By Jonathan Clements
Once you've paid for your house, how much will it cost you?
This is a crucial issue for anyone looking ahead to retirement.
The more expensive your home, the more of a drain it'll likely be
in terms of property taxes, maintenance, homeowners insurance and
more.
Suppose you own a home that, in addition to any mortgage
payment, costs $1,000 a month. You then get a fat pay raise,
prompting you to trade up to a larger house, which has double the
monthly expenses.
Result: If you stay in the larger home during retirement, you'll
need to come up with $2,000 a month, equal to $24,000 a year. Based
on a 4% annual portfolio withdrawal rate, that would mean $600,000
in retirement savings just to pay your housing costs, versus
$300,000 for the smaller home.
"I've always been an advocate of modest homes," says Charles
Farrell, chief executive of Denver's Northstar Investment Advisors
and author of "Your Money Ratios." A large house "means higher
costs in retirement and it makes it more difficult to save while
you're working."
Hitting Home
Whatever price you pay for a house, it'll often end up costing
you at least 2 1/2 times as much over the long term, Mr. Farrell
reckons. Say you buy a $500,000 home, put down $100,000 and borrow
the other $400,000.
You'll pay back the $400,000 with that portion of every mortgage
payment that goes toward principal. In addition, you might cough up
another $250,000 or so in interest, even after figuring in the tax
deduction. This assumes a 4.5% 30-year fixed-rate mortgage and a
25% federal income-tax bracket. Add that to the purchase price and
you're up to $750,000.
On top of that, Mr. Farrell figures the house might cost $20,000
to $25,000 a year, between property taxes, insurance, maintenance
and occasional improvements. To generate that income in retirement,
you might need $500,000 in savings, and probably more once you
figure in the taxes on any investment gains. That brings the total
tab to $1.25 million, or 2 1/2 times the purchase price.
Mr. Farrell's estimate for housing costs might strike some
readers as high. It's easy enough to get a handle on property taxes
and insurance. Annual property taxes typically run 1% to 2% of a
home's value, while insurance might equal 0.5%.
It's harder to get a grip on maintenance and occasional
improvements, in part because homeowners may go a few years without
any major expenses, but then fork over hefty sums for a new roof or
a kitchen remodeling. These projects, which are often necessary
just to maintain a property's value, are easy to dismiss as
one-time expenses--and yet they seem to roll around with fair
frequency.
Whether you think Mr. Farrell's numbers are too low or too high,
he makes an important point: High housing costs can make it tough
to retire, because they crimp our ability to save while we're
working and increase the nest egg we'll need to retire in
comfort.
Indeed, Mr. Farrell advises folks to buy homes that cost no more
than 2 to 2 1/2 times their gross income. That's doable in many
parts of the country, but it's almost impossible if you live in a
major city on the East or West Coast.
"The coasts are tough," Mr. Farrell concedes. "I know people
aren't happy with those figures, but they're prudent."
Two Lessons
This issue of housing costs brings together two themes I often
harp on. First, you'll have more financial breathing room--and less
financial stress--if you hold down your fixed living costs,
including mortgage or rent, car payments, property taxes, insurance
premiums and utilities. One rule of thumb: Try to keep these costs
to 50% or less of your pretax income. That way, if you're laid off,
you know you can get by on half of your old salary.
Second, temporarily cutting back spending is a key financial
tool, especially for retirees faced with rough financial markets.
The lower your fixed living costs, the more flexibility you'll
have.
Still tempted to buy the big home? Keep Mr. Farrell's math in
mind.
"If you're going to buy an $800,000 house, the real cost is
close to $2 million," he says. "You have to ask yourself whether
you can afford it. It's a tough one to fight against, because
people still have this perception that a home is a good investment.
But most of the time, it's a money pit."
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