Buying vs. Renting

Owning a home used to be a virtual requirement in attaining the so-called American dream. But that was when people drove 2-ton cars, smoked on airplanes and watched live television. Buying is a smart choice for many people, but it isn’t always the best deal, depending on the market where you live and factors such as how long you plan to stay in your home and the size of the home you want to purchase compared to where you’re renting.

Before you commit to buying, factor in the following points:

  • There’s a big initial investment involved. You have to pony up a lot of money when you purchase your house, from the closing costs (roughly 3% of the home’s purchase price) to the down payment itself. Not everyone has that kind of cash to spare.
  • Can you handle the debt? Lenders often look at your debt-to-income ratio: how your mortgage payments and other debts would stack up against your pay. Conventional lenders often use the so-called 28/36 rule when determining whether to offer you a loan. Your house-related payments (mortgages, taxes, insurance) shouldn’t exceed 28% of your pretax income, and all other combined debts shouldn’t exceed 36% of your monthly pretax income. (Much more on this later.)
  • Buying is more expensive than you think. You can’t simply compare your monthly mortgage payment to your monthly rent — these are apples and oranges, particularly when you consider that the place you purchase won’t necessarily be the same size as the place you’re renting. Though you can deduct some of your home-ownership expenses, you’ll have to pay property taxes, homeowner’s insurance, HOA fees and probably mortgage insurance, as well as renovations, maintenance, utilities, and other fees typically covered by a landlord. (You can directly plug numbers into a handy rent-buy calculator from the New York Times.)
  • Buying decreases ease of mobility. In today’s ever-changing job market, very few people can say with certainty that they’ll have the same employer in five years. It’s much easier, and less expensive, to leave a yearlong lease than to sell a home.
  • How hot is your market? Real estate is local and cyclical, so consider whether your area is better suited to renting or buying. If you live in a larger metropolitan area, the Case-Shiller Index is a useful at-a-glance look at how current real estate values where you live compare to historic highs and lows.

Is a home an investment?

Some people would rather put their money toward equity in their property instead of giving it to a landlord. While that math makes sense for many — especially those who plan to stay long enough to pay off their mortgage entirely — nobody can predict whether home prices will rise or fall in a given time frame, so don’t count on your home to be a cash cow.

What to do before you act

If you’re thinking about buying, follow these steps before making your move.

  1. Calculate your current debts, including car loans, credit card payments, and student loans. Remember the 28/36 rule mentioned above.
  2. Consider how much available cash you have. You’ll want enough to at least cover your down payment and closing costs, and don’t forget to leave enough in your bank account to cover any emergencies that might arise.
  3. Make sure you can put enough money down. Traditionally, lenders have required down payments equal to 20% of the home’s purchase price, but special programs allowing down payments as low as 3% are available. (Putting 20% down on a $300,000 home would require $60,000 in the bank — plus an additional $9,000 or so for closing costs.)
  4. Get pre-approved for a loan. Contact a lender to get pre-approved for a mortgage. This doesn’t require you to accept the loan; it’s just a way of showing real estate agents and sellers that you’re serious. One of the first things a prospective agent will ask is whether you’ve been pre-approved, so check off this box early in the process.

Are you better off renting?

Deciding whether to rent or buy is a big decision that requires serious “Where am I now?” and “Where am I going?” sorts of questions. It might be best to keep renting if you want to maintain maximum flexibility for personal or professional reasons, or if jumping into more debt right now takes you out of your comfort zone. Maybe you’re just not ready to face the responsibilities of home-ownership: repairs, upgrades, maintenance, yard-work and all the rest. Even thinking about the difference between cleaning an 800-square-foot apartment and a 2,400-square-foot house can make you want to take a seat and a deep breath.

Your local housing market could be working against you, as well. If you live in a hot market with eager house hunters chasing too few properties, it might be best to bide your time until a better buying opportunity presents itself.

The Magic of Compounding

The Magic of Compounding

Or what Albert Einstein called the 8th Wonder of the World!

I often get questions like, “Why should I invest in anything? Why not just leave my money under my mattress?” Aside from the obvious – your house could catch on fire and your life savings would go up in smoke, the true answer is that you’re missing out on the compounding that an investment offers.

Let’s start with – what is compounding?

Compounding, in finance, refers to the process in which an asset’s earnings, from either capital gains or interest, are reinvested over time to generate additional growth. Or basically – it’s interest on interest. So instead of just your principal earning money (linear growth), your principal and the accumulated interest on your principal earns money.

Let’s simplify; suppose $10,000 is held in an account that pays 5% interest annually. After the first year, or compounding period, the total in the account has risen to $10,500, a simple reflection of $500 in interest being added to the $10,000 principal. In year two, the account realizes 5% growth on both the original principal and the $500 of first-year interest, resulting in a second-year gain of $525 and a balance of $11,025. After 10 years, assuming no withdrawals and a steady 5% interest rate, the account would grow to $16,288.95.
Compound interest works on both assets and liabilities. While compounding boosts the value of an asset more rapidly, it can also increase the amount of money owed on a loan, as interest accumulates on the unpaid principal and previous interest charges.

Compounding can also work against consumers who have loans that carry very high interest rates, such as credit card debt. A credit card balance of $20,000 carried at an interest rate of 20% (compounded monthly) would result in total compound interest of $4,388 over one year or about $365 per month.

Pay Yourself First

Pay Yourself First

Very often I find people get into their 30’s, 40’s, 50’s, and even 60’s and no one bothered to teach them the ONE key habit that could change their financial lives.

 

It is the concept of pay yourself first.

A few weeks ago we worked through your budget. After figuring our your fixed expenses and your variable expenses, you subtracted the two of them from your income and came up with some number..hopefully a positive one. If you didn’t come up with a positive one, hopefully you went back and figured out where you can make some changes in your lifestyle.

For this particular post I’m going to assume everyone has a positive number.

Now, the mistake that most people make is that they hope that number is available in their bank accounts AFTER all their spending is done. The real power of the number is making sure you save that money UP front.

So every time you get a paycheck you put your savings aside, into a separate account, hopefully where it won’t seem as accessible for you as your spending money. This way, if you end up spending too much in a specific month, it’s not your savings that takes the hit, but your eating out towards the end of the month.

Essentially, the order in which you spend the money you earn matters and it should go something like this:

  1. Receive Income
  2. Move specific/planned amount to savings
  3. Pay all fixed expenses
  4. Spend the rest of it however you originally planned
  5. Move anything left over at the end of the month to savings (consider this a bonus to yourself).

 

The way you stop living paycheck to paycheck and build a nest egg and build an emergency fund and maybe do a million other things… including becoming a millionaire.. is to get into the habit of paying yourself first.

Think I should trademark the phrase?

Lining Up Your Stacks

Lining Up Your Stacks

That’s my fancy way of saying – take a second to calculate your Net Worth.

Your Net Worth is simply what is owned minus what is owed. Or in fancy finance terms: assets minus liabilities.

Your assets (what you own) are things like:

  • The value of your art collection
  • The value of your shoe/purse/car collection
  • The money you have in your bank accounts
  • Anything you may have invested in anything else
  • The “equity” in your home
    • The equity you have in your home is that amount of cash you’d have in your pocket if you sold it. This means it’s the value of your home today minus anything you still owe to the bank (or anyone else).
  • Basically, anything you own that can be sold for money today.

Your liabilities (what you owe) are:

  • Any debt you have of any kind.
    • This includes any amounts owed to banks, credit card companies, people, or loan issuers.

I want to be clear here: If you’re renting an apartment or leasing a car. These are neither assets or liabilities. There’s no ownership occurring. These are simply expenses. They provide no value other than your ability to use them but they are NOT an asset.

If your assets are greater than your liabilities- you have a positive net worth. If your liabilities are greater than our assets – you have a negative net worth.

Why is it important to know your Net Worth?

There are many reasons but the two most important ones are rather simple:

  1. You eventually want to have a very high positive net worth. This would mean that your assets are higher than your liabilities by a significant amount and therefore can presumably be liquidated over time to support your lifestyle.
  2. You need to know what direction you’re heading in so you can begin to prioritize your spending.

I’m going to touch on the first one in a later post in great detail so today let me focus on the second one.

Once you know what your spending is (please see last week’s post), you know what your priorities are. Are you actively supporting Grubhub and Uber or are you working on accumulating assets? If it’s the first of these two and you still have credit card debt, this may be an opportunity to make some changes. Take some time and figure out how you can start moving towards a positive Net Worth. Could you save more? Would it be prudent to realign your spending? Perhaps you can cancel cable for a few months and pay off some of your debt to get you a bit closer to your goals.

Huh Goals? Yes… Money Goals! Absolutely! What are yours?

Hello World, I’m here to help!

Hello World, I’m here to help!

Hello World, I’m here to help!

I run into so many people these days that are just CONFUSED about everything going on with their finances. Of course, as a Financial Planner, many of these people happen to be close friends and family… and I’m determined to help.

 

Let’s all be honest here:

Between bankers, planners, brokers, attorneys, accountants, and 17 other professionals – you could easily spend more money than you probably have in your bank just trying to find the right advice. We don’t learn personal finance in school and the world just serves to confuse us more the longer we spend in it.

I’m here to clean all that up. My personal mission is to help young professionals take charge of their financial lives – creating a “pay yourself first” system, avoiding unnecessary costs, and becoming empowered through knowledge. In my head, by reading this blog on a weekly basis, you will learn SO much about all the aspects of personal finance that you will become the “expert” among your group of friends regardless of what you do for a living.

It’s a HUGE goal but I’m honestly tired of our generation dealing with all the debt and so little in assets, and I’m here to turn the tide around.

One year from now, when you come onto this page, you’ll be able to search for a myriad of financial topics – new ones launching each Monday – and end the “googling” for Financial advice.

One rule: we’re officially best friends. You can reach out to me, ask me questions, ask for advice and we can most definitely hang out in the real world… and in return… all I ask is that you share anything you find valuable here with ALL the people you know.

Let’s start a new generation of Finance Savvy professionals asking all the right questions and eliminating all the confusion around personal finance.