The formula for how much home to buy, from ‘The Millionaire Next Door’

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  • For his book, “The Millionaire Next Door,” Thomas J. Stanely interviewed 500 millionaires and catalogued the financial lessons he learned from them.
  • He found that many of his interviewees owned homes that cost well below what they could technically afford. 
  • He suggests that anyone who wants to grow their wealth buy a home with a mortgage no more than twice their income to keep costs down.
  • In 2020, that’s not necessarily realistic in every market. However, the underlying principle of buying a home that’s less than you can afford hasn’t changed.
  • Policygenius can help you compare homeowner’s insurance policies to find the right coverage for you, at the right price »

For many American families, the bulk of their wealth or net worth is in their homes. 

According to data from the Federal Reserve’s 2016 Survey of Consumer Finances, the average American’s net worth more than doubles if they own their home, with the typical homeowner’s net worth at about $71,000 compared to the typical non-owner’s net worth at about $31,000. 

In researching his book, “The Millionaire Next Door,” Thomas J. Stanley interviewed more than 500 millionaires to learn how they built their wealth, and he found that most owned their homes. He also learned that most of those millionaires didn’t live in massive, luxury homes — rather, they lived in modest homes in affordable areas. Indeed, one of the millionaire families he interviewed had lived in the same 1,900-square-foot home for 20 years. 

In his book, Stanley offers a a simple formula for buying a home for anyone who wants to make their money go further. “If you’re not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s total annual realized income,” Stanley writes. 

It’s not a perfect rule — as home prices have risen faster than incomes, it’s not as practical (or possible) for most Americans to choose homes in that price range as it once was. But the basic idea still stands.

Looking at the ‘twice your income’ rule through a modern lens

Stanley conducted the last interview for “The Millionaire Next Door” almost 25 years ago, in 1996. Since then, the average home price has increased while the typical salary hasn’t kept pace. These days, it would be tough for the typical American worker to make the typical home fit into this budget.

In 1996, the average home price was $118,200, and the median income was $56,744. By 2017, the median home price had risen to $137,000, and the median salary t0 $62,626, according to Census Bureau data. Assuming buyers in both years made 20% down payments, someone buying the median-priced home with the median income would have come much closer to meeting this rule in 1996 than the 2017 buyer would.

There’s another reason this rule doesn’t make sense for all 2020 buyers: For those in expensive coastal cities, housing is a major expense.

Seattle-based financial planner Riley Poppy previously told Business Insider that the rules around how much to spend on a home have changed in recent years. “To figure out how much home they can afford, I like to see the principal, insurance, tax, and interest below 30% of monthly take-home pay,” he said. “That way, buying a home won’t impact their ability to save for long-term goals like retirement or college planning accounts for their little ones.”

Spending less on your home means more money to invest

Stanley also offers a few other benefits to buying a cheaper home.

“Living in less costly areas can enable you to spend less and to invest more of your income,” Stanley writes. That may not mean a drastic change, like leaving the west coast for the Midwest. It could be as simple as moving to a more affordable part of town. 

“You will pay less for your home, and correlatingly less for your property taxes,” he adds. Calculate savings over the many years you own a home, and it will make a big difference in your spending.

Stanley adds that you’re less likely to feel financially behind when you buy a home in a more affordable area. “You will find it easier to keep up, even ahead, of the Joneses and still accumulate wealth.” 

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