Whenever I work with business owners, they often ask me, “Justin, how big of a house should I buy?” In other words, they’re asking me how much money they should pay for a house. To answer their question, I quote famed American author and business theorist, Dr. Thomas Stanley. In his book Stop Acting Rich, Stanley says, “Nothing has a greater impact on your wealth and your consumption than your choice of house and neighborhood.” He goes on to say, “If you live in a high-priced home in an exclusive community, you will spend more than you should, and your ability to save and build wealth will be compromised…” Ultimately, the answer to “How much should a business owner pay for a house?” boils down to the question, “What do you want to accomplish in life?”
Most business owners have a desire to save money and build wealth. Why else would they invest in a business? They consider their business an asset, right? Likewise, most people think the purchase of a house as an investment, and they see their home as an asset. Technically, that’s true. Investopedia defines an asset as “anything of value or a resource of value that can be converted into cash.” Additionally, if you fill out a Personal Financial Statement for a bank, you would list your house’s value as an asset and your mortgage as a liability.
However, in his book, Rich Dad, Poor Dad, Robert Kiyosaki makes an astonishing claim that a house is not an asset. Instead, he defines an asset as “something which produces an income.” Since you cannot tap into the cash value of your house unless you sell it or refinance it, Kiyosaki would say that it is not an asset.
Some would argue that Robert was wrong. In fact, back in 2004 through 2007, there was a substantial real estate run-up. I can remember contractors quitting jobs at Fortune 500 companies, borrowing $300,000 to $600,000, building a house, sitting on it for two years, and selling it for twice its original value.
Some would even argue that right now, business owners should go out and buy as big a house as possible so they can watch the house exponentially appreciate, thus multiplying their net worth as was witnessed in past years. To that, I’m going to say, not a good idea. That’s when I lean on Robert Kiyosaki’s definition of a house. A house is not an asset. It’s not something you want to use to grow your wealth.
In contrast, your business is an asset. It produces income. Your house does not. Now, I’m not talking about rental property or commercial real estate; I’m talking about your primary residence.
Let me give you some data that I found. According to U.S. Census data collected from 1963 to 2008, the price of new homes increased by 5.4% annually. Similarly, the National Association of Realtors reported that the cost of existing homes increased by an average of 5.4% annually from 1968 to 2009. Pretty impressive. Furthermore, the Case-Shiller Index reported home values rising by 3.4% annually between 1987 and 2009.
At this point, I can hear you saying, “Man, Justin, that’s not too bad. That’s a 5% increase to my house’s value. If I can get a 5% increase, then I can go out, buy a huge house, and get a nice return.” Hold on there, Skippy. Between the years 2000 and 2019, housing experienced an average return of 2.35%. See, whenever I gave you the 5.4% rates, those ended right before the market crashed. The housing market doesn’t guarantee you a 5% return on your investment.
So many people go out and buy the most prominent house they can afford, but it’s detrimental to their long-term success. Dr. Stanley explains it this way:
“If you live in a high-priced home in an exclusive community, you will spend more than you should, and your ability to save and build wealth will be compromised… [P]eople who live in million-dollar homes are not millionaires. They may be high-income producers but, by trying to emulate glittering rich millionaires, they are living a treadmill existence.”
Friends, I don’t want to live a treadmill existence. I want to build real wealth, and I want to build true wealth while I’m accomplishing my dreams and my goals. Let me explain.
Back in 2014, my wife Emily and I built our dream house. We purchased 28 acres on the Tennessee River with cash, but we went to the bank for financing on our house. We weren’t trying to build anything showy or flashy; we just wanted to build a home that met our needs. Thus, we were shocked when the bank approved us for a loan amount of $800,000. That amount of money for a house may not be a big deal to you if you live up north or out west, but here in East Tennessee, the average cost of a house is about $171,000. $800,000 is a lot of money. So whenever the bank said $800,000, Emily and I laughed.
We decided to follow my advice since I’m a practice-what-you-preach person. We kept our residence as small as was feasible for our family to achieve our dream of living on a farm. If you exclude the property we had already purchased, Emily and I spent right at $300,000 to build our house. It’s 2,400 square feet, and in reality, it wouldn’t have been that much except we wanted wrap-around porches, a metal roof, and barn wood flooring.
Now, remember, the bank told us we could afford an $800,000 mortgage. In other words, we could have bought or built a house valued at $1,000,000 and paid $200,000 down – the equivalent of a 20% down payment. That will make our mortgage payments roughly $4,960 a month if you include costs for principal, interest, taxes, and insurance. At this point, I’m not even adding in the costs to repair, maintain, and improve on the house.
However, we chose to build a house that cost us $300,000. With the amount of sweat equity I put into the house myself, we saved the equivalent of a 20% down payment. The home is valued at roughly $400,000, but our mortgage cost us $300,000. Thus our monthly mortgage PITI payments come in at roughly $1,904. Not only did we save $200,000 in cash down payment, but we’re also saving $3,056 a month, or $36,672 a year!
Yes, we could have “afforded” $59,520 a year on house payments ($4,960 x 12 months), and we could have put $200,000 cash down on a million-dollar house, but that’s all we could have done. Most of our monthly budget would have gone into our house payments. We wouldn’t have the extra money in our budget each month to save or invest, nor would we have had the extra money in our budget to go on vacations or take care of life’s emergencies when they arise. All of our cash and monthly budget would have gone into one asset – our house – and that particular “asset” only earns roughly 2.3% – 5.4% annually (as we determined above).
Instead, we chose to live within our means. We didn’t want to invest all of our cash and monthly savings into our house. Our house will appreciate at 2-5% annually no matter how big it is or how much money we owe on it. Retirement accounts, investment accounts, and other assets typically earn higher returns than that annually, and we can tap into the power of compounding interest. Therefore, we wanted to diversify our investments and max out our yearly retirement account contributions. Additionally, we wanted to build up our emergency funds and have enough money left to take vacations and make memories.
For help building your ideal monthly budget, visit How Much Should I Pay Myself from My Business?
So what am I trying to say? How much should a business owner pay for a house? Well, you can buy the biggest house the bank says you can afford. You can. However, if you tap out your monthly budget on house payments, you will not be able to build wealth other places, nor will you have enough cash on hand to take care of life’s emergencies as they arise. Mostly, your house will be your biggest and only asset, and as Robert Kiyosaki explains, it’s not making you any money. To retire to the life of your dreams, you’ll have to sell the house to capitalize on your investment. But do you want to do that?
You don’t have to buy the biggest house you can afford. Sure, you want to be comfortable in the house, but you don’t want to sink all of your wealth into one asset. If you buy a house worth much less than the bank says you can afford, you can invest your cash and monthly savings into other assets. You can invest in your business’s growth, invest in the stock market, invest in retirement accounts, save for vacations of a lifetime, save for your children’s educations, and much more! You can have a beautiful house and still reach your financial goals and dreams.
If your goal is to live in the biggest and best house, then do it! However, if your financial goals are more comprehensive than that, buy small, and save big.
Stay with us in this Personal Finance for the Business Owner Series as we talk about what type of mortgage you should get for your house!