over $900,000. And his portfolio has grown to be worth $4.6 million. I'm sorry, his net worth is 4.6. Total portfolio value of $3.7 million. So again, pretty solid. Not quite as liquid as Nancy, but a slightly higher net worth.
- [05:56]
Brian Preston
Now, I will say it's kind of interesting to see right there that John is higher than Nancy. So there are some benefits. Americans. I'm not disappointed because I think it's part of the American dream. You want to get the house going. But I do think it's worth noting the spread is not as big as I think you would think. But let's think about the debt crusaders. What does it mean for them? Because they're obviously, they forgoed investing until they got this debt extinguished. And it is important to note we are in a unique time right now. Interest rates are a little bit higher. So this probably is going to minimize the behavioral impact of being so aggressive. Whereas if this was lower interest rate, there might be a different answer.
- [06:41]
Bo Hanson
Yeah, so when we look at Earl, what we can see is his house grew at the same rate as John. So at the end of the 30 years, his house is also worth over $900,000. But because he did not begin investing as early as John, because he didn't have that time, his portfolio only grows to about three and a half million dollars. Now, again, when we look at the total net worth, he still comes in second with a net worth of $4.5 million. What I think is wonderful about this illustration is that all three of these individuals, because they were disciplined and because they were dedicated to saving and investing over the long term, I would argue all three of them were likely able to reach financial independence. Whether they bought a House, did not buy a house or how they prioritized paying off the debt. In my opinion, this is really an example of how behavior over a long period of time can have a huge impact on your financial situation.
- [07:41]
Brian Preston
Yeah, I mean, I like the fact, because we're going to talk about there are huge benefits to home ownership and the fact that it does allow you to have stable housing costs, rent change. Yeah, we go through inflationary period. Again, you kind of like it when you have a house because nobody's raising your rent on that. There's also are some tax benefits. You get to deduct the mortgage interest. You got property taxes that are deductible. And then. And of course you get the capital gains exclusion for 250,000 for an individual, 500,000 for a married couple. That's big to get out of taxes completely on the appreciation of what could happen in the house. And then the third one, this is not necessarily a financial thing, but it is nice to take out the transient part of life where you're moving around all over the place, especially if you're raising a family. You can grow roots, you can settle down, your kids can make neighborhood friends. There are a lot of those aren't necessarily financial, but those are definitely benefits for having a house.
- [08:42]
Bo Hanson
Now, look, in reality, we recognize that this case study is super simplified. It's not as easy as just looking at the hard numbers here, thinking about the tax benefits. We think that home ownership can be a wonderful wealth building opportunity. But personal finance is personal. And so before you jump into home ownership and before you decide is this part of your financial journey or should this be part of your financial journey, we want to walk you through some key factors that you ought to think about to determine. Does this make sense for me? And one of the very first factors, and this is probably not going to come as a surprise, especially in today's day and age, is where you live.
- [09:23]
Brian Preston
Yeah, I was kind of shocked as we were meeting as a content team and when Megan showed me the contrast between the two cities we chose, it is shocking. And I feel for you people who live in a high cost of living area is because the median housing pricing in some of these cities is. It's just jaw dropping. And you know, the easiest example I can think of is we looked at Los Angeles.
- [09:49]
Bo Hanson
If you think about Los Angeles, the median home price there is about $1.2 million. Well, the median rent to be able to rent a place in Los Angeles is only about $2,800. So there's a wide Differential between these two. If you think about buying a home in LA, when you factor in the down payment of 3% plus the closing costs, you're going to have to spend $84,000 of initial costs. And then over the life of paying the mortgage, you're going to spend another $3,200,000. At the end of that, you are going to have equity built up in the home and the home value will have increased. But even when you back out the home value, it takes about 24 years before it was more advantageous to buy in LA than it would have been to rent from NLA if you're only measuring it in terms of capital outflow. So if you live in a high cost of living area like that, it makes a lot of sense likely to continue to rent over buying.
- [10:49]
Brian Preston
So we wanted to compare that. So that way, when people look at this is obviously where you live matters. And that's why we wanted to focus on this key point of the first factor is where you live. But we want to contrast it with where we're from. We're both from metro Atlanta, we're from the south side. And look at this. The median home price is $369,000. Median rent is $1,875. It creates a different scenario.
- [11:16]
Bo Hanson
Yeah. When you think about buying a home in metro Atlanta, again, if you factor in down payment plus the closing costs, you'll have a total buy in of about $22,000. And then over the course of the break in period while you're making your mortgage payment, you'll pay in $445,000, but you will have built equity in the home of about 182,000. So when you track the math in metro Atlanta, if you can buy a home and you can live in the home for at least 11 years, it's likely that you will have come out better owning the home than renting. So when you think about where you're choosing to live and whether or not you're going to buy a house in that geography, it really depends on how high the cost of living in that specific area is.
- [12:01]
Brian Preston
By the way, if you want to know one of the things we did to kind of help us with this calculation, the New York Times has this calculator where you can compare ownership versus renting. And that's one of the things we use to kind of power this analysis. And it was very helpful. So you too can go out there and play around with that yourself.
- [12:18]
Bo Hanson
Now.
- [12:18]
Brian Preston
Now, number two, here's the second factor is what you can afford.
- [12:23]
Bo Hanson
Yeah. So you may determine, okay, well, I'm in an area and homeownership in this area makes sense. Then you have to figure out, are there actually homes here that I can afford? And if you followed our content for any amount of time, you know, we have a few rules of thumb. And one of our rules of thumb is that when it comes to buying a house, you want your monthly housing costs to not exceed 25% of your monthly gross income. So if you even decide that this is a place where I should live, then you have to factor in, can I afford to do it? We have a great tool that can help you do that. If you go to moneyguide.com resources, we have a home affordability calculator that will actually walk you through. You input the variables, you input your data, and it will show you, how much can I afford based on my income, based on my interest rate, based on the term of loan? I'm going to go with to determine, are there homes in my area that would satisfy the affordability?
- [13:18]
Brian Preston
Yeah. And we wanted to make sure if you were asking yourself, what, when they talk about 25%, what does that include? We're talking about principal, we're talking about interest, we're talking about the taxes, and of course the insurance. But there's a lot more that goes into housing. But we wanted to show you, we know it's a unique time to be buying houses right now. So we want to give you the definition of what 25% was. But especially since rates have changed so much, we have come. Look, you guys know this because the majority of Americans still have mortgages that are less than four and a half percent. But here we are in a market now where rates are greater than six and a half percent. Mortgage interest rates impact your payment significantly.
- [14:00]
Bo Hanson
Yeah, it's wild when you think about, for the same priced house, if you were going to buy a $400,000 home, what that looks like from an affordability standpoint varies wildly based on the interest rate. If we had a 3% interest rate like what we saw a number of years ago, and you were again going to follow the money guy rules and you were going to put 5% down and you were going to make sure that you're tracking your monthly payment with a 3% interest rate is going to be a little under seventeen hundred dollars a month. Well, the income that you would need to have as a household to be able to afford that home would be about $81,000. If interest rates were 5.5%. Now your mortgage goes from $1,700 a month to almost $2,300 a month. That means, again, to stay inside the money guy rules, you would need a household income of about $109,000 to make sure you're staying inside the affordability range. And then if interest rates are closer to where they are now, 7%, it's likely that your monthly mortgage payment's going to be almost $2,700 a month. That means that the income that you would need at those interest rates to buy the same size house, the same priced house, a $400,000 house, is going to be nearly $130,000 a year. So interest rates can have a huge impact on your decision to buy and whether or not a home makes sense in your situation.
- [15:24]
Brian Preston
What I'm amazed by, BO is how fast this is all moving. I mean, you would think that, okay, when these guys talk about 3% rates, I remember that was probably like pandemic and before. But we have a great slide showing you this is in flux right now. We did from November of 2023 to now, November 2024. That's just one year. And look at the spread here. I mean, this is significant. We've got on the 30 year mortgage as high as 7.5%. But there were periods and look, I know that maybe because we're only looking at this on a weekly basis, there was a day or so where rates did go on a 30 year below 6%. So we've seen massive fluct in just the 12 month period and hopefully that's going to settle down at some point.
- [16:09]
Bo Hanson
But don't mishear us. Look, we understand that housing is difficult and it's a hard decision. And we're throwing these rules out there and we're giving you these parameters and these guardrails because we want you to stay inside of them. We recognize it's not easy and it's difficult out there, but far too many folks are not doing this. They're not following these rules. And we know that right now the typical home buyer spent 40% of their gross income on their mortgage payment in this last year. And if you're spending 40% of your capital just on housing, it begins to crowd out all of the other financial goals you have. It begins to crowd out your ability to build and save for the future. That's why we put these guardrails in place.
- [16:54]
Brian Preston
Well, I get worried about the people who. Because if that's just your principal interest, your taxes and your insurance, what happens when you put in There, the utilities, when you put in there, the maintenance, you can quickly see how housing can become 50% of your take home. And what scares me is that there are too many people that are house rich, life poor. And it puts you, it squeezes you in to where you're not getting to save for the future. You're not getting to build memories. You're on this treadmill to basically pay for the house. We've got to figure out how we can help people get out of that rut.
- [17:32]
Bo Hanson
We wanted to show you. Okay, how much does this actually squeeze lifestyle? If I am one of those first time home buyers who's spending 40% on housing as opposed to only spending 25% on housing? Look at this. If we assume that you have an income of $100,000 and let's assume that interest rates on mortgages are around 6% and then let's assume that when you buy a house, you're going to have about 1% of the value of the home in maintenance costs. You're going to have another 75 basis points or 75%. Maybe that's PMI that you're paying, or maybe there's homeowner association dues that you're paying and you're going to come up with a down payment of 5%. When we think about affordability, if I'm going to follow the money guy rule and I'm going to say that I'm going to put 25% down, that means that just my principal interest, taxes and insurance are going to be a little under $2,100 a month. The average first time home buyer last year went up to 40% in principal, interest, taxes and insurance, that's over $3,300 a month. Well now when you begin to bolt on maintenance costs and then you add on PMI or HOA dues, what you thought was only going to be 40% of your gross housing costs is actually almost 50%. Even for those folks who stay at that 25% threshold. When you add maintenance costs and when you add PMI and you add these other expenses, your actual GROSS Gets to 31% of your monthly take home. So when we think about housing and we want to stay inside the affordability range, it would not be horrible of you to even be conservative to say, hey, I want my all in housing costs to stay below 25%. If that were your goal, then when you just think about principal, interest, taxes and insurance, if you could even get closer to the 20% threshold, you're just going to set Your future self up for success. To actually be able to save and build for the future, I think it's.
- [19:32]
Brian Preston
Important to say, look, we are very sympathetic with how hard it is to get into your first home right now. But I also want to lean in and talk to my financial mutants who sometimes as you start getting pay raises and things are going well, you start getting that itch to upgrade and don't. I love showing this because you see the cost, the cash flow impact on a monthly basis. This is very important for you guys to pay attention to because there's so much of life. If you're letting it all go into housing, you're creating a huge obligation for yourself. And I think so many people, we often say money is just a tool. And if you are losing, focus on the fact that you have all your money going towards housing. You have to go to work, you have to wake up and go to a job, maybe you even don't even love. But so you can afford this house, you're losing the flexibility. And I think what most of you actually are craving is the ability to do with your time what you choose to do. And the sooner you can actually create margin in your life and actually control what you're expending to start saving and building your army of dollar bills, the sooner you'll be able to make decisions out of your choice, not out of the obligation. And that's why when people get into housing decisions where they're paying 40, 50%, it not only puts them on the dangerous edge of failure, because if all of a sudden you lost your job or any of the assumptions change, you'd be in trouble, but it also puts you in this hole that you're that much further than having the margin to build your army of dollar bills and build independence.
- [21:09]
Bo Hanson
If we just think about the illustration we went through, we said that the monthly payment, just looking at principal, interest, taxes and insurance, was something like $3,300. If you were like the average first time home buyer last year that was spending 40% of their gross income there, if you could figure out how to maybe you buy the more reasonable home, you're not buying the $512,000 home, you're buying the $260,000 home. That frees up about $1,500 a month in your budget, well, that $1,500 a month can go towards retirement contributions, go towards groceries, go towards creating memories, go towards saving for the kids, go towards all of the other things in life that you want to fund. We don't Come up with the money guy rules as a means of putting a restriction or a collar around the things that you're doing. We try to put them there to keep you from boxing yourself into a helpless situation that you can't get out of. And the reality is, if you do find yourself in a situation where, man, the numbers just don't make sense, I just can't make this work. That's why we started with the case at the very beginning, showing that you don't have to buy a house, you don't have to be a homeowner to be able to build to financial independence, to be able to build for financial success. There's nothing wrong with renting, even if renting might be what you're just doing for this specific and particular season of your life.
- [22:36]
Brian Preston
Yeah, I think the bigger thing, and it's what I was alluding to, is what are you doing to watch the cost of housing versus everything else in your life? And do you have enough margin to where you can own your life that much sooner? You know, we. But we did something key when we did that first analysis at the beginning. We gave everybody the benefit of the doubt that they were actually optimizing their decision, meaning that they were. If you're renting, then you were saving the part that was not going towards buying a house, you were investing that for the future. If you were buying a home, you still were investing for the future, even outside of the house, even for the debt crusader. I think, sadly, and this is why we. The third thing we want to talk about is factor number three. What are you doing with your margin? Is unfortunately for the majority of Americans, you guys, it's like an either or. You're either choosing to be good with money, where you have a house and you're saving, investing, or there's the other Americans where the only decision they seem to be making is I'll buy a house. But they never save and build wealth outside of their housing decisions.
- [23:42]
Bo Hanson
This is not just anecdotal evidence from us. Look at this. We actually have from the Federal Reserve data showing household net worth as well as growth in financial assets, inflation adjusted from 1989 all the way through 2022. And what's really, really interesting is when you look at financial assets, these are checking accounts and Savings accounts and 401ks and Roth IRAs. Those types of accounts aren't really increasing. So when we see individuals net worths increasing, it's not because of the liquid assets in their balance sheet. What it actually is, the net worth that's actually increasing is just because of the housing decision they've made because their house has increased. So even for folks that are able to make the decision and get into a home that they can afford, they're not actually taking that margin and applying it towards building for a great big beautiful tomorrow. And what's amazing is it doesn't take a lot. A little bit can go a long way if you can just give it enough time to let it happen.
- [24:49]
Brian Preston
Yeah, I mean, it really does make me sad when I see all those big announcements where they say how much people's net worths have gone up. And the cynic in me is like, take out housing and see how much has happened and you'll see there's not. So we actually wanted to go a step further. We said, okay, look, if people, the typical person is doing 40% and we're saying it ought to be 25%, that $1,500 a month, that margin. And we said, but maybe that's too aggressive. If you said, Hey, $1,500 is too much money, let's just take half of.
- [25:22]
Bo Hanson
It, half of it.
- [25:23]
Brian Preston
Let's do $765 a month. Because remember, small incremental decisions really do have huge impacts in your future life. We said, let's take 765amonth. What does that look like in 10 years? What does that look like in 20 years? What does that look like In 30 years? And you guys are going to see the results of those small decisions.
- [25:43]
Bo Hanson
Just that one small decision. Again, this is assuming you can earn 8% on average after 10 years. Just saving that $765 a month would turn into $142,000. By the time you make it to 20 years, it's turned into $454,000. And by the time you make it all the way through a 30 year full mortgage lifecycle instead of buying that more expensive home, that likely is only going to increase at the rate of inflation over the long term. That small incremental decision to save that margin and build for the future could be worth $1.1 million by the time you have that mortgage paid off.
- [26:25]
Brian Preston
What I love is this illustration is it also shows that letting your army of dollar bills grow upon themselves is the compounding effect. It doesn't grow linearly, it grows in a compounding way. And that's why this really is a seven figure decision. If you can. Because you can't eat your house. I mean, in retirement you're going to unless you sell the house and you're moving to a lower cost of living area and you're going to use the equity for retirement. You're going to need some assets outside of living in that house. So that's why this is so important. And let's focus on on the path to wealth. After going through these illustrations and working on this, what were the key observations we kind of figured out?
- [27:08]
Bo Hanson
Yeah. Is home ownership the best path to wealth? Well, maybe. It depends. You want to make sure that you're in an area where buying is actually worth the investment, that it actually makes sense to buy over rent. And if you make that decision, you want to make sure that you're in the home long enough to justify the decision. You also want to know, what can I actually afford? And how do I build a budget that sustains that? I don't want my eyes to be bigger than my wallet. And I get myself in a situation where my housing decision crowds out all of the other financial goals that I want to fund. And I have to make sure that while I'm making those decisions, I'm not just banking on the house to be my piggy bank. I'm also putting money to work outside of the home so that when I get to financial independence, when I get to retirement, I've actually done the hard work of letting my army of dollar bills work for me.
- [28:03]
Brian Preston
Yeah, this is one of these. I always tell people when you start the house shopping endeavor, it's exciting, but you have to be careful. Don't skip out on doing your homework of actually figuring out what you can afford, what is your cash flow, what are your obligations. And don't let somebody. Just don't assume that the real estate agent or the mortgage broker is going to be looking out for your retirement, all your things, because they might give you a number that is 40 to 50% of your income. And just because they can get you approved at that does not necessarily mean you can afford that. And I think that. And also for all of you who are feeling scared or you're feeling behind because you want this American dream, but it feels like it's running from you because housing prices have gone up. We've come through this inflationary period. I do want you guys take a deep breath, realize we had a huge rate of return on real estate that happened at the beginning of the 2020s with this inflationary period. And I just, I think that yes, housing will continue to go up, but I don't think it's going to run from you as fast as maybe it does. So don't let that recency bias make you feel like, hey, I have to go make a desperate bad decision when you really need to be thinking about this. More from a holistic what does your whole financial life look like? Are you thinking about retirement? Are you thinking about housing? Are you thinking about how all these things work? There's a reason we have the financial order of operations so you can take the emotion out of things and actually have a non step system to navigate this well.
- [29:38]
Bo Hanson
Making the right decision at the wrong time can often be just as bad as making the wrong decision altogether. That's why we put together tools like our House Buying Checklist and have the Home Buying Calculator so that if home buying is part of your financial journey, you can make sure that you do it the financial mutant way.
- [29:58]
Brian Preston
I hope everybody takes away that this was not an either or decision on housing versus Investing. It's really a both because your money should work harder than you do. I'm your host Brian Preston. Mr. Bo Hanson Money Guy Team out.
- [30:12]
Bo Hanson
The Money Guy show is hosted by Brian Preston. Abound Wealth Management is a registered investment advisory firm regulated by the securities and Exchange Commission. In accordance and compliance with the securities laws and regulations, Abound Wealth Management does not render or offer to render personalized investment or tax advice through the Money Guy Show. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.