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.
Tea says
When it comes to buying a home, most mortgage lenders will allow you to buy whatever you want because they make a commission off the sale. Whatever they tell you, buy a home that is $50,000 less than what they estimate you can afford. We were approved for a $250,000 mortgage and we bought a home for $180,000. Even our mortgage guy said we did it right!!!
Václav says
In 2006 my wife and I were looking for a house. A mortgage broker negotiated with banks and we got an approval for 100% mortgage with monthly repayment of 80% of our combined net income. We came home and thought “This can’t be right, how can anybody sign-up for that?” But apparently lot of people did. So we just kept on saving for the house deposit. In 2008 the market collapsed. We bought a house in 2009 for a much better price and with a reasonable mortgage. 2006 was filled with the Fear Of Missing Out (FOMO) pushing the prices up and the people towards insane decisions.
I feel sorry for everybody who suffered in 2008. And I believe if you’re told everywhere that you can afford something and that the price will always go up and now you still have a chance to buy, the only one you’ll ever get … you’ll start believing it. If it’s a house, a car, an expensive watch, a holiday, whatever. But everyone telling you that has an agenda, they get rewarded for selling you more than you can afford. You are the one who ends up in trouble for spending more than you can afford. So in this case it is ok to be selfish – do what is good for you, don’t overcommit and don’t overspend.
Carol says
What the bank told me that I could afford and what I thought that I could afford when we were purchasing a house were two very different things. I would not have been able to sleep at night if I had purchased a home at the price they were telling me I could afford.
The longer you’re in debt, the more money the bank makes.
I’m very happy with the decision I made.
Eric says
Those looking to sell something love those “comforted” by their “purchasing power.” Unfortunately, that “comfort” tends to be a slippery slope. As someone who practiced bankruptcy law for some 30+ years I can directly attest to those whose comfort levels ultimately left them mired in debt while also working endless hours to try and pay it off ironically leaving them even less time to enjoy their “things.” It really can become a vicious circle and financial issues have been the “death” of many a relationship. While making a nice income I conservatively budgeted for myself and my family to avoid a similar scenario. We hardly suffered. In fact, materially we did just fine and have enjoyed life. BUT, there is a HUGE amount of truth to the phrase about filling one’s life with experiences not things…and, especially, if those experiences are shared with family and/or friends. I truly doubt that anyone eventually met their maker saying “God, I just wish I had bought more cars and homes” as opposed to “God, I just wish I’d spent more time with my spouse, children and/or friends and had even more experiences, whatever those might have been.”
Melanie says
So glad I had grandparents that were money savvy, surviving the great depression!! I was taught to save, invest and not buy more than you can afford, pay cash as you go!! At age almost 50 we are debt free including the house!! Pay cash for our vehicles also our annual Florida family vacation!! We eat at home buy groceries on sale and create menu from there!! We buy clothes and other items at thrift stores or on clearance!! YOU CAN DO THIS!!
Susan says
You’re my kind of gal, Melanie! Same story with our family. We have a thrift store called Savers in the next town, and what’s so great is that if you make a donation, (clothing, books, household goods) they give you a card that you get punched for discounts on your purchases. I LOVE being able to declutter and buy clothes at an even cheaper price at the same time.
Lisa says
What a great idea that store has!! They get more inventory as people get rid of things they don’t need for things they do! I love it!!
Valerie Rogers says
Based on numbers of those struggling with debt, the current financial system has too much potential for getting people in trouble. Too tempting for many to have what everyone else has and what’s wanted *Now*, rather than what they can afford. Therefore, all this credit makes no sense to me. It’s a stronger foundation to have what’s affordable, pay cash for (wow what a concept!). That’s how I run my life, always have.
adrian rackham says
I spoke to my father only a few weeks ago , we were discussing buying a house now , comparing it to my situation and his , and my oldest daughter and her partner struggling to save for a deposit , and the exsistance in the UK of lifetime mortgages, and do mean LIFETIME!
The banks are the issue, my father said that he could only get a mortgage based on 1 wage , my mortgage was 2 , now its 2 and then some , why purchase now if you will never pay it off ? For the last 30/40 years borrowing is based on false economy, unfortunately people are still getting sucked into it .
Mary says
My 52 year old son recently told me he bought the truck of his dreams. $70,000 price tag, but he bought a low mile, used for $54000. That is a lot of money. Of course I gave him my motherly advice. Can you afford the truck or can you afford the payments? He could afford the truck and planned to keep it forever.
I have been preaching to my children the theory of stuff learned from Joshua.
We are retired, living on SS and our draws on our investments. We still spend too much money, everything costs so much. We winter in Florida, rent rather than own, have a lake house, over 40 years, long paid for, our home, way to big for us but also paid for a long time ago, and would cost more to downgrade. There still is taxes and insurance, upkeep etc.
And my husband does woodworking, always buying wood, tools, and I’m thinking he worked so hard he deserves to enjoy the years we have left. The kids don’t want our money, but they will get some, depending on how long we live.
It’s a fine line. We don’t need stuff, yet if we want it we can afford it and have room for it if it replaces something.
No longer buying t shirts when we travel. Lol.
Too long life story here, but so thankful to Joshua for his course on decluttering, not only home, but mind, body, and soul.
Peace in your life is the true gift. I pray everyone can find it.
Akatah Dorcas says
This is an eye opener to me. It’s really explains what goes on when people take loans and are not able to pay back. I’m so happy I read this article, it was really helpful.
Christina says
This is a really great distinction and I can only imagine that these current “financial systems” will only change when the majority stop participating in them. If this thinking was shared in schools and colleges and taught at home, I can only imagine what a “wealthy” country we could be with affordable quality Health Care and quality food, these would be an ordinary expense, not a ball and chain as in for so many today. Thank you!