This One Mistake Could Delay Your Retirement by 10 Years


A while back, during a housing boom (remember those?), I watched a TV news segment about homeownership. The reporter was interviewing a young married couple shopping for a house and the wife said: "My parents told me to buy the biggest house you can afford, so that's what we're doing." After all, her parents probably saw the value of their home rise to many times its original price, eventually becoming one of their biggest assets — just in time for retirement.

In fact, on average home values do rise — by about 4% per year, keeping pace with inflation — and over the long term this growth can be substantial. So on the surface, this "buy the biggest" strategy seemed to make sense. A bigger purchase price must lead to a bigger ending price, right? Maybe so, but something bothered me about this advice; a piece of the puzzle seemed to be missing, but I just couldn't put my finger on it at the time.

Buy the Biggest You Can Afford?

Fast forward a few years later. My wife and I and our two infant sons were squeezed into a one bedroom unit of a 2-family home. It was time to find something a little roomier. But why buy something only a little roomier? Why not buy the biggest? That's what we did…we purchased a McMansion. The parents of that young couple from the news report would have been proud of us. Just think how big our home's ending price would be after 30 years!

My Big House Ate My Cash Flow

What I failed to realize was that 30 years was a long way off. It was time to live in the present, and that meant making an enormous mortgage + property tax + homeowner's insurance payment every month. Add to that the ongoing maintenance, utility, and repair costs and what at first seemed to be a golden nest egg turned out to be a money pit. Our McMansion drained every last cent of our monthly income.

That's when I discovered that the missing piece of the puzzle I had been looking for was cash flow. Sure, a house is a large asset that grows in value; that's the good side. Unfortunately, there's also a flip side: It can be a cash flow killer. The bigger the mortgage the more negative your monthly cash flow.

In our case, over the full term of the mortgage we would have paid an extra $420,000 on this super-sized house compared to a more modest one! That's money we could have used to repay other loans or to invest in our retirement account, enabling us achieve financial independence many years sooner.

Downsize for Better Cash Flow

What did we do to correct the mistake?

We downsized. And it worked. Suddenly we had a comfortable monthly positive cash flow cushion. What a nice feeling that was.

Ah, but sometimes even a good decision can take a bad turn. We soon realized that we over-corrected and downsized to a house that was too small and inadequate for our growing family. So what did we do next? We approved plans for a $120,000 addition. After that came the bathroom renovations. I think you know where this is going. The lesson this time was that a small house can become a money pit, too.

The Goldilocks Principle

The key, then, is to apply what I like to call The Goldilocks Principle to home buying: Look for one that's not too big or too small, but just right. How? Run the numbers beforehand, when you're shopping. To help with this use the following table, which allows you to compare the monthly negative cash flows associated with homes you're considering. Your goal is — all other things equal — to find a house with the lowest (or nearly the lowest) negative cash flow.

I've pre-filled this chart with hypothetical numbers but the template is universal and you can use it to compare actual homes you're interested in purchasing. As you can see in this example buying Property 2, a bigger single-family home, would cost an additional $425 every month compared to Property 1, the condo. Over the term of a 30 year mortgage that adds up to an extra cost to you of $153,000. Ouch!

Now take a look at Property 3.

It's also a more expensive $250,000 house but is a two-family rental, which means there's some positive monthly cash flow (from rent) to offset all those negative numbers. In fact, because of the rental income from just one of the two units the total negative monthly cash flow is $655 lower than the single-family house having the same purchase price, and it's even $230 per month lower than the condo!

So rental properties give you an opportunity to buy a higher-priced property (which translates to a much higher ending sales price over time) while also reducing your monthly negative cash flow. The rental income can even be used to help pre-pay your mortgage, which might then create a net positive monthly cash flow after all expenses. So it offers an opportunity to have your cake (or porridge) and eat it too.

Don't Forget Other Costs

One other thing to consider, though. In addition to these estimates of cash flow at the time of purchase, you should also estimate repair costs and future improvement costs after moving in. As I learned first-hand, those large lump sum future expenditures can make all the difference between a good and a not-so-good home choice, so be sure to also give them careful, honest consideration.

Purchasing a home is a big, complicated decision. Emotional considerations are part of the equation, and they should be. After all, your family's comfort and your choice of a community are part of the package. But try not to let your emotions overwhelm the financial considerations. You'll want to get the decision right the first time rather than learn the hard way as I did. A bad decision on this one item, if uncorrected, can delay your progress towards financial independence by as much as a decade. So to help ensure a balanced review, filter your decision with immediate and longer-term cash flow considerations and let the numbers guide you to the choice that's best for your budget and for your long-term financial security.

Was monthly cash flow a consideration for you when you purchased a home? Please share in comments!

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Guest's picture

I recently read several good posts on downsizing, frugal living, home sharing and less costly retirement locations on the site Retirement And Good Living. Downsizing can reduce or eliminate a mortgage and reduce or eliminate recurring costs (maintenance, taxes, etc.). All money that can be put into the retirement nest egg. The site provides information on many retirement topics including finances, health, retirement locations, part time jobs, volunteering, travel and more.

Guest's picture

This article makes me laugh. It's like a no-win, damned if you do, damned if you don't scenario. And really, an attached rental is your ultimate solution? It's a rare person who will want to invest in/commit to/take the risk of renting out their property and being a landlord. My point is that buying a home is a gamble, just like so many other things in life. You can prepare all you want, but ultimately you have to be willing to take a chance. You can't calculate every single thing in life and expect it not to change. Everything on your flow chart is subject to change...and not just small change, but drastic change. I'm not saying it's a bad thing to prepare, but again, life and everything surrounding it is unpredictable. Relegating a purchase as big as a home to a flow me, it just doesn't make sense, when there are so many other things to consider, and when this thing called life changes so frequently.

Guest's picture

Thanks for the comment on this - much appreciated. No question about it, change happens. And I absolutely agree that becoming a landlord is not for everyone. Hopefully, though, the chart does illustrate how different housing choices can have a big impact on your monthly cash flow, and that can lead to dramatic long-term consequences on your retirement plans.

Everybody has their own views and experiences. I'm of the school that teaches "You can't manage what you don't measure." True, you can't measure everything precisely but my experience has been that using the best measures available gets me to a better outcome than avoiding the numbers completely. But again, that's just what works for me.

Guest's picture

Like so may people, when seeing the actual numbers and the reality of the purchase, you would rather shrug the numbers off and bury your head in the sand. Yes things can and do change but numbers do lie. The fact that you don't like the numbers or don't want to believe does not make it false. Hopefully you can get beyond the knee jerk reaction of realizing that maybe your "wants" are either unrealistic or detrimental to your financial health and make a wise decision based on facts rather than emotion (which was clearly pointed out in the article). If you chose to make a decision because it is something you just want at all costs, that is your decision to make. That will not change the facts of what it will mean to you financially. It would be best for you to acknowledge that as part of your decisioning process and either accept it and go forward, dealing with the facts no matter what it means to your future. At least you wi have made an educated and informed decision rather than just "gambling" with you and your family's future.

Guest's picture

Yes cash flow was my primary focus & after 10 years I can tell you I thank goodness I stuck to my guns on that. We would have been on the street twice except that we had a small mortgage & frugal overall life style. You can never guess right on a house.... Mine is too small, hoping that compels the kids to finish college so they never have to move back home :)