bostonbubble.com

[GenXer]

CL: This is exactly what some people are doing, but this doesn't work for everybody. Some people literally need to be told what to do - otherwise they will end up doing the wrong things.

[john p]

GenXer:

What I'm saying regarding the 401k is that you don't use it for the down payment but count on it for an emergency fund. Please plug in what you'd use for inputs. Thanks again...

For example:

Assume household income of $125k (2 earners, almost equal pay, both in early 30's) no kids yet.

Family ready to purchase a house for $400k. This type of house was selling for about $500k in 2005.

Down payment of $40k (10% down payment).

Emergency Fund of $35k in a cash equivalent account.

About $65K combined in 401K's. Jobs are somewhat secure but this market is a wildcard for everyone.

Home Inspection Report unveils $15K of work that needs to be done in the next few years and the wife wants to spend about $15K to personalize the home.

This is what I consider to be a typical scenario.

Could you critique this situation and in doing so, try to remain realistic with respect to the amounts a typical family would have i.e. people in their early 30's don't typically have $100k of walking around cash... I'm just asking should a family be able to say that I have an ok emergency fund for the probable, but if the shit really hits the fan, I can tap my 401k.

I have a feeling that your global answer is to RENT, but if you were to consider buying, could you plug in the inputs that you think are right?

[Boston ITer]

[Chee]

John p.
We were like this typical couple, but didn't buy a $400K house.
Now we have 2 babies and I am not working, so our household income decreased.
We have enough for a 20% down payment with enough savings left over to live for 2 years.
We don't feel comfortable taking on that amount of debt.
Even I return to a full time job, then we will have to spend a lot money for the daycare and transportation (MBTA and parking).
People like us should really buy something around $200K.
But there is no such house around Boston, because people are calculating like you and never make kids or being a house poor.
I see houses less than 400k but they are either in a bad area or total dumps that will need a lot of repair work.

[CL]

Boston ITer - the reason to save 200K is to put 100K into housing and 100K into cash/cash equivalent. I think people needs to maintain certain amount of financial flexibility before committing to a big mortgage, exactly to survive in situations you described.

Chee - well done for not over-extending your finance.

[GenXer]

john_p: 401k money is not emergency money. Its your retirement money. If you can't save enough for retirement because you had to use it in an emergency, well, you just blew it. The cash you save, an affordable house price, a big downpayment and your 401k are all part of an overall risk management plan. No reason to cut corners. Just make a better plan. So don't go to Europe with the kids every year for a couple of years. People are into instant or near-instant gratification. It doesn't have to be this way.

Chee: And neither do you want to buy anything with 1 income on the line. Unless you did so a long time ago, it would be a terrible idea right now because of a huge risk involved if your husband's job gets cut. Why subject yourself to this real risk? You can easily rent a 3-bedroom with 2 kids anywhere in the area.

This is the way I'd rank different savings components:
1) Emergency cash (~$100k, more if you have a big family, already own a house or have a business). This works out to be about two years worth of expenses for most people.
2) Retirement savings (bare minimum is $20k a year for 35 years is a good ballpark for a 30 year old, but definitely more if you are older)
3) Various expense accounts - new car, downpayment (different from emergency savings), house expenses, other types of expenses that can be predicted

So its not enough to have emergency savings - if you are not contributing to your 401k/IRAs you are only delaying the inevitable.

[CL]

I agree with GenXer - using 401K for emergency is something you should do only as absolutely last resort. It's better than bankruptcy, for sure, but in a sense using 401K for emergency is similar to using credit card for emergency. It gives you instant liquidity at a very high cost and you need to pay back in future anyway.

And I totally agree with the instant gratification issue.[/u]

[john p]

Guys, regarding the 401k, what I'm saying isn't use the 401k as an ATM.

I'm saying that a person puts down 10% to get a more favorable rate, has an EMERGENCY FUND OF $35K and if the SHIT REALLY HITS THE FAN (AS A LAST RESORT), use the 401k.

If what GenXer says is the way it ought to be, people won't be buying homes until they are in their early to mid 40's. Buying a home in cash is unrealistic to 97 percent of people. If GenXer's clients that he advises are in the top 3% then fine, but does this financial genius have any practical applications for the rest of us?

Hell, what I'm saying: 10 percent down and a $35k emergency fund is more than what 90 percent of first time buyers have.....

People will be tapping their 401k's this year and it is a last resort. In case you haven't noticed, this is the worst recession since the Great Depression. GenXer is knowledgeable and I want to pick his brain regarding those that are in this scenario. To many the shit has hit the fan and the emergency funds have been depleted. People planned to weather a 50 year storm and we got hit with a 100 year storm.

[GenXer]

Actually, most of my clients are no different from the posters on this forum. However, beause they are in different stages of planning, I have a unique insight into what works and what doesn't. So in fact, my clients are teaching me about what works and what doesn't.

Let's refreame this whole discussion. The point is NOT only to survive a recession intact without losing your house, but it is to thrive and become financially independent at some point in your career, rather than subsist on the handouts from the government. At least, I see this as my mission as an adviser.

So in fact, if you are NOT able to hit the goals I outlined previously, this says something about your priorities. A house is not a priority. Retirement savings is. You can live without having a house. You can not become financialy independent without funding your own retirement income.

Most people who wasted lots of money on very expensive houses will find out too late that they can't afford to retire. Same thing happens when people spend $50k a year on each of the 2 kids for 4 years for a liberal arts degree. It doesn't take a genius to see this, but this is exactly what people are doing. House + college is the biggest drain on most people, and it is enough to land them on Social Security.

As far as john's question, I don't believe there is such a thing as good enough, for a simple reason. We DON'T KNOW how much is enough! We never do. That is why I prefer to oversave than undersave. Knowning the kinds of expenses that one can incur (and the more wealth you have, the MORE your losses can be), it is only prudent to buy yourself this extra layer of wealth insurance.

[CL]

GenXer - I have to admit I like your post more and more. Fully agree people generally overspend on education and undersave on retirement.

Which is also the #1 reason why if you do buy a house, make sure you are comfortable with the WHOLE school system (not just elementary schools) and prepare to send your kids their all the way to public high school.

The only thing I will add is I agree with John P that buying home with all cash is unrealistic to a lot of people. A lot of Asian friends I know actually did that, though they end up buying starter home at first which may or may not be wise. Of course it's good to be debt free, but short of that, I think it's fine to have mortgage as long as you have a safe, flexible and realistic game plan to manage the debt load.

John P - I think 35K emergency cash is a tad low. It probably cannot (or just barely) cover 1 year of expense.

[GenXer]

CL: This was just a 'risk management' argument - you are definitely right that unless one gets an inheritance, it may be impossible to buy a house with cash. Yet, if you are making $100k, you probably shouldn't buy a house more expensive than $300k, so it is not unreasonable to pay down at least 30% of it ending up with a small mortgage.

The problem is, risks are hidden, and just because nothing happened to you or your friends yet doesn't mean it won't. Deciding which risks are worth worrying about is an issue worth considering.

It may be that one ends up buying a house at age 40 - well, so be it. Maybe you will have more time to spend with kids until then - housework takes way too much time.

[john p]

Sorry to push you guys on this point but what you're saying is kind of important.

During the bubble people didn't see the need for an emergency fund, the home appreciation was a MUCH safer bet than the stock market in many minds. People didn't think about the leveraged risk.

Today, not only banks are playing it more conservative, so too are new buyers. They have the bejeezus scared out of them and they won't make any moves unless they are insulated with a ton of money and their retirement prospects are secure. The prerequsites to buying are so high that it is going to significantly reduce the number of buyers out there. I pressed on the 401k point because if you guys weren't putting that in a lock box, I'd factor more activity with people on the sidelines.

Guys model out in your minds how this will play out if your approach becomes the main stream thinking. Also Boston IT'er's notion of equating prosperity with flexibility and it really is a game changer with the place of real estate in ones lives.

There is a lot of pent up demand. There are people who have been renting for years now and they want to get into a property bad. Just the $8k Stimulus deal was enough to bump up the sales, even with a head wind of unemployment.

The promise that delayed gratification pays off I really hope works out for you. I hate to see responsible people people lose out. So let me ask you this, if you're making retirement your number one priority, where are you putting your money and how is putting it there any different than in a house? Also, if everyone decides to rent, what do you think the rents will be like in 30 years when you're still paying rent and someone else has paid their last mortgage payment? Currently, people who have a small nest egg often have a house that is paid off so their main expenses are property taxes, property repair and basic utilities.

I think the bottom line is inflation. I think that somewhere in the next five to ten years we'll have a big wage inflation and my 4 bedroom house's mortgage will be cheaper than a 2 bedroom apartment. I say this because wage inflation is the only way things will balance our problems. If people become financially bonded and can't buy anything, our only recourse is to devalue our currency to devalue our debt. The debtors and people like GenXer won't like it because they have held up their end of the bargain, but in a democracy, the majority wins and often times the responsible get screwed. Herd mentality is where it is at. The herd basically says screw, I'm not going to pay and what are you going to do about it? You and what army? Obama owns the Army and his his people are the ones that are up to their ears in debt so who do you think he's going to come down on the side of?

I think you guys are the bedrock in our society, I'm just warning you to keep your eye on government interaction. Justice isn't the "priority" of a democracy when they are hungry, even if their hunger is a self created hardship.

[Kaidran]

Are you seriously suggesting that only Democrats are heavily in debt?

[john p]

I meant to say the creditors and GenXer won't like it if we devalue our currency to devalue our debt.

Second correction: I think in five to ten years, my mortgage for a 4 bedroom house will be less than renting a 2 bedroom apartment.

Do you guys think it is worthwhile to game out a scenario where you pay off your house quickly?

I mean I bought a somewhat expensive car in 1998. I got a BMW 3-series for around $23K brand new (I negotiated pretty good even back then). Today that car has 125,000 miles (barely broken in and it has been paid off for 7 years. That is 7 years without a car payment and I'll most likely have it for another 5. Now sure I could have invested that money. If I leased a car for $200 per month, I could have saved and invested an extra $250 per month for five years. So that means I could have saved a whopping total of $15,000 in five years. That $15,000 would have been burned through in 50 months (just over 4 years) if my new lease were $300 per month. Now I've had the car for 12 years, and my break even was really 9 years, so I got ahead the past three years and what I project to be the next few years. This is my thinking.

Gaming out your thinking in this car analogy. You lease something cheaper until you can buy that BMW 3 Series. It now costs $30k for that car so you'd have to lease something cheap for 10 to 13 years in order to save enough to pay for the car cash. Then, in 13 years you'd have a brand new 3-series that you could drive for another 13 years. That isn't flawed logic my friends. I get it.

Let me do one more check however....

If I've had five years to save because I've been car payment free and I'm saving $450 a month for five years, I'm at $27,000 at year ten and you guys are at about the same amount, except the only difference is that I've been driving a 3-Series and you've been driving a Ford Focus.

Let me do one more check.

If instead of buying a brand new car, I bought the house I am living in which cost $350k back then (1998). I would have saved $1,000 per month on my mortgage, and if I got a roommate, I would have gotten ahead on the deal, meaning that with a roommate or two and the mortgage tax deduction, it would have been cheaper for me to buy that place than to rent and today, I'd be able to save an extra $1,000 a month and this is all after the worst real estate bubble and correction in the nation's history.

Where are you guys currently living, a cardboard box? I mean what is the rent and how much are you really able to save after you factor in buying with the mortgage tax deduction? Are you able to clear $500 per month by not buying or $1,000? I can't imagine it being any more unless you're in a YMCA.

[john p]

Oh, one other thing, if I bought the house I currently live in 15 years ago, I'd only have 15 years left on the mortgage (a mortgage that would have been over 1,000 dollars cheaper).

After taking into consideration the mortgage tax deduction, my 4 bedroom house would be about $2,250 a month mortgage, so my analysis is not out of the realm of possiblities that in 10 to 15 years a four bedroom house's mortgage could be less than rent for a 2 bedroom apartment.