Fake Rich is the condition of appearing wealthy while drowning in debt. Being Fake Rich is a dangerous choice, learn how to avoid it.


What is Fake Rich

I heard a story a few days ago that turned my head. A listener called a radio show to ask for financial advice. The man was making $300,000 annually, lost his job for just a few months and “lost everything.” His family declared bankruptcy, their assets were sold off, their debts were settled for less than they owed, and they were left with nothing.

He was so frustrated and disillusioned with “the system” that he didn’t even want to go back to earning a big income again. “The risks are just too high for wealthy people.”

I’m gonna stop you right there, Mr. Caller.

If you have been earning $300,000 per year for a while, and you cannot afford to take some time off without having bankers descend on your estate to repossess everything you own then you are not “wealthy.”

Instead, you are “Fake Rich.”


Fake Rich: Definition

Fake Rich is a phenomenon where you acquire more and more debt as your income increases. To the casual observer, you appear wealthy. But, your Net Worth is near zero, and any temporary disruption in your income can lead to long-term, devastating consequences.


Fake Rich is an Easy Trap to Fall Into

As your income rises, something magical happens. Lenders of all kinds try harder and harder to get your attention. By combining different types of debt, you can borrow so much that your payments are up to 50% of your gross pay.

A $300,000 annual income is $25k gross per month and about $18k take-home. That income would allow debt payments of up to $12,500 per month. If all goes well, our radio friend will have about $5,500 per month discretionary money. Sounds great, right?

But, by going into that much debt, the caller has to continuously earn a ton of money just to break even. $12,500 per month is $150,000 per year in payments. This is incredibly risky.

If he loses his job for any reason, he needs to find a new job making at least his old salary, or he will be bankrupt. And, he will need to do that immediately.

Even if he has a short, 3-month disruption, he may never be able to recover. During those three months he will have missed nearly $40,000 in payments. If he gets a new job and goes back to his old $300k income, he will still have an incredibly hard time catching up. Each month he will have $18k take home pay, he will have to make the ongoing payments of $12,500, and even if he put 100% of his discretionary income toward his missed payments, it would take him over 7 months to pay back the $40k he missed.

But, he cannot do that because he still needs to eat.

How to Get That Much Debt

How hard is it to get enough debt for $12,500 in monthly payments? Super easy. I’ve seen it a million times.

First, the House

33% of your take-home pay is a nice number, which in this case would be $6,000 per month. If you assume that about $1k of that is insurance and taxes, then that would buy a house worth about $1 million.

Then, the Cars

Two, mid-range luxury cars should do nicely. If each is about $80,000, then the payments on those would be about $1,400 per month, each. So the total automobile debt is about $2,800 per month. (In case you don’t think that is real, Mercedes has a sweet 60-month 2.99% deal on their $75k-$100k GLS SUV, which would be $1,350-$1,800 per month).

If we round that up, then we have about $9,000 in housing and transportation costs each month.

Plus, Some Furniture and Student Loans

Add in some credit cards, student loans, furnishings for this million-dollar house, and voila, it’s pretty easy to get $10k to $12k in monthly payments on an income of $300k.


If you’re anything like me, then your palms are sweating just reading about that kind of risk.

But, what you may not realize is that even if your income is lower, if you have taken out the maximum debt you qualify for, then you are in the exact same situation.

Sure, you may not have $12.5k in monthly payments. But, is your debt close to 50% of your gross pay? How many months could you go without a paycheck? Would you have anything left if the bank repossessed the things you owe money on?

Are you Fake Rich?

Don’t Become Fake Rich

How can you avoid becoming Fake Rich? Well, the answer is not complicated. But, it is hard to do.

First, you need to build your financial house on a strong foundation. I like the Four Pillars of Personal Finance:

  1. Spend less than you make
  2. Have emergency savings
  3. Have diverse investments
  4. Rebalance

Second, you need guard rails on your borrowing. There are very few things I use debt for:

  • Real Estate
  • School
  • Cars
  • Absolutely nothing else

And, finally, when you do go into debt, do not fall into the ‘what do I qualify for’ trap:

  • Real Estate: 20 / 3 / 15. Put 20% down, don’t spend more than 3-times your current annual gross pay, and keep the payment less than 15% of your monthly gross pay.
  • School: Pick an affordable program. Never borrow more than 2x your expected pay increase. Payback within two years of graduation.
  • Cars: 20 / 4 / 10. Put 20% down. Take a loan for no more than 4 years. Payments should be no more than 10% of your gross pay.
  • Pay cash for absolutely everything else

Real Wealth Provides Freedom

Let’s apply these rules to our radio caller’s life and just see how much different it would have been when he missed three months of income.

Emergency Fund

Mr. Caller had $18k take-home pay when he was working. A good emergency fund is 3 to 6 months of expenses. If we assume that he can live comfortably on $15k per month, then he needs at least $45k in an emergency fund.

By keeping his lifestyle in check, he should be able to turn his $18k monthly income into a $45k emergency fund very quickly. If he put $10k aside each month, he could live on $8k, which is way more than pretty much everyone else! In about 5 months, the emergency fund would be full.

Mortgage

After filling his emergency fund, he could have saved up a nice down payment on a reasonable house. His maximum budget for the payment is 15% of his gross pay, which is $3,750. If you take a little off for taxes and insurance, he should be able to get into an $800,000 house. And, that is less than 3x his annual income, so the purchase price fits our guideline.

At $10k per month, it would take just under a year and a half to save up a $160k down payment.

Cars

One of the biggest risks in this scenario is car debt. If you don’t put much down or get a long term car loan, you will owe more than your car is worth. Then, if you run into a short term financial problem, you cannot even sell your car. But, if you put plenty down and get a shorter loan, you will never be upside down on your car.

Based on the rules, Mr. Caller could have up to $2,500 in car payments. This is not much less than he had already, but the difference is the 20% down payment and the four-year loan. Instead of two $80,000 cars, Mr. Caller should only spend up-to $60,000 on each car. And, put at least $12,000 down on each car. That way, both cars will be fully paid off in four years and they will never be upside down.

At 10k per month, it’ll take just over 2 months to save up the $24k down payments.

Big Picture

Mr. Caller went bankrupt because he had $12,500 in payments every month with no emergency fund.

By following the four pillars of personal finance and some debt rules, Mr. Caller would have zero debt until he has at least $45,000 in emergency savings.

Then, after he has fully gone through the plan and has his mortgage and his car loans, his total monthly payment will be no more than $6,250.

He can have his emergency fund, his dream home, and two fancy cars in less than 2 years!

When times are good, that leaves him almost $12,000 discretionary income every month out of his $18,000 take-home pay.

If he loses his job, he can use his emergency reserves to make his payments and feed his family for 6 months! That should be plenty of time to either land a new high-paying job or sell some assets, pay down debt, and live a simpler life.

If you can take 6 months off and have no risk of losing your $800,000 house or your two $60,000 cars, then you’re getting a lot closer to real wealth, and a lot farther from ‘Fake Rich’.

It is super important to notice that there really wasn’t that much difference in lifestyle. Mr. Caller can still live in a very nice house with two very nice cars. Sure, he didn’t get to run out and buy all that stuff on the first day of his new job. But, a two-year runway is a small price to pay for a lifetime of sleeping well at night.


Final Thoughts

‘Fake Rich’ is a phenomenon that has become the norm. As your income increases, lenders will throw offers at you nearly every day. It’s a trap. Don’t take the bait.

Don’t ask someone else how much debt you qualify for.
Instead, ask yourself how much you can afford.

If you just slow down a tiny bit, you can be in complete control. You can still have a nice house and a nice car. But, you will also sleep at night knowing that you are prepared for whatever life throws at you.

One of the scariest things about having maximum debt is that everything in your life has to go perfectly or the whole house of cards will collapse.

That’s not rich. That’s Fake Rich.

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