Posted in Personal finance, Spending

Good Buy or Good bye a house purchase

I had been thinking of upgrading to a bigger house for some time now. This is a difficult decision when you struggle to justify more debt, more wants and lifestyle creeps.

There are various factors to consider in deciding whether you buy that next dream house or say goodbye to your wants for a duration, till you are better prepared.

There are two aspects to this –

  • a numerical analysis
  • a behavioral analysis

Numerical Analysis

white graphing paper

What can you afford?

It is definitely not what the lender tells you in a pre-qualification or pre-approval letter.

You have to see the following numerical aspects in your finances.

  • Do you have cash for down payment? Usually 10-20% of the purchase price is a good thumb rule. 20% is better to avoid Private Mortgage Insurance, which will increase the monthly payment otherwise.
  • Add the mortgage payment to other costs like Property Taxes and Insurance.
  • Are there any up-front rehab costs? Can you get those repaired by the seller?
  • After adding up all costs, adjust your monthly budget to see where you will stand once you buy this house.
  • See the impact to your net worth and asset allocation once you spend the cash for down payment. Although it moves from cash to Home Equity, it can skew a previously well thought out asset allocation across stocks, bonds, real estate and cash.

What should you pay?

There are two main items where you have to shop around and get the best deals out there.

  • Purchase price. Since here we are dealing with numbers, the only thing that matters is whether you are paying too much.

    • List price offer or a multiple offer situation can quickly escalate the price and throw all deals out of the window.
    • Assess what all rehab needs to be done. It is better to get a contractor estimate during the inspection period, so that you can back out if found expensive.
    • Try to buy 10-20% below the price after subtracting any projected rehab expense.
  • Interest rates – This will depend on your credit score and the interest rates available in the market.

    • Getting estimates from various lenders will help compare the best rates.
    • Take into account closing costs and points as these can be significant and varies quite a lot across lenders.

What are the future costs?

A house purchase does not end with the closing. In fact, in terms of expenses it has just started.

Many people take on big house purchases only to realize later that the recurring costs or the holding costs of the property are too high and severely constraint their finances.

  • Holding costs

    • After you have accounted for the P.I.T.I (Principal, Interest, Taxes and Insurance), you need to make sure you still have enough slack in your budget to save for unforeseen expenses.
    • You need to have a cash cushion (preferably separate from your 3-6 months worth of emergency fund) for this property. The HVAC can go bust, the roof may get damaged in the next storm or there could be a disastrous water damage.
    • You also need to consider increase in Property Taxes and Insurance year after year.
    • To correctly account for the holding costs, you need to budget an amount every month and sock it away in the Home Maintenance Fund.
  • Future sale or rent value

    • No one stays in the house forever. You will also move at some point.
    • It is important to decide how you project the use of this house once you move out. Do you plan to convert it to a rental or sell it?
    • Decide on a tentative time frame when you may move out. Based on this and the neighborhood real estate projections, find out what the future sale value or rent will be.
    • Will the rent cover all the P.I.T.I expenses per month? Add a few more expenses like reserves for maintenance, capital expenditures (big expenses like roof),  property manager (whether you use or not, just budget for it). To effectively analyze this, learn about Cap rates, Gross rent value etc.
    • If you plan to sell it, will the appreciation rate be enough to justify your costs, with a sale commission of 6% and all the money you will spend on Property Taxes, Insurance and upkeep of the house over the years.

After you can define a good deal by satisfying most (if not all) of the above parameters, it is time to take stock of some behavior patterns.

Behavioral Analysis

woman wearing white dress standing near building

Do you really need to upgrade? What are you going to sacrifice?

Often it is our wants that itch us constantly to make that lifestyle upgrade. Whether it is keeping up with the Joneses or simply growing out of your current residence, it is a natural behavior trait for most people.

Answering the following questions may steer you to a better decision.

What is the motivation? A better neighborhood, schools or simply more space?

What exactly is the motivation? Is it due to moving to a better neighborhood, or moving to a better school zone? Or is it that the family grew and everyone needs more space?

This should be evaluated purely on basis of needs. For example, for more space can you rearrange or sell off unnecessary furniture and create more space in the process?

How will you clean and maintain the bigger house?

While buying a bigger house sounds exciting, think about maintenance. A bigger house brings in more maintenance headache. And we are not talking about money expenses here (we did that in the numbers section), but the overall energy you will need to keep it clean, mow the lawn and maintain the appliances, carpet etc.

Do you like more debt or want to manage debt?

For most people, buying a house with cash is not an option. So invariably you will take up a larger mortgage, whether you have one currently or not. Overall your debt increases. This has to be justified by the future stability of your job or the state of the industry or business you are dependent on. Or simply the peace of mind and how much debt will still keep you comfortable.

Is this going to be your long term buy?

If you buy a house (not an investor deal) and turn around to sell it, you will lose a bunch of money. Even after few years, it is difficult to break even. So if you are not staying in the house for longer, it will be another expensive switch few years down the line.

Thus it is better to justify all the needs and factors and make sure it will be a long term buy.

Can you rent first and then check out similar homes in the area?

Often the reason could be to just move to a better neighborhood for schools, or get more space. However instead of finalizing a buy, you can always rent a house in the desired area and then check out better deals as they hit the market.

This has the disadvantage of spending some money on rent, but in this section we are analyzing non-numerical aspects. Renting for a year or two will give better idea of the neighborhood, bigger house etc. and better justify the buy decision for a longer term.

Conclusion

All the above factors may seem daunting and may not be possible to satisfy to make a rational decision.

Some of the factors like rent to value ratio can be area specific. If your area is very expensive, then some of the numerical analysis will not give favorable results.

Hence it is important to consider other factors and take an overall informed decision.

This will also prevent the almost inevitable buyer remorse which is very common as you inch towards the closing date.

Once you take a decision, enjoy your mansion.

concrete building surrounded with flowers near roadway
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Posted in Personal finance

Beware of ripoffs

Everyone does financial mistakes, some large some small.

The personal finance industry is designed to chase you for your money, for obvious reasons. The people working in this industry has to make a living and profit. Nothing wrong with it, however there are some unscrupulous greedy professionals and companies who will siphon off your money before you realize what happened.

I too have been a victim of such tactics, where that sinking feeling is unavoidable once you realize you have been swindled. You vacillate between blaming yourself for being careless to simply justifying as how would I know.

I have made other stupid mistakes many times, thankfully most of them were small.

Here are 2 big ones which I will remember throughout my life, and hopefully draw some lessons not to repeat the same.

Insurance masquerading as investment

In 2005, when I started my journey of personal finance (I was earning for 8 years with no savings/investment), I decided to open an investment account with one of the big international banks in India. They had what was called a “Wealth Management” division that would help me all the way in opening an account to choosing my investments. What a convenience! I just had to commit a specific amount to be invested by a certain time, either through a lump sum or regular investment.

So I met with what they call a Relationship Manager. The lady came to my home to advise me, suggested some good mutual funds (I later researched they were decent performing ones) and setup an investment account. I was thrilled and excited to start my first investment, and then came the unsuspecting pitch.

She told me investments in mutual funds are risky, so alongside I should also invest in something very stable with tax-free and better returns than a CD. Diversification, Tax-free and stability all sounded perfect music to my ears, and I resonated to her plan. What followed next was I signed up for a so called U.L.I.P (Unit Linked Insurance Plan or Cash value life insurance).

So far so good, only couple of years later I inquired about the fund value or the surrender charges. By this time, I started reading about charges and commissions on financial products. To my utter disbelief, the product I signed up for (which seemed perfect then) had a special charge of 60% of my first year’s premium. They called it the Premium Allocation Charge. Wow!! Why would you charge to allocate my money? and 60%?

Even robbery at gunpoint would have sounded harmless in comparison. 🙂

That was my first big ripoff, I eventually bailed out of it few years later by minimizing my loss. In the subsequent years, the I.R.D.A (Insurance Regulatory and Development Authority of India) realized this dishonest practice by insurance companies and their agents, and reduced the charges to more like 4-6% and now it is clearly documented in brochures and illustrations.

Lesson: Do not mix investments with insurance. Insurance companies have no edge over low cost mutual funds. If there is a guarantee of principal, the returns are paltry and most of the profits are distributed to their agents. For insurance, term plan has no better substitute.

Fact check: In later years, I came across a relative who was selling such products. He told me agents who perform well are rewarded with paid for vacations to destinations in Europe. No wonder where 60% of my first premium went. 

Real estate bought wrong

Real estate is a high return, high risk product. Even when you are buying a home, you have to be knowledgeable in every step of the process, guard yourself against potential rip-offs. Everyone you come into contact is trying to make big bucks (and very quickly) in that industry.

My share of stupidity in this area is huge.

I bought my second home (condo) in India from a new builder, but who was also very well known to me. His claim to fame was honest communication, promised execution, good discounted price and quality of construction. The deal was really a good one, from both price and quality.

As things progressed (the development cycle was for 3 years), I became confident and  upgraded to a bigger sized condo. As the earlier one was not delivered, it was an arrangement to switch the contract to the new one and I would be paying the difference.

It was like upgrading to business class from the economy class, by paying the fare difference. Except that it was not such a smooth ride. 

The blunder I did was not to insist in a new contract being signed immediately and the title of holding the new condo to be defined. Since the builder was known to me personally, I somehow gave the benefit of trust and waited patiently for him to switch the contract. Meanwhile as the payment system demanded from his office, I continued making the scheduled payments up to almost 90% of all dues.

A year down the line, things went south for this builder and I realized that something is wrong. On digging further, it came out that the new condo was not approved in the building plan and cannot have a regular title yet. Just to clarify, there is no Title insurance or Title company in India. Usually the transactions are directly between buyer and seller (or builder) with an optional broker mediating in between.

It took me the next couple of years to untangle the mess, and I lost a huge amount of money and mental peace in getting the title legitimized.

Lesson: Know the process and only thing you trust is the paperwork. Do not take any verbal assurances. In the above incident, I had only myself to blame for the stupidity. 

Fact check: I later came to know it was a deliberate lie (while selling the unit to me and in my follow-ups) by the person (builder) I knew very closely for years. Trust no one. 

So those are the two biggest financial suicides I signed up for.

crime scene do not cross signage
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