If you’re interested in financial independence, I highly recommend the book Set For Life by Scott Trench. In this post, Scott covers 5 ways to buy your first house… some are much better than others if financial independence is your goal.
Set For Life by Scott Trench is one of my favorite books I’ve ever read… He offers a very simple and attainable approach to creating financial freedom.
This is my second post on Set For Life by Scott Trench… if you missed the first, you can check that our here: Why Wealth Creation Begins With Frugality
If you’re interested in building finanacial freedom, you have probably considered buying a house or investment properties…
Scott breaks down the financial consequences of buying your first property ranging from house hacking to buying a luxury home.
The below passage is taken directly from Set For Life by Scott Trench… reach out with any questions, takeaways or ah-ha moments.
“Is buying a house a good investment?”
“This is a question asked by millions of Americans. And after reading Chapter 4, you know that this is a trick question. Housing is not an investment; housing is an expense. And the two primary options for most Americans are to either buy or rent. Both of these choices cost money.
The more house one purchases (or rents), the less wealth one builds. Even over very long periods, and in all but extraordinary market conditions, buying a home is still an expense that takes money out of one’s pocket.
In the last chapter, we discussed how someone earning a median salary with just $12,300 saved can not only wipe out this expense entirely but will also actually build wealth with their housing.
For full- time nine-to-five wage earners interested in financial freedom, there are very few financial decisions more impactful than this one. Those who fail to house hack are missing out on perhaps the most powerful wealth-building tool available to ordinary Americans.
However, not everyone will house hack, either for reasons specific to their personal situations or because they have short-term lifestyle goals that are prioritized above and beyond early financial freedom. The purpose of this chapter, then, is to examine the potential long-term effects of buying a property on one’s finances and optionality later in life.” – Set For Life by Scott Trench
5 Ways T0 Buy Your First House (And Their Financial Consequences)
Way No. 1: Buying a Luxury Home – Set For Life By Scott Trench
“This type of purchase involves buying the most expensive home one can possibly qualify for. It involves stretching oneself to the absolute financial limits to own the best possible piece of real estate in the best possible location. It’s the most destructive way to purchase a property, and sadly, it’s also very common.
Sally is a 27-year-old hardworking young professional with an excellent job making approximately $80,000 per year. She used her life savings of $25,000 toward the down payment on a $425,000 luxury condo overlooking the city right next to the big sports stadium. Sally thought this was a good investment because condos in that part of town are the most in demand in the city, and she thinks that this type of property “always goes up!”
Sally had a killer housewarming party and invited all her friends over. Three years in, Sally finds that prices have only risen modestly, and she can no longer afford to keep up the fancy vacations she took as a renter, regularly upgrade her car every year or two, and go out to her favorite restaurants with the frequency that she used to. Rising HOA fees, coupled with the already expensive mortgage, force her to continually sacrifice in other areas of her life. Meanwhile, another new complex was recently built with far more in-demand condos than hers. Friends no longer want to go to her place to hang out, instead going to another friend’s condo in the newer, fancier building.
Tom and Nancy are a 34-year-old couple with an infant son and a daughter on the way. Combined, they have an annual household income of about $130,000 and purchased a $650,000 home in the best school district in their city. They used their entire life savings, outside of their retirement funds, toward the down payment and borrowed a little money from Nancy’s father to cover the rest. They believed they were planning for their children’s futures. They believed this was a good investment because “the schools are so good and we’ve got such a great view.”
A few years later, Tom and Nancy are finally able to save up some money. It’s been a tough few years. They can never seem to save as much as they want, maintaining their property is a lot more work than they thought, and prices haven’t risen as much as they hoped they would. They are stuck for at least a couple more years in their house. Tom was recently offered a job that pays significantly more in a city much closer to Tom and Nancy’s parents. Unfortunately, Nancy can’t get a job that pays anywhere near her current salary in the new city, so Tom has to decline the job. It’s a shame, because Nancy would have liked to stay home with the children, but right now they just can’t afford to move because they can’t sell the house. Who knows if another opportunity like this will come Tom’s way?
This is the dream, right? Work hard in school, get a good job, get married, save up, and then you can buy the house with the white picket fence on top of the hill and send your kids to the best schools that your region has to offer. Unfortunately, this is also a quick way into the middle-class American Dream graveyard. This type of first-time home purchase is often accompanied with financial choices such as:
- Putting all of one’s savings, outside of retirement accounts, into the home
- Borrowing for the down payment from friends and family
- Using over a third of one’s after-tax take-home pay to cover the mortgage
This type of person espouses benefits to buying this type of property such as:
- Getting to live in the cool part of town
- Sending one’s kids to the best schools
- Central location and accessibility to highways and cities
This type of purchase is so sought after because the people who purchase this type of home or condo have the coolest housewarming parties, the biggest smiles, and the most jealous friends and colleagues.
People think that folks who purchase property of this type must be doing something right. Why, then, is this such a bad plan?
When you stretch yourself to your financial limits to buy property, you sacrifice almost everything else. In effect, you mortgage away virtually every other financial decision you can make in life. Here are some consequences of this choice:
- Your career. You know that place where you spend most of the hours of your day, most of the days of your week, most of the weeks of your year, most of the years of your life? That place? Yep, you lose almost all career flexibility when you stretch to buy property. You have only two choices: (1) stay at your current job or a very similar one that pays very similarly in your current city or (2) hope for a massive raise and huge signing bonus to help if you want to move elsewhere.
- The stability of your financial position. Because you stretched yourself to your financial limit to qualify for the loan, you’re basically paycheck to paycheck maintaining the status quo until you get a raise. Furthermore, you will be hit with unexpected and irregular maintenance expenses as a real estate owner, and if you are unable to save up, these irregular maintenance expenses become disasters.
- Entertainment expenses. Because you deplete your cash position and incur greater monthly payments, if you stretch yourself to your financial limits to buy a primary residence, you may find that you must cut out other lifestyle choices like eating out, vacations, new cars, etc.
- Relaxation time. Your relaxation time is limited, partially because of financial reasons listed above and partially because you have to spend more time maintaining your home than you did previously as a renter. You surely can’t afford to outsource maintenance in this position.
Despite the rather obvious consequences of buying property like this, folks do this all the time. They intentionally gravitate to this type of transaction, ignoring all the negative consequences listed previously and putting themselves in a weak long-term financial position dictated by real estate values in their local market.
Also remember that just because you’re buying a “reasonable” property that’s not in the expensive part of town, that doesn’t mean the property is reasonable for you. If the most you can possibly qualify for is $300,000, then you’re guilty of buying in this manner if you buy a $300,000 property. It’s the same financial and decision-making effect as the guy stretching himself to the max buying a $750,000 home.
The harmful effects of this type of purchase can be mitigated or masked if the buyer experiences rapid appreciation or if the buyer earns significantly more income shortly after the purchase. By the way, even if the market does shoot up, the purchaser of a luxury home could have benefited far more from that growth if they had instead purchase a modest home and used the leftover proceeds to buy investment real estate in the same area instead.
In short, stretching yourself to your financial limits to buy a primary residence is a choice that may cost you dearly in your ability to make future decisions. You should understand that by purchasing that property, you may be willingly sacrificing optionality in many other areas over the next five to ten years.
The purchaser of this type of home will very soon come to think of their home as their biggest asset. This will be true for them. Sadly, they will allot most of their household savings to mortgage payments, “investing” hundreds of thousands of dollars in their monthly mortgage payment over the years. Because they are continually dumping such a massive portion of their income into their housing, their home will, by default, become their largest asset. In most scenarios, they’d generate far, far more wealth with less housing, putting money into other types of true investments.
If you aspire to early financial freedom, don’t buy the most expensive piece of real estate in the most expensive area with your first home purchase. Don’t lock yourself into a mortgage and physical location that limit your freedom for the foreseeable future. You never know what might happen in a few years, and retaining the option to move without dire financial consequences can put you at a huge advantage. Instead, buy a home that affords you the luxury of future choice.” – Set For Life by Scott Trench
Way No. 2: Buying a Home That Is Well within One’s Means – Set For Life By Scott Trench
“When people buy a home that is well within their means, reasons like “I felt like it was time to buy” or “I’m tired of paying rent” often accompany this decision. While more conservative than purchasing the most expensive piece of real estate possible, this type of purchase can also have long-lasting financial consequences that leave the buyer at the mercy of the market and needlessly delay early financial freedom.
Jeff is tired of paying rent and has been responsible with his money for a long time. After working hard for about four years, he has a solid nest egg of $35,000 and decides to put $20,000 toward the purchase of a decent condo in his city. He qualifies for up to $400,000 in financing but decides he is more comfortable with properties in the $300,000 range as that would put less pressure on his budget and allow him to save more. After living in the property for a few years, Jeff meets a wonderful young lady, and they decide to get married and start a family in her hometown. Jeff sells his property for a modest gain and moves onto the next stage of his life in a new city.
Abby and Jared are ready to start a family and decide it’s time to move to a home of their own. They make a combined $120,000 per year and have $50,000 saved up. While their lender tells them they could qualify for a property in the $700,000 range, they decide to purchase something far more reasonable around $400,000. They know it isn’t in the best school district but figure they can save far more money in a more modest property and, if they find the schools unsuitable, can move when their children reach school age. A few years later, Abby and Jared unexpectedly have triplets, and the home they purchased is no longer suitable. They sell their home and just about break even, buying a slightly larger property with room for their new, unexpectedly large family.
Many conservative folks who don’t run the numbers or who don’t have a long-term outlook on their financial positions buy property in this manner. These people are in a much better position to handle life decisions than folks who buy a luxury home as in Way No. 1 above. But while they will not expose themselves to as much pressure as those who stretch to their financial limits, they aren’t getting ahead either. They still shell out a large amount of cash with the down payment, take on a mortgage, and have to maintain their property. However, people who buy more reasonably are protected in down or steady markets. They have more exit options, and they aren’t so stretched that they lose all flexibility in other parts of their lives.
For those seeking early financial freedom, buying property that’s reasonably affordable is a better bet than buying expensive property. The owner will come out a little ahead compared to renting an equivalent unit, assuming they stay there a long period of time. However, “affordable” is relative. Someone who makes $250,000 per year might find a $750,000 property to be within the comforts of their budget, while someone who makes $50,000 per year might be stretched with a $350,000 purchase. It is up to you to determine whether you can easily afford the payments on a property and still have plenty of cash on hand to handle problems as they come up.” – Set For Life by Scott Trench
Way No. 3: Buying a Home with Multiple Exit Options – Set For Life By Scott Trench
“This type of purchase involves buying a property that’s very affordable. It also involves thinking through the exit strategies and possibilities that may come up later. The smart homebuyer will buy a place that’s well within their means, will have plenty of cash left over after the purchase, and will buy a property that would make sense as a rental if they had to move out in the future but were unable to sell for whatever reason.
Angie has always been careful with her money. She drives a modest car and works hard to earn a $60,000 yearly salary. She is tired of paying rent and is willing to sacrifice a little in the location or size of her living space in exchange for a property that will allow her to lower her monthly housing payments and build equity over time through appreciation. After months of research and discussions with investors, real estate agents, and homeowners in her area, she settles on a few select neighborhoods that meet her needs and patiently waits for a good deal on a property that she can easily afford. She also looks for property that would be easy to rent if she were to move, so she only looks at properties where market rents would cover the mortgage payment. Eventually, she finds and buys a property that meets these critera.
Three years later, Angie is promoted and relocated to Europe on a two-year rotation. She rents out her home, hires a property manager, and moves overseas to advance her career. When she returns, she finds herself in the favorable position of having made a modest income on her rental property over the past two years and built substantial equity, as the area has become more desirable. She is presented with three excellent choices: move back into the property, continue collecting rent, or sell and cash out on her substantial equity.
People using Way No. 3 are getting smarter and more creative with their housing purchases relative to using Ways No. 1 and 2. In this type of purchase, the prospective purchasers put in time and research commensurate with the significance of a large financial decision. They are also thinking, “What’s next?” as a part of their decision-making process. While they intend to live in the area for at least a few more years, they understand that preferences change and want to be prepared for any eventuality.
These folks are looking for a property that will give them three excellent options: live in it happily, rent it out and cover the mortgage, and sell it at a gain a few years down the line. They aren’t buying the most expensive real estate they can possibly afford, hoping prices will go up, and they aren’t just hoping for a reasonable, conservative deal. They are in it to make a financial decision that benefits them both today and possibly in the future.
The person buying solidly in this category will know their market, understand the math behind renting versus buying, intend to live in the property for several years, and have contingency plans for selling the property or renting it out in the event their life plans change down the line.
This is a reasonably smart way to go about buying property. If you’re buying property with this mindset, it’s likely that your home won’t cause you undue financial stress and you’ll be able to move on with your career and life on your terms.
While this is certainly not a bad way to buy a first home, the fundamental problem with this line of thinking is that you only really make money on your investment if the value of properties in the area that you’ve selected actually does go up. This is often something that’s outside of your control.
Those aspiring to early financial freedom will consider this method of homebuying to be the first acceptable method described.” – Set For Life by Scott Trench
Way No. 4: Buying a Live-In Flip – Set For Life By Scott Trench
“This way of purchase involves buying a property with a lot of “value- add” opportunities (read this as “in need of fixing”). The buyer intends to go in and take the home from a state of disrepair to excellent condition. This gives the buyer the option to sell at a gain, rent for profit, or to continue living in a luxury home at a bargain price.
Ashley and her husband work hard at excellent jobs. They understand that a home isn’t typically an investment, but they are looking to change that by creating value. Every two to three years, they buy a run-down property in a good location, move in, and begin fixing it up on their nights and weekends. Over the course of the first year in each property, they turn the somewhat dilapidated structure into a luxury home and enjoy their handiwork for the next few years before selling it and moving on to another similar home.
Benefiting from improvements that have created hundreds of thousands of dollars in additional home value, Ashley and her husband then sell their homes largely tax-free. They put the profits from each sale partially toward another property and partially toward the things they really want in life. It’s like having an extra salary in exchange for some weekend and evening work on the property. After just two or three such transactions, they accumulate almost $500,000 in after-tax gains, solidly cementing their financial futures.
This type of strategy is called a “live-in flip.” The obvious downside is that to be successful, the homebuyers will either have to fix the property up themselves or hire contractors to do the same. This means doing work-and sometimes a lot of work—to add value.
The advantage, of course, is that the homebuyer is no longer dependent on the value of properties in the local area going up to make their profit. If they understand what the property will be worth after all the repairs are made, the homebuyer can, at reasonably low risk, go into the purchase with the expectation of a profitable exit down the line. They can also take as little or long as they desire to fix the property up, and they can do so at their convenience-so long as the property is habitable upon the purchase and can be lived in comfortably during the improvement phase.
Furthermore, when live-in flippers go to sell their properties, they can often exclude most of the capital gains on their primary residence from taxation, a nifty loophole as part of the Taxpayer Relief Act of 1997. Imagine making hundreds of thousands of dollars, or several times your salary, and not paying a penny of taxes. This tax-advantaged cheat code to building wealth can be repeated about once every two years by those who plan carefully and execute with precision.
Buying a property like this is an excellent way to create value from your housing situation, work on your own terms to create tax-advantaged wealth, learn how to do construction and basic home maintenance, and set yourself up for a strong financial reward just a few years down the line. While you may not have any cool housewarming parties when you buy, showing off your work a year later with a beautifully remodeled home might be even better!” – Set For Life by Scott Trench
Way No. 5: Buying a House Hack – Set For Life By Scott Trench
“House hacking is the most advantageous way to buy a first or next property. It involves purchasing an investment property that would make immediate sense as a rental but living in one of the units or bedrooms. The owner can live for free or at exceptionally low cost, while others pay rents covering the mortgage payment. This is the way to turn one’s housing expenses into a wealth-creation tool.
Garrett is a single 20-something and understands that while housing is his largest expense, it doesn’t have to be that way. He determines it’s in his best interest to stop paying rent, and he finds an affordable duplex that needs some work in a carefully selected up-and-coming neighborhood. He gets a fair deal on the duplex, moves into one of the units, and begins to fix the place up. None of his friends are impressed by this purchase, and he hosts relatively few parties and social gatherings. A few months later, he rents out one side of the duplex to some handpicked tenants and uses their rent to cover his mortgage payment.
This allows Garrett to live with essentially no housing costs— costs which suck up a large fraction of the incomes of his peers who are still renting—and to build equity at the same time.
Garrett repeats this twice more in the next three years, each time buying a multiunit home and renting out the units. Garrett is now the one hosting most of the parties for his friends in a nicer house financed entirely by the cash flow from his rental properties, and he makes money in his sleep.
Kim is a savvy buyer and notices housing is cheap due to recent events in her local market. She buys a large house close to her family with some extra bedrooms and fixes it up with occasional help from her father. She is soon able to rent out some of the other rooms on Airbnb. She is delighted to find out that her area is in high demand for short-term rentals, and that her city prohibits Airbnbs unless the host lives in the property. As a result, Kim has little to no competition, and high prices enable her to make several thousand dollars per month-almost as much as her salary—simply by renting out the spare bedrooms in her house. A few years later, Kim has a money-printing machine of a house; has seen a several-hundred-thousand-dollar increase in her home’s value, thanks to her improvements to the house; and works part-time in a job she enjoys, with Airbnb income covering almost all of her living expenses, not just her mortgage.
Drew and Carol are a young couple with elementary school-age children. Instead of buying a fancy house in the best school district around, they plan for their kids’ education and their financial futures at the same time by buying a duplex in the second-best district. Using the rent from their friendly, handpicked neighbors living in the other side, they’re able to save very quickly.
Because they have the tenants’ rent helping to cover their mortgage, just three years later, Drew and Carol can afford a more expensive triplex in the very best school district in the state. Their kids enter middle school in the best possible situation, and unlike their peers, Drew and Carol can afford to live in the area while taking a family vacation every year. Carol even recently quit her job to have more time with the kids. Drew and Carol do not earn higher salaries than their neighbors—it’s just that their entire housing situation, and maybe a little extra, is covered by the rents from their duplex and the two other units in their new triplex.
House hacking is the optimal financial decision for most first-time buyers. As Joe showed us in the last chapter, house hacking entails buying a piece of investment real estate with the intention of living in it, while renting portion(s) of the property to cover the mortgage payments. This enables the owner to live for free or for much less than other local homeowners or renters. It’s like benefiting from all the advantages of homeownership without the mortgage payment. It is also generally far less financially risky than renting, renting, regular homeownership, or buying an investment property.
House hacking rewards first-time buyers in many short- and long- term ways financially, and it offers flexibility in their decision-making process that’s far superior to the other property purchasing options discussed earlier. The house hacker can live in the property indefinitely, sell the property at will, or turn it into an excellent income-producing asset. That combination of choices is rarely available to first-time homeowners who choose one of the other ways.
Taking the next step, a house hack should make sense as an investment property at the time of purchase. You put yourself in an advantageous position if you buy an investment property that a professional real estate investor might consider. Furthermore, house hacking can be combined with the live-in-flip strategy discussed earlier. It’s feasible to buy an investment property that needs some work and fix it up, increasing both the value of the property and the rent that it can command.
The house hacker even gets the added benefit of choosing their neighbors! In many cases, people moving into new areas are cautious about the types of people in their neighborhoods. As long as you aren’t discriminating illegally, you can choose the kindest, quietest neighbors who apply, and you can kick out (either by evicting or refusing to renew a lease) the ones you don’t like. It’s just like owning a townhome, except with the bonus of picking your neighbors and using the rent you collect to cover the mortgage payment.
By this point, you should have a clear understanding of the consequences of buying property. Millions of Americans think they are living the dream when they buy the biggest, fanciest, best-situated property they can afford. But that purchase comes at the cost of other dreams. Few can save significant portions of their earned income when 30 percent or more of their salary goes to their mortgage payment. These people will have large monthly upkeep expenses and a shorter financial runway thanks to their “lovely” homes. Don’t do this to yourself. Wait until you are well on your way or have arrived at early financial freedom, and then use the passive income from your first or second starter homes or house hacks to cover a mortgage payment on a long-term residence. Don’t cripple yourself financially right from the beginning!” – Set For Life by Scott Trench
