We Need to Kill the Idea of a “Starter Home”

These insights could save you from a self-made financial disaster

Photo by Paul Kapischka on Unsplash

Making money decisions based on what society expects will crush your finances.

When my wife and I bought our house in 2016, we had a family BBQ to celebrate. One of our relatives walked into the backyard, and before he even said hello, he told us that our house was “cute” and declared that we “won’t be here long.” The implication was clear; in his opinion, my wife and I make too much money to live in this house for more than a few years.

We live in what many people would describe as a “Starter-home;” A 3-bedroom, 2-bathroom house.

The idea of a starter home is that you use it to get you to get a foothold in the local real estate market. Then over time, you continue trading up for bigger homes until you have your “dream house.” The concept has kept millions of people who make a lot of money from achieving financial freedom.

It’s time to kill the idea of a starter home.

Runaway real estate prices only create losers

Real estate prices have been rising steadily in most wealthy countries. A common narrative in the media is that these hot real estate markets have created “winners” and “losers.” I look at this differently; runaway real estate prices only create losers.

The losers in hot real estate markets are clear, anybody who has been dreaming of buying a home but can no longer afford to do so. I live in a real estate market where prices are up 50% since the start of the pandemic. I have lots of friends who feel despair coming to the realization that they may never be able to own their own homes.

I would argue that in the long run, all of society is a loser when house prices reach unattainable levels. If people can’t afford to own their own home, they begin to feel like the system is broken. Once you go down that road, it’s a quick trip to political extremism.

You might think that there are some winners in hot real estate markets. Surely, people who own homes right now are winning. I argue that homeowners aren’t winning as much as they are losing less.

I say this for two reasons.

1. That increase in home equity is like the “empty calories” of wealth. Unless I want to take out a second mortgage on my house, the only way to access my increased equity is to sell. But, I still need somewhere to live, and if my home price has increased, the other houses in my city have also increased in value.

2. Runaway home prices tend to get people even more excited about real estate. As real estate gets more and more media attention, more people will think it’s time to double down and sell their “starter home” and buy that dream house “before prices go up even more.”

I know people who are considering selling their “starter home” that is now worth $700,000 due to a huge run-up in price and buy that “dream house” for somewhere in the range of $1 million to $1.5 million.

This is financial insanity.

Running through the numbers of upgrading your starter home

Before I go much further, let me say that if one of your life goals is to live in a big house, who am I to tell you not to?

I just want people to ask themselves two questions.

1. Do you really want to live in a big house, or are you feeling external pressure from family or societal expectations?

The worst possible reason to buy a bigger home is that you feel like you need to show your family, friends—or even worse random people on social media that you are financially successful.

This is the easiest way to fall victim to “lifestyle inflation” which as I explain in chapter 17 of “The Financial Freedom Equation” is one of the easiest ways to ensure you never build financial flexibility in your life.

2. Do you understand the massive opportunity cost of moving past your starter home?

I’ll use the real-life example I mentioned above of a family who’s considering selling their $700,000 starter home for a dream house in the range of $1 million to $1.5 million.

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The basic numbers

• First, you might be thinking $700,000 for a starter home!? Welcome to Canadian real estate. This home probably cost half as much 5 years ago.

• Let’s assume this family has $200,000 left on their mortgage, which would give them about $500,000 in home equity.

• I’ll split the difference and assume they land on a dream house worth $1.25 million.

The change in monthly housing costs

To understand the increase in monthly housing costs, we need to consider how moving from a starter home to a dream house will impact the three primary costs of owning a home.

1. The mortgage payment.

2. Property taxes.

3. Maintenance.

I’ll assume a 2.5% mortgage rate on their current mortgage and their new mortgage in the dream house. As a rule of thumb, we can assume property taxes and annual maintenance both come in at 1% of the value of the home.

Let’s start with the monthly cost of the starter home.

• A $200,000 mortgage on a 25-year amortization and a 3.5% interest rate would come in at $896. Let’s round it to $999.

• Annual property taxes would be approximately $583 per month.

• Annual maintenance would be approximately $583 per month.

The total monthly cost of the starter home = $2,165.

Now let’s look at the monthly cost of the dream house.

• Applying their $500,000 equity to the $1.25 million dream home would imply a mortgage of $750,000. With a 25-year amortization and a 3.5% interest rate, the monthly mortgage payment would come in at $3,745

• Annual property taxes would be approximately $1,041 per month.

• Annual maintenance would be approximately $1,041 per month.

The total monthly cost of the dream home = $5,827

The difference, $3,662, is a 169% increase in monthly housing costs. Now, if living in a “dream house” is your #1 financial goal, and you earn a household income north of $300,000, you might be able to squint and make this math work.

I should note that this is some generous math I could come up with as I did not account for the tens of thousands of dollars they would pay in taxes, closing, and moving costs.

Even if you can “afford” the payments, the opportunity cost is massive. If this family stayed in their starter home, that additional $3,662 would allow them to pay off their mortgage in less than 4 years.

Even better, they could invest that money and put themselves on a fast track to financial freedom.

The huge downside of buying a dream house

Forget opportunity cost; here is the real danger of trading up from a starter home to a dream home, especially in a hot housing market.

What if real estate prices go down?

Buying a home is one of the least diversified assets you can buy.

A home is a single unit (your house) of a sub-sector (single-family houses) of one asset class (real estate) in an incredibly limited geographic market (one neighborhood, within one city, within one state/province within one country.)

If you trade up to your dream house, and then the loval real estate market collapses, you could be underwater on your mortgage. This means the value of your home is now less than your mortgage. You are now stuck in that dream house, and even though the value collapsed, the mortgage payments, tax bills, and maintenance costs don’t go away.

It’s not hard to imagine a scenario where “upgrading” to a dream home can turn into a financial nightmare.

So let’s kill the concept of starter homes. You don’t need to climb the property ladder to be financially successful. A home is a place to live; let’s stop treating it like a speculative asset or a status symbol.

Find an affordable home that you enjoy living in and learn to be happy with what you have.

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This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.

I originally published this post on Medium. It has been updated and republished on Substack as this is the permanent home of all my best work.