- Investment Workshop 59: Are Robo-Advisors Compatible With FIRE? - June 22, 2020
- Reader Case: Grounded in Vancouver and Dreaming of FIRE - June 19, 2020
- Real Estate Agent Gets Crushed by Real Estate Math - June 8, 2020
It’s Friday, so you know what that means…Reader Case time!
Today’s reader jumped out at me because of the provocative subject line: It is EVER OK to buy a house?
Now, we here at Millennial-Revolution.com have taken some strong positions on housing, but don’t get us wrong. We’re not against HOUSING, we’re against massive, unsustainable DEBT. After all, the decision to buy a house has to be weighed against the cost of rent. If it cost $1,000,000 to rent every month, yet buying cost $1, then obviously it would makes sense to buy. So there’s a balance point somewhere on that continum where it makes sense to do one or the other.
So let’s see which side of that argument our reader’s on, shall we?
I’m interested in your take on whether it’s better to buy in my situation. You are generally highly in favor of renting but most of the case studies I’ve heard are for people who live in cities where the numbers are much different. We already own a home but I’m curious what your numbers say. Some other rent vs buy calculators say we are better off owning a home if we stay 3-5 years minimum but I’m curious on your perspective.
39 years old, married with 3 kids ages 13, 11 and 8.
Gross income $108,000 + ~$12,000 bonus.
Net income $63,000 + bonus amount. This is what goes into our bank after taxes, 401k, medical, dental, and HSA come out.
Monthly spending is roughly $4,400.
We have two paid for vehicles (2007 Honda Odyssey and a 2007 VW Jetta)
We bought a house 2 years ago for $110,000 and still owe $23,000 on it. The monthly payment on it is $718 for a 15 year fixed interest rate at 3.75% which includes property taxes and homeowners insurance. (taxes are $162 and insurance is $72)
To rent a $110,000 home in our area would cost around $800-$1000.
We have ~$300,000 in a 401K, ~$10,000 in a Roth IRA, ~$15,000 cash and ~$10,000 in an HSA. I also have a pension with a cash value of ~$100,000.
Both the homes we have owned were foreclosures purchased below market value. The first home we made $25K on mostly due to buying at less than market value. The current home is valued at $160,000 and we purchased for $110,000. Repairs have cost about $5,000 so we have currently gained about $45,000 in equity.
My wife would prefer to own a home so it can be painted and customized to her liking. I like the idea of tax free gains which the tax laws allow if you live in the house for 2+ years.
Even without these “special circumstances” it seems to me we are slightly better to buy a house for $110,000 vs renting for ~$900 if we stay there for 5 years or more. What is your take?
Now, in the endless rent vs. own debate, there are so many rules of thumb floating around the internet that it makes your head spin. The Rule of 90, for example, states that you take 90, subtract your age, and that’s how much of a percentage of your net worth should be in real estate. The 1% rule, popularized by Paula Pant from AffordAnything.com, states that buying only makes sense if your monthly rent is greater than 1% of your purchase price.
Which one is correct? Damned if I know.
The fact is, these rules of thumb are just first-pass estimates. Nobody actually advocates spending hundreds of thousands of dollars based on a quick back-of-the-envelope calculation. If you dig deeper, you realize that Paula actually advocates using the 1% rule just as a way to tell if a property deserves further investigation. She makes her purchase decisions based on many, many factors that can’t be summed up in a pithy rule of thumb.
So I don’t use any of them. Instead, I run the math.
And I’ve found that regardless of whether you actually choose to pursue FIRE or not, the process of calculating your FIRE date delivers a really useful, concrete way of evaluating nearly every financial decision. Should I do A or B? I don’t know! But if you calculate your FIRE projection under assumption A vs. assumption B, the choice becomes clear because it translates something we all have trouble processing (money) into something we can all process easily (time). Is this decision worth an extra X years of working? If yes, go for it! If not, don’t.
So without further ado, let’s MATH SHIT UP!
How Much is this House REALLY Worth?
Even though we talk about finances so often here, I like to remind people that at the end of the day money is just pieces of coloured paper. The ACTUAL resource we need to manage is time. We all only have a limited amount of time on this planet, and money only has value when translated into the resource that REALLY matters.
And that’s why even though the rules of thumb mentioned above can be useful in weeding out truly shitty deals, the real acid test comes from seeing how much of your time this house will cost you. How many years of wage slavery does this convert to? And are you willing to pay that price?
So let’s find out.
Here’s the summary of RoO’s numbers.
|Income||$63,000 + $19,000 (401k) + $6900 (HSA) = $88,900|
|Expenses||$4,400 per month, $52,800 per year|
|Assets (non-housing)||$300,000 + $10,000 + $15,000 + $10,000 + $100,000 = $435,000|
OK so where do we stand here? First of all, let’s figure out his FI number, which is $52,800 x 25 = $1,320,000. Ouch. That’s a big number.
And now let’s figure out how long it will take to get there given his current trajectory.
At his current income/spending levels, his savings rate per year is $88,900 – $52,800 = $36,100.
And given his current, rather impressive investable assets of $435,000, we can predict RoO can retire in…
OK great. We now have a baseline number. Now let’s simulate the scenario that RoO sells his house.
By his estimates, he can get $160,000 for it. After real estate commisions of 5%, and after paying off his mortgage, he should net $160,000 x 0.95 – $23,000 = $129,000. This amount he can add to his investible assets.
But, he’d now have to pay rent. He’d save $718 in mortgage payments, taxes, and insurance, but have to pay ~$900 in rent for an equivalent place. This actually increases his costs, and on the surface this sounds like it’s not going to work, but let’s run the numbers.
First of all, his FI number will slightly increase to ($4,400 – $718 + $900) x 12 x 25 = $1,374,600.
His starting balance and savings rate also changes, to $435,000 + $129,000 = $564,000 and $36,100 + (718 – 900) x 12 = $33,916, respectively.
And his time-to-retirement? Well, let’s see…
Slightly over 10 years. So surprisingly, despite the fact that his per-month costs by moving to renting went up, the amount he made on his house (even after real estate commissions) more than made up for the difference. By selling and moving to renting, he will save 2 years of working.
So is continuing to own that house worth 2 years of RoO’s life? I have no idea. Only he and his spouse can decide that.
Pay Off The Mortgage
Sometimes our readers really show how smart they are, because they saw a solution that I initially missed:
Why doesn’t he just pay off the mortgage?
And I was like well duh, why didn’t I think of that?
If RoO took his Roth IRA contributions plus the spare cash he has, he’d have just enough to completely kill the mortgage. Which at an interest rate of 3.75%, you’d think wouldn’t make too much sense, but it does eliminate a big chunk of his housing costs. Right now, he says he’s paying $718 a month, including $162 for taxes and $72 for insurance. So that means his mortgage payment is $718 – $162 – $72 = $484.
What does that do to the math?
Well first of all, it would reduce his FI target. Lowering his monthly spending by $484 would bring his annual spending to $3916 x 12 = $46,992. And that would make his FI target $46,800 x 25 = $1,174,800.
It would also, however, shave $23,000 off his starting balance. BUT, it would also increase his monthly savings since he can put that saved mortgage payment towards his retirement portfolio.
So put all these factors together into our handy dandy spreadsheet, and what does it do to his time-to-retirement?
10 years, baby! So that means by paying off his mortgage now, he gets the best of both worlds: he (and his wife) get to stay in their house, and still retire in the same amount of time that it would have taken if they had sold it and went back to renting!
HUGE thanks to our readers for this one for the catch, especially Marie Jacobs, Jack, frugalgenx, Nate, and Court. We are so lucky to have such kick-ass clever readers here on MR 🙂 You guys/gals are the best!
So does it make sense for RoO to own his home? At his current situation, not really. He could retire two years sooner if he sold, got out the equity, and rented.
BUT, as our astute readers pointed out, if he were to pay off the mortgage, he’d get the best of both worlds: stay in the house AND retire in 10 years.
So even though it’s rare that owning a home beats out renting, in this case it’s true.
That’s the power of math. Math doesn’t judge. Math simply lays bare the truth.
And the truth is…it doesn’t matter how you spend your money. All that matters is how you spend your time.
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