I received my first significant raise when I was 31 years old. It was roughly a 40% raise. We immediately bought a house that cost twice as much as the one we lived in prior.
With a signed contract in hand (and a borrowed $5,000 to meet the down payment requirement), the bank approved our loan for the new, much bigger, much more expensive home.
I have a friend. Let’s call her Stacy.
For most of my life, Stacy has been as hard-working an individual as I’ve ever met. She chose a career to make a difference in her community and never regretted it—often working long hours for little pay.
She and her husband are loving parents to their two children. Last year, Stacy changed her career. She took on a new role, still serving others, but now incredibly well-compensated (from what I know about the industry).
Within a few months of her new job, Stacy had bought a new red BMW and took her family on a week-long vacation to Europe.
I don’t know all of Stacy’s story. But from the outside looking in, her story is similar to mine—and not unlike many others.
Our current financial system allows us to acquire credit based on income, rather than wealth. It grants purchasing power not based on what we’ve accumulated, but on what is expected to materialize.
That’s why I could get approved for a loan twice as much as my previous mortgage with only a letter and confirmation that the monthly income would be received. And that’s why my friend Stacy was able to begin living a luxurious lifestyle with hardly any actual money in the bank.
This is not a commentary on whether that should be true or not; I can see the argument both ways. This is, instead, just a commentary on the fact of the matter and a call for each of us to remember that “purchasing power” is not the same as “getting ahead financially.” We should not fall for the false sense of security it can bring.
Again, I’m not opposed to credit based on income as an opportunity for society. Because of credit based on income and history (rather than entirely on net worth), my wife and I were able to buy our first home and begin building equity with just 10% of the total cost.
Additionally, it allowed me to attend college on a modest student loan. Or it may allow others to start a new business or purchase the supplies necessary for a new occupation.
Economists will also argue that increasing the purchasing power of individuals to income rather than net worth allows the economy to grow and wealth to be built. As a general rule, I see the merit.
However, on a personal level, it is helpful to recognize that the temptation to take out credit based on income (rather than wealth) can be detrimental to our long-term financial health. It allows us to spend money like the wealthy, even though we are not.
My wife and I never were able to get ahead financially in that house because we needed to pay off such an expensive mortgage each month. We started with $0 in the bank when we moved in, and left with $0 when we moved out. Looking back, I wish we hadn’t doubled our mortgage on a 40% raise. I wish we had bought something smaller and found more breathing room in our finances first.
If you are just getting started on building a financial foundation, or are struggling to get ahead even after many years, maybe one reason is that you are spending based on income rather than net worth.
Remind yourself that net worth is not the same as income. Net worth is only what is left at the end of the month. Inflating your expenses or credit line, just because society allows and your bank or credit card say you can, is rarely the best step forward.