Hopefully you noticed that my posts were less frequent lately. It’s true. The blog has taken a back seat for a over a week now. But I haven’t. I’ve been busy with preparing for a new grandchild.
Last week, the Mrs and I were on edge because the due date for the newest bundle of grandkid joy was on Wednesday of last week. We had prepared our work that we would leave at minutes notice and subsequently be out for a couple of days.
Well, that text came early Thursday morning. The water had broke and contractions started. So we hauled off for the 4 hour drive to be with the kids when the new grand baby arrived.
Clover Selah was born around 1030 am. Momma and baby girl are fine. She weighed in at 9.1 pounds and was 21″ long. That’s a keeper!
The Mrs and I spent 4 days down there to help where we can with getting Clover settled into the new world. Clover is grandkid #7.
So, that’s what we’ve been up to. What would PawPawFi be without the grandkids right? I mean the Paw Paw does come before the Fi part.
Hope all is well with y’all. If you have something you wanted me to cover, please let me know. I’ll get back to writing real soon.
When you don’t invest, you also loose all compounding interest you would have made from the investment. That doesn’t sound all that bad until you look at the numbers in detail. So, let’s look at this in more detail.
Let’s consider a $1,000 gift, a tax return, or just $1,000 you saved at some point in your life. If that money is blown, you not only don’t have the $1,000 from before, but you’d lose all the compounding interest. Still, that doesn’t seem like it’s enough for Average Joe to show restraint and invest in his retirement. So what right? It’s only a grand.
Twenty year old Average blew his $1,000 on a new couch and a great meal at some high dollar steak house. He’s young, working hard and deserved the best. He deserved to splurge with his new found extra money.
Twenty year old Smoking Joe, on the other hand, heeded advice he had heard that investing early is the surest way to maximize his money. So, he invested his $1,000 in a tax sheltered retirement account in a low cost mutual fund with a 10% return over the last 20 years and forgot about it. He never added any money to his investment.
What is the total impact at retirement? A lot. The compounding interest on investments has a massive effect over 20 and 40 years. So much so that at age 60, Smoking Joe could withdraw over $1,800 every year and theoretically never run out of money by implementing the 4% rule withdrawal model. The 4% rule will be covered in a later post. For now, just trust me that it works.
That $1,000 invested at age 20 is literally a $45,259.26 decision. At age 60, Average can’t even remember what his couch looked like. But Smoking on the other hand can buy 1.8 new couches every year if he wanted. That $1,000 is a big decision when looked at with the opportune cost model.
Now, fast forward just a decade. Average and Smoking were sitting at a park watching their kids play. Average said his old couch is 10 years old and he needs a new one. Average was bragging that he bought a good quality couch 10 years ago and it served him well. He went on to say how he had spent his $1,000 tax return on a brand new couch. Smoking commented that he invested a $1,000 tax return at the same time and it was doing fairly well. Curiosity got the best of Average and he had to ask Smoking how the investment did. Smoking pulled out his phone and showed him a the balance of $2,593.74.
Impressed with this, Average was determined to get in on some of this investing. He decided instead to invest $1,000 he had for the new couch immediately and nurse that couch a little longer until he could save up for a couch. So, that’s what he did.
Jump ahead another 10 years. Now Average and Smokey are sitting next to each other at a kids sporting event. Average was proud that he had followed his friend Smokey’s investing advice. Average was telling Smokey that his $1,000 had grown from that initial investment to $2,593.74 just as Smokey’s had done a decade earlier! Again curious, Average was curious about Smokey’s investment. So, again, Smokey pulled out his phone and showed Average his $1,000 had grown to $6,727.50.
This can go on and on, but I summarized how $1,000 will grow from age 20 to age 60 below in a chart. You can see that by delaying 10 years, Average’s investment would be only $17,449.40 versus Smokey’s $45,259.26. That 10 year delay for Average’s investment cost him more than half of what it could have been had he invested earlier.
The above examples shows the power of compounding interest. It’s a very powerful tool that you should take advantage of as soon as possible. The earlier the better in the long run. If you miss the early opportunities, you’ll have to put a lot more of your money away to have the same wealth that you would have if you invested earlier. A late start is still much better than not starting at all. So, don’t delay in getting started.
That $1,000 couch can cost you $45,259.26 in your retirement. Was it worth it?
So, we covered ratios in the last post. The focus of that post was to show you the basics of a ratio for buying a house. Now you know and understand the ratios that are recommended in relation to your income. You understand that the 20% recommended down payment is the minimum you should put down on a house. Let’s run through a few examples to show you the impacts of a few scenarios. Sometimes a picture is worth a lot of words. In this case, the picture will be a spreadsheet. Before we get started, here are some of the areas we’ll cover.
I ran all of the calculations through Mortgagecalculator.org. It has the most complete variables necessary to truly capture all of the costs. Be wary of the bank calculators that only show principle and interest. While that’s a big portion of your monthly rate, it’s not the whole picture. So, I’m going to lay out a few things in this post to help you truly capture the total costs you can expect.
First, there’s the purchase price. You may hear people say things like “I paid $200,000 for the house”. They are referring to the purchase price. By the end of this post, you will know the cost of the house will be much more than the purchase price… unless you pay in cash.
Then there’s the down payment. You’ll want to put 20% or more down on a house so you avoid paying PMI (Private Mortgage Insurance). Remember that’s where you get to pay for the bank’s insurance in case you don’t make good on your money. That 20% should be your minimum. You can put down as much more as you want.
Next comes taxes. You can’t get away from taxes. Taxes can be a considerable expense…especially in Texas, where I’m writing this post. What Texas loses in income tax, they make up for in property taxes.
You’ll also want to have insurance. This isn’t the PMI insurance. This is the homeowner’s insurance that you pay for things like a hail storm that trashes your roof, fence, etc. The bank will require you to have insurance if you finance. If you pay in cash, it’s a good idea to pay just to protect your home from an unexpected diseaster.
What we’ve covered above is referred to as PMTI. PITI is simply Principle, Interest, Taxes and Insurance. Everyone will pay those when financing a home. But don’t forget or confuse PITI with PMI. Remember PMI is that insurance for the bank that you get to pay. So, the total monthly cost will be PMTI plus PMI. The less you put down the more PMI’s cost goes up.
In order to show the differences in PMTI plus PMI, I’ll set a few variables so you can see the impact of the changes. I’ll also randomly choose Grand Prairie, Tx as our city of choice to nail down the exact taxes for a property. Limiting the variables should help you see the long term impacts to your finances for the choices you make.
The house will be a $200,000 house in Grand Prairie, Tx. The interest rate is going to be set to 4.33% which is fairly close to the current rate. Your rate will likely vary somewhat based on down payment and your credit score. So, 4.33% is good for illustration purposes. The property taxes for Grand Prairie are 2.921736% of your home value or $5,843.47 every year. That amount will be divided by twelve and added to your monthly payment. Homeowner’s insurance is set at $1,000 per year. Again this will be broken down and spread across your monthly payments. The three scenarios will be putting 5%, 10%, 20% down for your down payment. The Term will also be either a 30 year or 15 year fixed rate mortgage.
# PMI Pmts
Total PMI Pd
Total Int Paid
Cost for House
Take a good look at the chart. Study it for a bit and see if you can find the Big Rocks.
The first thing I see is that the final cost for the house could be anywhere from $257,824.10 to $357,377.24. So, depending on how you set up financing for your house, you could pay a lot more. Maybe this would help with some perspective on just how much that is. Let’s say you make $57,000 per year. If you are inefficient you would work for more than 3 years just to pay for the interest and PMI if you put minimal down and finance for 30 years. You’d only have to work for one year to pay for the interest if you put 20% down and got a 15 year mortgage.
The second thing I see is that by far, the biggest difference in what you pay in interest is determined by the length of financing. The longer you finance, the more you pay in interest. Many folks say that they will finance for 30 years and pay early. Statistically, they don’t though. So, if you are in that small percentage, you’re likely not. I tried that and didn’t do well. It wasn’t until I locked myself into the 15 year mortgage that I actually stuck to it.
The last thing I see is more of a reflection. Being in the military, I’ve never truly owned any houses. I mortgaged them. So, I’ve pretty much have been paying interest for most of my adult life. While I did make money on every house I’ve mortgaged, it was done through improvements, etc. I’ve never run the numbers, but I’d be lucky to break even considering all the interest I paid. I wonder if I would have come out cheaper if I only rented and paid cash for a house.
So, as you can see from the chart above, there’s a lot of ways you can buy a house. This post points out a few different ways and for many different lengths of time. Use this information and the thoughts to do it as efficiently as you possible can. In just this one example, it could mean you save about $100,000. What can you do with $100,000????
You now have the tools to make an efficient decision. Don’t be Average!
What’s in a number? A number standing alone is meaningless. Especially in personal finance. Something like $10,000 without comparing it to other factors is surrounding the number is just an amount of money. If that $10,000 is buying someone’s car outright with cash for someone who makes $30,000 a year, it’s a significant amount to that person. That same $10,000 paid as a down payment on someone’s $250,000 Bugatti sports car who is making $5,000,000 per year is less significant in that person’s personal finance. That $10,000 is hardly anything compared to the $5,000,000 annual income. But someone who’s buying a $100,000 car outright with cash for someone making $300,000 per year, the financial impact is exactly the same as the first person buying the $10,000 car in the first example. The ratio is what matters in these examples.
We started to touched on Ratios a little bit in the last Post with Warren Buffet’s house. In that example we were comparing his home’s value to his net worth as a percentage. His house is really a very, very small part of his net worth. This post will look at important financial ratios that banks, landlords, and many other people who try to manage personal finance.
Since several of the readers have asked about buying a house in the near future, we’ll cover a few ratios for buying a house. I first heard of a ratio for buying a house when I purchased my first house. During the application process, the loan officer informed me that I could get a loan for up to 28% of my income for the house. But there was a caveat. The total of all my debt could not be more than 32% of my income. Since I was an Average person, I had more than 4% (32% – 28%) in consumer debt. This limited my first home to less than the standard 28%. I don’t remember exactly what the numbers were at the time. The point is that I had a lot of credit card debt and it effected my loan to buy my house. That was one of the earliest wake up calls that I may be in trouble. So, I started tracking these ratios periodically.
I’ve never really thought about that ratio for several years now. While writing for this Blog, I’ve noticed these ratios have changed! They haven’t changed for the better either. The newer ratios are 28% for your house and 36% for the total debt ratio. While that may seem better, it’s not. This is not in your best interest at all. Here’s why I don’t agree with the ratio.
The 28/36 ratio allows for 4% more than the old ratio. That’s a 100% (4% to 8%) increase in consumer deb! So what they are doing is allowing you to charge more depreciating assets! They haven’t increased from 28% for the generally appreciating asset called your house. Not that I’m a fan of financing to the maximum, but the above shows where the banks interests are focused. What they did was basically allowed for the Average consumer to borrow more money for the highest interest rate category. That means they make more money and you lose more money to interest.
So, you loose the flexibility to use that second 4% that you could put towards an emergency fund, for food, or for investing. You are also loosing the opportunity cost of that 4% compounded over the years if you invest it in your retirement. That’s worth you seriously considering before you decide to max out how much you can borrow on a house and credit cards. Let me say it again: That’s worth you seriously considering before you decide to max out how much you can borrow on a house and credit cards. The old 28/32 ratio was hard enough to recover. The 28/36 ratio would be much harder. So, don’t be Average and max out your credit. Live below your means and invest the remainder in your future.
By now, most of you by now have read about how much credit can cost you. You know to avoid it on depreciating assets. Assets that don’t appreciate in value or provide income should never be financed. So, when buying a house, don’t forget that wasting money on depreciating assets can really mess up your chances to minimize your interest costs. Remember all numbers in relation to your objectives of financial independence. Don’t get caught up in the Average American dream of owning a house at the expense of your financial future.
Maxing out your credit to purchase a house will significantly hinder your ability to save for your future. It will strap you for cash and for emergencies if you don’t have those in place before you finance a house. So, before you even consider buying a house make sure you have a fully funded emergency fund and an appropriate down payment.
Why is the down payment of 20% or more stressed by so many financial people? Because of two major reasons. Fist, it shows the mortgage company that you have skin in the game. You have 20% equity, so the bank has less risk. You are more likely to pay on time and not walk away leaving the bank with a house. They are not in the house buying business. They reward you for this by giving you a favorable interest rate. So, you’ll be financing less and at a lower interest rate. Over the life of your loan, the reduced financed amount and the lower interest rate will be a significantly less amount you pay to the banks.
Secondly, you won’t have to pay for Private Mortgage Insurance or PMI. PMI is insurance that the bank makes you pay for to insure that they actually get the money back that they lent you. That’s right, they make you pay insurance for them! You get absolutely no value for this either. So, you are losing money here too. In most instances, 20% down will eliminate this PMI. PMI increases with the cost of your house. More expensive house will require a more expensive PMI payment. So, just save at least until you get the 20% down to avoid throwing this money away by paying for the bank’s insurance for your home loan. Don’t do it. If you can’t afford this 20% down, wait until you can.
So, don’t be Average. Learn your financial ratios so you get a better picture of your major purchases such as a house.
How much is enough? Since a home and vehicles can be such a large part of your expenses, especially when you are young, let’s address that first. You surely don’t need the excessive stuff above. You may want it, but you don’t need it.
How much house is enough? Warren Buffet is a extremely rich guy. If you don’t know him, take a few minutes on google and check him out. He lives in house that’s .001 Percent of his Net Worth. Think about that for a second to let it sink in. For some perspective, if your net worth was $1,000,000 your house would be $10 ($1,000,000 X .00001). Yep, that’s ten dollars. The $10 represents how difficult it would be to purchase the house from your cash or investments. This house he bought in the 1950s is an insignificant part of his wealth. He could afford a way more expensive house if he wanted. He’s said he’s happy where he lives. If he felt he could be happier in another house, he would move. But he’s content. There’s no need for him to spend any more to chase a bigger house to keep up with others. He has what he needs and wants.
Granted, he’s worth $60-80 billion, so he’d need a massive house to even begin to approach 1% of his net worth. But that’s not the point necessarily. When you have enough, you don’t need more. When you are content, you don’t need more. When you are happy, you don’t need more. That’s my point.
You’ve often heard things like “your home is your biggest investment”. While your house is an appreciating asset, it doesn’t generate any income. Money is tied up in your house where you can’t spend it or truly invest it. Practically, that means that if your home is your biggest investment, more than half of your net worth isn’t going to generate income. Having that much of your net worth inaccessible and tied up means that you can’t spend it. It also means that it’s not generating income. So, you’ll have to work longer to build assets that can actually generate cash either now or in retirement. That’s the classic house rich, money poor scenario. You have an expensive house, but you don’t have much money for other things like properly investing for your future. Being house rich can severely limit your flexibility to get ahead financially.
This is really amplified when you are young. Your young years can have the most impact on your wealth in retirement when you invest efficiently. When you neglect your retirement in your early years, it’s much harder to catch up due to the time that has passed. The compounding interest from these early years really help to build up an investment nest egg of investments to carry you through your retirement years. Don’t become house rich and cash poor.
Here’s a great article looking at home ownership in total. Avoid the Dream House Trap. It talks about how an expensive house can strap you with large expenses. Those expenses, if not properly balanced against your income, will be felt financially a lot more. It will limit your ability to have flexibility to properly invest in other income generating assets to help you through retirement. The Average people in America frequently overlook how a house can trap you in the rat race just to stay afloat.
You need a roof over your head to shelter yourself from the elements. People do live in grass huts, modest homes and mansions. They all provide the basic requirements of shelter to keep you alive. People are also happy in each of those examples. Each example is also more costly. Grass huts are cheap, modest homes are reasonable, and mansions are extremely expensive. So, choose your housing carefully without overestimating your needs.
Next, let’s talk about cars. We’ve touched on those before. This is likely the second biggest expense that can cost lots of money if not done smartly. Since I’ve been into Choose FI a lot lately, here is an article about new cars and here’s a podcast if you listen to those. The bottom line is that your transportation costs can eat up quite a bit of your income.
Over the course of your, at least 40 years of driving, decisions you make can literally cost you hundreds of thousands of dollars if you are not wise in your choices. Those hundreds of thousands of dollars can either boost your income during retirement or drag you down. The choice is yours. If you haven’t read my article about the brand new car I bought, please go back and read my post. Buying a new car was not a good financial move for me.
You do need transportation. Most will drive cars or trucks versus mopeds or bicycles. Just as in houses, the choices vary widely. They will impact your finances one way or another. Make well informed decision on how your choices will impact your finances. A cheap used car can get you from point A to point B just as well as a brand new high dollar sports car. So, it’s truly up to you which path you choose. Choose wisely and position yourself for success in retirement.
These two major expenses can make or break your finances in the long run. They are the Big Rocks. So, make wise decisions based on facts and solid information that will meet your financial goals. Don’t overestimate your needs and max out your wants. Find the sweet spot that can work for you. If you have to have the cat’s pajamas, you’ll pay more for things at the expense of your financial security in your later years.
Make finding contentment a goal with whatever you have.
In the beginning of 2017, my wife was diagnosed with a brain tumor about the size of a walnut. It was located behind her left eye, approximately two inches deep from her temple. Luckily, she wasn’t having strokes, seizures, balancing problems, vision problems, or significant pain. She was literally experiencing only a very slight toothache that the dentist and doctors couldn’t diagnose or make go away. I’m convinced that having the proper insurance helped save her life and her functioning as a whole and happy person. Keep reading, it gets better…
She tried antibiotics, nerve medications, expensive dental x-rays, acupuncture… all to no avail. Something told her to continue to pursue the slight, single toothache. Most people, including myself, would likely just have given up and lived with it. But she stuck to it and I’m sure glad she did! She continued to see our general physician after the dentist was convinced the tooth was not the issue. Our doctor suspected that something may be going on with her Trigeminal Nerve, prompting him to prescribe a CT scan. My wife called me at work the next day telling me that two masses had been found on the CT scan. This began our introduction to the world of neurologists and neurosurgeons.
The journey began with seeing a neurologist who immediately referred us to a neurosurgeon. The neurosurgeon quickly ordered an MRI and then an MRI with contrast. When all was reviewed, he said she needed to have surgery on the tumor that was attaching itself to the trigeminal nerve (thus the tooth ache) and that he could perform the surgery. Not being what she wanted to hear, we agreed on getting second opinion. We met with another brain surgeon at one of the most recognized brain surgery centers in Dallas. Again, a very experienced neurosurgeon said she needed surgery and he could do it. She still was looking for the answer she wanted…no surgery. By this time we asked a friend who had actually had successful brain surgery years ago for his brain surgeon’s information. When we met with this neurosurgeon, he said he agreed that she needed surgery, but refused to do it because it was located in too difficult of an area. He told us she needed a specialist! Who knew? I thought all neurosurgeons were “special.” She needed a true specialist in skull based surgery. He recommended two doctors in the Dallas area. However, we also researched others throughout the country.
Thanks to a couple of people we met who had gone through similar “complicated” brain surgeries, we chose the best skull based brain surgeon in Dallas – one of the two the doctor had recommended. This guy only takes on the most difficult cases. (That’s four brain surgery consultations if you are counting.)
We continued with many MRIs in order to get “more slices” in the MRI and, of course, more consulting with our chosen special surgeon. Within a few weeks, surgery was scheduled. The 10 hour surgery was, thank God, successful and she was on the long road to recovery!
What followed were more MRIs, more doctor appointments, checkups, staple removals, meds, etc. Today, I’m happy to report that she’s recovered and doing well. The tumor was benign too! (The secondary tumor is currently behaving itself. Prayers appreciated.) It has definitely been a long ride back to health.
One thing I haven’t brought up in this post so far was costs. With me being retired military, along with having great insurance through my employer, the costs were never really a concern. My primary insurer had no deductible and a $6,000 catastrophic cap for out of network coverage. It was only $3,000 if we stayed in network. My Tricare insurance from the military would also cover part of that expense if any was remaining. That was well within our emergency fund’s capacity. If there ever was an emergency, this was it.
This knowledge that our financial risks were very limited allowed us the freedom to get the best care available. We were able to get multiple opinions and consultations without giving it a second thought. We were able to have the necessary MRIs for proper diagnosis and a successful surgery. We were able to go to all the follow up appointments. Cost just wasn’t an issue and never got in the way of the best care available.
I’m also convinced that if one of the other non-specialist brain surgeons would have done the surgery, she would be plagued with complications from the involved surgery. Where this tumor was located required a team of specialists to ensure the best possible outcome, not just a confident brain surgeon. Sure, they could have gotten the tumor out, but at what cost to her brain and surrounding nerves? We’ll never know because we were able to choose the absolute best.
The total cost for my wife’s brain surgery was just over $500,000. Early on in this process, we reviewed our policies to ensure what our financial exposure limit would be. We reviewed this against our emergency fund. It was well within our means to only pursue the best. This wasn’t a coincidence. We had made decisions long before to set us up to be in this position. We chose wisely on the insurance coverage and types we needed to get quality care.
We could have gone the cheap route and only used Tricare and a cheap supplement versus full medical insurance from my employer. But then, life or death decisions could be influenced by the financial impact at the expense of excellent care. We could have been forced to go to only “approved” doctors. That’s something that we were not willing to sacrifice.
Having adequate and appropriate insurance allowed us to pursue a long journey to a happy ending.
I was excited about going to the beach, but kids take it a couple of levels up! The grandson woke up this morning and was doing his “going to the beach dance” at 0630!
Before noon, he settled down on the road trip.
We had a blast once we actually made it to the beach in Port Aransas. I didn’t realize that I would be able to drive the truck on the beach. It’s really a big benefit when you have a family. We had shade all day.
The PawPaw next to us and his son built this awesome sand castle. He even shared some of his secrets on his building techniques with us.
Little man was kind of worn out, but couldn’t go to sleep last night. He didn’t want to miss anything.
Now, I’m all set up for another fun filled day at the beach. I got out here to watch the sun rise and stake a claim on the primo spot. Another grandson met us down here yesterday. I now know why they call grand kids “grand”. They really are a lot of fun. We’re going to have a grand day today!
The master was holding class today!
Building sand castles makes you hungry! The boys are putting down some PB&J sandwiches.
The finished product! The kids got bored and hot, but the master endured.