Does it pay to be a Roommate or Mortgage Owner?

Things I wished to have known before I got a house.  When I started my first job after university all I dreamed about was being a homeowner.  I was sick of the flea bag apartments that I rented in College.  I spent my nights watching home remodeling and flipping shows.  I was salivating at the thoughts of transforming a home into a dream home.  Seriously, how hard can it be – the TV shows does it in 22 minutes, and I have a degree in engineering.   So basically, I was a naïve graduate.

One day at work, I had the opportunity (maybe I should rethink that term) to meet with a broker and real estate agent after they had presented on the topic of home owning as an investment.  Does it bug you that broker is the word “broke” + “er”, and I know the combination with “large” + “er”, implies more?  Basically I become more broke (“broker”) after the meeting.   

They recommended all these crazy ideas, “no down payment”, “interest only”, etc.    Then they approved this boy who has only worked a few months in his life for a 450K loan, “Houston we have a problem”.   Well luckily I was not 100% fool, as I ended up around half of the max approved loan with a 30 year industry standard loan – because I recognized that “interest only” loans sound a lot like a rest of life rent agreement with the option to own. 

So here are some thoughts I wish I had prior to my broke decision,

1.       Cheap rent and maximize savings – here is a true scenario, my friend/colleague rents a room for around $450 a month.  If I had signed up for that for 3 years, I could have saved at least $100K in the bank, assuming a take home (after taxes) of 55K a year.   I would have spent only $5400 on rent per year.  It pays to be a roommate.

2.       Look at the amortization table for a mortgage and realize that the first several years are interest only.  The home payments (principal and interest) is roughly 1700 for a 260K loan at 6.75% (I was told the rates were going to hit 12%, what would you do – BUY?).  Basically this house will be paid off in 30 years at 20,400 a year in payments.  So the real purchasing cost of this home is, 20400 * 30 = 612K.  WHAT A DEAL!

a.       So wait a second, what if I rented for 6 years and nearly bought outright? I would only had to finance 60K, and with my savings rate of 100K in 3 years, I would have the house paid for in 9 years.  Screw the 30 year loan, rent from a friend, share a space for a FEW years

In the 7 years of working and wasting money, I have realized if I had just watched some of these expenses I would have been so much wealthier and stress free.  I don’t plan to repeat any of these mistakes, and I plan to talk everyone years off who attempts to go where I have gone.  The next 7 years I will be WEALTHIER and HEALTHIER.

A simple plan for reclaiming your finances – cancel the credit cards

Most American’s have been sold into debt and with little savings to show.  We are constantly marketed too.  Weekly my mail contains credit card offers, personal loans, car loans, and Victoria secret catalogs.  Some of us bite into these offers, using debt to accumulate things we didn’t need.  But those ads on TV sold us!

I struggled with my personal finances, even though I made a great salary.  The amount you make doesn’t necessary reduce any stress in personal finance, the more you make the more you spend.  I made a lot of stupid purchases, which cost me.   In 2007, I used a credit card to finance my home remodeling and my other shopping habits/addictions.  Initially I racked up nearly 20K. My sister walked me through paying it down in a little over a year.  However, I really didn’t analyze the stupidity of what I did.  So, I just repeated this again, using two credit cards to rack up another 30K.  The house is still in a remodeling state and I have a couple video games that are in original packaging – and I don’t think they will become collector’s items.  Also, did I mention I have a projector for sale, never used?

The second time I did this I was ashamed of what I did.  In 2009 my coworker saw how stressed I was, because all the money I earned belonged to banks in America, well most of it.  He was concerned and suggested to abandon my dependence on credit cards.  So I did the smart move, I cut up the cards and paid the minimal payments – did I mention I have a PhD in Stupidity.  Yes, I didn’t pay down the balance, and allowed the lending companies to generate over $5000 a year off my balance. Talk about hardcore stupid tax.  At least I received nice Christmas cards from the CEOs of credit lending companies.

To kick off the new year of 2011, I re-watched “Maxed Out”, and read a couple of books by Dave Ramsey and Elizabeth Warren (see below).  They advocate building an emergency fund to help end those false dependencies on the credit cards.

·         So step 1 for me was making sure all my credit cards were shredded.  I also had to disable them on internet sites that save them, such as Amazon and eBay.  I found even after cutting, I was still tempted to purchase stuff using them on those sites.  

·         Step 2, I loaded my savings account with cash.  It was a comfort to have a thousand plus as a buffer for any minor rainy days.  Which totally happened, and I wasn’t as stressed.  Just re-fill the buffer with each pay check, novel huh.

·         Step 3, pay off the credit cards and loans. I separated mine by their interest rate, e.g. credits cards first followed by student loans.

·         Step 4,  build a huge emergency funds for several months.

To keep motivated I constructed an awesome excel sheet for all my debts.  Each time I paid something down I emailed a progress report to my family for encouragement – my family was a big support.  It was amazing how much more I learned about financial management from just trying to become debt free.  I got excited about savings, investments, insurance, home ownership, and finally felt like an adult with a plan. Try it!

Although I am not out of the woods yet, I still have student loans to pay off (<3k). The real change this year (2011) was at Christmas I did not receive any holiday greeting cards from the credit card companies.   Needless to say I am okay without the credit cards, because I have something better – cash.

 Recommended Books & DVDs 

The Fragile Middle Class Teresa A. Sullivan... Best Price $4.62 or Buy New $25.42	All Your Worth Elizabeth Warren, ... Best Price $2.48 or Buy New $10.20
Your Money or Your Life Vicki Robin, Joe D... Best Price $4.99 or Buy New $10.88	MAXED OUT Best Price $2.99 or Buy New $2.99

Eric’s $60K Decision

*** note - the images, and graphs have been removed ***

When I graduated university (2006) I was driving a paid for 2001 Sebring, which ran great!  However, my co-workers (also recently graduated) went out and got amazing rides – Porsche Boxters, Nissan 350z, Acuras, Corvettes, and even a Lotus Elise.  They got the financing from the dealership or the local credit union.  A few of them made fun of me for not having the super sports car.  Then the Sebring as stolen and totaled - so I got a check from the insurance company.

The insurance gave me the kbb value for the car, and off I went.   I fell into the car trap - needing a car to find my identity.   I went down to the local credit union and took out a loan for a 2006 Mazda Rx-8, luckily it was used.

However, I had just signed up for a $323 payment every month for the next six years – ouch!   After watching my paychecks get zapped by a mortgage, car loan, and insurance payments - I decided enough is enough. Now the RX-8 is gone, and I am driving a used 1996 mini-van. I have my reasons for driving a van over a car at this time. First, I got an amazing deal.  It is paid for with cheap insurance.  Also, the van is great for hauling drywall and lumber for a home remodel.  Furthermore, I think my fiancée secretly loves it, since she says the seats are so comfortable.

On to the story:


After graduating university in 1992, Mr. Eric Engineer landed a great job.  In his first year after graduating he was making $78,000 a year.  This was very exciting to Eric and his family.  Eric had a goal since he entered university, to own a BMW.  Eric told his family once he started working that he planned to save money from each pay check for a new BMW (see below).

After saving and working hard with many hours of overtime, Eric had been able to save $65,000 in two years!  That Christmas in 1994, he announced to his family that he would take saved money and get a nice new BMW.

After New Year’s Eric went to various auto-dealers in the area hunting for the ideal BMW.  Eric test drove a super BMW (740i), priced at around $ 65,000.  Eric said “this is it.”

The dealer suggested that Eric should take the car home and show the family.  Eric felt like a real success driving in that car. “Look at me now”, he could now say to those who doubted him in the past.  He smiled at the thought of getting rid of the rust bucket he drove during university.  He was now riding in style.

At home that night, Eric’s father was very happy for son’s achievement.   However, his father was bit concerned with Eric’s choice to spend all he had saved on the car.

Eric’s dad was a financial planner, so he suggested to his son that they should sit down and look at other alternatives (e.g. his lost opportunities).  Eric had never taken a course in finance, and he was clueless about the power of compound interest.

That night, after running some estimates based on the S & P 500 performance with his father, Eric was convinced now to purchase a nice used car and invest the remaining balance into a mutual fund.

Eric was a bit embarrassed to return that BMW to the dealer the next day, but he knew his financial security was at stake. That month Eric was able to get a good used BMW that still looked nice for around $6000, and was able to invest the remaining money into an index fund that mirrored the performance of the S & P 500.  How did this choice pan out for Eric?  See below for the results of this $60,000 decision.


BMW (ROI) vs. S&P 500 (ROI)

As we can see, the BWM consistently lost value (15% a year) – no surprise here.   While the average return for performance of the S&P 500 was about 10.6% between 1995 and 2010.  Eric’s decision of how to spend the $60,000 resulted in a choice between $3000 verse $624,000 in 2010.  Eric was very happy with his decision to drive a nice used car.

Sources:
·        Motortrend 
·        MoneyChimp  
·        Kelly’s Blue Book

Books that have changed my ideas on Money:

Dave Ramsey's Total Money Make Over, which I read in Feb 2011, and it changed my direction.  I followed his recommended baby steps and got out of debt!  Now I am saving and investing thanks to this book's simple instructions and motivation.  Read it!