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.
Sally says
“Credit” allows us to spend money like the wealthy, even though we are not. —- great line .
When really we should strive to “save” money like the wealthy!
We should all strive to have some of our hard earned money remaining for ourselves.
Ruth Brye braden says
When my husband and I were looking for our first and only house, the real estate agent did the same thing to us.
We refused her estimation of buying a house 3 times our income. We decided to buy a home with a mortgage that could be paid by the person with the lowest income.
It was a wise decision. We paid the house off in 7 years and it was for the best. My husband lost his job and we were still ahead.
People try to convince you that you can incur more debt . I totally disagree with the ‘spend money and it will help the economy’ mind set. It is the basis (among other things) for the high credit card debt andcreation of the mortgage crisis years back. Need to think in the long term, don’t we?
Jon Herrin says
Very important distinctions made in this piece. Thank you!
My wife and I have the best incomes we have ever had in our lives. Yet, my car is 11 years old and my wife’s is 16 years old. We still cook at home most of the time … and drink box wine (!). Oh, we do enjoy a meal out here and there, and there is a great sense of peace knowing that we could go out and buy new cars if we needed to. But, by living below our means, by NOT taking advantage of our purchasing power, we are building up our actual ‘net worth,’ paying off our house, and laying aside a comfortable nest egg for the retirement years.
I wish I had lived this way when I was 25 years old!
Tyson says
Love this concept and honestly, I need to get better about spending within my means so we can start building a financial reservoir rather than being (stressed, but) content with our river.
One thing I struggle with is that every time I get promoted or move up in my career, my established colleagues are already living on their credit (I assume) at that level – it’s challenging to keep control of spending when ‘keeping up w the joneses’ in the next office is suddenly so easy to do.
joshua becker says
Yup, I have heard that. Especially in higher-income industries. My suggestion is to look around – almost certainly not everyone is living on credit.
Teddy says
Our now-grown children didn’t think we had much money. Our house payment was $300 when contemporaries were $1,300 or more. We always saved at least 10% of income and paid double principle on mortgages. We retired at 55. We live in 2,000 sq ft in nice community. We have 2nd house on River. We drive our cars 10 yrs before replacing. Our only regret is we should have spent more money on kids. So we do now. And we travel across country to see grand kids (except 2020-21). We have a hard time NOT being thrifty!
Karen says
My husband and I chose to live below our means, so to speak. We could have had a bigger house, a newer car, but we didn’t. We learned a lesson from an older couple who could have afforded many things—she would shop at CarSense for a well cared for high end vehicle 3 years old. Maggie would tell us, why would I pay for the depreciation? Very smart cookie.
We are mortgage free, actually paid mortgage off many years early. Just because the bank will make the loan, doesn’t mean you can afford it in reality. The old formal was one and a half times your income for a mortgage. So yes making 75,000 a year is only a mortgage of 112,500 BUT it is the sensible number.
Good luck out there in our materialistic world. It’s tough to live with less. But no mortgage is truly a wonderful way to live.
James says
Great post Josh. The way our banking system works, people can loan themselves into exponential leverage as their income goes up. Reminds me of the book The Millionaire Next Door, and how many high income, low net worth, individuals exist.
Dave says
This is a trap that keeps so many people from building real wealth. I know because I was caught in this trap most of my adult life. We live in a society that preaches this gospel. No money down…easy credit….72 month car loans. We live at the ragged edge of our allowed credit and wonder why there is no cash in the bank when the furnace breaks. But hey! Furnace-o-rama is offering 12 months of no interest….
Jacob Fleming says
Your focus on long-term financial health is what’s needed more in our society and is, unfortunately, difficult to find. Even financial institutions that have the intentions of helping their members financially are often focused on increasing immediate purchasing power rather than increasing long-term wealth. Thank you for the great reminder to stay focused on net worth!
Hiatt says
Great article! I was recently approved for a $516K loan to purchase my first home. I’d be a fool to take that. I’m looking for a condo/townhouse that’s around $175K or less. But this is a sellers’ market right now so I’m thinking of waiting to see if Congress will pass the $15K down payment grant for first time home buyers. I’m in no rush to buy and I still rent. Enjoyed reading your articles. Thanks for writing!
Abigail Muller says
I have done the same thing! My advice is to purchase a home that will have excellent resale value!
Chris says
Thanks for this article. We were in the same situation in our earlier married lives and I agree with every word you said. It was a hard 6 years before we moved to a different city. What the bank says you can afford is not really what you can afford.
Katherine says
I find that so many people lack will power to save. People feel entitled to reward themselves with the little things that add up and eat away at the chance to build wealth. When people use credit cards for every purchase, they are removed from the real cost of the purchase and thinking they will need to make a sacrifice on something else. Credit allows you to live beyond your means and create a false sense of wealth by surrounding yourself with stuff.
We have been debt free for nearly 10 years and this gives us peace of mind. The older I get the less I want, which makes it easier to save.