Daniel: Don’t Read This. Will Make You Too Crazy. July 2, 2003January 22, 2017 Yesterday, Daniel S. told us about his new $495,000 starter house. Today, one of you offers some tougher love than I did. I just suggested he hold off on the home improvements. Mike suggests he turn right around, having owned it just a few weeks, and sell: Mike Gavaghan: ‘A $495,000 house needing $40,000 in improvements? A $400,000 debt from two loans and $100,000 income? Yikes! How can your advice to Daniel S. be anything short of ‘Sell’? ‘Our stories are remarkably similar: identical income, similar fields, young family, work-at-home spouse. I can certainly identify with his desire to get the growing family out of a cramped apartment, but I also know how much money is left at the end of the month on that salary – and I don’t even pay state income tax. His $2,674/month mortgage payment doesn’t even pay down the $75,000 home equity loan, so his already high 32% debt ratio is really substantially higher. ‘I also remember reading in The Millionaire Next Door how the price of a house relates to the standard of living in the neighborhood and the cost of maintaining that standard of living. Daniel might not completely realize what he’s signed up for! ‘How can he possibly have any money left over each month? This has already cut into his ability to save for retirement (down to a scant $6,000/year plus whatever, if any, his employer matches). Does he have anything left to put away into an emergency fund? His son’s education? What if he needs to borrow to buy his next car? Where is _that_ monthly payment going to come from? Perhaps a large chuck of the $40,000 “home improvement fund” should be earmarked for his next vehicle purchase instead? ‘For $100,000 less mortgage, he’d have less square footage and a longer drive to work, but an extra $830/month left in his wallet (actually, even more since his property tax would be lower, too). Let’s consider what he traded in exchange for his dream home: $10,000/year less to put toward financial security, retirement, a nice summer vacation, and perhaps some new furniture. For $200,000 less (still a $300,000 home), he could double the spending money he has left! ‘My wife and I aren’t exactly shining examples of careful budgeting. We married in 1995 with a combined debt of $80,000 (car loans, student loans, and credit cards) and a combined income, at the time, of $75,000. I know the fear of living one missed paycheck from disaster. I also know how exhilarating it was in 1999 when, after years of belt tightening, we paid it all off (although the telecom bubble of the late 90’s helped by making 1999 a banner year in terms of my salary). ‘Since then, living below our means has allowed us to buy two vehicles with cash, survive two layoffs without going into debt, and cover the $6,000 orthodontic bill for my wife’s braces. Our kids are begging to go to Disney World next year, and we know we can deliver on our promise to take them there without borrowing on credit cards. My wife has the option of going back to work full-time in a few years. We certainly don’t have a lifestyle that requires her to do it. Financial security isn’t just exhilarating, it’s liberating. ‘Daniel has signed himself up for years, maybe decades, of financial risk and fear. What about that $40,000 cash? He’ll burn through that in no time if he gets laid off for even a few months. How will he save it back up again? The burden of being the sole source of income for a spouse and child is an awesome responsibility – Daniel’s wife has placed an enormous amount of faith in him. I know how that responsibility can seem unbearable when it’s a struggle to make ends meet. ‘Daniel will, of course, bear a substantial cost in selling his house in exchange for a smaller one, but the crushing amount of interest he’s paying on his current mortgage ain’t cheap, either. Daniel and his wife will have to run the numbers and compare them to their priorities. Is spending every available dollar on their house really worth all the other luxuries and opportunities they traded for it? ‘Stay’ or ‘sell’ isn’t a clear decision, but I’d definitely urge them to give strong consideration to ‘trading down’. They’re in a frightening situation. I know; I’ve been there.’ ☞ Well, I have always been a fan of living beneath one’s means. But having just bought the house, this is a tough call. Selling and moving could easily cost close to 10%, all things considered – $50,000. So maybe the better alternative is to tough it out. Or perhaps put it on the market at $549,000 and see what happens. Two years from now, he could be laid off and in deep trouble with this – or earning $115,000. And three years from now, his wife really might go back to work, which he estimates would add $45,000. If we get deflation and he loses his job, he’s got a problem. But with inflation, this could one day be a $1.2 million house with a fixed 5.75% mortgage – the envy of new buyers having to pay, say, 8%. But, yes, it’s a tough call. # Kinda silly, but go to google, type in Weapons of Mass Destruction, and click ‘I’m Feeling Lucky.’ ‘If this is class warfare, then my class is winning.’ – Warren Buffett
The $495,000 Starter House July 1, 2003January 22, 2017 Daniel S: “I recently bought a house for $495,000 near Boston. Usually a financial conservative, I’m afraid I’ve bitten off more than I can chew. (I bought the house because I’ve recently started a family and the size/location of our apartment was becoming a problem and I think I got a relatively good deal for my money.) On the $495,000 house, I put $100,000 as down payment, and took out a $322,700 loan at 5.75% fixed 30 year. Then I took out a $75,000 home equity line of credit (2nd mortgage) to avoid paying jumbo rates. Home equity line is at a 3.75% teaser, up to 4.25 in 6 months and then tracking prime. I know that the rule of thumb is that up to 28% of income can go towards housing, taxes, and insurance. Currently, without paying down the home equity line, my payments are $2,674/month, which is 32% of my $100,000 (pre-tax) income. I have about $40,000 cash which I’ve promised to my wife for home improvements. My wife currently stays at home but will hopefully be working again (making around $45,000/year) when our son goes to school, in 3 years. I’ve been working at the same company for six years and am relatively secure there, but I am in a volatile field (telecommunications). I just made the first mortgage payment and I’m worried. Should I be taking drastic steps to reduce my budget? I’ve already cut my 401k contribution from 15 to 6%. Should I forget the home improvements? Any other advice? ☞ Don’t forget them, just postpone them – savoring the anticipation of someday making them and knowing that by waiting you will feel less pressed and sleep better. In the meantime, you might do the small, inexpensive ones and the do-it-yourself ones? FDR Steve Morley: “I laughed when I saw your mention of FDR in last week’s posting. Neither Dad nor I can ever remember Grandpa saying anything complimentary about ‘that goddamned Roosevelt’. Grandpa was primarily a dairy farmer on an 86-acre tract who probably paid about $1.37 into Social Security during his working lifetime. Of course, he also lived to the ripe old age of 98, happily picking up his check from Uncle Sam every month and complaining about FDR whenever he could work it into the conversation.” POLITICS AND PERSONAL FINANCE Jeff Martin: “I certainly understand your readers wanting to focus on finances. But isn’t a discussion of what the government is doing exactly that? Are we now so distant from what is going on in Washington that we don’t realize how decisions made there affect our money back at home? I can’t believe that it has become so essential to save corporate CEOs (and probably quite a few unemployed folks with nice inheritances) hundreds of thousands of dollars in taxes that we need to turn people away from emergency rooms and kick old folks out of rest homes. Some people seem to think that the elderly and sick children will just magically disappear if the government stops funding the agencies that help take care of them. I seriously doubt that’s going to happen. Personally, I’m at a loss to understand how anyone can equate the desire to feed and provide a decent education to the children of America with ‘left-wing drivel’. It will be interesting once some of these people get to be older and NEED help, if their attitude changes.” Alicia: “Anyone who can’t see the connection between Bush politics and personal finance hasn’t been looking for a job, enrolling kids in school, paying FICA, purchasing health insurance, and/or investing lately. Anyone who doesn’t notice that a huge surplus has been turned into a huge deficit with very little benefit to 98% of the populace probably doesn’t know much about finance anyway.” “If this is class warfare, then my class is winning.” – Warren Buffett