The cost of living in a "High-Status Neighborhood"

Question

I was reading this question about The Millionaire Next Door, after recently finishing the book myself. I remember that the book warned against living in a "High Status Neighborhood," in keeping with the theme that many millionaires became rich by spending less.

This confuses me, because as far as I can tell, paying a mortgage in an area with more expensive homes tends to yield more equity for you as a homeowner. I know they mention that the purchase price of a home should be no more than twice one's annual income... but if I'm following this rule and still living in a "high status neighborhood," am I doing something wrong? How can I calculate the tradeoff between having a cheaper mortgage payment and owning a more valuable home?

Answer 1

I believe the advice against "living in a high status neighborhood" is less about the difference between a cheaper mortgage and more about the "high status" lifestyle and keeping up with the Joneses. For example, you wouldn't just be expected to have the lawn mowed regularly, but that you spend more on lawn care to make it look nice. And you can't be the one guy in the neighborhood driving the beater Civic surrounded by Porsche SUVs.

So sure, if you're willing to be the black sheep of the neighborhood, go live in that high status area, but most people will spend more to live that high status life.

Answer 2

While a home can be an investment, it is also an expense. When you own your home, you are effectively landlord and tenant at the same time.

The investment return on a house consists of price appreciation (which historically is in line with inflation) plus net rental income. As a homeowner, your rental income is "imputed" rather than real, because you are effectively paying it to yourself.

When considering a house, look at its market rental value and ask yourself whether you would choose to live there at that rate if you were renting. If not, it suggests that you are buying a more expensive house than you need, and you will not actually benefit from the full value of the imputed rent. Thus, you are missing out on a key component of what makes housing competitive with other investments.

Money spent on a more expensive house than you need is partially wasted, in the sense that even if the house appreciates in price, the expected appreciation is lower than that of other investments like stocks where you could have put the extra money.

Landlords count on full market rent (with reasonable allowance for vacancies, etc.) as part of the value proposition that justifies investing in a house when other investments like stocks are also available; this is part of the market mechanism that determines house prices. So when buying a house, you are tying one hand behind your back financially if, by living there, you are not getting value equivalent to that rent.

Answer 3

For more expensive houses, you also pay more in interest.

Also, just because you buy one particular house doesn't mean that you need to stay there forever. You can still build up equity by purchasing a lower-cost home. This could make the more expensive houses more affordable over time.

Also, consider what equity can actually do for you. If I have $50,000 in equity, that doesn't mean that I can write a check for $50,000. The only way you can actually cash out on that is if you downsize to a less expensive house.

Consider too the opportunity cost of buying a more expensive house. If one house has a $3000 per month mortgage and another house has a $2000 per month mortgage, you'd technically end up with more equity in the first case, but in order to see whether you would actually be better off you'd have gotten the cheaper house and invested the other $1000 (or used the extra $1,000 to pay off the mortgage faster). You would need to consider the extra interest you would pay, too. Not to be discouraging, but over the lifetime of a loan, the interest could easily double the purchase price. For example, the total interest you pay on a $300,000 home could easily be another $300,000.