Most people forget that a home is a type of purchase. When we hear the word purchase we tend to focus on small-ticket items like clothes, shoes, or groceries. Perhaps it is because we tend to associate loans and mortgages with large-ticket items, while purchases tend to be geared towards small-ticket items.

In reality, a mortgage is really just a loan to purchase your home. When deciding on this purchase and larger purchases should be given greater contemplation. Yet it seems that we spend about as much time evaluating home prices as we do shoe prices. We need to be more disciplined and cognizant when considering a home purchase, especially if this is your first one.

Choose wisely when deciding how much you are going to pay for the price of your next home as purchasing too much home can have devastating long-term financial consequences. Without question, a home is certainly an investment.. You borrow money to purchase the asset (a house) that you expect to appreciate in value over time. Truth be told, I do not believe that purchasing a home is a significant wealth generator nor does it appreciate well over time. Residential real estate barely beats inflation to the tune of about 1% per year. I would hardly call that a significant wealth generator.

However, a home can be a wealth eliminator, if purchased incorrectly. Purchasing too much home will have long reaching implications that will devastate your finances. If you do not have at least 20 percent to put down on a  home, you are looking at too high of a purchase price.  

The benefits of putting at least 20 percent down on a home are:

• Smaller monthly payment
• Lower interest rates on your loan
• Less interest accumulated over the life of the loan (assuming you make the payments)
• No mortgage insurance (MI or PMI)
• Your offer will be more attractive to the seller

Be advised, the purchase of your home- especially your first home- sets off a chain reaction that may last for decades to come. Many of the successes (or failures) of your future financial journey depend on the decisions you make when you are young. If you overextend yourself on the purchase of your home you dramatically reduce the power of your savings. That should be reason enough to purchase a home well within your means.

The reality is nobody actually cares what house you are presently living in. Nobody cares how many square feet it is, how many bedrooms it has, or if it has a pool or exposed wood beams. Truth be told, the only person any of these things should ever have any meaning to (aside from yourself) is whoever you try to sell it to down the road. That's it. Technically, you will only ever need two people to "judge" the value of your home, you and whoever buys it from you.

With that out of the way, the single most repeated mistake in American society is over-mortgaging themselves on a home. This is commonly referred to as being "house-poor" or being "married to your mortgage". 

A more expensive home has implications beyond just a larger monthly mortgage payment. Consider that a higher purchase price will also have the following effects:

• Increased closing costs (when both buying and selling)
• Higher property taxes
• Higher homeowner's insurance
• Increased broker or lender fees 
• Increased commission to real estate agents (when both buying and selling)
• Mortgage insurance (if unable to make at least a 20 percent down payment)

If there is one thing that I consistently see that dramatically alters the trajectory of a financial journey, it is the purchase of your home, especially when considering a first-time purchase. If nothing else, understand that a home is a place of shelter and comfort. Truly assess whether you require such luxuries that high-priced homes afford or if you can delay those wants until you can truly afford them down the road.

Especially when you are young, the goal is to save and invest as aggressively as possible. Far to often, the roles are reversed. Mistakenly, people are doing things backwards by spending when they are young and trying to save when they are older. It should be the other way around. One of the largest impacts you can have on your savings is by diligently assessing the purchase price of your first home. Buying a house for even $5,000 over your true budget can have lasting implications that will be difficult to recover from.

Until next time...

• Enough Already! A House is Definitely an Investment.
  
• The Power of Compound Interest

Two major steps are out of the way at this point. To review, they are:
​
Step 1. Calculating Your Net Worth or Lifetime Earnings and Savings

Step 2. is broken down into 3 phases.

1. Eliminate debt (excluding mortgage)
2. Build a 3-12 month emergency fund.
3. Payoff your mortgage, in full

​

After eliminating toxic debt and building an emergency fund, you will finally be in a position of relative financial strength. For step 2, focus hard on paying everything off. Some of you may want to keep your mortgage, but please realize that the interest on the loan (even if it is only 3%) can dramatically reduce the amount of money you are putting toward investing over the course of 30 years (average mortgage duration). Remember, over the course of a 30 year mortgage, the average homeowner pays 2.5 times the original purchase price​ due to interest.

The first two steps of this journey were highlighted in Part 1 and Part 2. If necessary, go back and review those. The sole purpose of putting those two steps together is to get to the point of attaining a positive net worth. 

After crossing the threshold into a positive net worth, now you can begin to focus on your savings rate. Savings rate is defined here as the percentage of your take-home pay put towards savings. 

Here is a typical way to begin figuring out your savings rate. It is broken down into 2 phases.

A. Find out what your after-tax take-home pay is by assessing:

• How much you are paying in taxes?
  • This includes Federal, state, and local levels as well as the employee and the employer payroll taxes - payroll taxes typical go towards funding Medicare and Social Security
• How much money goes towards your health insurance premiums?
• How much do you contribute to other employer-provided benefits including, but not limited to:
  • Vision
  • Dental
  • Disability insurance
  • Life insurance
  • Long term care insurance
  • Liability Coverage
  • Professional licensure or certifications

B. How much you are adding to the following accounts on a weekly, biweekly, or monthly basis?

• Employer sponsored retirement accounts
  • 401 (k), 403 (b), 457 (b), 401 (a), Definied Benefit plans or pension plans
• Self-directed retirement accounts
  • SIMPLE IRA or SEP IRA for business owners
  • Traditional IRA or Roth IRA for individuals
• Bank accounts
  • Traditional savings, CD's
  • Be careful including checking or money market accounts here since you are likely going to be spending from these accounts and not saving in these accounts
    • One exception would be those of you saving for a down payment for a home in a checking or money market account
• Brokerage accounts (taxable)

To calculate your savings rate, what percentage of your after-tax, take-home pay (section A. helps you determine this) goes towards accounts listed in section B. above.

Savings rate = (monthly savings amount/monthly take-home pay) x 100

Now that you have determined how much you are contributing to saving, look at this figure at least twice per year to see if you can increase it.

Never stop doing this step. Ever. You want to see throughout the "seasons of life" if you can be more and more aggressive with your savings efforts. Only you will be able to determine for how long and how much money needs to be accrued before you relax this plan.

Many have used The Shockingly Simple Math Behind Early Retirement article as a means for figuring out their "FI number". Perhaps this will be your next step as well.

To increase your savings rate, you can focus on income and expenses. Ideally, focus on both for the biggest impact. 

The goal: Increase income and decrease expenses simultaneously

Ways to increase income:

• Earn a bonus at work
• Ask for a raise
• Start a business on the side, or a "side hustle"
  • Blogging, eCommerce, Landscaping, etc.
• Do "gig" work
  • Freelance, surveys, Uber, Lyft, Fiver, Instacart, respond to Craigslist gigs (take your mace with you)
• Sell stuff on Craigslist or Letgo
• Update your resume and find a new, higher-paying job 

Ways to decrease expenses:

• Focus primarily on The Big Three
• After that, look into these secondary sources:
  • Negotiate or Research Lower Insurance premiums, especially home and auto
  • Improve energy efficiency in your home for a lower bill - some companies offer rebates on more energy efficient items such as buying a new refrigerator, etc.
  • Cook at home
  • Avoid buying new clothes
  • Wear out your old shoes before you get new ones
  • Regular vehicle maintenance to avoid big future expenses
  • Appeal your property taxes
  • Decrease subscription services
  • Reduce or eliminate cable services

The wider the gap between income and expenses, the greater potential your savings and thereby investments will have.

If you only have $100 saved, who the hell cares if you invest in something that generates a 25x return... you'd still only have $2,500 dollars---hardly enough to make you rich. This is a 2,500% return on your initial investment of $100. Guess what, "the market" typically returns 8-10% over time, not 2,500%. 

Remember, your most powerful weapon at your disposal is compound interest. The way you make compound interest even more powerful is by saving, early and often!

Step 1 - Calculate Your Net Worth or Figure Out Your Lifetime Earnings vs. Savings

Step 2 - Attain a Positive Net Worth (most often by eliminating debt) and create some breathing room with a fund of at least 3 months worth of expenses

Step 3 - Determine your savings rate and find ways to increase it

• Ideally you continue with step 3 for the remainder of your life---or at least the remainder of  your earnings lifetime

Disclosure: This post may contain affiliate links wherein I get a commission if you decide to make a purchase through these links, at no additional cost to you.

In Part 1 of this series, I discussed the importance of getting a grip on how much money has flowed into and out of your life. You had two choices on getting started:

• Calculate your net worth

or

• Calculating you lifetime after-tax income and compare it to your total present-day account values.

We start here to paint a very clear picture and teach you just how inaccurate your lifelong story about money truly is. You need to understand what your previous money management routine has yielded because it creates an excellent way to track where all your money has gone over your earnings lifetime.

The first step of this program was to find out how much your worth. Now what? Step two has three phases - debt elimination, emergency funds, mortgage payoff.

If you are in debt, and have a negative net worth, there is no such thing as good debt vs. bad debt. 

It's all bad debt if you owe more than you have saved. If you are living beyond paycheck to paycheck, stay away from borrowing any further. Slowly begin to turn the ship around on your debt. Start with all forms of debt except for your mortgage ​(that comes later).

Begin with the debt snowball or debt avalanche methods. They have been hashed out in great detail and people love Dave Ramsey's Total Money Makeover book for strategies on how to kill debt as quickly as possible. To that end, I will not repeat what others have already outlined better than I. Go read Dave's book or Google search "debt snowball" or "debt avalanche" to pay off all forms of debt except for your mortgage. 

Age old wisdom advises 3-6 months worth of expenses in your savings account. That is your emergency fund. If you have had difficulty with savings in the past, especially if you have accumulated a history of significant debt, then aim for 12 months of expenses in an emergency account. History tends to repeat itself and the larger cushion you have the greater space you put between yourself and toxic debt. 

Above and beyond your emergency fund, maximize your effort to phase 3 (highlighted below). 

How much for an emergency fund? Anywhere from 3-12 months worth of expenses. The way to decide where you fall in the 3 to 12 month spectrum is being honest with yourself about your previous spending and saving habits. If you have never owed significant debt and are already a disciplined with your savings, 3 months works out just fine. If you previously owed more than $100,000 (excluding your mortgage), aim for closer to 12 months in an emergency fund. 

To has this out further, let's use an example. Say you previously had $25,000 in student loan debt and $30,000 in car debt, after you pay off the full $55,000 consider having 6 months worth of expenses in your emergency fund (right in the middle of our 3-12 month range). If your monthly expenses are $2,000, you would want to accumulated $12,000 in savings and/or checking accounts to fully load your emergency fund. This is not money earmarked for spending however. You are not to touch your emergency fund unless there is a major repair, accident, or true emergency that requires immediate cash-flow.

After eliminating all forms of debt (excluding your mortgage) and building 3-12 months in an emergency fund, the next step is to finish off your mortgage debt.

Many self-proclaimed professional money managers disagree with this one. However, consider that the average person who takes the full 30 years to payoff their mortgage pays 2.5 times as much for their home as the original listing price. 

Even in a market with all-time low rates under 3%, the effect of interest can be brutal when factoring the full cost of homes. Consider that the average American has $202,284 in outstanding mortgage debt according to Experian. Even at historically low rates of 3%, that can be $6,000 per year in interest alone early in your mortgage due to the typical amortization schedule. By the same schedule, nearly all of your initial payments for the first few years of a mortgage go towards interest payments. This means you will initially live in your home without actually paying down your principal whatsoever! 

Paying off your mortgage as quickly as possible is like earning a guaranteed rate of return on your money. Early on, you will be getting a rate of return equal to the interest rate on your loan.

I do not make this recommendation likely however, have you ever met anybody who has significant financial trouble who has a fully paid off home? Neither have I. Not yet, at least.

Part 2 of this series has three distinct phases. Phase 1, eliminate debt excluding your mortgage. Phase 2, save 3-12 months in an emergency fund. Phase 3, pay off your mortgage in full.  


In part 3 of this series, we will discuss what to do once you have established and completed Steps 1 and 2.