"But you know, love grows best in little houses,
With fewer walls to separate,
Where you eat and sleep so close together,
You can't help but communicate.
Oh, and if we had more room between us, think of all we'd miss.
Love grows best, in houses just like this."
was a top 10 hit 20 years ago for country singer Doug Stone. It's a contrary message in a culture where people often think bigger is better. Could little houses also be better for your financial security?
There is nothing wrong with living in the house of your dreams for your family. Just make sure it does not become the nightmare for your retirement. If you are able to adequately fund your retirement, the size of your home is not a financial concern. However, if you are not already saving 10-15 percent of your income for retirement, you should think twice about what size of house is best for you.
I recently spoke with an acquaintance who mentioned his school teacher mother was retiring soon. She had nearly $1 million in her IRA. School teachers don't get paid a lot of money, but this woman paid off her home early and was able to invest what used to be a mortgage payment every month.
At the other extreme, more and more retired people are still paying a mortgage. The Federal Reserve Survey of Consumer Finances reported that in 1989 less than 16 percent of retired homeowners had a mortgage. The Consumer Financial Protection Bureau estimates that the figure is now over 30 percent, with an average mortgage of $70,000. With lower income in retirement and higher medical expenses, having a mortgage payment can limit lifestyle choices.
Another national trend has been the size of the homes we live in. In the 1950s, an average family lived in a 1,000 square foot home. By the 1970s, the average family lived in a 1,500 square foot home. A June 2014 report from the U.S. Census Bureau revealed the average size of homes built last year hit 2,600 square feet. That's an all-time high that surpassed even the housing bubble years, when homes averaged around 2,400 square feet. People living in bigger homes can "afford" them, but it comes at a cost.
To afford a bigger house some homeowners are attracted to new 40-year mortgages or interest-only mortgages. While this makes the mortgage payment smaller, it means the homeowner does not build equity like they can with a shorter-term mortgage.
For many people buying a larger home is a big keeping-up-with-the-Jones move. Does it really make sense? People are buying bigger homes than prior generations while at the same time having smaller families. If your kids have to share a bedroom with a sibling, will it scar them for life or build a close relationship that will last a lifetime?
Apart from the higher price tag that comes with a bigger home, there are secondary costs that are also more expensive. You will pay more in property taxes every year and it may cost more to heat and cool a larger home. Over a lifetime this could be tens of thousands of dollars.
Picking a smaller house could make you a millionaire at retirement. Here is one example how this could work: With a bigger house you can get a $200,000 30-year mortgage for a payment of around $1,000 a month. However, if you buy a smaller home with a $130,000 mortgage, you can get the same payment of around $1,000 and pay off the home in 15 years. If you were fortunate enough to buy your home at age 30, you would have your mortgage paid off by age 45. If you then took your $1,000 monthly payment and invested it in retirement savings for the next 25 years, there is a very good chance (though no guarantees) that this could grow to $1 million or more.
Using this same example, if you chose the larger home with the $200,000 30-year mortgage, you would have your mortgage paid off at age 60, giving you 10 years to invest your $1,000 monthly payment for retirement. With luck, you might get up to $200,000. So compare a big empty house plus $200,000 to a smaller house with $1 million. I hope you like your McMansion.
An unfortunate reality is that most people are not saving enough for retirement to maintain the lifestyle level they are used to. There is only so much you can save by eating brown bag lunches and skipping that morning candy bar from the vending machine. If you can make do with a little house, you could end up with a big retirement nest egg.