013, Mortgaging a House

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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.

Price Down Pmt % Down Term (yrs) # PMI Pmts Montly Pmt Total PMI Pd Total Int Paid Cost for House
$200,000.00 $10,000.00 5% 30 79 $1,592.98 $7,679.17 $149,698.07 $357,377.24
$200,000.00 $20,000.00 10% 30 71 $1,539.23 $5,325.00 $141,819.22 $347,144.22
$200,000.00 $30,000.00 15% 30 40 $1,485.40 $2,833.33 $133,940.37 $336,773.70
$200,000.00 $40,000.00 20% 30 0 $1,364.90 $0.00 $126,061.53 $326,061.53
$200,000.00 $10,000.00 5% 15 37 $2,086.49 $2,929.17 $68,666.11 $271,595.28
$200,000.00 $20,000.00 10% 15 26 $2,006.69 $1,950.00 $65,052.11 $267,002.11
$200,000.00 $30,000.00 15% 15 14 $1,926.89 $916.70 $61,438.10 $262,354.80
$200,000.00 $40,000.00 20% 15 0 $1,780.42 $0.00 $57,824.10 $257,824.10

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!

011, Enough Already

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.