Laura’s note: A version of this column ran in USA Today on Tuesday. Yes, Friday is usually round-up day, but I just got off the red-eye from LAX and this is all I got right now.
Grads, Pursue a Realistic Dream
by Laura Vanderkam
The big headline during recent graduation seasons has been what percentage of mortarboard-sporters will move back home with mom and dad. One widely quoted poll claimed the “boomeranging” rate was 85%. While that estimate is undoubtedly high, we do know that the rate of new household formation — people striking out on their own — plunged during the Great Recession. About 400,000 new households formed annually during its depths, compared with a long-term average closer to 1.3 million.
As the economy recovers, though, the new household formation rate is coming back up. That’s good news for the economy (and stores like Ikea) but it’s a more nuanced matter for those entering the real world this spring. Because when it comes to finances, young people have been on to something. Finding cheap housing is the best thing you can do to improve your balance sheet — freeing up far more cash than cutting out those lattes. The trick for young grads is to keep that same mindset through life, as the huge house that will eat up a third of your income starts beckoning. Rethink what’s sold as the American Dream— ownership of a house you have to stretch to afford — and you might discover the real American Dream. That is, the freedom to pursue happiness.
Housing one-third of spending
According to the Bureau of Labor Statistics’ Consumer Expenditure Survey, housing accounted for one-third of American households’ spending in 2010. (Realtors and online calculators sometimes say you can spend a third of your gross take.) When many people do the same thing, it shapes expectations of normal behavior. To be sure, if you have a low income, you’ll need to spend big just to afford somewhere safe. But what’s interesting is that Americans higher up the income scale consider it normal to stretch, too. People earning $50,000 a year hunt for $150,000-$200,000 houses; families earning $200,000 often eye $800,000 homes, not $500,000 ones.
The usual argument for stretching, on the ownership side at least, is that housing is an asset — a way to build wealth. Alas, it’s also a quick way to lose wealth, as Americans with underwater mortgages can attest. But even if you’re buying low (or are renting), here are practical reasons to rethink the more-is-more mindset as your income climbs.
First, spending less on what is most people’s biggest expenditure gives you the flexibility to change your life that cutting coupons just can’t. Kristen Hagopian’s family went from earning $100,000 a year to $50,000 when she decided to stay home with her kids for a few years. While this Philadelphia-area mom knows her way around a thrift store — and shares tips on her Brilliant Frugal Living radio show on Philadelphia’s 1180AM WFYL station — all the discount shopping in the world wouldn’t have helped if the family had a $400,000 mortgage.
A better option
Fortunately, they didn’t. “Do yourselves, your sanity, and your bank account a huge favor, and go for a home you can easily afford on one income,” Hagopian advises. That requires careful shopping and perhaps repairs, but “the work you put into finding such a home will be richly rewarded down the road with a much clearer, much faster path to financial freedom than just about anyone else you know.” You could change careers. You could retire early — not a bad trade-off for a smaller yard.
Second, happiness research finds that spending on experiences makes us happier than spending on things. We anticipate our fun beforehand and savor the memory afterward — something hard to do with a sofa. Spending less on housing means you can afford a lot of vacation. That’s what Danny and Jillian Tobias discovered. They landed good jobs in the Washington, D.C., area after college, but rather than spend a third of their income renting (or buying) a swanky apartment, the couple rented a “very, very cheap” one, Danny reports, that cost about 15% of their combined income. The payoff? In five years they saved $80,000, which they used to travel the world. Over the course of two years, they climbed Mount Kilimanjaro, they saw the mountain gorillas in Uganda, they followed the old Silk Road overland from Turkey to China. “We’ll have our memories for the rest of our lives,” Danny says. “In a way, it was an investment in ourselves.”
This strikes me as the real American dream — investing in a great life, not just great granite countertops. Obviously, you can’t live in Mom’s basement forever. But as young graduates start the household formation process, it helps to remember that money spent on one thing is money not spent on something else.
Once you start earning good money, it’s tempting to look for a place that will impress the Joneses. But “Americans tend to easily get swept up in the idea that we need to create the perfect home as soon as possible, and we can end up bankrupting ourselves in the process,” says Kimberly Palmer, author of Generation Earn: The Young Professional’s Guide to Spending, Investing and Giving Back. “Sometimes you have to consciously fight back against that cultural pressure to overspend on a home, whether the pressure is coming from parents, friends or HGTV.”
Spending 20%-25% of your income on housing, rather than 34%, leaves 9%-14% for building a life. That can make you so happy, you won’t care what the Joneses think.
Laura Vanderkam, author of the new book All the Money in the World, is a member of USA TODAY’s Board of Contributors.
Photo courtesy flickr user turkeymom4bacon
If we moved to Mountain View, CA and wanted to buy a small two bedroom house, it would cost ~800K. To get a 500K house we’d either need to buy a condo or commute, which doesn’t sound like fun in CA. We definitely would have to wait to buy.
If we stay here, where a 3000 sq foot 4 bedroom + extras house is only ~$250K it would be difficult to earn 200K/year. (And we were able to buy a house right away.)
I wonder how much of that is non-linearities in cost of living/salaries. It costs a *lot* more to live places where it’s easier to make 200K. Maybe there’s places like Chicago or Seattle that would make the pr(making 200K) and housing costs a linear relationship, but I’m not sure.
Seattle is definitely NOT that place. While not as expensive as the Bay Area, you can’t find a free standing, livable house for much less than $500K within a reasonable commute from either downtown Seattle or Bellevue/Redmond where those “good” employers are.
If you’re willing to drive 1.5-2 hours each way, housing costs drop off, but that is so not how I want to spend my days.
From what I understand Chicago is similar – if you’re within a reasonable commute distance it’s ridiculously expensive.
Rent is a different story – if you don’t want to own, you can probably find an OK apartment with a reasonable commute and save some money.
For us, though, home is our “good life” – we’re not big travelers, and are homebodies in general so I do want a place that suits our needs. We were lucky to find that 7 years ago and are planning NEVER to move to another place in Seattle – this is the right one for us. (Barring some financial emergency or whatnot.)
Amen and amen. One of the smartest things I have ever done was buy a really cheap house. It’s a great house in a great neighborhood, but we stumbled upon a killer deal when we were straight out of college and pounced. (Now we’re 33.)
Having that tiny payment has given us so much flexibility over the years to try experiment in our careers, do work we love in the nonprofit sector, and not freak out when emergencies happen, because there’s plenty of wiggle room in the budget. When we bought a smaller house, we really bought a TON of freedom.
We’re not “car people” either, which also helps!
I’m afraid this article is a little too simple and pat. Of course, one has greater financial flexibility with lower housing costs than higher housing costs. The real issues are the trades off that could potentially drive one to a higher-priced house: zip code, commutes, school district, crime/safety, proximity to family, walkability, availability of public transportation — to name just a few things. It doesn’t really do much to advance the discussion to assume people are putting themselves in debt to impress the neighbors or buy granite countertops. It makes people defensive, and unfortunately, makes the advice-giver sounds a little too smug and self-congratulatory.
As an aside, for someone who doesn’t travel, but rather entertains at home, a sofa might be just the purchase for those experiences you mentioned.
I sometimes think about this advice and fall into regret for buying in the city (definitely paying more than we would in the burbs; but still less than 30% of our take-home) and paying even more for a relatively large outdoor area and an extra bedroom. But then I remember WHY we bought where & what we did…we live car-free (which is actually REALLY rare even in the city most of my friends have cars), with huge monetary savings, and the extra bedroom means we are comfortable even after adding 2 kids to the mix & can have our parents stay & help out, etc… without space crunch. The outdoor space, well we use it every day we possibly can and it is full FULL of memories in every single square cement-covered inch.
I guess I’m saying that its really good advice that people should take into account, but there may be reasons to deviate a little, depending on your priorities.
Thanks for your comments everyone! Yes, of course, there are circumstances where one will find happiness in spending more, or in which it might be wise. When I first moved to NYC, my roommate and I set a budget that turned out to be right at the dividing line of walk-up vs. a doorman building. We got a cute place (a very nice walk up building) but in hindsight we probably should have raised our budget by $300 a month total and gotten a safer building. But as for the buying in expensive cities question, in expensive urban areas, I think there’s a lot to be said for renting. People think you’re throwing your money away, but if your house declines in value (which it has for many, many people), you’re throwing money away there too. Renting may be better suited for the way many people work these days, with jobs being shorter term endeavors than in the past. You might be able to rent a place with a short commute that you couldn’t buy. In smaller cities there’s less rental stock, but then home prices are often more reasonable. They are here – you can definitely buy a nice home in the philly inner burbs (15 minute drive) for less than $500,000. Quite a bit less if you want, and there’s a reasonable professional community here of families earning in the $200k range.
I was intrigued (while watching HGTV in a hotel room) to watch a show on first time home buyers. Both young ladies were approved for far more mortgage than they chose to use. I think the concept of spending less than you can is really getting out there, especially with young people having seen their parents stuck in underwater houses and the like. One of the women on the show explicitly said that she liked going out with friends and shopping and such, and didn’t want to change that when she became a homeowner. So she bought cheaper than her income would have permitted.
Another issue is our tax policy, which makes mortgages and local property taxes a tax writeoff… but not childcare for business owners or drycleaning for working women… or a cleaning service for working woment for example… the reason many wealthy people own 2 million houses is that they are a tax shelter for income and assets !
The general idea is very good…we live in a university town and I’d love to finish our garage and turn into a studio apartmental rental… manyfolks are afraid of rental properties but if I could get $1000 for a rental unit .. how long would it take me to save in retirement assets to produce $1000 income a month… maybe like $250,000 whereas we could finish the garage for $20,000. Also home equity is a great tool for small business owners at least right now … b/c the interest rates on it are much lower than bank loans etc. ours is under 3%… course interest rates move… let’s hope they stay low for now!
The mortgage thing made it on my final exam this semester. (Empirically) The mortgage subsidy doesn’t encourage home ownership like it was intended to do but it does encourage people to buy larger houses!
Actual childcare should be deductible for working people up to 1.5 the median cost in the area and up to the income of the lower earning spouse, if married.
Unfortunately, this still treats living-together couples as singles for tax purposes.