Reader Case Study: Can We Buy Our Dream Home?
Welcome to this month’s Reader Case Study in which we’ll address Jack and Elizabeth’s question of whether or not to buy their dream home. Case studies are financial dilemmas that a reader of Frugalwoods sends to me requesting that Frugalwoods nation weigh in. Then, Frugalwoods nation (that’d be you), reads through their situation and provides advice, encouragement, insight, and feedback in the comments section. For an example, check out last month’s case study.
P.S. Another way to get support on your financial journey is to participate in my Uber Frugal Month Challenge! You can sign-up at any time to join the over 11,900 fellow frugal sojourners who’ve taken the Challenge and saved thousands of dollars.
I probably don’t even need to say the following because you all are the kindest, most polite commenters on the internet, but, please note that Frugalwoods is a judgement-free zone where we all endeavor to help one another, not to condemn.
With that I’ll let Jack and Elizabeth, this month’s case study subjects, take it from here!
Jack and Elizabeth’s Story
Hello, fellow Frugalwoods followers, we’re Jack and Elizabeth! We’re 28 and 29, we’ve been married since 2014, and we live in the Appalachia region with our mustached, polydactyl cat. Although we were both raised in the area, we didn’t bump into each other until we were at Miami University of Ohio studying architecture, and didn’t start dating until we both moved back home after graduation. A marathon first date in the summer of 2012 kicked off the best five years of our lives (so far!), including a four-week cross country road trip where Jack proposed in a hot air balloon over the Grand Tetons.
Through Jack’s passionate use of spreadsheets and budgeting, we’ve managed to eliminate all of our student debt, pay off two vehicles, and build up significant equity in our home, while taking several cross-country road trips.
We work at the same Architecture and Engineering firm, which allows us to carpool. While we both have a background in Architecture, I (Elizabeth) have transitioned into marketing, while Jack has shifted into a BIM (Building Information Modeling) coordinator role. We’re also both enrolled in a graduate program through Marshall University for a degree in Technology & Project Management, which we’re fortunate to have primarily funded through our employer. We’ll pay about $6,000 total for both of our Master’s degrees.
While we both love what we do and adore the company we work for, becoming financially independent in the near future is a major goal of ours. We hope to start a family in the next few years and love the idea of being able to spend as much time with our children as possible. This doesn’t necessarily mean we’ll both stop working – only that the need to work 40 hours a week will go away (or so we hope!).
Both of us are heavily involved in activities outside of work and graduate school, which doesn’t leave us with much time at home. I (Elizabeth) run a local online magazine, which has evolved into a local lifestyle company. I also serve as President of the Board of Directors for a nonprofit focused on downtown revitalization, belong to our local Kiwanis club, and love helping my mom in her boutique store.
Jack is similarly involved with several nonprofits and an education-based business incubator and maker space. Additionally, he’s working with the founder of our company on a start-up solar energy operation.
As much as we love all these extra-curriculars, not being home has its drawbacks. We tend to eat out more than we’d like, we don’t make enough time for food prep and exercise, and we fall behind in housework. At the same time, we’ve adjusted our budget accordingly – cancelling our internet, not subscribing to cable television, not utilizing AC during the summer, etc. However, these small savings don’t quite make up for not being able to fully enjoy our home.
The House Dilemma
We bought our current home in June 2014 for $107,000. It’s a 1,500 square foot 1950’s mid-century modern ranch and we purchased it knowing we wanted to give it a complete makeover. However, we wanted to pay it off first to minimize the accrued interest and speed up our journey towards financial independence. To date, we’ve paid more than $40,000 in principal and only $8,000 in interest.
At this rate, we could have the home paid off by May 2019–when we graduate with our Master’s degrees–and then start funneling money towards renovations. Knowing that we also want to start a family in this time frame, the renovations are starting to seem overwhelming. We also recognize that this home could become too small as our family grows, although it could also serve as a motivator to accumulate less stuff, which is something we’re already working on.
But this was all before our dream home came on the market last month…
Perched on our all-time favorite downtown street, this beautiful mid-century modern house–which we could easily see becoming our “forever home”–is a whopping 3,000 square feet with a view overlooking the city. Sustainability is important to us and we love that this house was designed with that in mind, capitalizing on strategies such as daylighting, thermal mass, solar orientation, and more. Unlike our current home, this house has been updated with new appliances and finishes throughout, and the only renovations needed are the master bathroom and the roof.
The roof is a concern, and we estimate replacement would cost at least $65,000 and need to be done within the next decade. We spoke with a roofing estimator and this home has a commercial-style flat roof with lots of skylights, which–combined with a number of other factors–means it would be significantly more expensive to replace than a standard roof. This would be on top of the $279,000 list price, which we’ve always viewed as out of our price range. After crunching the numbers, we think it’s doable, but not without some significant trade-offs.
We compared what it would cost to renovate our current home vs. buying our dream home and the numbers are pretty similar, given the right balance of mortgage terms.
Nevertheless, we’re having a difficult time weighing the options. We fear that signing up for an expensive mortgage will chain us to our desks for an additional decade and keep us from spending as much time with our family/community as we’d like. On the other hand, it would be wonderful to live in our dream home–a beautiful and inspiring place–where we wouldn’t need to worry about what to renovate next!
Current Home vs. Dream Home
- Dream Home Asking Price: $279K
- Dream Home Projected Purchase Price: Our initial offer would be $242K and we wouldn’t go higher than $251K
- Current Home Projected Selling Price: We hope it’d sell for between $110K-$120K
- Projected Downpayment: 20% of purchase price of $242K = $48,400; $251K = $50,200:
- We’d pull this together by selling the Mustang; selling our current home; and using all of our savings (currently $2,360).
- Another option: there’s a bank willing to give us a 15-year, no PMI mortgage with only only 10% down, but the interest rate is higher and the monthly payments would be $300 higher.
- Projected Monthly Mortgage Payment (we’ve spoken with several banks already):
- 15-yr Mortgage Monthly Payment (PITI) on $251k, 20% down @ 3.24% = $1,698
- 15-yr Mortgage Monthly Payment (PITI) on $251k, 10% down @ 4.25% = $1,987
Where We Want to Be in 10 Years:
- Finances: Ideally rapidly approaching Financial Independence–or–as an acceptable compromise, be able to support our family on one income.
- Lifestyle: We enjoy being out in nature. We want to be healthier so that we can pass this passion onto our family. We’d love to live closer to downtown (which our dream home is) so that we could walk to amenities and be home more in order to cook for ourselves. We’d like to find a better work/life balance, which is something we’re actively working on. On the rare occasions we find time off, we plan road trips to visit family out west, see National Parks, hike, and cruise scenic byways. We hope to start trying to have children in the next five years, so hopefully in ten years, we’ve added two more members to our little family!
- Career: We’d both like to develop our departments in our company and create a legacy towards a more profitable and sustainable future. However, in ten years, we’d also like to reach a point where working full-time is an option, at least for one of us but preferably both. That’ll allow us to pursue one or more of the many other passions we hold dear. For me, that’s investing more time into my nonprofit volunteer work and developing the magazine. For Jack, it might be growing the solar energy company or starting his own building energy analysis and consulting firm. Bottom line, in 10 years we either want to love our jobs so much that we cannot wait to get to work, or be financially independent.
Jack and Elizabeth’s Finances
Yearly Take Home (Net) Income
|Monthly Take-home||$5,345||After taxes, insurance & 401k deductions|
|Annual Take-home||$64,137||After taxes, insurance & 401k deductions|
Note: our cell phones are both covered by our employer
|Additional Mortgage Principal||$2,100||On track to be paid off by May 2019 (aka 10 years early!!)|
|Mortgage, Taxes + Insurance||$905||$107k 15yr mortgage @ 3.675% (current balance: $61,700)|
|Utilities (water + gas + electricity + trash)||$300||Most expensive estimate of bills combined|
|Groceries and Household Supplies||$250|
|Car Payment for Chevy Volt||$210||$12K loan @ 1.49% thru 2020 (current balance: $9,623)|
|Graduate School Tuition||$167||$2,000 annually|
|Dining Out + Coffee + Alcohol||$135||We know…this is way too high|
|Charity||$90||To various local nonprofits and one national organization|
|Car Insurance (Volt)||$51|
|Car Insurance (Mustang)||$38||We’d sell this car (and hence this insurance cost would disappear) if we bought our dream home.|
|Gifts||$30||Average spent per month on birthdays, holidays, etc.|
|Gasoline for cars||$20|
|Subscriptions||$18||Hulu and Spotify subscriptions|
|401ks (combined)||$148,600||Since marrying, we’ve tried to max this out every year|
|Vanguard Brokerage Account / ETF Holdings||$960||Just started this year|
|Misc. Savings Accounts (combined)||$1,400||Usually just enough to cover a small unexpected event|
|2014 Chevrolet Volt – It’s Electric! (4yr @ 1.49%)||$9,120||A year ago, we purchased a used Chevy Volt, because the car payments were almost identical to our prior monthly gas budget. Plus, we have free charging at our office! We still owe $9,623, so we know we’re upside down on this one, but it’s cheaper per month than paying for gas and better for the environment (at least regarding emissions)|
|1994 Chevrolet S10 – kind of a beater||$1,388||Parked/unlicensed/uninsured for now – on reserve for when we start working on our house – started once every other month to keep engine from freezing up|
|“Drivable Emergency Fund” – 2010 Mustang GT||$15,887||Admittedly Jack’s guilty pleasure: paid off and tons of fun on road trips through the Appalachian Mountains|
|2007 Honda CRV (on the way out!)||$6,645||Selling to Elizabeth’ parents (monthly-payment style) as soon as I can get the spark plugs changed and coolant flushed, maybe this coming week weather permitting?|
|2014 Chevrolet Volt (4yr @ 1.49% – Orig. 5/2016)||$9,623||Ouch. We know, but we get free charging at work!|
|Current home (15yr mortgage @ 3.675% – Orig. 6/2014)||$61,700||Not too shabby|
Jack and Elizabeth’s Questions For You
1) Is chasing a dream home wise at our age? We’ve worked hard to be able to raise a family debt-free and weren’t looking for new home, but just happened to come across this one and fall in love. It’s at the top of our “someday when we’re debt free we might consider a home like this” price range, but we can’t believe something this well-designed exists in our hometown! Mortgage interest rates are historically low in our area, but it feels a little bit like we’re at risk of falling for the old “ON SALE, BUY NOW!” trick, at the cost of significant interest ($53,000-$80,000 total depending on our down payment) over the next 15 years. Ultimately, we’re afraid we might be trading financial stability (read: freedom) for traditional American Dream convenience and flair, both of which are difficult to put a dollar value on.
2) Would we be stretching our monthly budget too tight if we bought our dream home? There’s a $900 – $1,200 increase (depending on our down payment) in mortgage (PITI) + utility costs with the dream home, which would now last for another 15 years instead of just two. This would require a number of changes from selling extra cars to lowering 401k and investment contributions. We’d love to put a solar array on the roof of the dream home too, but it takes a larger solar array to power the bigger house (and charge our electric car). This would only be viable if we go with the 10% down route, and is not the best ROI given current electricity prices in our area.
3) Should we renovate our existing home and save to buy a dream home later? Building sweat equity in our current home was always our intention. We daydream about how to improve this home, such as installing solar panels that would further reduce our electricity costs and provide free charging for our car. Getting so close to paying off the mortgage has us putting renovation estimates together and it’s remarkable how similar the price of renovation is compared to the asking price of the dream home. Another consideration is that our current home is smaller and thus has lower utilities, taxes, and insurance.
4) Are there glaring issues in our lifestyle? Admittedly, we spend too much on the convenience of prepared food, so we’re trying to make shifts in our life/work balance to make more time to cook. Tuition is only a temporary commitment, but we can’t help but think there are other ways to optimize our spending. We want to continue cutting frivolous expenses and avoid lifestyle inflation in preparation for having children.
Mrs. Frugalwoods’ Recommendations
I want to start off with a huge round of applause for Jack and Elizabeth! They’ve accomplished a great many financial feats: paying off their student loans (hooray!), maxing out their 401ks (more on why that’s fabulous here), waiting to renovate their existing home (more on why I love that here), and they’re carefully considering the purchase of their dream home.
I love that they’ve already gamed out the downpayment and mortgage scenarios and spoken with several banks before putting in an offer! All worthy accomplishments and I commend them for putting themselves in such a strong financial position. We could call it a day right there, but this is a case study after all and they’ve asked for our help, so here goes!
Cash On Hand aka An Emergency Fund
Jack and Elizabeth need it and they don’t have it. This isn’t the heart of their question today, but the fact that they only have $2,360 in cash right now makes their decision tougher. Their plan to sell their Mustang, and convert that money into an emergency fund, is a great idea and one I endorse. 401ks and an absence of debt are two important components of a healthy financial portfolio, but they’re only half the equation. Jack and Elizabeth (and everyone else reading this) need to build up two other types of reserves:
- An emergency fund held in a checking or savings account that can be accessed immediately (like while you’re standing in the hospital) in the event of an emergency. The total amount should be somewhere between three and six months’ worth of living expenses–I prefer six months, but some folks are comfortable with less. An emergency fund is your insurance against disaster. It’s the difference between an unexpected job loss or car breakdown or health issue being a crisis that you have to take on debt to pay for, or, merely a question of withdrawing money from your emergency fund. An emergency fund is not to be spent on Christmas or vacations, it’s for emergencies, such as if you both lose your jobs tomorrow and can’t find new ones immediately. Anytime you need to use some of this cash, replenish it as quickly as possible.
- A portfolio of low-fee index funds. Jack and Elizabeth already have this through their Vanguard account, so they’re on the right track! However, they should contribute a great deal more to it each month because this is where wealth is created. Without investments, you’re not going to grow your wealth and early retirement/financial independence/living on one salary won’t be possible. 401ks are AWESOME, but they won’t help you in a classic early retirement scenario because prior to age 59.5 years, you’ll pay a penalty to withdraw the money (there is an exception to this rule, called the Roth Pipeline and my good friend The Mad Fientist has this excellent article on the topic). More on how to craft a frugal investment portfolio here.
How much money does a person need in order to retire early or declare financial independence? It depends on: 1) how much you spend every year; and 2) your tolerance for risk. Without going into all the math (which would be a whole post in itself), the general rule of thumb for early retirement–enshrined in the academic Trinity Study–is that you should be able to live off a 4% annual drawdown of your investments. This means you’re skimming 4% off your investments to cover all of your living expenses every year, which doesn’t harm the longterm health of your investments.
Since Jack and Elizabeth spend $53,388 per year at present, according to the 4% rule, they’d need roughly $1.34M in order to retire early. This sounds like a lot, but don’t be daunted! With extreme frugality and higher incomes, this could be possible for them. Additionally, since Jack and Elizabeth aren’t 100% set on early retirement, a smaller amount would enable them the flexibility they crave–to only have one person working, or to work at lower paying, but more fulfilling, jobs. The golden rule is that frugality–and the resulting money in the bank–gives you options.
Stop Paying Down Your Mortgage
Jack and Elizabeth are no slouches–it’s not like they’ve been frittering away their money–they’re judiciously funneling it into paying off their mortgage early. The only problem is that they’ve done this to the detriment of their emergency fund and their investments. A paid-off house is a wonderful thing, but you can’t use a paid-off house to buy groceries or pay for health insurance if you’ve lost your a job (you might be able to get a Home Equity Line Of Credit, but that’s not a guarantee and certainly not if you’ve lost your jobs).
In addition to the fact that a paid-off house is an illiquid asset (unless you’re able to sell it quickly, which is an unknown), there are opportunity costs to paying off a mortgage. Namely, you’re missing out on the potential investment returns you’d enjoy if your money was instead invested in the stock market.
Mr. FW and I choose to hold mortgages on both our primary residence and our rental property because, mathematically, our money is better deployed in the stock market thanks to the average annual rate of return (7%) that you can expect after many decades of remaining invested in low-fee index funds. Essentially, money is better leveraged in the stock market than in a paid-off house.
If you have a low fixed interest rate mortgage, like Jack and Elizabeth do, then from a mathematical standpoint, I wouldn’t pay it off early. I view holding a mortgage–and having money properly invested in diversified assets (aka low-fee index funds)–to be a much less risky decision.
Why? Say you funnel all of your extra money into paying off your mortgage early. Then, a month later, you lose your job and your cars break down OR your dream home comes on the market… and all of your money is now tied up.
Additionally, a mortgage is an excellent hedge against inflation. Inflation is when money becomes less valuable and the neat thing about a mortgage is that it’s denominated in the dollars you originally paid for the house and so, over time, as inflation increases (which generally happens), the money you’re using to pay off your mortgage is “cheaper.” Essentially, it’s not bad to hold a mortgage and it’s actually a fine component of a diversified portfolio of assets. Paying off your mortgage to the detriment of investing is a lot like putting all of your eggs in one basket.
It’s not that it’s a bad thing to pay off a house–it’s just that it comes at the expense of other opportunities to grow wealth. Many of us who are early retired/financially independent choose to hold mortgages–even though we could afford to pay them off tomorrow–for the above reasons. Bottom line: financial independence can happen with a mortgage; but it absolutely cannot happen without cash on hand.
To Dream Home Or Not To Dream Home?
I am a big proponent of loving where you live. I think it’s an integral component of being a content, frugal person. The more you cherish your home and your town, the less likely you are to spend money going out to the movies or eating in restaurants. Jack and Elizabeth expressed that they’re interested in spending more time at home and I think that’s wonderful. I commend them heartily for analyzing and considering this purchase carefully. However, at the end of the day, there’s no right or wrong answer–rather, there are several different options.
A big part of this decision for Jack and Elizabeth needs to be a consideration of how important it is to them to retire early/achieve financial independence. At their current rate of income and expenses, they can’t do both–at least not anytime soon. However, if they’re able to: 1) increase their incomes, 2) boost their savings, 3) not pay down this mortgage early, then in the future we could be looking at Jack and Elizabeth, early retirees in their dream home with kiddos running around.
One of the cons of their current home is their desire to renovate it. I agree wholeheartedly with Jack and Elizabeth that trying to tackle a full-house renovation while pregnant or with small child(ren) is not setting yourself up for success. Can you do it? Sure. But is it wise/fun/advisable? Probably not.
And so, I put this question to them: Could you live with your current home as is, un-renovated for the long haul?
If so, then I’d say early retirement becomes a very real proposition, provided they can funnel a lot more money into their index funds. But if not, then I think they might as well buy the dream home since they’ve cited it would cost the same amount to renovate the existing home.
Renovations are stressful, time-consuming, and often end up costing more than expected. Plus, there’s no guarantee they’ll get a solid return on the renovations. Typically, except in super hot real estate markets, you don’t see that money again. Yes, they’ll probably be able to sell their house for more if it’s updated, but I’d want to get a realtor’s take on what’s possible. How fancy is the neighborhood? What are updated homes on their street selling for? Pull as many comparables (similar homes that’ve sold recently) as possible before touching so much as a paint brush. Often, there’s a cap to how much people are willing to pay in a given market–regardless of how snazzy the upgrades are. In my opinion, they should renovate their current home only if they want to live in that home for a long time.
Dream home, on the other hand, has a fixed price tag. The specter of replacing the roof is yet another reason to cease paying off mortgages early and instead start saving up and investing cold hard cash. Since the roof doesn’t need to be replaced immediately, I don’t see that as a reason not to buy the house, as long as they’re confident they can save up the cash to pay for it in ten years’ time. You do NOT want to take on debt (via a HELOC or a credit card) in order to pay for a renovation. As for the master bathroom that they mentioned needs renovating, if it’s not a health/safety concern, I’d say put that on the back burner and save up the cash to pay for it and DIY as much as possible. If they buy the dream home, they should do so knowing the master bathroom will remain un-renovated for many years.
Since lowering expenses will help anyone reach a goal faster, I’ll take a quick pass at how Jack and Elizabeth could save more every month, although I will say, they are pretty darn frugal already!
- Sell all the cars except for the Chevy Volt. Pay that off and then don’t ever get a car loan again. Once again, the beauty of having cash on hand is that you’ll be able to pay cash for your future (used) car and avoid the interest of a loan. Not paying insurance on the Mustang will save $456 per year.
- Ditch the subscriptions. This isn’t a ton of money, but it’s $216 per year to funnel into investments. Here’s how we watch TV for free. And for music, I listen to free Pandora.
- Tweak the groceries/household/eating out budgets to maximize cooking at home. That being said, they’re not spending all that much in these areas to begin with. However, there are certainly savings to be had, so let’s say $50 a month, or $600 per year.
- Go on a clothes-buying ban (here’s how)! This’ll give them another $420 per year.
With all of these savings, I realize that the per month and per year amounts sound small. However, what I’m thinking about here is the opportunity cost of not investing this money. If Jack and Elizabeth followed these suggestions, they’d be on track to save $1,692 more this year. No big deal, you might think, but just wait…
If Jack and Elizabeth put this amount into their low-fee index funds this year and then added that amount every year? In 30 years, they’d have $172,707.59 (based on a 7% return, which is considered an average annual return over the longterm from the stock market). You do have to remain invested through recessions and downturns in order to reap these dividends and also decrease the risk in your portfolio as you near traditional retirement age (for more on investing, go here). This is why I say that every single expense merits consideration–it really and truly all adds up.
Of course the other end of the frugality spectrum is to increase earnings. With their Master’s degrees, hopefully Jack and Elizabeth can both command higher salaries. Additionally, with all of their involvements outside of work, I wonder if they’ve considered turning one of those hobbies/vocations into a revenue-generating side hustle? This could then be leveraged into a post-early retirement side hustle that they enjoy doing and brings in some extra cash–win win!
Another thing that leapt out at me is that Jack and Elizabeth work for the same employer. While it’s fabulous they can carpool and wonderful that they both like working there, it also sets them up for a certain amount of risk. If their company were to experience a downturn, or go through lay-offs, they’d both be exposed to that threat.
If they instead worked for different companies, they’d be spreading out their risk a bit more. Again, it’s an all-the-eggs-in-one-basket scenario, which I’m not a fan of. Plus, the fact that they work in a somewhat boom/bust field–architecture–makes me worried for the next recession, since architecture is notorious for laying folks off during economic downturns. I don’t think it’s imperative they work for different employers, but it would mitigate some of their job security risk if they did.
Jack and Elizabeth are in a good position to make this major life decision and any route they choose is going to be just fine. As I see it, here are their priorities:
- Build up an emergency fund and investments.
- Reduce expenses.
- Look for ways to increase income, either through their formal jobs or through their other interests.
- Decide which is more important: retiring early/financial independence or buying dream home.
- If the answer to #4 is “both,” then double down on numbers 1, 2, and 3. I think both goals are possible for them!
Ok Frugalwoods nation, what advice would you give to Jack and Elizabeth? They will both reply to comments, so please feel free to ask any clarifying questions!
Would you like your own case study to appear here on Frugalwoods? Email me (firstname.lastname@example.org) your brief story and we’ll talk.
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