While I believe the best thing millennials can do to improve their financial situation is increasing their income, if you are going to focus on cutting costs, go Top Down. I touched on this topic when I talked about the strategy we used to pay down $60,000 in debt while building a $90,000 nest egg, keep the big costs low people! There were a lot of comments alluding to the fact that they have had success using that strategy as well so I know we are in good company.
Before we get to the top down cost cutting, I want to take a look at the top down costs for the average American. This chart was published by The Bureau of Labor and Statistics in 2015. It breaks down costs per major category and should give us starting points for our top down cost cutting exercise.
Top Down Cost Cutting for the Average American
We are going to focus on the Big 2 (excluding those pesky, borderline criminal, thieving, taxes) – Housing and Transportation, as they clearly distinguish themselves from the other categories in this study. After that, everything gets too granular, and this is all about Top Down Cost Cutting, not let’s find a way to save 39 cents at the grocery store. Mr. AE doesn’t like cutting coupons.
I also don’t feel like I should be preaching about cheapening out on food, since we do our fair share of eating out and don’t skimp at the grocery store.
Looking at the chart above, Housing and Transportation cost make up between 48 and 54 percent of the sample groups costs.
Ouch. We gotta fix that.
I do want to note that the housing costs do have more than just the mortgage, property taxes, insurance or rent cost so they are a little inflated.
Top Down Cost Cutting: Mortgage or Rent Cost
Own or Rent, it doesn’t really matter to me, the “standard rules” are nonsensical and a crazy high percentage of income.
By law, lenders can’t approve mortgages that would take up more than 35% of your monthly income. And most lenders stick with even more stringent requirements, limiting a mortgage payment to 28% of a borrower’s monthly income – Forbes Article
35% is criminal. Between taxes and your mortgage, you would only have 40% of your income to live off of (not to mention you should be saving and investing a good chunk). 28% is better but still too high in my opinion. Remember that this expense is coming out of your account every single month. Every percent you cut off is substantial.
In the middle of writing this post, another housing stat in the news caught my eye: “Americans Who Can’t Afford Their Homes Up 146 Percent“. That number is based on a federal guideline and states if housing costs make up over 30% of income, people will have a difficult time affording other necessities. That fits right in with the average we see in this study, meaning too many people are house poor and cash-strapped.
Something I have never done before on this blog…..Let’s see what Mr. Dave Ramsey has to say about housing costs!
House payment 25% or less of my monthly take-home pay – Dave Ramsey
25% of take-home pay (if you made 100K/year, filing jointly) would be about 19% of your pre-tax earnings (depending on tax situation). Mr. Dave is on to something, and I agree with him that should be the max you spend on your mortgage (including property taxes) or rent.
When we were looking at new houses, we made a conscious decision not to be house poor. We told our Loan Officer how much we were planning on spending and were promptly informed we could spend a lot more on a house. After a brief stare down and a hard pass from us. We went on with our current spending plan (don’t worry, I didn’t rage rant in this guys face, even though he deserved it).
We currently spend just under 13% of our pre-tax income on our mortgage, property taxes and insurance. Less than half the average, if you can hit that number or lower I guarantee you can build wealth.
Obviously, the less you make the more difficult it can be to follow this guideline. Especially if you live in an expensive area and make below an average income. All the better reason to spike that income – sometimes it’s the only logical option.
The biggest downfall for implementing this strategy is the costs/hassles associated with moving if you own a home. However, If you are serious about pursuing Financial Independence, it is going to be far more difficult to achieve if you are turning over 25% or more of your pre-tax money to put a roof over your head.
Back to Own or Rent……..I lied, I do have a preference. There are a few advantages to buying that can’t be ignored. Tax write-offs and building equity being the main ones. I get that there are distinct benefits to renting and owning a home is not for everyone, but you are making someone else rich. I have never really understood the argument that “I don’t have to pay for repairs, insurance, etc.” – You are paying for it, just not directly.
Top Down Cost Cutting: Transportation
I am still blown away by how much Transportation eats into the average families budget. Up to 19% of income just to get around town? How many miles are people driving to work every day? Are people joyriding around town like a lazy government employee?
My assumption is people are overspending on vehicle purchases, this may be a bit hypocritical considering we still have a car payment, but as you will see below, we can also afford it. According to Edmunds.com, the average monthly payment on a new vehicle was $483 in 2015.
So if you have 2 payments……Yikes!
For the people dropping cash leasing or buying new cars ever 2-3 years: It’s not about the ride, it’s about the destination. You don’t need to drive around town with a sweet car to impress your friends. I would rather have a buddy that rolls up in a P.O.S. with a great 6 pack than a guy bopping in with some Coors light and a Mercedes. #Priorites.
Our Yearly Transportation Costs:
- $5,040 – Car Payment
- $1,400 – Gas
- $1,109 – Insurance
- $1,080 – Metro Pass (public transportation)
- $321 – Maintenance
We spend approx $8,850 per year on Transportation or 6.1% of our income. That is a full 10% below the average found in the study. Are you starting to see why we can save 40% of our take home pay?
My love of public transportation is sky high, we save over $3,500 a year taking the bus to and from work. If you want to read my full-out love letter you can see it in this post.
So…… should I sell my cars and put my house up for sale?
Such a tough question to answer on a broad base, but individually it is a very important one to look at. If you are spending 48% or more of your income on housing and transportation I think you need to take a serious look at your situation. It will be worth putting in the effort to make a big-time change.
I like to look at it this way – with a few tough decisions you could save 10-20% of your income. Compare that to making hundreds or thousands of decisions to save a few bucks in your day to day life. The Latte Factor is real, but it is a constant commitment. Personally, I would rather sacrifice unused square footage in our house and a new car.
Factors to consider:
- Can I find a cheaper home in my area (or closer to work) that will fit my needs?
- Do I have rooms that I haven’t used in months? Should we downsize our home?
- Can I use public transportation, carpool or even bike to work?
- Is it worth it to sell my car and buy something more affordable?
- Do I need to look like a boss sitting in traffic?
What say you? Am I batshit crazy? Would you rather find ways to cut a few dollars multiple times a day or find a few ways to save big? Any other Top Down Cost Cutting categories we should target?