A Smaller Home Pays Dividends

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Having a house that meets your needs can really propel you to financial freedom. Photo by Dillon Kydd on Unsplash

When Mr. Moneyaire and I were searching for our first place together we were told to buy a home we could “grow into.”  We were being encouraged to purchase a single family home, with a yard and 3 to 4 bedrooms.  Our parents, aunts and uncles, understandably wanted us to get a home we could raise a family in.  In the craziness of the housing bubble, we were being approved for a home as described above.  Many people were purchasing homes like this or getting swanky condos in the city in trendy neighborhoods. 

We certainly debated where we should get our first home together. After crunching numbers we talked about what we wanted for ourselves.  Having a larger home or living in a high cost of living area came with a larger mortgage payment.  It also meant a longer commute. Our goals included travel, being financially comfortable, and having short commutes, but not having a large home. We talked about what we wanted and what we were willing to give up. Ultimately, we decided to start small and move into a larger home when we required one. We decided that living in a higher cost of living area, even though more fun, wouldn’t further our financial goals.

Starting small

Our first place together was a 1 bed 1 bathroom condo. It was just a 15 minute commute to work and about 15 miles outside the city.  We loved it.  It had a washer and dryer in the unit, a community pool, a workout room, plus major utilities like water/sewer, Wi-Fi, heat and gas included in the association dues.  Best of all, we could afford this condo on Mrs. Moneyaire’s salary alone.  By keeping our expenses low, we could afford housing, food, utilities, cell phone and a car payment on Mrs. Moneyaire’s salary alone.  This meant Mr. Moneyaire’s salary could be used towards investments, travel and towards Mrs. Moneyaire’s MBA; all things we had discussed were important to us. 

Later, we decided to buy a larger home that we felt worked for a family of three or four.  It’s where we currently live and plan to stay for a while.  Our home is about 1,745 sqft – small in comparison to the homes of our friends and family.  We kept our housing expenses to about 15% of our income. This meant we avoided going into debt to afford vacations and we took out reasonable student loans for Mrs. Moneyaire’s masters.

The biggest way we’ve benefited is by taking our savings and investing them.  Below are 8 ways having a smaller home can get you to be financially independent faster.

1. Smaller down payment

The more money you put into a property the less liquid you become. A 20% down payment is the traditional amount home buyers put down, primarily to avoid Private Mortgage Insurance (PMI). PMI is the insurance banks put on loans where the down payment is less than 20% to protect themselves in case of a loan default. PMI can cost around .5% to 1% of the entire loan amount a year! This can be about $62.50 to $125 a month. This is quite the premium to have to pay. The good news is, if you make under $100k a year, you can deduct PMI from your taxes. However, not paying PMI in the first place will save you A LOT more then what you might get back in a tax deduction.

To get a 20% down payment the math works like this: for every $50k of a home’s purchase price, you’ll need to put down $10k. If you are hoping to purchase a home for $500k, the down payment will be $100k… by getting a home for say $400k, you can save $20k in down payment money.

From one pocket to the other, right?

Now, you may think that a down payment is money that you just move from a bank account into your home – it stays with you. This is true… until there’s a loan default. If you have $100k into a $500k property and can’t make a mortgage payment, you’re in trouble. The bank can take the home and keep the money you’ve paid towards the home, principal and all. Also, the money you put into your home is something called an “illiquid asset.” This basically means its very difficult to convert the equity, or money you have in your home, into cash.

Have you ever heard the term “house poor”? This is what that means – that you have a home in which you’ve put and/or are putting a lot of your money into, and that means you don’t have much cash on hand to purchase things like furniture for that home… more on that later though.

Point is, the smaller home you have and in a lower cost of living area, the less that property is going to cost and that translates into a smaller down payment and the more cash you can keep and put to work in investments.

2. Smaller mortgage

This has been key to our financial success.  The more money you keep and invest, the faster your money grows.  There is a very good argument that homes are also an investment.  For many people, it’s the single largest investment they have.  However, you can’t eat your home.  What I mean by this is that you can’t take the equity from your home and buy groceries or other things, unless you take out a home equity line of credit (HELOC) or perform a cash out refinance or sell.  But when you do this, the money is a loan that has to be repaid at interest.  If you sell, you still need a place to live.

Put your money to work

Instead, if you have a smaller home and dedicate less to a mortgage payment, you can invest the surplus in the market. Dividends or royalties you earn can buy food, or heck, even pay for your mortgage.

Instead of getting a larger home, we’ve used the money we would be putting towards a more costly mortgage into mortgages for investment properties we rent out, and when the time’s right, sell. Being landlords has had its ups and downs. If you ask Mr. Moneyaire at the right time he’ll even admit it’s been good for us. We also had to learn to become pretty handy. Mr. Moneyaire is an expert on replacing toilets and Mrs. Moneyaire has learned basic electrical work. Plus, the income we earn from our properties and the rise in equity we enjoy from those properties (which we do on occasion sell for a profit) make it worth it.

You’re probably thinking, “but wait, you can deduct your mortgage interest from your taxes!” That is true, but the Trump Tax Cut and Jobs Act, capped that. Now, according to the tax law you can only deduct interest on up to $750k of the initial mortgage principal balance. Also, you can no longer deduct the interest from a home equity line of credit (HELOC) unless that loan is used for a home improvement.

3. Smaller property tax burden

I hear very often that owning a home is a great investment. That’s true on a lot of levels, but probably not on a financial one. Every year you own a home, you have to pay property taxes. When I buy stocks, I don’t have to pay taxes on those shares every year, like I do with real estate. If my Tesla shares skyrocket 1,000% I still don’t pay taxes on those shares, until I sell those shares. When you own a home, you have to pay taxes on it. If you don’t, the county you live in can take your home away, even if you’re current on your mortgage payment.

When taken into account with maintenance costs and the costs associated to free up equity in a home by selling it, refinancing or taking out a HELOC, homes shouldn’t be what you consider your retirement fund; they aren’t really a great investment. That being said, I would still advise folks to own a home, just not at the expense of saving and investing in other ways, like into the stock market. I know what you’re thinking, “but wait I can deduct my property taxes on my federal tax bill.” Sure, but only up to $10k thanks to the Trump Tax Cut and Jobs Act.

Occasionally, Mr. Moneyaire and I will look at single family homes in our town with an extra 500 to 1,000 sqft and a yard. However, the property taxes would be nearly double (not to mention the increase in mortgage we’d pay). This effectively keeps us in our cute little townhome. Paying an extra $500-$1,000 a month on property taxes would really reduce how much we could invest.

4. Lower heating/cooling costs

The smaller footprint your home is, the lower your heating and/or cooling bills will be.  The bigger your home the more it will cost to heat or cool it. According to this calculator, it costs about $795 a year to heat an 1,800 sqft home in Pennsylvania and $950 for a 2,500 sqft home.  Cooling costs will raise your electricity bills. The larger a home is the larger the AC unit needs to be to properly cool it, and the larger the unit is, the more electricity it will consume.

Further, replacing an HVAC system is going to cost more the larger your home is. All costs to maintain or replace things go up as the square footage of your home increases. Which brings me to…

5. Lower maintenance costs

The smaller your home the smaller the maintenance costs will be.  For example, we had to replace nearly all the windows in our home because they were broken and weren’t very efficient.  We replaced all the windows in our home at a cost of $12k.  Friends of ours, who have a larger home, and more windows than we do, were looking at a cost of $21k to replace theirs.  Ouch. 

6. Less maintenance time

Our house is smaller which means it takes less time to clean and to do other maintenance, especially outdoor maintenance. Having less space to keep up means it takes less time to keep up. This means you’ll have more time to dedicate to other pursuits.

Fortunately, we live in an association where all our exterior maintenance, including landscaping, is taken care of by the association (at a cost, of course).  I say fortunately because not having to spend weekends mowing grass or installing mulch or shrubs etc. has freed up our time to pursue other things, like buying and rehabbing investment property.  Investing in property has helped us create a passive stream of income plus we enjoy the appreciation from the property itself.

Time is money

The time it takes to maintain the exterior of our home doesn’t turn into income for us.  With the time savings we’ve had, we’ve put some of that time towards building up our investments. Being a landlord or flipping a property takes a lot of effort. Being a landlord means continued time commitments when maintenance issues come up and when a tenant turns over. There’s always the risk of someone damaging your property or a non-paying tenant. Being a real estate investor isn’t always as passive as it sounds, but with the right systems in place it can reduce your risks and provide passive income.

7. Lower insurance costs

Insuring a townhome (the type of dwelling we live in) means we don’t have to purchase single family insurance; we purchase condo insurance.  Our HOA insures our dwelling studs out and we insure everything studs in.  Being part of an HOA that purchases the insurance to insure our home along with dozens of others means we get cheaper insurance rates as a group. This means we save hundreds every year just on insurance.

Insuring a smaller single family home still provides costs savings over insuring a larger home. How much you’ll pay to insure your home depends on where you live and the value of your home. The more your home is worth the more it’ll cost you to insure it.

8. Fewer furniture needs

Having a smaller home means you don’t have to get as much stuff to make it feel like a home.  On top of the down payment, taxes, maintenance costs, the time costs, insurance – it’s a wonder how we’re able to afford furniture. Furniture costs a lot of money and its another one of those depreciating assets, often times.  It can cost thousands of dollars to furnish a home.  Buying furniture and decorations for your home can put you into debt if you have to finance it. If you aren’t using entire rooms of your home for days or even weeks at a time, it’s a waste of space and money, especially if you’ve paid to furnish those rooms. 

The time savings we’ve enjoyed means that Mr. Moneyaire has had the opportunity to learn how to make furniture.  Mr. Moneyaire made most of the furniture for Baby Moneyaire’s room – saving us thousands of dollars we otherwise would have spent at Pottery Barn.    

Just right

Living in a home that’s the right size for your family and budget will free you from the burden of worrying about a big mortgage payment and all the other associated costs. Keeping housing and other related costs well below our means has given us the opportunity to save our time and money and the apply those savings to investment properties and the stock market. Having a smaller home than you can afford pays dividends.