You have likely heard age-old sayings like “ignorance is bliss” and “whatever you don’t know, won’t hurt you.” But when it comes to retirement planning and where reverse mortgages fit into the equation, what you don’t know can actually be hazardous to your ability to live comfortably during your non-working years.
Retirement income planning is complex. More often than not, crafting a plan that best suits your individual needs requires the consideration of many moving parts, not the least of which requires answers to questions such as when do you plan to retire, for how long, and how far will your savings take you?
To complicate matters even more, there is also a wide variety of investments to choose from as you plan for your financial future. Often times, one of the most important assets retirees currently have at their disposal is one of the most overlooked investments that can support their retirement in a meaningful way. The answer: home equity.
A largely misunderstood asset
For homeowners age 62 and older, a reverse mortgage allows them to convert a portion of their home equity into tax-free loan proceeds, which they can use without restriction. Unlike a traditional mortgage, reverse mortgage borrowers receive payments from the lender in the form of their home equity.
As borrowers access their home equity, the reverse mortgage loan balance increases. Borrowers are not required to make monthly mortgage payments toward the loan balance, however, they must continue to pay their property taxes and insurance associated with their property. The loan balance becomes due and payable when the borrower dies or otherwise vacates the home secured by the reverse mortgage.
Retirees have typically turned to reverse mortgages to increase their cash flow in retirement, which has helped them meet a variety of spending needs, such as paying for the costs of in-home care and modifying their homes to better support their physical needs.
Aging in place is especially important for people nearing or already in retirement, according to a survey by The American College of Financial Services, which found that 83% of adults age 55 and older said they don’t want to relocate in retirement.
Despite this vast majority of retirement-age Americans who want to continue living in their current homes for as long as humanly possible, only 14% considered using a reverse mortgage to aid them in this desire.
One of the main reasons why reverse mortgage considerations fell short was because 7 in 10 survey respondents were generally misinformed about these products, especially when it comes to using reverse mortgages as a retirement tool.
Strategic retirement planning
As previously mentioned, reverse mortgages can be used to meet a variety of retirement spending needs. But they can also be used to supplement other retirement savings and investments a person might have.
Because there are a lot of misconceptions out there today—as evidenced by the survey responses—The American College says products like reverse mortgages need to be given a second look by consumers, as well as financial advisors who might not be up-to-date on the latest research.
Such research has shown that home equity, when accessed through a reverse mortgage line of credit at the beginning of retirement, can provide a valuable source of cash flow that takes pressure off of having to spend from investments such as 401(k)s and Social Security.
This occurs because the reverse mortgage credit line grows over time, typically at the same rate at which the loan accrues interest. If left untouched for several years, the balance in the credit line could grow significantly, thus giving the borrower a sizable pool of funds to help supplement their retirement.
“Hopefully that’s the biggest takeaway from this survey,” said Jamie Hopkins, professor of retirement income planning and co-director of The American College New York Life Center for Retirement Income Planning. “Advisors and consumers need to start thinking about home equity, including reverse mortgages, as part of the retirement income planning process.”
If you would like to know more about reverse mortgages and how they can be used as part of a strategic retirement income plan, contact your trusted financial professional or visit HUD.gov
[Editor's Note: The following is a guest post by Ben Miller, CEO & Co-Founder, Fundrise.]
Most of us earn a living based on the work we do five days a week and then every few weeks or so we receive a paycheck. When we quit working, the paychecks stop and we’re left with whatever money we may have saved. This is called active income.
However, some people (likely including the visitors to Lazy Man and Money) are fortunate and smart enough to strive to build what are known as residual or passive income streams, payment that you continue to earn even after the work required is done.
How can you earn residual income?
When given the option, most of us would much prefer to continue to reap the benefits of our work even after we’re done. Why then do so many people support themselves only through active income? One answer is that most assume the ability to earn residual income is a luxury that can only be created if you’re already wealthy. However, there are many ways to create residual income streams that don’t require huge upfront investments.
One of the most well known forms of residual income is owning stock in a publicly traded company. Residual income streams can also include royalties from the sale of a book or song. Additionally, real estate -- both residential and commercial -- has become one of the most popular ways to build residual income. Historically, building a residual income stream through real estate has required a large upfront investment, both of time and money, but thanks to new investment vehicles those wanting to earn passive income through real estate have many options to choose from.
Ways to Build Residual Income through Real Estate
Real Estate Investment Trusts (REITs)
In the 60’s, Congress passed a law creating Real Estate Investment Trusts, large portfolios of income-producing real estate. A REIT is required by law to distribute 90% of its earnings to investors each year. Due to their special tax status, REITs must follow strict compliance standards and thus carry a certain quality standard for both the vehicle’s investment strategy and the real estate experience of the managing team.
Today, an estimated 70 million Americans invest in REITs.
There are two primary types of public REITs: traded and non-traded. Traded REITs offer the benefits of being traded openly on an exchange, giving investors liquidity. However this liquidity is likely to be priced into the value of the shares, resulting in a “liquidity premium”, or lower relative returns for all investors, regardless of whether or not they choose to sell their shares. Furthermore, traded REITs tend to be correlated to broader market volatility, meaning that the value may fluctuate depending on how the stock market is doing, regardless of whether or not anything has changed with the underlying properties owned by the REIT.
On the other hand, non-traded REITs have become more popular because of the perceived consistent double-digit dividends. However, non-traded REITs have recently come under heavy scrutiny because of the large upfront fees often charged to investors -- and dubious practices around the disclosure of those fees.
New Technology Platforms
In the past few years, new platforms have emerged that use technology to make the process of real estate investment more efficient, resulting in increased transparency, lower fees, and higher returns. As the broader financial technology space grows, more and more investors are moving to online platforms that give them more control over their finances and take advantage of the efficiencies that transacting on the web can offer.
These companies aim to offer the benefits of public market access, but with lower fees that potentially help investors earn better returns. Fundrise, one of the pioneers in the space, has leveraged both technology and new federal regulations to offer investors the first ever low-fee, diversified commercial real estate investment available directly online to anyone in the United States, no matter their net worth.¹ Fundrise is working to do to real estate what Vanguard did to stocks - create a low-cost way for individuals to invest a diversified pool of assets. The savings they generate through more efficient technology are passed on to investors in the form of potentially better risk-adjusted returns.
Over the past six months, the company has launched the first ever eREITTM investments - two different $50 million real estate investment trusts both with direct online distribution models. You can learn more about Fundrise here.
However, it’s important to remember that every platform uses a different set of due diligence criteria to determine what investments it offers its members and, as with any investment, investing in real estate through an online platform carries significant risk.
Investment Property
An investment property is an asset purchased with the sole purpose of earning revenue, through leasing space within an asset or an eventual sale. Owning an investment property can result in both potential appreciation value over the long-term and direct tax benefits of depreciation.
However, acquiring an investment property often requires a large upfront investment ($100K to several million dollars depending on the type of asset) and lots of hands on work. Furthermore, as with any investment, investment properties carry the risk of large, unexpected, and costly problems, which many investors do not have the experience or time to effectively handle. An investment property is relatively illiquid -- meaning you can sell at any time, but the sale process can often take months and may be unsuccessful.
Private Equity Funds
Conversely, a private equity (PE) fund is a collective investment fund that pools the money of many investors to invest in real estate. Private equity funds often consist of several different investments, which increases diversification for investors. Additionally, PE funds are often managed by real estate experts with very rigorous underwriting standards.
Traditionally private equity fund investments are illiquid and carry high investment minimums. Private equity funds are often formed by institutional investors and high worth individuals with a "two and twenty" fee structure, meaning a 2% annual asset management fee, and 20% of any profits earned by the fund.
Regardless of which avenue you decide to pursue to earn residual income, an essential part of the investment process is objectively evaluating each opportunity as it arises and working hard to remove any preexisting biases. Take your time to figure out which approach makes the most sense for you and your investment goals and remember that diversification into different asset classes is one of the most effective ways to build unique streams of residual income, and a profitable portfolio!
This information does not constitute an offer to sell nor a solicitation of an offer to buy securities, nor does it contain any individualized tax advice. The information contained herein is not investment advice and does not constitute a recommendation to buy or sell any security or that any transaction is suitable for any specific purposes or any specific person and is provided for information purposes only. Each investor should always carefully consider investments in any security and be comfortable with his/her understanding of the investment, including through consultation with investment and tax professionals.
1. However, under the Regulation A+ rules, each investor is limited to investing no more than the greater of 10% of such investor’s net assets or gross annual income.
I lived in Silicon Valley for around 6 years. I say "around" because, as a New Englander, it's hard to keep track of time in a place that doesn't have seasons. My wife and I often talk in terms of, "That April when we got two feet of snow" or "that summer when it rained every weekend."
Sorry, I got a little off-track there. Discussing weather in Silicon Valley is a whole other topic. There are microclimates and even sub-microclimates as I read that article. None of this related to money, but I find this stuff interesting.
What I really wanted to highlight today is a video.
Before we get to that video, I want to tell you that I personally feel the message of the video and it's a large reason why I moved back to New England. Financially, I covered some of our reasons for moving in this article back in 2012: Financial Analysis of Moving From San Francisco to Boston.
This video is actually "old news" from October of 2015, but things haven't changed... and they won't likely change for a long time. If anything they've only gotten more exasperated.
If you haven't watched the video above, you should. It isn't short, but I'll think you'll get more value out of than a Friends or Seinfeld rerun (not that there's anything wrong with those!)
And if that isn't enough emphasis in watching the video, think about the last time you been to an open house with a barista. I'm guessing it was, ummm, never.
One of my favorite parts of the video was the mention of the house being listed at 1.888 million. The "888" lucky number in Chinese culture is why I wrote "nearly 900K" in this article.
I can't help but point out the information at the 4:30 mark. A small condo, with asbestos concerns, that has highway noise concerns, is listed for a shade under a million dollars... and that was the "teaser" price to lure a bidding competition.
That's a lot to chew on. It's easy to say, "Hey it's supply and demand... and there's a housing shortage."
It is supply and demand, but the video points out that there's no housing shortage. Many of the houses are empty, bought by overseas investors... and they don't want the "hassle" of renting them out at $4000 a month.
Can you imagine a world where the investor doesn't want to collect nearly $50,000 a year? I can't.
I'm reminded of a conversation I had with a co-worker back in 2006. He said I should buy a house instead of renting. I thought it was the most ridiculous thing I've heard considering Housing Prices in California? Hold your hat! and Survivor Winner Can Buy a Starter Home. As a side note to the last link it's fun to read in biography "joined the business strategy group at Internet search firm Google." In 2006, Google was characterized as an "Internet search firm." That's an accurate description, but I think you'd sound like an alien using those words today.
I greatly agree with much of the video, but around the 19 minute mark, I need to disagree. I don't believe that the extremely high prices in one region prohibits people from having "a place to live." It's not like the people in Silicon Valley have no other options.
In fact, around 80 miles away there are people almost begging to sell their houses. Remember the millions that was highlighted above? Here's a great quote from that article of people further away, "His home now is worth about half the $126,000 he paid for it." I'm going to use my exceptional math skills to estimate the home value at around $63,000.
[This is the second part of My 2015 Financial Year in Review. You can read more of my financial picture at that link as I publish more articles.]
If you read my year in investing, you may have come away a bit depressed. (Or maybe you enjoyed a little schadenfreude.) Whatever you felt, get ready for a second dose of the same.
The quick story is that we have three condos aside from the house we live in. My wife and I each bought condos (before we met) near the height of the market (around 2003). We got married and a job opportunity moved us to California with them both under water. The only solution was to become reluctant landlords. Refinancing them to low 15-year rates (thanks Double HARP!) and using renter's money to buy equity has worked wonders over the last nearly 10 years.
In 2013, we did the ultimate in dollar cost averaging purchase. We bought another condo unit in the community my wife bought into a decade before. She paid around $140K for her original one... we paid $95K for this new one. And yes, today they are probably worth between 115K and 120K each.
So far everything looks like it's going towards a nice happy ending right? I hope so, but what we experienced in 2015 was far from happy.
The thing with real estate is that they require maintenance. The condo that I bought in 2004 needed a new heating/cooling HVAC unit. It was still on the original equipment... now over 40 years old. The property manager said that I might be the last unit with the original equipment. When I got the complaint that it wasn't working this summer, there was no way around avoiding the expense. My bank account was soon nearly $9000 lighter. That would have been easier to take if I didn't have to replace nearly every appliance in the unit earlier in the year.
A few months later I found that the place needed new windows and sliding glass doors. That was another few thousand dollars. I should be thankful that it is a small apartment without too many windows.
We'll get to the blogging update in a bit. For now, let's just say that blogging money doesn't cover 5-figure bills well.
This was followed up with another HVAC failure. This time it was the property we bought in 2013. Fortunately, it was just the cooling unit, so it only cost us around $4000.
None of this was a surprise. When you have original equipment in places that are 30-40 years old, the cost is expected. In hindsight, we should have had a separate fund specifically for real estate maintenance. Instead we used our emergency fund. I suppose it doesn't really matter which pool of money it comes from, they are essentially the same thing. Maybe I'd feel better about the expenses if I saw the money come out of accounts that it was earmarked for all along.
There were quite a few months that between this and other surprise expenses, we were writing four-figure checks each month. The only question was what number the check started with.
However, much like the year review in investing, there's a silver lining at the end of the story. We ended up paying down $18,000 in debt between all the properties (which includes our primary residence). It would have been $38,000 of debt paid down, but we added $22,000 in debt when we got a HELOC to buy solar panels. This is one of those cases where I'm fine to adding "good" debt as it will save us money over the long haul.
Many people in real estate focus on properties that are positive cash flow (they make more money that they cost this month). This can make a lot of sense, but I don't believe it is everything. I'm fine with losing a little money each month as we quickly build equity. In about 12 years all the properties will be paid for and I estimate they'll bring in about $35,000 a year after taxes and maintenance expenses. That's a great income stream to have in retirement.
If you were to draw up a plan for how to invest in real estate on a white board, it would look nothing like what we've done. At the same time, sometimes you can make some lemons into delicious lemonade.
I got news a few weeks ago that the first property I bought, a condo, has major design flaws. You'd think this would have been uncovered in the first 40 years of its existence, but it wasn't.
Every owner has to pony up an estimated $15,000 for the project. One of the reasons I love condos is that the cost of snow removal, roof repair, repainting, etc. is all wrapped in the HOA fees... except that it clearly isn't. It's a good thing that the average American keeps tens of thousands of dollars in an emergency account to deal with these things... except they don't. Most Americans can't afford a $1,000 emergency expense.
(Please excuse the sarcasm. It's a little therapeutic for me given the news)
The condo association put together a few different payment plans. Each owner can:
Pay the $15,000 up front (funding from whatever source you happen to have available).
Use a credit line they were able secure at a 4.7% fixed rate over 15 years. In this case we'd pay an estimated $130 per month.
A couple of different combinations of 1 and 2 where we'd pay half the money up front and reduce the monthly payments.
I think this presents an interesting financial situation/challenge.
The association points out that if you get your own home equity line of credit, you might be able to deduct the interest of the loan. However, if you take their credit line you wouldn't be able to. Of course, since it is an investment property, I wouldn't be able to deduct the interest anyway...
... or could I? If I got a home equity line of credit on my current home and paid the $15,000 to the association, I'd be able to deduct the interest on that line of credit. It could be a good plan, but I tapped our home equity for our solar panel purchase.
We were working on paying that down with this year's tax refund and hoping to make another huge dent with the solar tax credits next year. We'd clear up around $15,000 just to put it back on with this roof project. We'd get a lower rate at least at first. Our HELOC is an adjustable 3%, and it looks like the Fed is looking to raise rates. At least it would be tax deductible, right?
Mathematically, this is the best option. But, sometimes there are other things to consider.
When I look at the option of using their credit line, I find that it has a couple of non-mathematical advantages:
It would leave us with $15,000 in our HELOC. More safety net is better than less safety net.
If we sell the condo, the new buyer pays off the loan. This might be wash in the sales process, but it will still feel better to make someone else pay for the bad roof.
Some may ask, why not just tap our emergency fund? Our emergency fund has been hit to the tune of $35,000 this year. I know! That's crazy stuff, right? I'd say that 75% didn't come from "emergencies", but from maintenance of our investment properties (expensive stuff like windows, HVAC systems, and kitchens). The other 25% were legitimate unexpected emergencies.
The lesson here is that it isn't cheap or easy to be a landlord. Our gains on the properties are paper equity. Since they were bought between 2003 and 2004 are valued at significantly less than what we paid for them. (They were never intended to be investment properties, it was just making the best of a bad situation.)
I'm heavily leaning towards using the associations line of credit and preserving ours in case we have another year like this one.
I love reading articles where people reach financial freedom at an early age. A couple of weeks ago, I mentioned how Joe Udo is growing a dividend snowball to reach his financial freedom.
Today, I bring you the story of Mr. 1500 of 1500 Days. I first met him at last year's personal finance convention, FinCon. Quite honestly, I saw his small plastic dinosaurs show up on my Twitter feed and figured I had to stop by and say hello to them. Gimmicky, yes... but it worked.
Recently Mr. 1500 told his story of how he became a millionaire at the age of 40 on RockStar Finance. As he says on his own site, he doesn't make a top income, he's not ultra-frugal, and he's had some setbacks. Despite all that, he got there.
How did it all happen? There was a mix of modest living, focusing on savings, investing, and letting compound interest do its thing. Two things caught my attention. The first was his very un-Lazy approach to everything. He openly says that he worked really hard when he was young. After an 80-hour work-week, he'd do the second thing that caught my attention...
The Live-In Home Flip
I'll defer to Mr. 1500's words:
"When I started at my first job post-college, along with paying off those loans, I signed up for the 401k immediately and began saving. I also bought my first home for $140,000. It was a starter house that wasn’t pretty, but had a great location. I made modest improvements like putting in tile and painting. With a strong real estate market at my back, I sold the home a couple years later and made $100,000 in profit. My wife and I looked at each other and said, 'Hey, let’s do that again!'"
And they did it again. It's not clear from the article how many times they did it. He makes a great point that they didn't have to pay capital gains on the profit, because they lived in the house for a couple of years (thanks IRS tax-code!). This money was reinvested in more property and stocks.
So flipping houses is the answer. Cue a short tune from my new favorite TV show:
(Did I mention that I have a 1 and 2 year old?)
But not so fast...
Mr. 1500 then tells of a setback where they bought a grand property just as the housing market collapsed. They put a lot of work and a lot of money into it. They broken-even on the money they put in, but not the work. It was a waste of valuable investing time and energy.
We've all seen the house flipping shows where everything turns out great at the end. I don't think I've ever seen them lose money. (Side Note: This unfortunately leads to those shady house flipping seminars that you hear on the radio.) Reality check: Flipping houses is difficult and requires a lot of specialized knowledge, especially if you are aiming to do it in 6 weeks like in the TV shows.
There was a sizable portion of luck. The real estate market giveth and it taketh away.
So which is it? Is it awesome, hard work, being smart, or just hoping to be lucky? Like everything in life it is a combination of all four.
Lady Luck can go either way. You are never going to control her, so you might as well just do her thing. Working hard and being smart almost always pay off. For Mr. 1500 the combination paid off in real money early on when Lady Luck was with him. When Lady Luck left, the combination helped prevent actual monetary losses.
So is the live-in flip awesome? I think it's great for many people. I'm not handy, so it isn't something I could seriously consider. If I have to outsource all the work, the chance of profiting is lower.
For me, the key would be to buy a real bargain. Mr. and Mrs. 1500 "sought out ugly houses in great neighborhoods. If a house had pink toilets and green appliances, [their] eyes lit up with joy." Maybe there's a chance at getting a deal in foreclosure. If you are able to buy low, there's less of a chance of market crash making it worth less.
I'd also minimize my risk by buying a place that I could live in myself for years in a worst case scenario. If that grand property was one they were comfortable living in, they could wait out a stock market crash.
I'd also consider the "rentability" of the property. A condo might be a good option. If it doesn't sell, you can rent it out and make some money while you are building equity. When the housing crash turned my wife and my condos upside down (not literally, "equity-ly"), being able to rent them was a savior. The downside is that when you rent a property it becomes an investment property. When you sell an investment property you might have to pay capital gains tax (consult your local tax advisor).
Finally, I'd keep in mind that the improvements are taking place over a couple of years. That should be a lot of time to do some of the basic upgrades. You aren't "on the clock" like the professional house flippers in TV shows.
If you are able to minimize the downside risk, and capitalize on the sweat-equity of fixing up a home, maybe you too can make a six figures on a flip. Do this a few times at a young age like Mr. 1500 and maybe you'll be able to retire early too.
According to the article, you get a tent in a backyard with access to shower and can eat inside. It wasn't quite clear if you are allowed to use the kitchen to cook. I tried to find the particular listing and the closest I found as this this tent, but the name and price is different, so maybe it is a copycat.
So who is going to pay $900 a month for a tent in backyard? It wasn't long ago we were renting a 2 bed, 2 bath, 1200 sq. ft townhouse about 40 miles from Boston for that money. Well this tent is in Silicon Valley... very close to Google's headquarters. And as long as it includes a parking spot, is really ideal commuting location to hundreds of businesses that are paying six-figure salaries.
The real estate market out there has always been out of control. When we lived there, we found it a much better deal to rent. In September of 2006, I wrote about a 2 bed/1.5 bath, 1650 sq. ft home a few streets away from us. The price was $1.125M.
Of course a housing crash has happened. In New England, I'd say that most homes have not caught back up to their 2006 pricing. From a sampling of properties that I am familiar with, I'd say they are still down 20-25% from there.
Today, the same house that was 1.125 in Sept. 2006 has a Zillow Zestimate of over 1.5M. So while prices where I live now have dropped 20-25%, they've gone up 25% down there. The sample sizes here are tiny, but it's consistent with what I've seen.
So while the idea of a $900/mo. tent seems extremely crazy the real estate market out there, almost makes it somewhat viable. My experience is that if you are working at Google or Facebook the expectation is that you essentially live on "campus" anyway. Maybe you don't need much more than a tent for the rare 5-6 hours that you want to "get away from work?"
Usually when I see prices get beyond comprehension there's a crash. Almost every fiber of my being believes something like that is coming soon. There's got to be a way to get cheaper talent in other areas of the country without offering $200K salaries so that everyone can afford shacks that run 1.5M dollars.
However, I asked a friend who has been in Silicon Valley for more than 25 years about a crash. She says she's never seen a significant one. In her opinion, things will just reach a peak and either slowly deflate or just stay stagnant for awhile. I could see that scenario as well.
In the meantime, if you live there and have the space, why not put up a tent? It's probably not a lot of work for an extra $10,000 a year.
Last week, I got an alert from Zillow about a house for sale that caught my attention. The price per square foot was under $110, which is less than half of our home would appraise at. At nearly 4500 square feet, it was quite a bit of house. The location was just a few streets over. I figured it must be a huge dump, but the pictures of TWO new kitchens indicated otherwise.
As luck would have it, the house had an open house scheduled. I had to check it out.
I pulled into the quiet cul-de-sac and there was a couple there about to enter. This worked out well as the real estate agent gravitated to them first. I like to look around, especially when I'm in browsing/not buying mode.
I quickly learned that the pictures were very strategic. The new kitchens were very impressive... granite counters and stainless steel appliances. They were big and there were a couple of big areas for entertaining.
The house even had a sound system installed throughout it. However, in sharp contrast to the kitchens, it was cassette tape. The bathrooms were from the 70s. There was certainly signs of age, but not nearly as much as one would expect for the price.
There was some work to be done, but I don't think it would be too expensive to bring it up to date.
Just a Few Problems
I think the house is a steal for someone, but maybe not us. We just finished putting solar on our house, so we are somewhat committed for a bit. While our house may get a little small with two growing boys in it, this house was much bigger than what we needed. I thought about what it might cost to heat and cool it. Then there's furnishing it.
It lacked some of the features of our current house such as a master bedroom with a master bath. It was nothing that couldn't be fixed... the question is whether you wanted to.
The biggest problem though is that we don't have the cash for a down payment. We could do something where the sale of our house is a contingency, but I don't want to get into that situation. I don't think it would be worth it considering the other problems.
Despite all this, I love a good bargain, and I have had the house rolling in my mind since I saw it.
Taking a Step Back...
It was then that I realized something, new opportunities are always just around the corner. It was just a couple of months ago, I wanted to buy a huge property for AirBNB. Before that, I was intrigued by a neighbor's house that was put up for sale. I had envied it for awhile, but again the liquidity wasn't there to seriously consider the discussion.
If we go back a year or two, we did take the opportunity to expand our real estate empire, and thus far it has been a terrific decision.
I'm starting to learn that it is okay to let things go. There's something else coming around the bend. Time to work on getting prepared for it.
That title may sound extreme, but the sentiment seems to be a growing trend amongst some extremely intelligent personal finance bloggers.
When intelligent people make intelligent arguments, we can learn from the discussion. I just hope I can hold my "other side." You, as always, will be the ultimate judge.
Who is deciding that owning a home may not be right for them?
My inspiration for writing this post comes from Evan from My Journey to Millions. A couple of weeks ago, he expressed a mild disdain of his current home ownership situation. (My font can't show the sarcasm that comes with the link.)
Those authors all agree about the typical headaches of home ownership. It's work. You have to fix stuff. Or worse, pay other people to fix stuff. And that stuff never seems to be cheap.
I find Evan and Collins take of home ownership from an investment perspective most most interesting. Collins creates a list of 20, yes twenty(!) things that a bad investment would have. They include: illiquidity, high commissions, leverage, never paying dividends, requirement of paying interest, immobile, lag inflation, fragile, heavily taxed. You should definitely read it.
The points he brings up are all correct and extremely defensible...
... but...
Why I Think you Should Buy a Home
As with everything in personal finance, opinions are... personal. Marquit writes that owning a home is a problem when a new job opportunity comes up forcing a move. Conversely Evan stated the stability of home ownership in raising a family is one of the benefits.
I'm usually "all-in" on one side of any argument. I don't like to be wishy-washy. However, in this case, I can certainly see both pros and cons.
Allow me to tell you my own home ownership disaster story... and then still make an argument for home ownership.
A little more than ten years ago, 2005, my mother expressed concern about the real estate market. My brother had been trying to save money for a down payment for a home. Whatever he seemed to save was negated by the rising cost of homes. If he saved $20,000, the price of homes went up $30,000 meaning that he "lost" $10,000 by sitting on the sidelines. My mother's concern was that home ownership would never be attainable at the current rate of rising prices. A few decades before that she bought the home we grew up in for around $24 in beads.
What a shame it would be lose out on the American Dream forever!
Around this same time, my roommate got married and started down the path of starting a family (selfish jerk, right?)
These two circumstances lead to my mother helping me (well completely financing a down payment) for a condo costing nearly $300,000. Things were awesome as the value appreciated above $300K.
However, as we all know, the bubble burst. The value dropped to around $175,000. I had "lost" over $100K, some of it was even my own money (as opposed to my mother's).
What a disaster of epic proportions, right? Not exactly. And here's why I think you (or most people) should buy a home.
I found a wife, we moved to San Francisco, and I rented the property. It's been rented for almost 9 years now. I lose money on it every month from just the mortgage. It's a headache being a landlord. I spent $8,000 putting a new heating and cooling unit in it last year.
Wait this isn't convincing you, is it?
The value has increased from that low to above $230K. It's still less than what I paid for it, but the mortgage is under $170K now. I have nearly $60,000 in equity.
That's some serious forced savings. Would I have taken $6000 a year and put it into savings or investments? I like to think I would have. However, I'm not so sure.
I have refinanced it with a 15 year mortgage and I'm 3 years into it. The money going to principle is growing and growing to the point where it is nearly $1000 a month. In 12 years, I'll certainly have some repairs to make. However, at that time, I'll get around $1500 a month after expenses... which could cover my car payments or other expenses I have.
My wife has a similar story with her condo that she bought before we met.
We even bought an investment property together at a market low in 2012. That property is up around 20% in value and our equity just seems to grow with it. (We are even making money each month even with the 15-year mortgage.)
I've laid out a financial case for being a landlord. It's easy to claim owning a home is better when a renter is financing a large part of it.
However, what about our purchase of the home we live in? I humbly suggest you consider the alternative. Few people are handing out free living arrangements, which leaves renting a home.
The "investment" in renting a home is worse than buying a home. You never build up equity. You are subject to increases in rent that may surpass inflation. If you don't like that, I hope you enjoy expensive moving costs. If you have a family, let's hope that move isn't out the city and school system. You might not have to fix anything, but you can't change things either.
Finally, the real American Dream, financial freedom may become the unattainable. Let's presume your rent is $2000 a month today. That's $24,000 a year. Using the rule of 4% (or more accurately the the rule of 25), you'll need to save $600,000 to throw off the annual income for that rent.
What's worse? That $2000 will likely be $3000 in ten years due to inflation. Did your $600,000 investment grow to $900,000 in that time while you drawing it down to pay for your rent? I hope so.
This is certainly a valid path to financial freedom. The intelligent people that I mentioned above, surely know this.
Personally, I'd like to be on the receiving end of payments and I even with compound interest, saving a half million dollars seems like a lot of money.
Now it's time for you to weigh-in. What do you think about buying a home?
There is something to be said for renting. Actually, there is quite a lot to be said for it. There is so much to be said for it, in fact, one wonders why anyone would ever want to become a home owner in the first place. Homeownership is the single most recognizable aspect of what we call the American dream.
Without a doubt, there are certainly some benefits of owning vs. renting. When owning, one can do any internal home improvement project one wishes. External projects are possible. But some require a permit. Owning a home is beneficial for credit, auto insurance, and anything else where status and credibility are considerations. Owning a home can also be a valuable investment that can pay off big later in life. So if you think you’re ready to become a homeowner, here are a few things you might want to consider:
How to Turn the Purchase into an Investment
Buying a home can be a great investment. But it is not automatically a great investment. There are things you have to do to insure a good return on your investment. The first thing is to make sure you are buying a property that will retain its value. There are many declining neighborhoods that may look nice enough at first glance. But further inspection shows a lot of For Sale, and worse, For Rent signs. Those signs are indicators of declining property values. You can loose your shirt buying the wrong home in the wrong part of town.
You will want to invest in the right kinds of home improvements. Some of them actually decrease property value. Swimming pools are a good example of something that can actually lose you money when it is time to sell.
You will also want to be aware of options beyond selling the family home. One of the most popular methods of extracting value from a home is the reverse mortgage. You can use a reverse mortgage calculator to determine the amount of the home finance assistance you need.
The thing to remember is that a home is not an automatically good investment. But it can be made into a good investment with a little planning and elbow grease.
Are You the Do-it-Yourself Type?
It has been said of swimming pools that they are big holes in the ground where you pour money. The truth is, that sentiment could be used for everything related to home ownership. A home is a series of expensive, unfinished projects. No amount of money, time, or energy will ever see all the little things taken care of.
The question is how you plan to deal with that challenge. Are you the do-it-yourself type? or do you plan to deal with all home improvement projects by picking up the phone and calling in a professional? Both strategies can be rather costly. Doing it yourself requires a bigger financial outlay than you expect, regardless of the project. It will also cost you in property value when it is time to sell. No one wants to buy a house full of DYI projects that you should have never done yourself.
Still, hiring out everything is impractical for all but the 1%. You are going to have to have a strategy that involves both savings, and educating yourself to become proficient at home improvement tasks. If you do not plan for this aspect of home ownership, you could end up greatly disappointed.
Have You Considered the Alternative?
As has already been established, there is nothing wrong with owning a home. But there is also nothing wrong with renting an apartment. Home ownership does not make you a better person than anyone else. It does not make you wealthier. It does not make you smarter or more successful. Just as there are good reasons not to own a car, there are reasons not to own a house. Don’t dismiss the alternatives. Examine them carefully. Make an informed, rather than an emotional decision.
