How much house can I afford?

by Larry MacDonald for Money Sense Magazine

Q: My fiancée Michelle and I are building a custom home together. We have a $1.5 million budget in mind but we’d like to go higher if we can afford to. Or should we actually be spending less? We need to make a decision and we’re not sure what to do. — Darren, Toronto

A: There is no doubt that you guys are in a unique position. Darren, you’re earning the entry level minimum this year, but hope your agent can negotiate a big contract next spring. Your career could last 10 years, but an injury or a bad season could easily cut things short. And it’s hard to say what your potential income-earning ability might be thereafter.

I find it’s really hard to budget when you have variable income. I see this a lot with business owners and commissioned salespeople, but for professional athletes, it can be even more extreme. I caution young people in extraordinary financial situations like yours to be really careful about overcommitting too soon.

One of my biggest worries about long-term financial planning for anyone is the power of compound growth. While the investment industry touts compound growth as a positive, a financial planner like me sometimes sees it as a negative.

If you guys buy an expensive home and start an expensive lifestyle now, it can be incredibly difficult to rein that lifestyle in if things don’t go as planned. All the ancillary costs that go along with the home you’re considering like property taxes, renovations, furniture, the car in the driveway, etc., all cost money—and the amount of money is no doubt more than what you really need to spend. It’s about what you choose to spend in this case.

Choosing to spend an extra $10,000 a year when you’re 25 is actually a $1.3 million decision. That’s because spending $10,000 a year, indexed to inflation, from age 25 to age 90, represents an extra $1,311,262 in expenses over your lifetime.

I’d argue that you guys are entitled to splurge a bit because you’ve worked hard to make it to the level that you’re at and financially, you’re already way ahead of most of your 20-something counterparts. So the key here is going to be balancing today and tomorrow and the risk of tomorrow not working out exactly as you see it in your dreams.

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