Housing Dilemma….Part 1

As I have mentioned in previous posts in 2017, I am struggling with a Housing Dilemma which has paralyzed me for the last month and a half. It took me some effort to break out of it and write this post. In this post on my Housing Dilemma (Part 1), I will try to detail two big dilemmas I am facing. Your feedback will be very much appreciated. In Part 2 of the post, I will write about my decision…which hopefully will give me some peace and closure.

Looking back…

I discovered Financial Independence…kind of by accident around 2003. My first blog post ever via this blog was on 07/21/2014. I re-read that first post again and realized that my goal of FI was 10 years from 07/21/2014 i.e. by 07/21/2024, I should have achieved Financial Independence . To be honest, it was more of a stake-in-the-sand kind of goal rather than a well thought out date based on pure math. But, setting this date has got me far ahead of my expectations from when I started this blog.

My goals when I started this blog…

I went back to read what Financial Independence meant to me. From there, I got the following goals. These early goals were refined a bit more…but they still are the main pillars of my FI strategy.

  1. Emergency Fund for 12 months of expenses
    1. Achieved
  2. Multiple Passive Income Streams that produce $50000 per year for years 50-70
    1. On hindsight, this goal was too aggressive at my current funding level 🙂
    2. Depending on my housing decision, I may need additional funds OR more time. But I am happy with the current progress (Jan 2017) and will surely continue with this goal!
  3. College Fund for my kid
    1. Will be achieved in the next 8 years
  4. A retirement fund that covers 30 years of expenses for years 70-100
    1. Will be achieved in the next 8 years
  5. A paid off roof for my family
    1. The biggest question mark 😦 More on this later
  6. A $100K medical fund to help fix emergency health issues…not sure about insurance with preexisting health issues.
    1. In 10 years, if I do not dip into the emergency fund, that fund will be folded onto the medical fund. And I will need to add some more money of course.
    2. But, will surely be achieved.
  7. Life Insurance to cover my family.
    1. Note that this is insurance coverage outside of work to protect my family.
    2. Achieved!

Biggest Question Mark

Financial Independence to me meant that the family abode was paid off. Basically, zero debt with a healthy passive income to boot was my dream. I have come to realize that the big decision of buying a family abode is comprised of a few smaller decisions:

  • Location:
    • I live in a HCOL (high cost of living) area…can we move out of here to a LCOL (low cost of living) area?
    • For various reasons, moving is not an option for our family. All our connections (family and close friends) are here and uprooting everything is not practical.
  • Money:
    • The best case scenario for me is a mortgage amount of somewhere between $425K to $525K. I analyzed this in three posts….the final one was this. Links to the other two are within.
    • No mortgage => no tax deduction on the mortgage interest. I have been paying more tax than needed for the past couple years while I was building my passive income engine. Need to correct this.
  • Kid’s Deadline:
    • We have moved 3 times within the last 7 years and that has taken a toll on my kid the most…3 different schools and zero long term friends. My kid enters middle school next year and I want to drop down roots before that…most possibly another school change but hopefully the last one until high school. So, I have appx 1.5 years left to buy a house.
  • Satisfaction:
    • After visiting many open houses and considering the needs and wishes of our family (size, school district, space, layout, etc), I have come to the decision that a “satisfactory” house is a 3B/2B SFH in a reasonably good school district with low crime. This will cost me anywhere between $850K to $950K…depending on how far into suburbia I am willing to move to. Trust me, you will not get a mansion for this…welcome to my HCOL area 😦
    • In waiting to buy a house, our family spent a few vagabond years. We were saving up for the down payment as well as building the passive income streams. Whatever house we buy will be the one we will stay for the next 18 years atleast. So, the criterion of a 3B/2B SFH is not something I can relax.

So, it seems to me that the only criterion I can relax are:

  • Money
  • Kid’s Deadline

Depending on which of the above two criterion I relax, there can be a few different directions I can go in. And here comes the dilemma.

Housing Dilemma 1: Relax Money criterion and stick to Kid’s Deadline

A mortgage size between $425K and $525K will fit into my FI window. Assuming the worst case cost of $950K for a house, I will need a down payment of $325K to even bid for the house. I have some down payment money but accumulating $325K will take me many many more years.

Vivianne suggested one way: sacrifice some retirement funding to build this down payment up.The stock market is at insane levels…so, perhaps not investing in 401K for a year is not a bad idea. Cons are:

  • Even if I stop investing in 401K and stop adding new funds to my passive income streams, I can save a max of $20K to $25K over the next year and a half.
  • 401K funding is the only tax-efficiency move I have going for me….don’t want to lose this…
  • Can I sacrifice my passive income streams? Hmm…..

So, lets say I relaxed my mortgage limit and took a $625K mortgage (analysis)…the jumbo loan limit in my HCOL area. This means my FI plan will need to be extended to 15 years at least. Say, I am agreeable to this as well. So, what is the dilemma then? Buying at the peak.

One of the good articles that explain what I am trying to say is Case-Shiller House Prices Bubble 1.0 vs today. 2006-2007 was the largest housing bubble in history. And in my HCOL area, prices today are much much more than 2007 prices. If 2007 bubble was the largest bubble, what does it make the house prices we have today? It is really insane 🙂

I concur with the above article as I have personal proof of it. Here is one example of a sfh that a friend bought in Dec 2007….

  • Dec 2007: 922K
  • Dec 2009: 699K
  • Dec 2013: 883K
  • Dec 2016: 1200K

Even if I assume that 2016 is Bubble 2.0, if the bubble pops, I cannot expect the prices to go back to 2009 prices…at best, the prices might settle around 883K (2013 prices).

Conclusion: With this background, is this the right time to bug a house? Is this the right time to commit to a huge mortgage that will require mandatory full employment for the next 15-20 years? Even if we deduct mortgage interest deduction of $20-$30k ($625K mortgage @ 4.5%), if the house price drops by 200K, would it be a smart buy? I am not so sure….especially since even refinancing will be ruled out for underwater homes.

Housing Dilemma 2: Relax Kid’s deadline and keep Money 

Lets say I will wait for the house prices to fall to a reasonable value…say appx $800-850K for a sfh 3br/2b home in a reasonably good school district with low crime. Let us say that this price reduction will only happen in 2020 i.e. three years from now. I can save money for the home down payment and still stick to the $525K mortgage. But, this means I have to continue to rent and potentially move again for my kid’s middle school i.e. continue the Vagabond family life 😦

I hate to put my family through another temporary move, but lets see what this option of delaying a home purchase till 2020 brings us.

  • I can save enough money for a down payment to let me pick a $525K mortgage i.e. stick to my FI schedule of 10 years….
  • I am not buying at the peak of the market….a peak which is really really historic. I have seen my close friends struggle in the 2008 housing bubble , lose jobs and houses and saw first hand what devastation it can cause for families.

So, what do I lose by postponing my purchase?

  • Obviously, I feel that I am not being a responsible parent and husband by elongating the vagabond life by another three years.
  • I am going to lose the tax benefits of a mortgage…most probably in the highest earning years of my life….i.e. when I could most benefit from a deduction in taxes.
  • House prices may rise up even more….hey, anything is possible 🙂

I cannot do anything about the first con and the third is not realistic in my opinion. But I can do something about the second. What if I purchased one or more cash-flow positive rentals in a LCOL area? Here are some positives:

  • Use leverage to add one more income stream
  • Diversify my income stream to include rental income along with dividend income
  • Get the mortgage tax deduction

Some negatives are:

  • The rental purchases also will be at the top of the housing market bubble…unless I identify a market that is not so frothy.
  • Remote rental management…lack of time is so prevalent in my life now…so, how does one manage remote properties? Can I identify a rental management agency to help me out? Doable but will take some work.
  • If housing market falls in 2018, I will not have enough money to take advantage of it.

Conclusion: With this background, is this the right time to postpone purchase of family residence and buy a rental property instead? I will be getting the tax benefit and hopefully get the renters to pay off most of the mortgage. And over time, diversify my passive income stream as well. Am I being too selfish in signing up my Kid and wife for few more years of Vagabond life?

Readers

If you have read this far, I truly appreciate it! As I said before, the above two dilemmas have paralyzed me for the last month and a half. If I may ask one favor, do you have any thoughts on how I can solve my dilemma? Which option should I pick: Dilemma 1 OR Dilemma 2? Am I missing any pros/cons in each dilemma? Feel free to share your valuable opinions! Thank you very much!

How much freedom did I buy today?

I was having a very tiring day today…a few tiring days actually and I was totally spent when I came home. I checked my blog emails and found some uplifting comments from readers of one of my blog posts. My spirits got recharged due to those comments. Thanks to Tristan (Dividends Down Under), Ambertreeleaves (ambertreeleaves) and Mister SLM. I decided to put my recharged spirits to good use and write a blog post that I have been thinking about sharing for quite a while. This is my way of paying my dues for the good karma that came my way today from the three wonderful people mentioned above.

Back in mid 2014, I defined what Financial Independence means to me in one of my very early blog posts (link). The plan definitely has changed a bit over the last two years. But, I have been executing this plan with all the motivation and money that I can muster

Along the way, I realized one profound motivational idea that I will share via this blog post. I have spreadsheets that track my monthly dividends going all the way back  a few years and in there, I track which of my monthly needs are funded fully by my current passive income.

One day, while updating that, I realized this profound motivational question. Every now and then, I have a rough day at work or at home and sometimes both 🙂 I keep myself motivated by asking myself this question: How much freedom did I buy today?

Here is my answer.

  • My Passive Income goal is
    • $4000 per month (Why $4000 pm?)
    • $48000 per year
    • $131.5 per day ($48K/365)
  • By end of this year, if all goes well, my monthly passive income will be $750 per month. This has come through a lot of sacrifices…both by me and my family.
  • How much freedom will $750 pm buy me?
    • $750/$131.5  =>  5.7 days per month => 136 hours per month => 4.38 hrs a day (31 day month)
  • To put this in perspective, here is the amount of freedom $750 pm of passive income will buy me:
    • 4.38 hours     of absolute freedom every day!
    • 5.7 days         of absolute freedom every month!
    • 68.4 days      of absolute freedom every year!
    • 2 months      of absolute freedom every year!

When I started working many many years ago, saving was defined as money that I did not spend. I was very aimless and had no idea of Financial Independence. Obviously, money vaporized like water. It took a nasty and depressing curve ball in life to start me on a search to something different and I ended up discovering Financial Independence by accident (my first blog post). Thanks to the wonderful world of FIRE bloggers, I found my “something different” i.e. Financial Independence and Early Retirement. Though, it is not going to be as early for me…but better late than never hey !!

The question that keeps me motivated and fills me with enormous drive is the question:

  • How much freedom did I buy today?
    • My answer is 4 hours a day. 
    • What is yours? 

Hope this question motivates you to keep striving for FIRE!

Live now vs Save for FIRE….

I read a wonderful article today written by my fellow Belgian FI blogger AmberTreeLeaves. The article of his title was “endless doubt on FIRE“. I was behind on my FI blogger reads and read it a week too late. But, the article was very thought provoking and I would really recommend a read.

Since there were already quite a few posts, commenting there was probably not going to be too helpful…hence this new post 🙂 Hope AmberTreeLeaves does not mind stealing an idea for a post from his blog!

That post by AmberTreeLeaves raised a conflict that I often had and continue to have within myself. One sentence from the post captures this conflict very well: The conflict is mainly between travel /live now and prepare FIRE.

I go through the same conflict in my mind….not just with travel, but also things like buying a car, etc. My parents sacrificed a lot in their present and postponed all their enjoyment to the future. And it did not end well. I went through some years where I did the opposite…living for the now..I guess I was running away from my parent’s philosophy. And when I discovered Financial Independence, I swung the other way….live for the future only and my family was none to happy about it 🙂

But, I have now come to a fair medium. I have come up with a decision framework that helps me rationalize live now OR live for the future vs the benefit I am getting. This has helped making sacrifices easier. Let me state two example cases.

  1. Lets assume a family vacation costs $5000 on average and hypothetically our family’s post tax take home salary is $60000. My requirement is that I want to have one vacation each for the next 10 years before my kids head out to college. So, I need roughly $50000 to fund all the vacations. $50000 adds one additional year to my family’s expected FI target. Considering that we will never get that many chances to spend time together as a family after kids head out to college, this addition is worth it to me.
  2. Now consider purchasing a new luxury car like some of my friends have. The car costs $80000 and after financing and maintenance costs, it can rise up to $90000 at least…yes, I could not believe it 🙂 With the same post-tax family salary of $50000 per year, it would add almost 2 years to my expected FI target. For me, getting freedom 2 years earlier is more important than driving a luxury car. Don’t get me wrong…I like the cars…I have sat in them and I think they are awesome….but not awesome enough compared to achieving freedom 2 years earlier…for me.

I am trying to apply this framework for every major decision…it had helped me rationalize family vacations and buying a new car. Next is applying this for buying a home. I am curious how do others deal with this conflict. Lemme know your thoughts please.

And once again, thanks to AmberTreeLeaves for a wonderful and thought provoking post. It took me back in time to a period when I learnt some important lessons.

Investing in real estate….passively :-)

Over the past couple months, I have been thinking about all things real estate. Basically, the question boils down to: in what ways can I add a real estate component to my financial portfolio.

  • First, I was thinking about what is a “good mortgage amount” that fits my criterion for FI in 10 years. My primary residence will not be an investment in real estate, but will add a real estate component to my financial empire 😉
  • Second, the question that came to my mind was: can I somehow add a real estate component to my portfolio before purchasing my primary residence?
    • I use Personal Capital to track where my portfolio is and it is an AWESOME tool to track all your finances in one place. The one feature I really like is that it breaks down all the funds in your portfolio into the following categories, JUST by taking the names of the different funds like VDIGX, VTCLX, etc. For example,
      • Large cap, mid cap, small cap split
      • Cash and bonds split
      • Alternatives (real estate, etc)
      • US and International split
    • Personal capital pointed out a weakness in my portfolio diversification w.r.t. lack of investment in Alternative Investments like Real estate, hedge funds, commodities, etc.
    • Hence I started looking at how to add a real estate dimension to my portfolio.

This blog talks about the options I investigated.

Option 1: Rental Property Investment

I live in a HCOL (high cost of living area) on the west coast. Real estate is normally expensive in my HCOL area, but it is especially so in today’s market. There are many reasons for it, but primarily I would say that institutional investors and foreign investors are the main reason. For example, many houses that are listed in the market nowadays come from Berkshire Hathaway Property Holdings!

Anyways, I searched for a couple of rental properties (1B and 2B ones) in and around my area (radius of 25 miles max) and used my blog friend Well Rounded Investor’s Real Estate Income/Expenses spreadsheet. She is truly a well rounded investor, with investments in real estate and stocks. I played with numbers for some rental properties using her spreadsheet and I somehow never broken even on any property….not even close.

I could go more than 50+ miles from my area where the nos are a little bit more friendly, but I would not know the area and it would be a maintenance nightmare. Adding the cost of a property manager will make the numbers very unfriendly.

Another option is to go out of state and invest in rental properties. For example, my office colleague invests in Washington State rentals, but his sister is the property manager…huge trust advantage 🙂 I do not have such an advantage and when I barely have time left to breathe…out of state property investment is too much of a reach.

So, I tabled this idea for now. I will continue to learn from the real-estate-wise blogging friends and hope to add one or more rental properties to my portfolio at a later date.

Option 2: Investing in REITs

REIT is a short form for Real Estate Investment Trusts. REIT funds invest in real estate investment trusts i.e. in companies that purchase office buildings, hotels, and other real estate property types and generate income from renting out the properties. Most of the income produced is distributed as dividends to the investors.

Take for example VGSIX/VGSLX (Vanguard REIT Index Fund). This fund invests in many real estate investment trusts..the top 10 holdings of this fund are:

  • Simon Property Group Inc.
  • Public Storage
  • Equity Residential
  • Health Care REIT Inc.
  • AvalonBay Communities Inc.
  • Ventas Inc.
  • Prologis Inc.
  • Boston Properties Inc.
  • HCP Inc.
  • Vornado Realty Trust

One can invest in a REIT Index (VGSLX) or invest in individual REITs themselves. But, I prefer index funds for diversification. We will talk about this later.

Advantages:

There are a few advantages to owning REITs or REIT funds

  • Adds real estate exposure to one’s portfolio with minimal upfront cash.
    • For example, minimum purchase for VGSIX is $3000.
    • A relatively safe rental property investment in my HCOL area needs at least $70000 (20% on a 350K rental).
  • Diversifies the risk
    • A single rental property => all the risk in one single location and with one single tenant.
    • REIT investment => risk is distributed across multiple locations and multiple tenants.
  • Diversification of assets
    • REITs invest in different assets compared to most companies whose Stocks and bonds we invest in.
    • For example, a REIT that operates hospital buildings will generate  income even in market downturns where stocks and bonds may tank.
  • Liquidity
    • A rental property is not a liquid asset i.e. it cannot be sold quickly to generate money….selling a REIT fund is as easy as one click…ofcourse, quick selling both assets can lead to a loss.
  • Low effort (passive) Asset
    • Once you put in the effort to choose a REIT or a REIT index fund and set up the automatic investment option, there is no further effort required. A really nice asset for busy people 🙂
    • A rental property requires much more effort to manage…even if you are using a property manager. The variables with a rental property are many….quality of tenants, quality of property manager, quality of the property, etc etc

Disadvantages:

  • A REIT is not a tax-efficient investment
    • A REIT generates dividends that are treated as Ordinary Income. So, for folks already in the high income tax bracket, the dividends are taxed at a very high rate.
    • A rental property on the other hand provides an opportunity to claim tax deductions due to mortgage interest deductions, property depreciation, etc etc.
    • For high income tax brackets, tax efficient properties can be a boon.
  • Capital appreciation potential
    • A rental property, bought at the right time, can appreciate many times faster than a REIT fund can.
      • Especially, those that were bought around 2009-2011 time frame.
    • This is especially important when you leverage the buy using a mortgage i.e. pay $70000 down payment for a $350000 property and sell it when it reaches $550000 and make $200K profit leveraging money from a bank mortgage.
  • Single trick pony
    • Rental properties provide the triple threat of an ability to lower taxable income, potential for capital appreciation and doing all this by leveraging money from the bank.
    • REITs are a single trick pony….ordinary income every month.

Conclusion 

Both rental properties and REITs have their own charm. For me, at this point in my life, I am short on two things:

  • Time
    • I do not have time to spare. Between working full time and preparing for a job hunt, I am totally out of time. And a new job means putting in max effort in the first year to establish myself. So, I do not anticipate more time in the next year.
  • Down payment money
    • I am saving for the down payment for my primary home and cannot afford another down payment in the immediate future.

Considering that, I decided to invest in REITs. More specifically, I chose a REIT index fund called VGSLX. It is a Gold rated fund from Vanguard, the low-cost king of mutual funds. I had an IRA in my tax-advantaged portfolio that had accumulated gains over the past 3 years. So, I moved some of my gains in the IRA target date funds into a new position in VGSLX. REITs have gone down a couple percent this year and are close to their 52 week lows. So, I am am getting in with a little bit of a cost advantage. I expect the REITs to go down more this year and I will move a little more of the IRA gains into my real estate position of my portfolio.

I do not expect to tap into my IRA/tax advantaged retirement holdings until many many years from now. If my passive income strategy works out, I may never have to tap into it 🙂 Anyways, the REIT index fund will have many many years to compound all the dividends in a tax efficient way. So, go REITs !!

Mortgage Case Study 3: $425K mortgage

This post is the third in a three part case study in finding out how much mortgage should I take on to fit into my plan to FI in the next 10 years. The first post is here and the second post is here.

In the first post, I considered the feasibility of a $625K mortgage. My conclusion was that having a $625,000 mortgage will definitely not fit into the 10 year FI plan that I have. From the calculations in that post, we are talking close to a $5000 pm mortgage payment. Adding 5 more years to the FI plan will be sufficient. So, if I get a $625K mortage, the following things have to happen:

  • Pay $5000 pm mortgage
  • Work for 15 more years

In the second post, I considered the feasibility of a $525K mortgage. My conclusion was that having a $525000 mrtgage will not fit into the 10 year FI plan that I have BUT will will fit into 11 years i.e. one more than my 10 year FI plan. So, if I get a $525K mortage, the following things have to happen:

  • Pay $5000 pm mortgage
  • Work for 11 years

Adding one additional year of work seems most acceptable 🙂

This post will consider a $425K mortgage and see how t fits into my 10 year plan for FI.

My Mortgage Assumptions

The basic assumptions I will make about the mortgage, beyond the max amount of $425000, are:

  • Interest rate per year 4.5
  • Mortgage start date May 2016
  • 30 year mortgage

With that, I am going to crunch some numbers for a 30 year mortgage. My ideal early retirement is in approximately 10 years. But, I cannot afford a 10 year mortgage…trust me on this…I have crunched the numbers and it is not pretty. The best case for me is a 30 year mortgage. Why?

  • It is a safe bet because
    • the monthly payment is the lowest among 10, 15 and 30 year mortgages
    • in case there is a loss of income, having a lower monthly payment is very helpful until the income source restarts
  • It is very flexible
    • If there is money available, then I have the option of paying more to simulate a 10 or 15 year mortgage

Hence for safety and flexibility, a 30 year mortgage is the best option for me.

What does my monthly payment look like for a $425,000 mortgage?

I have used a mortgage amortization calculator (link below) which gives me the details on how my monthly mortgage payment is split into interest and principal repayment and how long before my entire loan is repaid. I am going to use that calculator to come up with the nos below.

Case 1

Mortgage term in years 30
Monthly payments $2153 (Total = $2153 pm)

Case 2

Mortgage term in years 30
Monthly payments $2153
Monthly extra payment $800  (Total = $2153+$800 = $2953 pm)

Case 3

Mortgage term in years 30
Monthly payments $2153
Monthly extra payment $1600 (Total = $2153+$1600 = $3753 pm)

Case 4

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $2847(Total = $2153+$2847= $5000 pm)

This case is a new one for this $425K post to have one case for $5000 monthly payment that was there in the $625K post.

How soon can I pay off the $425,000 mortgage?

Case 1: $2153 pm

Mortgage term in years 30
Monthly payments $2153

DATE         PAYMENT  PRINCIPAL  INTEREST   TOTAL INTEREST       BALANCE
June 2016  $2,153.41  $559.66       $1,593.75    $1,593.75                   $424,440.34
June 2031  $2,153.41  $1,097.81    $1,055.60    $245,164.17               $280,396.50
May 2046   $2,153.41  $2,145.37    $8.05           $350,228.52               $0.00

Repayment time is 20 years.

Case 2: $2953 pm

Mortgage term in years 30
Monthly payments $2153
Monthly extra payment $800

DATE           PAYMENT  PRINCIPAL   INTEREST   TOTAL INTEREST   BALANCE
June 2016    $2,953.41  $1,359.66    $1,593.75     $1,593.75                $423,640.34
June 2031    $2,953.41  $2,667.05    $286.36        $183,263.19            $73,695.52
Sept. 2033    $732.16     $729.42       $2.74           $187,088.56            $0.00

Repayment time is 18 yrs approximately.

Case 3: $3753 pm

Mortgage term in years 30
Monthly payments $2153
Monthly extra payment $1600

DATE          PAYMENT   PRINCIPAL   INTEREST  TOTAL INTEREST  BALANCE
June 2016   $3,753.41   $2,159.66    $1,593.75    $1,593.75              $422,840.34
Sept. 2028  $2,502.98   $2,493.63     $9.35          $129,254.63          $0.00

Repayment time is 12.5 years approximately.

Case 4: $5000 pm

Mortgage term in years 30
Monthly payments $2153
Monthly extra payment $2847

DATE          PAYMENT   PRINCIPAL   INTEREST  TOTAL INTEREST  BALANCE
June 2016  $5,000.41    $3,406.66     $1,593.75   $1,593.75               $421,593.34
Dec. 2024  $2,677.86    $2,667.85     $10.00         $87,719.94            $0.00

Repayment time is 8.5 years.

Additional expenses

In all the above calculations, the astute reader might have noticed that I left out two parts from the above calculation:

  • Property taxes from the calculation.
    • Assuming a 1.25% property tax rate, it is not unreasonable to have a $1000 per month property tax in my HCOL area. But, assuming that this expense is tax deductible, I will ignore this cost.
  • House maintenance expenses
    • From the experience of our current rental, I estimate house maintenance expenses to be roughly about $2500 per year i.e. $appx $200 pm
  • Home insurance
    • Lets estimate this to be $200 pm.

So, approximately $500 more per month needs to be budgeted for house maintenance and insurance expenses.

Conclusion

Having a $425,000 mortgage will definitely fit into the 10 year FI plan that I have. Note that this with a $5000 pm mortgage payment. So, if I get a $425K mortage, the following things have to happen:

  • Pay $5000 pm mortgage
  • Work for 8.5 years

This plan seems the most acceptable one from a money perspective 🙂

Conclusion from the 3-part mortgage series

I considered three different mortgages and their feasibility to pay them off within my 10 year FI plan and the results are:

  • $625K Mortgage:
    • Pay $5000 pm mortgage
    • Work for 15 more years i.e. 5 more years than my FI period of 10 years
    • PLAN FAILS by 5 years
  • $525K Mortgage:
    • Pay $5000 pm mortgage
    • Work for 11 more years i.e. 1 more years than my FI period of 10 years
    • PLAN FAILS, but only by 1 year
  • $425K Mortgage:
    • Pay $5000 pm mortgage
    • Work for 8.5 years i.e. well into my FI period of 10 years
    • PLAN SUCCEEDS!!

So, the best case scenario for me is a mortgage anywhere between $425K to $525K. Yeah!! I am super happy to have this number!!

Links

Mortgage Case Study 2: $525K mortgage

This post is the second in a three part case study in finding out how much mortgage should I take on to fit into my plan to FI in the next 10 years. The first post is here.

In the first post, I considered the feasibility of a $625K mortgage. My conclusion was that having a $625,000 mortgage will definitely not fit into the 10 year FI plan that I have. From the calculations in that post, we are talking close to a $5000 pm mortgage payment. Adding 5 more years to the FI plan will be sufficient. So, if I get a $625K mortage, the following things have to happen:

  • Pay $5000 pm mortgage
  • Work for 15 more years

This post will consider a $525K mortgage and see if it fits into my 10 year plan for FI.

My Mortgage Assumptions

The basic assumptions I will make about the mortgage, beyond the max amount of $525000, are:

  • Interest rate per year 4.5
  • Mortgage start date May 2016
  • 30 year mortgage

With that, I am going to crunch some numbers for a 30 year mortgage. My ideal early retirement is in approximately 10 years. But, I cannot afford a 10 year mortgage…trust me on this…I have crunched the numbers and it is not pretty. The best case for me is a 30 year mortgage. Why?

  • It is a safe bet because
    • the monthly payment is the lowest among 10, 15 and 30 year mortgages
    • in case there is a loss of income, having a lower monthly payment is very helpful until the income source restarts
  • It is very flexible
    • If there is money available, then I have the option of paying more to simulate a 10 or 15 year mortgage

Hence for safety and flexibility, a 30 year mortgage is the best option for me.

What does my monthly payment look like for a $525,000 mortgage?

I have used a mortgage amortization calculator (link below) which gives me the details on how my monthly mortgage payment is split into interest and principal repayment and how long before my entire loan is repaid. I am going to use that calculator to come up with the nos below.

Case 1

Mortgage term in years 30
Monthly payments $2660      (Total = $2660 pm)

Case 2

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $800  (Total = $2660+$800 = $3460 pm)

Case 3

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $1600 (Total = $2660+$1600 = $4260 pm)

Case 4

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $2340 (Total = $2660+$2340 = $5000 pm)

This case is a new one for this $525K post to have one case for $5000 monthly payment that was there in the $625K post.

How soon can I pay off the $525,000 mortgage?

Case 1: $2660 pm

Mortgage term in years 30
Monthly payments $2660

DATE         PAYMENT    PRINCIPAL    INTEREST   TOTAL INTEREST   BALANCE
June 2016  $2,660.10    $691.35        $1,968.75     $1,968.75                $524,308.65
June 2031  $2,660.10    $1,356.12     $1,303.98     $302,849.86            $346,372.15
May 2046  $2,660.10     $2,650.16     $9.94            $432,635.24            $0.00

Repayment time is 30 years.

Case 2: $3460 pm

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $800

DATE           PAYMENT  PRINCIPAL   INTEREST   TOTAL INTEREST   BALANCE
June 2016   $3,460.10   $1,491.35    $1,968.75    $1,968.75                 $523,508.65
June 2031   $3,460.10   $2,925.36    $534.74       $240,948.88             $139,671.17
Feb. 2035   $2,947.53   $2,936.51    $11.01         $253,009.45             $0.00

Repayment time is 19 years.

Case 3: $4260

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $1600

DATE         PAYMENT   PRINCIPAL  INTEREST    TOTAL INTEREST    BALANCE
June 2016  $4,260.10   $2,291.35    $1,968.75    $1,968.75                  $522,708.65
Mar. 2030  $2,914.45   $2,903.56    $10.89          $180,830.60             $0.00

Repayment time is 14 years.

Case 4: $5000

Mortgage term in years 30
Monthly payments $2660
Monthly extra payment $2340

DATE          PAYMENT   PRINCIPAL   INTEREST  TOTAL INTEREST  BALANCE
June 2016   $5,000.10   $3,031.35     $1,968.75   $1,968.75               $521,968.65
July 2027    $3,519.20    $3,506.05    $13.15        $143,532.21            $0.00

Repayment time is 11 years.

Additional expenses

In all the above calculations, the astute reader might have noticed that I left out two parts from the above calculation:

  • Property taxes from the calculation.
    • Assuming a 1.25% property tax rate, it is not unreasonable to have a $1000 per month property tax in my HCOL area. But, assuming that this expense is tax deductible, I will ignore this cost.
  • House maintenance expenses
    • From the experience of our current rental, I estimate house maintenance expenses to be roughly about $2500 per year i.e. $appx $200 pm
  • Home insurance
    • Lets estimate this to be $200 pm.

So, appx $500 more per month needs to be budgeted for house maintenance and insurance expenses.

Conclusion

Even without adding the “Additional expenses”, having a $525,000 mortgage will definitely not fit into the 10 year FI plan that I have. Note that this is even with a $5000 pm mortgage payment. Adding 1 more years to the FI plan will be sufficient. So, if I get a $525K mortage, the following things have to happen:

  • Pay $5000 pm mortgage
  • Work for 11 years

Adding one additional year of work seems most acceptable 🙂

The next case study (last) will tackle a $425K mortgage.

Links

Mortgage Case Study 1: $625K mortgage

This is a three part case study in finding out how much mortage should I take on to fit into my plan to FI in the next 10 years.

I wrote about preparing for the next recession here. In fact, what I really meant is that I want to not just prepare but PROFIT from the next recession instead of bracing myself and riding it out. One of the important lessons I learnt from past recessions, from personal experience and that of others, is as follows:

  • Big items (houses and cars) should always be purchased in a recession or bust period.
  • A mistake make in either of the two can take years and years to recover from…especially the house.

My main goal for the next upcoming recession is to buy a home for our family. We have sacrificed a lot over the past years. We had to rent in many places due to affordability issues and my kid has taken the brunt of all the moves…in terms of not having a constant set of friends both at home and in school…especially in school due to the many times we have moved and changed schools. I am ready to put down roots in one place so that my family can settle down.

Questions to answer

I live in a HCOL (high cost of living) area on the west coast. Moving out of here is not an option for me and my family….this is where my family is, this is where my friends are and this is what I call home. So, got to live the life here, including the high cost of housing. So, the questions that come to my mind are:

  • How much does a 3Bed/2Bath home cost in my area?
  • What is the monthly mortgage payment going to look like?
  • How soon can I finish paying for the house? Considering my ideal goal is to reach FI in 10 years……

How much does a 3Bed/2Bath home cost in my area?

As of today (04/20/2015), a reasonable 3B/2B home costs appx $1.2 million dollars. Yep…I am not kidding about this…sad but true. There seems to be no value for money. Since this is way way above my price range, I will wait it out for the next recession to calm the prices down a bit. It may happen in the next year OR the year after….not sure. But, whatever the cost of the house is, here are my rules:

  • I will not get a mortgage above $625,000.
    • This is the jumbo loan limit and I am not paying Mortgage Insurance and not maxing out my financial slavery.
  • Since the higher limit on my mortgage is fixed, the rest of the money has to come from the down payment
    • If I have $300,000 for down payment, then I can afford a house that costs $925,000
    • If I have $200,000 for down payment, then I can afford a house that costs $825,000
    • If I have $150,000 for down payment, then I can afford a house that costs $725,000

Doing it this way, I can calculate the worst possible price and anything under will be a nice to have! Assuming that, I am going to crunch numbers on a $625,000 mortgage and calculate the following:

  • What does my monthly payment look like for a $625,000 mortgage?
  • How soon can I pay off the $625,000 mortgage?

My Mortgage Assumptions

The basic assumptions I will make about the mortgage, beyond the max amount of $625000, are:

  • Interest rate per year 4.5
  • Mortgage start date May 2016
  • 30 year mortgage

With that, I am going to crunch some numbers for a 30 year mortgage. My ideal early retirement is in approximately 10 years. But, I cannot afford a 10 year mortgage…trust me on this…I have crunched the numbers and it is not pretty. The best case for me is a 30 year mortgage. Why?

  • It is a safe bet because
    • the monthly payment is the lowest among 10, 15 and 30 year mortgages
    • in case there is a loss of income, having a lower monthly payment is very helpful until the income source restarts
  • It is very flexible
    • If there is money available, then I have the option of paying more to simulate a 10 or 15 year mortgage

Hence for safety and flexibility, a 30 year mortgage is the best option for me.

What does my monthly payment look like for a $625,000 mortgage?

I have used a mortgage amortization calculator (link below) which gives me the details on how my monthly mortgage payment is split into interest and principal repayment and how long before my entire loan is repaid. I am going to use that calculator to come up with the nos below.

Case 1

Mortgage term in years 30
Monthly payments $3,166.78

Case 2

Mortgage term in years 30
Monthly payments $3,166.78
Monthly extra payment $800

Case 3

Mortgage term in years 30
Monthly payments $3,166.78
Monthly extra payment $1600

How soon can I pay off the $625,000 mortgage?

Case 1: $3166 pm

Mortgage term in years 30
Monthly payments $3,166.78

DATE          PAYMENT   PRINCIPAL   INTEREST   TOTAL INTEREST   BALANCE
June 2016  $3,166.78      $823.03          $2,343.75      $2,343.75                    $624,176.97
June 2031  $3,166.78      $1,614.42        $1,552.36     $360,535.55                $412,347.79
May 2046  $3,166.78      $3,154.95        $11.83           $515,041.95                $0.00

Repayment time is 30 years.

Case 2: $3966 pm

Mortgage term in years 30
Monthly payments $3,166.78
Monthly extra payment $800

DATE          PAYMENT   PRINCIPAL   INTEREST   TOTAL INTEREST   BALANCE
June 2016  $3,966.78     $1,623.03       $2,343.75      $2,343.75                     $623,376.97
June 2031  $3,966.78     $3,183.67        $783.11         $298,634.57                 $205,646.81
April 2036  $2,998.48    $2,987.27       $11.20            $322,092.87                $0.00

Repayment time is 20 years.

Case 3: $4766 pm

Mortgage term in years 30
Monthly payments $3,166.78
Monthly extra payment $1600

DATE           PAYMENT   PRINCIPAL   INTEREST   TOTAL INTEREST   BALANCE
June 2016   $4,766.78     $2,423.03        $2,343.75      $2,343.75                    $622,576.97
June 2031   $3,712.62     $3,698.75        $13.87            $236,733.59                $0.00

Repayment time is 15 years.

Missing expenses

In all the above calculations, the astute reader might have noticed that I left out two parts from the above calculation:

  • Property taxes from the calculation.
    • Assuming a 1.25% property tax rate, it is not unreasonable to have a $1000 per month property tax in my HCOL area.
    • But, assuming that this expense is tax deductible, I will ignore this cost.
  • House maintenance expenses
    • From the experience of our current rental, I estimate house maintenance expenses to be roughly about $2500 per year i.e. $appx $200 pm
  • Home insurance
    • Lets estimate this to be $200 pm.

So, appx $500 more per month needs to be budgeted for house maintenance and insurance expenses.

Conclusion

Even without adding the “Missing expenses”, having a $625,000 mortgage will definitely not fit into the 10 year FI plan that I have. Note that we are talking close to a $5000 pm mortgage payment. Adding 5 more years to the FI plan will be sufficient. So, if I get a $625K mortage, the following things have to happen:

  • Pay $5000 pm mortgage
  • Work for 15 more years

The next two case studies will tackle a $525K mortgage and a $425K mortgage.

Links

How to prepare for the next recession?

For the past few months, I am seeing some excesses in the market that has brought back memories of past boom+bust cycles. For example,

  • A 2bed/2bath condo sold for a neat $1mil,
  • A 3bed/2bath townhome list for $850K and sell for $1.2mil…I am not joking about this 😐
  • I saw many people jumping in to buy $70K cars
  • I saw people bid more than $100K over the list price to buy a very old home
  • ……

The above observations remind me of previous boom cycles and I felt that it was time to revisit lessons learnt from past boom+bust cycles. Hence this post. Hope it is useful for you. If you have lessons of your own to share, please do so…it would be much appreciated.

Boom+Bust cycles

I have faced two official recessions OR you can say a few bubble-pops in the last two decades of my life.

  • Economy was doing well..here comes the dot-com bubble pop in 2001
    • This was officially a recession
  • Economy was doing well..here comes the market tank due to the Iraq war
    • This was officially not a recession, but job losses were the same…..
  • Economy was doing well..here comes the real estate bubble pop in 2008
    • This was officially a recession

Before each recession, there is a period of bubble formation OR economic prosperity….pick your poison 🙂 One could go back in US economic history and one would find the same repeated pattern of BOOM and BUST cycles.

  • 2004 to 2007: Boom time; Bubble pop in 2008-2010
  • 1994 to 2000: Boom time; Bubble pop in 2001-2003
  • 1983 to 1991: Boom time; Bubble pop in 1992-1994
  • ……..

The current Boom cycle has been on from 2010 onwards…I.e. we are more than due for a Bust real soon…..can we benefit from this knowledge? If you are interested in how I plan to benefit, please read on.

What did I see or not see during these cycles?

  • For the 2001 bubble pop, I had no idea this was coming…I was a finance newbie and really did not even know what 401K meant. But, I did see a lot of job losses around me, close friends getting hurt bad and I myself barely scraping through..more luck than anything else….it was a very stressful time.
  • For the 2008 bubble pop, I could see it coming and did take some decisions like moving to a more stable job, creating an emergency fund, etc. But, I did not predict the severity of the recession….again, it was a lot of job losses around me and it was again a very stressful time. I was fighting so hard to retain my job and stay afloat that benefiting from it did not come to my mind.

But, since I was no longer a financial newbie, I was fortunate to be around people who, on hindsight, proved to be financial geniuses. I was not smart enough to financially benefit form the lessons at that time, but I plan to do so in the next recession. Here are some examples of a common patterns I saw during the boom+bust cycles.

  • A person I know dumped $150K into the stock market, in the worst of the 2008 bust cycle and by 2014, he had more than doubled…infact almost tripled his investment. At that time, I thought he had nerves of steel to do that but on hindsight, he was just making use of the recession. He has now officially retired and working part time just for the social connections.
  • A person I know, a financial newbie, bought a home in 2008, under pressure from family since a baby was on the way. She really hated the idea of buying and came up with all financial reasons not to…but, a relative who happened to be a real estate agent convinced her otherwise and  even dropped the commissions for the purchase. Her house is now $500K past the purchase price and she stopped working to spend time with the baby. She now looks like a financial genius and the relative loses no chance to rub it in.
  • A couple of people I know bought houses at the peak of the boom cycle in 2000, 2004 and 2007. They went through a lot of suffering with undervalued houses…especially with the threat of job losses hanging over their head. It took many many years to break even and some have not yet done it still.
  • Job loss means loss of two important things as well: Health insurance and Life insurance.
    • COBRA insurance premiums for a family of 4 can cost as much as $1900 per month
    • No job => no life insurance => no protection for family

What did I learn from these cycles?

The lessons I learnt can be broadly classified into the following points:

  • When you see excesses in the market, then it is a forewarning of an upcoming recession.
  • If your only source of income is shaky, then it is hard to take risks and benefit from the recession/bust cycle.
  • Big items (houses and cars) should always be purchased in a recession or bust period. A mistake make in either of the two can take years and years to recover from…especially the house.
  • Make yourself very valuable to your company….but at the same time, be prepared to interview for a job at any time

My plan for the next recession

An often heard sating is: Attack is the best form of defense. For the next recession, I plan to attack it with a goal to benefit from the recession, rather than take it lying down. Based on the lessons learnt from past recession cycles (previous section), here is the action plan I have implemented since April of last year.

  • Lesson: When you see excesses in the market, then it is a forewarning of an upcoming recession.
    • Action plan:
      • Watch for excesses in the market
    • Results:
      • I am already seeing the excesses in the housing market and luxury items.
      • Now, I am sure we are entering the first stage of a bust cycle.
  • Lesson: If your only source of income is shaky, then it is hard to benefit from the recession/bust cycle.
    • Action plan:
      • Create an emergency fund.
      • Develop passive income streams and take out the reliance on income from work
      • Remove reliance on life insurance from the place I work.
    • Results:
      • Starting last year, I have designed and implemented a Passive Income Plan
        • On average, it will pay me roughly $500 per month.
        • Of course, this is not enough to replace my income. But, it does take care of food expenses for the family.
      • I have a 12 month Emergency Fund to take care of any temporary loss of income
        • When the income source is shaky, it is hard to take a risk like buying a house.
        • But, if you can survive for a year without a source of income, the confidence to take a risk is very high.
        • Hence the one year emergency fund.
      • I bought Life Insurance coverage to protect my family.
        • Until last year, my life insurance was provided through my work.
        • But now, life insurance is independent of my work…so, even in a loss of income scenario, my family is protected.
  • Lesson: Big items (houses and cars) should always be purchased in a recession or bust period.
    • Action Plan:
      • Have patience to wait for the next recession to buy
      • Create a good down payment fund that is big enough to reduce the monthly payments
      • Learn how to evaluate a house
    • Results
      • The highest amount of pressure to buy a new car, a new house, etc comes from peer pressure. I can take it, but my family has a hard time dealing with it. I have managed to convince them to stick with my plan until now…they have sacrificed a lot over the last couple of years. Now, I have to deliver on the house at least in the next recession.
      • I have reduced my investments a bit to start accumulating $300 more per month into my home down payment fund. When the recession strikes, I will be ready with my home down payment.
      • I am learning how to evaluate a house for purchase by doing the following:
        • Watch home inspection videos on you tube
        • Watch how pricing is done by reading articles on the net and videos as well.
        • Watch how to not get fooled by real estate agents.
          • A staged house sends warning bells ringing in my ears now….
          • For example, I found a common trick of using undersized furniture (bed, chairs, etc) to make the room look bigger.
          • Damn…these real estate agents are good huh 🙂
  • Lesson: Make yourself very valuable to your company….but at the same time, be prepared to interview for a job at any time
    • Action Plan
      • Be rated near the top 20% in your company
      • Constant Preparation to make yourself ready to take a job interview on any day.
    • Results:
      • I have been working very hard to produce more things at work…but it has been slow digging. Likewise for my interview preparation.
      • But, now that I have plans in execution for all the other lessons, I will concentrate on this action plan for the rest of this year.

If you have read this far, then you really are a patient soul. Hope this info was useful in some way. Any tips you can share, please do leave a note in the comments section.

What is Financial Independence to me?

There are many definitions of Financial Independence out there is the web world. For example, “FUMoney”, Eary Retirement, etc etc. Each person who defined it was solving a problem in his/her life i.e. was trying to get free in some way. So, what does financial independence mean to me?

  1. Emergency Fund for 12 months of expenses
  2. Multiple Passive Income Streams that produce $50000 per year for years 50-70
  3. College Fund for my kid
  4. A retirement fund that covers 30 years of expenses for years 70-100
  5. A paid off roof for my family
  6. A $100K medical fund to help fix emergency health issues…not sure about insurance with preexisting health issues.
  7. Life Insurance to cover my family.

I am not sure if this is a realistic number yet….but this is a start. I hope to refine it over the next year or so when I have some more clarity on issues like housing.

Emergency Fund ($72K)

We live in the age of uncertainty in many areas and one of them is the source of income. I do not have super intelligence or super will power, but I sacrifice many things and work really hard. Inspite of that, I cannot say that I will never face a loss of income streams. So, this fund is there to take care of my worries for a while. $6000 pm for 12 months = $72K.

Details here.

College Fund for my kid ($80K)

College cost is soaring like crazy…looks like there is no end in sight. I wish I could fund the entire cost, but I am not sure I can. So, I have set a target of $20000 per year for 4 years of college. Anything more than this, the kid has to manage. I feel since we brought the kid into this world, it is our responsibility to build a proper foundation for our kid. A college fund is one part of the foundation. Maybe I will write another post about all the parts of the foundation I have planned to provide for my kid…..but that comes later.

Details here.

Multiple Passive Income Streams that produce $50000 per year ($1million Taxable account investments….for years 50-70)

Where I live, $4000 pm is an absolute necessity. A major portion of this expense is housing costs. A 2bed/2bath apartment costs around 2.5K to rent in a good school district. A mortgage for the same house will cost $4500 at least. If housing is taken care of, then $4000 pm will afford some luxuries like travel, etc. Else, this money would be necessary for basic living….sad, but true. Moving out of this area is not an option for me….my entire social circle is here and it is almost impossible to find such a set of good people anywhere else.

Details here.

A retirement fund that covers 30 years of expenses at $30000 per year ($900K Tax-advantaged account investments….for years 70-100)

I have been contributing to 401K over the past 14 years of working…but not much to show for this yet. I was not maxing out my 401K in the initial few years and the 2008 downturn wiped out a decent chunk. My current company does not match 401K. 401K has recovered a bit now but still way off target. PS: With my health issues, I realize that won’t live until 100…but running short for my family is not something I want.

One question to ask is: what is the difference between the passive income streams (yrs 50-70) and this retirement fund?

  • The first difference is the source of the money…taxable account vs tax advantaged accounts.
  • The second difference is that I want to give the tax advantaged accounts as much time as possible to accumulate and grow. If at all possible, I would like to not touch it until I hit year 70. After that the plan is to just take $30K out of it every year…which roughly works out to 3% withdraw rate. PS: Need to study issue of Required Minimum Distribution (RMD) from the 401k/IRA funds later.
  • The third difference is the type of investments. The money in the tax-advantaged accounts will be in target date funds..which get super conservative as the target date approaches. So, effectively, there will not be much growth for the money beyond the target date. But, the taxable account investments will continue to be invested in slightly more riskier and hence growth oriented vehicles so that there is some percentage of the portfolio that is geared towards growing the money.

The expectation is that a combination of the passive income streams and the retirement fund should provide a reasonably comfortable money pool for each month spent in retirement.

A paid off roof for my family ($850K $1millon)

This is one I am having most trouble with. In the past, I was unsure of taking on such a big commitment, especially due to many uncertainties in personal and professional life. Now, it seems like it is next to impossible, even with a more than reasonable down payment. I just don’t feel like paying a million dollars for a house that needs a million dollars worth of repairs. But, without this, I will surely not be financially independent. I do not have anyone else to rely on for housing…no parents or relatives. So, this is a must. I am hoping that when I reach a state where passive income streams are generating money to take care of basic necessities (say $1000 pm), I can take the plunge into housing…..which hopefully would have cooled a bit down by then.

A $100K medical fund to fix broken health issues.

I have accumulated some nasty health issues which need to be managed over the rest of my life. With uncertainties about health insurance for folks with preexisting conditions, I do not want to saddle my family with a huge medical bill. So, this fund should cover for any emergency health expenses. My current plan is that if the Emergency Fund is unused until retirement (touch wood), it will morph into a Health Fund for me. So, I am not going to work on this actively in the immediate future.

Life Insurance

There are few questions to answer when it comes to life insurance:

  • term life or whole life
  • how many years
  • policy value

I wanted to protect my family from any emergencies for my earning years i.e. until 65-70 years of age. I decided to go with Term Life Insurance and not Whole life. Apart from Whole life being a whole lot more expensive, the main reason for term life insurance is that by policy expiry time (65 or 70), I hope to have a reasonable financial plan for my family, even if I am not there. So, I have applied for term life insurance…the approval process took a long time but the policy has been approved! It costs me a packet every month…a bottomless pit…but, at least my family is covered until 70yrs of age.

Status at the start of the marathon called Financial Independence

07/25/2014        Emergency Fund                        100% complete

07/25/2014         College Fund                             29% complete

07/25/2014         Passive Income Streams            3.75% complete ($150 pm vs $4000 pm)

07/25/2014         Retirement Fund                        46% complete

07/25/2014         Roof for our family                     not yet

07/25/2014         Medical fund                              not yet

09/01/2014          Life Insurance                           100% complete