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.
Oh yeah. Hit this one on the head. I have a Doctor friend, who after years of making nothing and piling up student debt, started making big money. So she did what any good consumerist would do, she pays $3K a month for an Apartment that she could get a few blocks away for $2K a month and then goes and picks up a new Audi.
I am working on helping to coach her in the right direction, but she has new upside credit potential and wants to spend it. ::shrugs::
You could have just stayed in the same house and did an addition or renovation. There are tangible and intangible costs to moving. The main reason to move is better schools for kids.
Great article. I definitely agree “what I qualify for” and “what I can afford” are very different numbers.
Here is a slightly different take: thirty years ago, as a divorced single mother with a decent job, I decided to move out of a rental in a shabby neighborhood. I found the smallest, cheapest house in the best neighborhood (in a town with a truly exceptional school system). I wrote a very personal letter to the bank mortgage officer, asking them to override their normal 35% maximum payment-to-income limit, in order to grant me the mortgage. My payment ended up being 44% of my gross income. Because I chose good schools and a better neighborhood for my son, and because we were minimalists by choice, the expensive house was still managed. Work pay improved, life circumstances changed (I eventually, incredibly happily, remarried), and we paid the mortgage off in less than 30 years. We sold the house, slowly renovated over 30 years, and retired. My son (who is now earning his Masters in Electrical Engineering) and I had a terrific, minimalist life there, and we accomplished it by making some important choices – a lot of them, choices Joshua and others speak and write about – about vacations, eating out, ‘toys’ (both children’s and adult’s). The point is, you can choose to invest more of your money in a better house, in a better neighborhood, if it is part of your master plan for your family’s life and future. You can choose, and plan, and make the journey enjoyable, if you have conviction – you can do it!
Love this! 💕
I have never purchased a home because I am terrified of a mortgage and all the costs of repairs, ownership, etc. I am divorced from someone that abused me and messed up my finances BAD. It’s been 11 years and I’ve gotten it all straightened out now. I have good credit and a decent income however, I cannot get over this massive fear of being stuck in a place I don’t like or with some massive repair problem that drains my finances. I like being able to just call and have whatever problem arises fixed at no cost to me. Also, my rent is the same as a mortgage would be for where I live. I’m saving in the hope of paying for a very large chunk of whatever I do eventually buy one day in the future and only doing a 15 year fixed mortgage at most. After what happened to me, I’m extremely careful.
Agree! When we lost our house in 2011 due job loss & refinancing the mortgage several times, one salary wasn’t sufficient. It was then we decided to rent & not be troubled with owning a house & all the maintenance included.