February 2, 2014

Sunday 2/2/2014 Thoughts

I had been meaning to write a post for few weeks now, but life got busier as the new year started. One of the ironies of a buy and hold approach is that it is plain and boring. This is why I did not have much to report on this blog for the past few weeks.

The market has lost some of the ground it gained last year. But, I think that was to be expected. You can't have two back to back double-digit winning years and not expect any correction. Anyway, I am not making any changes to my portfolio. I am continuing to buy mutual funds in my portfolio as I had done in the past. If you are worried about the market, then I would say do not worry if you had a proper diversification in place as this is a good time to buy funds while they are cheaper in cost now.

On Tuesday of this week, I had one of the worst commutes ever. A snowstorm passed through Atlanta that brought the city to its knees. A mere two inches of snow during the middle of workday wreaked havoc to the 1+ million commuters who work in the city and commute every day from the suburbs. The problem was that the schools, government offices, and public and private employers let go of employees at the same time around noon. This caused traffic jams instantly. Snow quickly turned into ice by the evening. Lots of people were stranded on the highways. Many people had to abandon their cars and had to walk their way to homes or nearby shopping complexes. It took me 11 hours of commute, but I made it home safely.

Switching gears, I wanted to mention a couple of things I have been trying lately.

I recently downloaded a to-do list app called Any.do on my iPhone. I was looking for an app that syncs between a browser and the smart phone. This app fits the bill perfectly. Last year, I had trouble keeping track of things that resulted in un-necessary errands.This app allows me to quickly add items when I'm in front of a computer during the day in the office, and access that to-do list on my iPhone when I'm running the errands and vice versa. This app is available on iOS, Android, and Google Chrome platforms. After having used this app last month, I must say that my smaller tasks are now better streamlined.

I had written a blog post previously about how I was utilizing Bluetooth in my car to listen to podcasts and audiobooks during my commute. Now, I am listening to YouTube videos over Bluetooth in my car. One of the advantages of YouTube is that there is a wide variety of content and I'm just a search away from finding it. The problem with podcasts is that I don't have great enough control over what I want to listen on a given day. I will try to switch back and forth between the two.

This past month, I listened to a number of videos from Dr. Deepak Chopra, who has been one of my favorite authors. I like him as an author and as a spiritual teacher because a lot of his work is based on science. Dr. Deepak Chopra says that many of life's challenges can best be addressed from a spiritual perspective. But, the secret is that the level of the problem is never the level of the solution. In this interview at Google, Dr. Chopra talks about how we can expand our awareness to address difficulties in our lives. Enjoy the video.

January 10, 2014

Going Against the Cultural Norms

These days, I spend a lot of time thinking about life, my role as a family bread-winner, and my family's future. I know I am not a perfect human being. But, I strive to be a better person each and every day.

One thing I have always noticed about me is that I often find myself against 'what is considered as normal' in the society. I often get labeled as 'un-something' in a lot of things. While I don't worry about labels, I worry that my energy often gets depleted in fighting this mis-perception. How can that be, I ask.

Here are some of the salient points about me that I think fuels this mis-perception.

I have always been a quiet and reserved person. Because I was quiet, I chose study over play. Even though I did extremely well in my high-school exams, not many people believed in me.

Many people in my extended family thought that I was not up to the task in college. Many thought I was making a huge mistake going away from the family. In reality, I managed to attend a very competitive, one of the top engineering colleges. I even managed to come to the US to pursue graduate school and now have two MS degrees.

I was raised by two frugal parents who never saw a lot of money in their lifetimes. As a result, I am a frugal person. Don't get me wrong, we spend money, and a lot of it. But, we spend it on things that matter the most to us and satisfy our needs (as opposed to our wants).

I do not own a personal smartphone. I have one provided by my company and we get by with that. We use Tracfones as our personal cell phone. We use Magic Jack as opposed to expensive landlines or Vonage. We do not subscribe to cable, but enjoy a ton of good programming on Amazon Prime. We shop online and shop only when there are sales or clearances. We do not go for branded items except when it makes sense. We drive two fully paid off decent cars. We save and invest regularly. But, many people don't see the big picture.

We bought a medium-sized, decently priced house. We're currently in the 10-year mortgage and are planning to pay it off in two years. Some people I know have bought bigger houses with small down payments and with 30-year mortgage. BUT, in exchange for a larger mortgage payment, we're securing our retirement as well as education for our kids.

I often worry about the long-term future of our family and our financial security as I believe you are mostly on your own. I base all my decisions with long-term in mind not just for us, but also for our kids. This means, I often end up saying no to things that drain money. People often say, 'are you going to take all your money with you when you die?'. When they say this, they are often hinting that I should not pay much attention to long-term and spend what I have on instant gratification.

As you can see, I often do things that are contrary to what many people do. I am fortunate to have a wife who shares my beliefs in a number of things I do. But, we often find ourselves into getting indirect pressures based on what other people we know do. So far, we have resisted these pressures. But, discussing things through takes times and energy. This is where I feel that going against the cultural norms is hard.

America is a great equalizer in my opinion. Regardless of who you are in your home country (rich, poor, politically-connected, or un-connected), when you come here everybody starts off on an equal footing. It gives you an opportunity to start fresh with a blank slate. It is up to you what to make of that opportunity.

America gives you the freedom to chart your own pathI have certainly chosen a path that I think is best suitable for me and family. I think this is what people mean when they say America stands for freedom. It is really about freedom of self-expression, freedom of religion, and freedom to pursue happiness through your own path.

If you are reading this post, you probably hold similar views (or not). Otherwise, you wouldn't be coming to this blog that is mostly focused on stuff that seems boring. Thanks for reading and please let me know your two cents.

January 4, 2014

Andy Puddicombe: All It Takes is 10 Mindful Minutes

My new year's goal is to be mindful of the present moment.

When is the last time you did absolutely nothing for 10 whole minutes? Not texting, talking, reading, listening, watching TV,  or even thinking?

Mindfulness expert Andy Puddicombe describes the transformative power of doing just that: Refreshing your mind for 10 minutes a day, simply by being mindful and experiencing the present moment. No need for incense or sitting in strange positions.

January 2, 2014

My Investment Portfolio Returns - EOY 2013 Update

2013 has been the year of stock market recovery in the US and abroad. Both DOW Jones and S&P 500 indices reached new high's since the internet bubble of late 1990s.

S&P 500, which is considered as a broad barometer of the US economy, closed the year at 31.84%.

Total International Stock Market index capped 18% gains this year. Emerging Markets index performed poorly at 1.72% due to broader cool-off of emerging market economies in China, Brazil, Russia, and India.

The REIT index did not perform well this year because of the taper talks from the fed and somewhat slow-down of the house purchases in the last quarter of 2013 due to rising interest rates.

I do not invest in bonds. But, the Total Bond Market index is -2.31% this year. This is to be expected because equities rose faster which in  turn boosted investors' confidence. So, they moved money from bonds to stocks this year.

This year, I made a few tweaks to my portfolio.

  1. I re-balanced my portfolio four times during the year. I sold off some of the shares in the  S&P 500 Index Fund, Large-Cap Value Index Fund, Small Cap Value Index, and Small Cap Index Funds. This has resulted in quite a large amount of capital gains this year. The proceeds are being invested into a temporary fund Vanguard Target Date Retirement 2060. I am using this fund as a temporary placeholder as a house-payoff fund. We are planning to pay off our house at the end of 2015.

  2. This year, I moved  my brokerage account from Sogotrade to Vanguard. This account had XLE ETF (energy sector) and BRK.B (Birkshire Hathaway). I plan to simply hold these two funds forever or as long as I feel.

  3. I also added Vanguard REIT Index ETF to my brokerage account and invested $1000. I currently hold the Vanguard REIT Index Mutual Fund in the Roth IRA account. But, contribution limits prevents me from adding more to the real-estate part of the portfolio. The REIT Index performance took a backseat this year due to taper talks from the Fed. So, I saw this as an opportunity to grow the real estate portion of my portfolio. I will make some additional purchases of this ETF next year.

NOTE: As I think back, I feel that I should not have re-balanced my portfolio this many times during the year. I should have waited until the year-end to re-balance the portfolio. Because I was doing it whenever the market reached new high's, I may have missed opportunities for additional gains in the second half of the year. Oh well..as they say, emotions often get in the way and I got a little too carried away with rebalncing. I'm not planning on making further re-balancing until the year-end in 2014.

Below is personal performance rate of return calculated by Vanguard. It uses a formula called internal rate of return (IRR), which is a dollar-weighted return. IRR takes into account new money coming into the investment, as well as how long that money has been held. Don't confuse this personal rate of return with the returns posted for funds and indices (second table). The returns presented in these instances use a time-weighted calculation, which does not take cash flow into consideration.


Name  YTD  1-Year  3-Year  5-Year  10-Year
Entire Portfolio 16.2 16.20% 11.80% 12.30%   —

Overall, I am pleased with the performance of the stock markets this year. If you were out on the sidelines, you probably have missed 30% or so growth of your money. I hope the rally continues into the next year. But, I'm suspecting that gains will be modest next year.

December 29, 2013

Open Thread: Sunday 12/28/2013 Thoughts

I can't believe this year is coming to a close now. It has gone by very fast. Lots of exciting things happened for me this year. One of the most exciting things of them all is the birth of our second daughter in December. We named her Aarya.

I am working through the holidays this year as I used up all my vacation earlier. It is nice to work in the office when there is literally nobody around. I had lots of time to reflect upon my life goals this past week.

One particular thought that crossed my mind this week was what if I took early retirement at the age of say 45. I am 36 right now, so that leaves about 9 more years. I am not sure if I would be saving enough nest egg in the next 9 years that will last me the remaining half of my lifetime. The answer is likely no. I have not crunched any numbers. But, it is good thought that I will ponder upon into the next year. At the very least, it will help me set priorities and set up goals. Even if it is not 45, then may be it is 50.

Over the past few weeks, I have been trying to practice mindfulness in daily life. Being mindful is harder than it seems. Our minds are like monkeys, they are un-restrained, go from one thought to another. These thoughts are always about the past or the future, but never about the present moment. Mindfulness brings our minds, awareness, and focus to the present moment.

One of the techniques to bring your awareness from past and future thoughts to the present moment is to pay attention the in-breath (as it comes in) and out-breath (as it goes out) and the sensations it creates. It is quite hard to keep focus for long. But, with practice one can prolong this mindfulness focus.

Anyway, I came across a website called Wildmind Buddhist Meditation. The author, who is a Buddhist meditation teacher, is running multiple meditation programs throughout the year 2014 called The Year of Going Deeper. I have registered for all of them.

I am currently in the process of reading Emotional Intelligence: Why It Can Matter More Than IQ by Daniel Goleman. Through vivid examples, Goleman delineates the crucial skills of emotional intelligence, and shows how they determine our success in relationships, work, and even our physical well-being. What emerges is an entirely new way to talk about being smart. I am only halfway through, but the book is very insightful.

This is it for this week.

December 23, 2013

The Powerful Effects of Compounding

Compounding is like a snowball. As the snowball rolls down the hill, it gets bigger and bigger with each revolution as it picks up more and more snow.

Buy and Hold investing is similar to a snowball. The dividends and capital gains you receive each year, if re-invested, generate even more earnings in the following years. You receive earnings not only on your original investments, but also on any interest, dividends, and capital gains that accumulate. Each year’s potential earnings on your investment can contribute a little more to earnings the following year.

As time passes, earnings can contribute more and more to the total value of an investment to the point that it may be generating your annual salary's worth income. If and when this happens, you can consider yourself financially independent at that point.

BUT, the problem is that many people DO NOT get to this place when they retire. It is really a sad scenario because achieving financial independence is within everybody's reach if they understand the powerful effects of compounding.

I see people complaining of their inability save, yet they have all of the latest electronics and expensive lifestyles. In my opinion, most people need to evaluate what they are spending and reduce the wasteful expenditures. Once wasteful expenditures are under control, they can put that money to compound over a long-period of time.

Here is a powerful example why compounding matters.

Let's assume you invest $10,000 in a mutual fund that earns 8% annually and leave this investment for 20 years to compound. At the end of the 20 year period, it will grow to $46,609.

If you increase your investment horizon to 30 years, your investment will grow to $100,626.

Instead of just letting your initial investment to compound, what if you added $100 each year to it and let it grow. After 30 years, it will grow to $236,566.

If you added $500 each month ($6000 yearly), your nest egg will grow to $780,325. It is really not that hard to save $500 per month.

How about saving $1000 per month ($12,000 per year). It will make you a millionaire in 30 years.

If you stretch your savings rate to $1500 per month (effectively $18,000 per year), roughly maxing out your 401(K) plan each year, your nest egg will grow to over $2 million in 30 years.

And if you've got an even longer time frame—for example, if you're in your 20s and saving for retirement—after 40 years, your investment will have grown by more than $4.8 millions.

Is it really hard to save $1500 per month for your own retirement security?

The answer is actually NO.

Let's say you make median household income in the US of about $52000 per year. If you are married and file jointly, you fall into 15% tax bracket. Let's say your state has a 6% tax bracket. You owe about $11,000 in federal and state taxes. This leaves you about $41,000 in take home pay.

If you invest $18,000 towards your retirement, then that leaves about $23,000 towards your household expenses. To make a rounding number, let's say $24,000, about $2000 per month.

If you bought a $200K home (which is actually on a higher side), your monthly payment on 30 year loan @4.5% interest rates will be about $800. That leaves you about $1200 for utilities, food, transportation, and everything else. Can you manage your household with $1200? The answer is absolutely YES.

If you sacrifice on your lattes, expensive cell phones, cable bills and manage your household budget like a business, it is NOT impossible.

Saving Early: If you start saving early (I mean really early) as soon as you start your first job in 20's, you will have lots of time for your compounding to take effect. When you are single, not married, and without kids, it becomes very easy to save early. Once you get married and have children, it gets a little harder. So, the sooner you start, the less money you will be required to save later on when your priorities shift towards the family.

Bottom Line: For compounding to work, you need to: Sacrifice short-term instant gratification for long-term retirement security. Start investing now. Invest regularly. Be patient.

December 12, 2013

Simple Investing Is Smart Investing

Knowing how to invest your retirement nest-egg is really important these days. There are a very few companies that offer pension plans these days. Also, the days of earning interest from a savings account in the bank are long gone. People have to make smart decisions about investing if they hope to accumulate enough to last them through retirement and other life goals.

Not everybody wants to be a sophisticated investor who is well versed in technical analysis and can figure out ways of the markets. It is actually very difficult even for the pros who make living investing other people's' money.

What ordinary people like you and me with a day job and a family need is smarter ways of investing. One thing I have learnt through my investing experience is to keep investing very SIMPLE.

There are very simple rules you can follow if your goal is to get good returns at a reasonable risk. Remember, investment goal should not be to become rich overnight, but to get the returns that will accumulate wealth slowly but steadily over a long period of time, hopefully through the working career.

How do you invest smartly to get a decent amount of returns? Follow these simple steps.

Make A Plan

When you become serious about retirement investing, first come up with a plan. Without a plan, it is impossible to know whether you are on the right track or not. Your plan needs to document investment goals, your retirement horizon, your risk tolerance, and the mix and percentages of the assets you want own in a portfolio.

In your plan, document goals in two broad categories, short-term goals such as down payment on a house or a car and long-term goals such as kids' college fund and your retirement fund. To achieve these goals, you would need to calculate how much money you would need to save for these goals. Start putting money for short-term goals in safe assets such as CDs, money market funds, treasury bills. Put money for your long-term goals in stocks, bonds, and REITs. 

Diversify

Don't put all your eggs in one basket. Invest in broad-based quality securities such as index funds that will capture the returns of the entire markets. When you have built a diversified portfolio of funds, don't try to beat the market. Don't try to time the market. Save regularly. Stay invested at all times.

Get Emotions Under Control

Investors are often their worst enemy. Emotions often get in the way. One simple rule I follow is this: don't be greedy and don't give in to fears.

Fear causes to people to become excessively risk-averse. During 2008-2009, people pulled their money from the stock markets and put it in the safe assets like money market funds or CDs. After 2009, when the market recovered, many people didn't get back in until late 2012 or 2013 after seeing big gains in those two years.

Excessive greed is just as dangerous. Lots of people over-bought the overvalued dot com stocks leading up to the dot com bubble in the late 90s. When the bubble popped, many of the dot com companies shut their doors. The value of these companies wasn't what most investors paid for. Greed causes people to get in and out at wrong times.

Invest Regularly Through Dollar Cost Averaging

Dollar cost averaging is a good way to tamper emotions. Suppose, you just got a big bonus of $20,000. You are reluctant to invest because this is a big amount and you fear worse could happen to the stock markets. What if the market collapses after you just invested the money? That would be a major blow to your investment. But, if you split that $20,000 into 10 chunks of $2,000 each and invest regularly at the beginning of every month for the next 10 months whether the market has gone up or down, that creates a system that mitigates regret and forces emotional self-control. 

I have followed this system since 2008 and have stayed invested in the stock markets during all these years. The result is a lowered average cost of the shares purchased through the downturns. Another benefit of this system is that I don't think twice about whether today is a good day to invest or not. Because of this system, all my investments are automatic and happen every day of the week without my intervention.

Keep Things Simple

It is very easy to get drunk on the wealth of choices available and end up with an unwieldy portfolio made of scores of stocks and mutual funds. Investors with such a wide array of portfolio holdings think they are well diversified and insulated from the market downturns. Unfortunately, too many choices lead to overlapping of market slices. Additionally, too many choices will add trading costs. Not to mention more time will be required to research the securities. This is why you need to keep your portfolio simple.

One of Warren Buffet's tenets is to "never invest in a business you can't understand". Anyone who had followed this advice was spared during the great recession. In general, ordinary folks should stay away from complex securities such as collateralized mortgage debt instruments, commodities, options trading, principal protected securities, insurance products, funds that seek to double or triple index's gains, and funds that track obscure volatile indexes.

Make sure you understand what investments you have in your portfolio and why you have it. If you can't reason why something is there in the portfolio, then you may want to reconsider switching it with another investment that you can justify its existence.

Conclusion

If you follow these simple rules, the market will reward you handsomely when you retire. Most people abandon these steps when the going gets tough. But, that is where smart investors make most of their money. Treat volatility and market downturns as a blessing in disguise. It is a time to load up on clearance priced stocks and mutual funds and certainly not a signal to sell. If you stick with your plan and stay diversified, half of your battle is over. Let the markets do the rest of the work and keep patience. Remember, investing is not a sprint, it is a marathon.

November 27, 2013

Roth IRA versus Traditional IRA: Which is Better?

People who want to invest money for their retirement face a major decision regarding which type of IRA account to open — Roth IRA or Traditional IRA. Both types of IRAs have their advantages and disadvantages. So, the answer isn't a clear winner. But, the information below may help you decide which may be a suitable choice for your particular situation.

Tax Benefits

The biggest benefit of a Roth IRA is that it offers tax-free growth of your investments. With a Roth IRA, you will never pay taxes on withdrawals of your contributions. Also, you won't pay taxes on withdrawals of your earnings as long as you take them after you have reached age 59½ and owned the account for at least 5 years. In short, you fund the Roth IRA with your post-tax dollars (i.e. no tax deduction) and, in return, the government gives you the benefit of the tax-free growth of your contributions.

Reverse is true for the Traditional IRA. Traditional IRA offers tax-deferred growth of your investments. With a Traditional IRA, you fund your account with your pre-tax dollar (i.e. take tax deduction on your tax return). Your investments will grow tax-deferred until you retire. When you retire, you will pay ordinary income tax on withdrawals of all earnings and on any contributions you originally deducted on your taxes.

Income Limits

Now, there are some caveats and fine prints. For a Roth IRA, your contribution limit phases out at the Modified Adjusted Gross Income (known as MAGI) of $112,000 if you file as single head of the household or married filing separately AND at $178,000 if you file as married filing jointly or as a qualifying widower. See this chart from the IRS.

For a Traditional IRA, contribution limit and tax deduction depends on whether you or your spouse are covered by a retirement plan such as 401(K) plan at work.

If you or your spouse are covered by a retirement plan plan at work, then your tax deductions will phase out at $59,000 if you file as single head of the household AND at $95,000 if you file your taxes married filing jointly or as a qualified widower. For more info on the effect of MAGI on deduction of Traditional IRA contributions, see this chart from IRS.

For a Traditional IRA, if you or your spouse are NOT covered by a retirement plan at work, then there are no income limits if you file your taxes as a single head of the household or as married filing jointly or separately where none of you are covered by a retirement plan at work.

The deduction starts to phase out at MAGI of $178,000 if you file as married filing joint or separately and one of the spouses is covered by a retirement plan at work. See this chart from the IRS.

Age Eligibility

You can contribute to a Roth IRA at any age. In case of to the Traditional IRA, you must be under the age of 70½ to contribute.

Withdrawals

Another major benefit of a Roth IRA is that you are NOT forced to withdraw your savings during your lifetime. You can even leave this money to your heirs when you die. With a Traditional IRA, you will need to take the required minimum distributions (RMDs) starting at the age 70½.

Contribution Amount Limits

You can contribute a maximum of $5,500 ($6,500 if you are 50 or older) or 100% of employment compensation, whichever is less in 2013 or in 2014.

Penalties

For a Roth IRA, there are no penalties on withdrawals of your contributions if you held the account for 5 years. There is a 10% federal penalty tax on withdrawals of earnings before you reach the age 59½.

For a Traditional IRA, there is 10% federal penalty tax on withdrawals of both the contributions and earnings before you reach the age 59½.

But, you can escape that 10% tax penalty if you're withdrawing the money for a few specific reasons for either of the IRAs. These include:
  • Paying college expenses for you, your spouse, your children or grandchildren.
  • Paying medical expenses greater than 7.5% of your adjusted gross income.
  • Paying for a first-time home purchase (up to $10,000).
  • Paying for the costs of a sudden disability.
Be sure to check with the IRS guidelines on what will and will not qualify.

Discussion on which IRA is better

Deciding on which IRA is better or worse depends on a lot of factors including your current age, your current income, your future earnings potential, and your current tax situation.

Many experts believe that income taxes will rise in the coming decades for nearly everybody to support the national debt as well as social security and medicare programs. There is also another school of thought that says instead of raising income taxes, government will phase out or eliminate some of the tax deductions.

Given this information, if you are a young person at an early stage of a career and aren't in a higher tax bracket now but will be when you become experienced, then you would benefit from a Roth IRA. You will lose out on the tax deductions in the short-term, but in return, you will pay NO taxes in later years when you retire.

If you are in your prime earning years now and are in a higher income tax bracket, then you may want to consider investing in a Traditional IRA account. You will benefit from lower taxes now with the tax deductions. And, when you retire, you will pay taxes on your contributions and earnings. But, it may be likely that you may fall into a lower-income tax bracket as you would not be earning full salary.

Since projecting the future is always uncertain, you can hedge your bets and open both types of IRAs for yourself or between you and your spouse. In my own case, I have a Roth IRA for me and a Traditional IRA for my wife. Tax deduction lowers our taxes now with the Traditional IRA account and in the future Roth IRA will give you the security of tax-free withdrawals.

I personally don't know which way income taxes are headed and what will be our income situation when we retire. But, I feel comfortable with this choice.

Lastly, if you are confused, are on the fence, or don't know what to do, go with the default choice of a Roth IRA. Don't delay the decision to contribute because the longer you hold your funds, the longer time it will have for your investments to compound. Your compounded returns will more than offset the tax savings later down the road. The key thing is to get started NOW. Leave the rest to the economy.

November 13, 2013

Refinance, Stay-Put, or Sell an Underwater Home

A reader recently contacted me to get my advice on what he should do on his condominium. His mortgage is currently underwater. He wanted to know if he should try to refinance his home, stay-put with his current loan, or simply sell the home.

Situation

The reader bought a condo in 2007 for $230K with 5% down, leaving him with a loan of 218K, for 30 years @ 6.875% APR. The current balance on the loan is $200K.

After that, due to the recession, the value of the home dropped and the loan went underwater. Also, he could not refinance his home under the HARP program as his loan wasn't backed by Fannie Mae or Freedie Mac.

He did manage to save $40K through this period. This makes it possible for him to refinance now for $160K by putting $40K. But, he is thinking if it would be a wise investment because he wants to buy a single-family home in two years when his child starts school. His house is currently valued at $185K according to Zillow.

Some data points to keep in mind are that it would cost $1900 to rent a town home for himself. If he rents out his condo, he will earn about $1600-$1700 and it is not that difficult to find renters. But, the property taxes and condominium association fees will eat into the rent. Below is a breakdown of his current mortgage payment.

$1435 (mortgage) + $500 (escrow for tax) + $300 (association fees) = $2250

The reader has three possible choices:
  • Sell the current home and rent a town home for a couple of years until he is ready to buy his next home.
  • Refinance the current loan to a lower APR by putting $40K as a down payment.
  • Stay-put and keep paying into the high interest rate loan.

Which way shall he go?

I did some quick calculations. Here is my analysis.

Option 1: Sell the home for $180K

The reader will be taking following hits if he sells the home for $180K.

$11K (@ 6% listing agent's and buyer' agent commissions)

$2K (let's assume this money goes towards repairs or buyer asks for help on closing costs)

Total of the two costs: $13K

Net proceeds from the sale of the house: $180K - $13K = $167K.

Since he owes $200K on the mortgage, he will need to send $33K from his own pocket to the bank to pay off the loan completely.

Plus, he will need to rent a town home for 2 years.

Rent: $1900

Total rent for 2 years: $45K

Total hit on the reader's pocket: $33K (loan payoff) + $45K (rent) = $78K.

The balance sheet will be $78K negative if he sells his house now.

Option 2: Refinance the loan by putting $40K as down payment

If he instead refinanced by putting $40K to bring the loan-to-value ratio of about 0.8, he will save on the rent. Plus, he will build an equity. The only downside is that $40K will be immediately needed towards the down-payment. This money could have been earning 7-8% returns if it is invested in the stock market instead.

30-year fixed loan program
Loan: $160K
Interest: 4.5%
Principal & interest: $800
Escrow: $500
Condo fees: $300
Total monthly payment: $1600
Total savings from your current loan payment: $600
Total savings over 2 years: $14K

15-year fixed loan program
Loan: $160K
Interest: 3.5%
Principal & interest: $1100
Escrow: $500
Condo fees: $300
Total monthly payment: $1900
Total savings from your current loan payment: $300
Total savings over 2 years: $7K

These savings plus the equity would be net-positive. Of course, equity will be built only if prices will appreciate further in the next 2 years. If the condo appreciates to $200K in two years, then the reader would get back roughly $27K ($40K minus agents' fees).

Option 3: Stay-put at the high interest rate mortgage

Do nothing. Continue to pay high interest rate mortgage. The only advantage is that $40K savings would be earning 7-8% returns if it is put to use in the stock markets. But, the reader is already losing 6.875% on interest charges, so the net positive is not much.
Recommendation

Do NOT sell the house. Use your $40K savings to refinance towards a low-interest mortgage. The interest rates are still low and you can lock really good rates on a 15 year term or even a 30 year term. Costco is my favorite company to shop for competitive mortgage rate at some of the lowest origination fees banks. 

Before putting $40K towards the down payment, make sure that you're saving every penny for your next down payment fund. Also, make sure you have enough emergency savings or the means to support yourself if you lose a job. In two years, evaluate your situation and decide if you want to sell the condo or rent it out.

I'm personally a big fan of 15-year loan because it builds an equity much faster in the house. If you have equity, it becomes much easier to refinance or sell the house. So, if you are able to save more such that in 2 years time, you will have enough money saved for down payment on the next house, then just go for the 15-year term. Read more here on why I like 15-year term loan.

The other thing you may want to keep in mind, in two years, you may not (do not) need to sell your house. You can simply rent it out for $1600 per month. But, for this to work in your favor, 15 year loan would be suitable because most of your rental income then would go towards the principal as opposed to interest if you had a 30 year loan.

I hope this helps you.

November 4, 2013

Tips for First-Time Home Buyers

For us, it has been happy 7 years since we bought our house. Right now, my brother is in the process of buying a house, so we're helping him guide through this process. Here are the tips you may find useful when buying your first home.

Location, location, location: For most people, house is their biggest purchase and investment. Make sure to purchase a house in a locality that is suitable for your commute to work, proximity to shopping and dining areas, and more importantly schools if you have kids or planning on having kids.

Affordability: Before you decide to buy a house, visit a mortgage calculator website to see how big of a house you can afford. These calculators can provide details on how much your mortgage costs will be accounting for the price of the house, down payment, and the interest rate. Never buy a house more than you can afford.

Mortgage Term: Banks do a great job at marketing longer-term mortgages such as a 30-year mortgage. While such a mortgage can reduce your monthly payment, over the long period of time, most of that money goes towards the interest, leaving very little towards the principal. But, if you chose a 15-year mortgage term, more of your payment will be applied towards the principal. In a low-interest environment like today's, it is in your best interest to choose to a shorter 15-year term so that you can build equity faster.

Audit of Finances: Look at your monthly income and expenses and determine on how a house fits into it. Fannie Mae recommends that buyers spend no more than 28% of their income on housing costs.

Get a Local Real-Estate Agent: Buying and selling real estate is a complex matter. At first, it might seem that by checking local listings online, you could quickly find the right home at the right price. But, no two properties are precisely and exactly alike. Homes differ and so do contract terms, financing options, inspection requirements and closing costs. Also, no two transactions are alike. In this maze of forms, financing, inspections, marketing, pricing and negotiating, it makes sense to work with a professional who knows the community and much more.

Get Loan Pre-approval: Very few people can buy a home for cash. Almost everybody else finance their purchase, which means that virtually all buyers will require a loan. Offers that are presented with a pre-approval letter from the bank are given serious attention by the sellers. Also, the idea of a pre-approval letter is to get the loan that is right for you—the mortgage with the lowest cost and best terms.

Get a Home Inspector: Home inspection may sound like a cost you can save. But, make no mistake, a home inspection can save you thousands of dollars in the long run especially if you're buying a used house. When you find an inspector, don’t be afraid to ask questions: find out what their process is for inspecting a home, how long it usually takes, what their expertise is and what kind of information and paperwork you will receive after the inspection. Finally, be sure to follow-up on any red flags in the home inspection report by hiring experts to come in and take a closer look at a possibly radon issue or evidence of a pest infestation. Also, any problems found in the home inspection can be the source of negotiations with the sellers.

Understand the True Cost of Home-Ownership: Many first-time home buyers forget that there are costs beyond just the mortgage payment. The real costs begin after you move into the house. In addition to mortgage payments, you’ll owe property taxes, insurance and homeowner’s association fees, and be responsible for any maintenance issues that come up while you own the home. You should have a good handle on how much are the true costs of home ownership.

Shop Around for Mortgage: Like with any purchase, shopping around helps you find favorable mortgage terms at favorable lender costs. If you go from one lender to the other, you will notice that these costs fluctuate. Also, some lenders may offer you slightly better interest rate which could save you thousands in the long-term. I saved hundreds of dollars by getting my mortgage through Costco's mortgage program. If you obtain mortgage through Costco’s website from any of the lenders, then lender fees are capped and will never go above what Costco displays on its website. Plus, you consistently get better interest rates than advertised by any of the online or brick-and-mortar outlets. For example, if you are an Executive member, your lender fees will NOT go above $600.

Shop Around for Title Insurance: Title insurance protects the home buyer from problems arising out of fraudulent title transfers, unpaid liens, unpaid property taxes, or unclaimed stakes by the property heirs. Most mortgage lenders simply use a title company of their choice, you are not given a choice. But, you can choose to get a title insurance on your own directly and save several hundreds of dollars. Last time I refinanced, I used a company called Entitle Direct that saved me close to $500.