Is your first home a good investment?

This is a loaded question, obviously, because I just revisited the subject of buying your first home (of which I am now an avid fan) a week or so ago; Rick suggested:

Since equities also have a good long term investment record, why not scale back on the primary residence somewhat and invest in both real estate and equities?

At the time, I responded by saying: “The effect of the 20% Equity Rule and 25% Income Rule is to ensure that you are always investing AT LEAST 75% of your networth elsewhere (could be business, RE, equities, etc., etc.).”

Of course, that doesn’t address the question, as I have also said that these rules are up for grabs – meaning, you can just ignore them – when considering buying your first home.

Now, I am clearly a fan of buying your first home – you just need to go back to one of my very first posts to see that – but, it wasn’t always that way …

… I started by believing that there were other investments out there that performed better than your first home.

And, that still holds true; after all, as my Grandfather once told my Grannie when they had the same decision to make soon after immigrating to Australia:

You can’t always buy a business from your home … but, you can always buy a home from [the profits produced by] your business.

This still holds true … as does the 20% Equity Rule. In other words, if you are absolutely committed to using the funds to start a business, or are ABSOLUTELY committed to ALWAYS investing at least 75% of your Net Worth, then by all means keep renting.

It’s just that 99% of people will – sooner or later – fall off the investing wagon. It’s human nature.

Then they’ll end up with no investments, little net worth, and no home. Buying your first home, and using that as a springboard into other investments, is a great way to go; just remember what I said, way back in the beginning of 2008:

 If you are ready, willing and able to buy your first house, or you are thinking of trading up (or, down) …. here’s my advice:

Put aside the emotional decisions and just consider the financial impact, and that is: your house is the ONLY way that most people will ever get off the launching pad to financial success …

Why? Because, you are building up equity over time (even a flat or falling real estate market eventually climbs back up again) …

… but – and here is the key - ONLY if you are prepared to put the equity in your house to work for you … that means, borrowing against the equity in your house to INVEST.

What should you invest in first?

My wife just got back (well, just before our Noosa trip) from a trip overseas to attend her nephew’s wedding; and, the young happily married couple decided to spend part of their honeymoon in Australia … so, they are staying with us right now!

This was an opportunity for me to interfere in their financial lives … naturally, I couldn’t resist

It’s also an opportunity for me to share my financial plan for our younger readers, whether single or married.

The plan is simple:

Step 1: Start working!

Step 2: Use your pre-work spending and living standards as a guide to ensure that you save at least 10% of your gross salary; preferably more.

Step 3: No matter what your Step 2 Income and Expenditure, save at least 50% of any future salary increase

Step 4: That includes any ‘found money’ such as: change found on the street; tax refund checks; small handouts/inheritences from friends/family (naturally, you will ‘up this’ to saving 95% of any LARGE handout/inheritence); etc.

It won’t take too long to actually have some money (perhaps for the first time in your life) to think about actually INVESTING.

So, what to invest in? Stocks; car parks; italian art; … ?

It’s simple: your own home!

It will probably be a small house or condo to start with … possibly with some ‘fixer upper’ potential …

But, what about the 20% Equity Rule and the 25% Income Rule, which will ensure that you can only afford to buy a shoe-box (literally) at this early stage of your financial life?

You forget them for your first home …

… and, replace them with these guidelines:

- Put as much equity into your house (by way of making a deposit) as you have savings (you’ll want to keep a little buffer against immediate expenses)

- Borrow as much as the mortgage payment that you can afford, which will be the amount per month that you are currently saving (of course, you’ll want to keep a little buffer against extra expenses).

When you (eventually) get tempted to ‘trade up’ to a bigger house, that’s when you apply the 20% Rule and the 25% Income Rule!

But, shouldn’t you invest in something else first? Perhaps you’re not even married yet and can happily rent for a while?

This is true: but, buy the condo anyway … then you can evaluate if your rent is so cheap that you should rent out the condo for a while before moving into it. Same applies if you move to another location: rent out the house/condo and rent for yourself elsewhere until you are ready to trade up (or across).

Why?

Let’s decide whether, over the course of your life, real-estate will go up in price or down in price? The answer for all of history has been UP (over a sufficiently long period).

Decide whether you will ever want to own your own residence? Again, the answer is YES for the overwhelming portion of humanity (and, even if you think not, I guarantee that your eventual spouse will have a very hard go at convincing you otherwise).

So, unless you have an overwhelming reason to believe that RE won’t go up in price for the next X month/years, then you are compounding your money at RE’s typical growth rate (6% … depending upon who you believe and where you live) TIMES the leverage that the bank is giving you LESS (your mortgage payment/costs – rent you would have otherwise paid).

Run the numbers; it’s a VERY good/safe rate of return

Be the bank!

My son asked why I don’t just plonk by money into a safety deposit box to tap into those wonderful gross margins that banks earn buy ‘buying’ your money at 3% and ’selling’ it back to you (or to other people/businesses) at 7%.

That lead to a great discussion on P2P lending, which partially addressed the problem of risk for me: P2P offers filters to allow you to sort loans; ratings to allow you to evaluate loans; and FICO-based ’risk rated’ interest rates (circa 10%) to go along with all of this.

But, that doesn’t satisfy me …

And, it’s not because the banks have MUCH better systems to evaluate and manage loans and it’s their core business, it’s because I can do much better with my limited capital than P2P levels of interest.

Here’s two things to think about:

- Does P2P provide the annual compound growth rate that YOU need to reach your Number?

- Do you have the bank’s virtually UNLIMITED access to capital or is the amount that you can apply to P2P as a % of your Net Worth limited?

These points are critical: you have a limited amount of investment resource available to you and (probably!) a very large Number / soon Date to achieve using what you currently have as a springboard.

Now, let’s flip to the other side:

Banks dig into their ability to borrow (which IS the basis for their entire business, investment banking / asset management services aside) and lend to us for what?

Either to SPEND (on consumer items, if we are dumb) or to INVEST (in our homes, businesses, etc.) if we are smart.

So, let’s put those things together to create our own ‘bank’:

1. We have limited cash to ‘lend’ at our disposal, so we need to find a way to tap into vast amounts of borrowing power just like the banks.

2. Well, we don’t have the Regulations, Reputations, and Resources (e.g. access to the capital markets) that allow the banks to borrow (then lend) so much, but we do have something that allows us to achieve effectively the same huge jump in personal borrowing capacity: the spare equity in our houses.

[AJC: You knew there was a catch! If you don't have a house, have GFC'ed your equity out the window, or otherwise don't have enough equity built up yet, bookmark this post and take the rest of the day off ...]

3. If you DO have spare equity in your house, and can refi. to a fixed rate loan that locks in your borrowings circa 4% or so then you are probably now sitting on a relatively large sum of cash to lend, just like a bank (relatively speaking!).

4. So, you can either:

- Do, what the banks do and lend to somebody who needs the cash at a higher rate; e.g. P2P where you may get 10% for each 4% ‘unit’ that you supply … a VERY healthy 150% gross margin (plus, you have NO staff or overheads), OR

- Do, what I would recommend: cut out the middle-man and lend the money to yourself!

What would you do with that money that you have borrowed?

What any sensible investor would do with money that they borrow from the bank – depending upon their Number and their appetite for risk:

- Buy some investment real-estate,

- Buy stock [AJC: a friendly 'bank manager', no margin calls .... sweet],

- Start a business … it could even be a P2P lending business

That last one isn’t such a joke; I would be more tempted to invest IN a P2P business than I would be to lend VIA a P2P. Why?

It’s simple … the former gives me ho hum 10% returns (with some credit risk attached), whilst the latter gives me access to potentially, unlimited returns!

Are you worried about the risk of business failure?

Well, if the P2P site goes under, isn’t my risk of capital loss the same as if my cash was sitting in their investment accounts [AJC: which is one of the reasons why the SEC is VERY interested in regulating P2P, all of a sudden ... but, until they do ... ;) ]?

Safe as houses?

Well, I did ask for it, and the first cab off the rank for the ‘diss Adrian party’ is Dan who thinks that one of my favorite posts – Contrary to Popular Opinion, Paying Off Your Mortgage Is The Dumbest Move You Can Make – is ‘ridiculous’. Seriously, thanks for opening up an important new discussion with this comment, Dan:

This is ridiculous. The author apparently believes he is untouchable and will never lose his job, get sick, or die.

You can do all the complex math you want, but the simple fact of the matter is that Risk is the biggest variable, and I don’t see it show up in your equation once.

Don’t be stupid America, and dont prescribe to a system that encourages you to continue owing people money long after you need to.

Pay off your house, free up some income, then pay off your credit cards, pay off your car, and be a happier, less stressed individual.

Hmmm …. paying off your mortgage as a ‘risk management tool’?

Before we even consider why anybody in their right mind would pay off a (say) 8% mortgage before paying off a (say) 19% credit card or car loan, let’s review the substance of my “don’t pay down your mortgage early” argument:

Look at everything that you own as a business: if it’s your own home, separate the ownership of the property in your mind from it’s use …

… for example, even if it’s your own home, treat yourself as your own tenant and figure the rent that you would otherwise had to pay when doing the sums.

Then evaluate the investment against any other investment or ‘business’ …

… but, if you’re still trying to get rich(er) quick(er)?

If you own a home, don’t pay it off … use the upside to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ’businesses’ …

If you have other sources of income (businesses, investments) don’t spend it or reinvest all of it … use some of the spare cash to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ’businesses’ …

That’s my advice to you, but only take it if you want to be rich!

But, Dan says that the ‘math’ matters not, you should consider what happens if you “lose [your] job, get sick, or die”. Well, what happens?

If you have paid out your mortgage, your money is locked in the safest bank vault imaginable … all you have to do it sell the home to access the cash. Just pray that the market is an up market and not a down market, when these events outside of your control force you to sell. Or, would YOU prefer to choose the timing? Hmmm …

Of course, you could just borrow some money against the house; but then, aren’t you now putting yourself in EXACTLY the financial situation that Dan wants you to avoid: i.e. “owing people money long after you need to”?

And, even if you still do want to use your Zero Mortgage Bank, what are the chances of the bank actually lending you (or your survivors) any money when you are jobless, sick, or dead?

Oh, and let’s say that you do happen to be unfortunate enough to “lose [your] job, get sick, or die” while you are still in the 10-15 year period when you are well ahead of the 30-year payment curve, but haven’t paid off the mortgage in full, yet? How easy will it be to refinance, or even convince your bank to hold payments for you? Even if you THINK they will, you had better be certain

What do you reckon? Dan’s on the right track? C’mon, be honest … would you feel safer paying off your mortgage early, or letting it ride?

I think we’re screwed …

If you needed any evidence that the ‘global financial crisis’ – on a global macro level – and problems with the US real-estate market – on a global micro level – are still affecting people in the their day to day lives, you need read no further than Rischa in Seattle’s comment [AJC: I've added punctuation for your reading pleasure]:

From what I’ve read I think we’re screwed, but I’m not even sure what we can do. Here is the scenario: my husband and I bought this house about 10 years ago in the boom here; with both of us working we could afford the mortgage and our lifestyle easily. I’ve [since] been laid off and we’ve been living on my savings, which is now gone and I’m on unemployment, which is fast running out.

We’re about $100K upside down, we got a trad. loan 30 yr fixed, but without 2 incomes we’re sinking fast. We don’t necessarily want to stay in this house, in fact we want to move to a part of the country where the cost of living is less.

Any clues? What should we do? How do we get out of this when getting out would cost more than we have, even if we spent our retirement to get out? We would have less than nothing left!

Of course, it’s difficult to give Rischa personal advice – and, I wouldn’t do it – but, I could suggest that she go back to that post and reread the bit where I said:

Ask yourself the following TWO questions:

i) Can I afford the payments? If so,

ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?

If the answer to both questions is YES, then stay. If the answer to either question is NO, then sell/move … be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).

In Rischa’s case, the answer to the first question appears to be NO … and, she would prefer to be moving to a cheaper part of the country (and, cheaper house?), anyway …

So, it’s obvious that she can’t afford her existing house, but what would you do? Hang on to a losing proposition? Or, cut your losses?

Ooops! She broke the 25% Rule ….

I wrote a post some time ago about how I broke (nay, smashed!) the 20% Rule (you know, the one that tells you what % of your net worth you should have ‘invested’ – read: tied up – in your own home) when I bought my latest house – considering that we paid $4 mill., are about to renovate for at least $1 mill., and still own another $2 mill. house that we haven’t been able to sell due to the crash, I’d say that we need some major corrective action … which, I outlined in this post.

The next housing problem that I wrote about, doesn’t affect me (as we paid cash for our houses) but, was how to deal with the now-all-too-common situation where you are ‘upside down’ on your mortgage.

Now, thanks to Alexandria who commented on that post with a question, we can now assess the third major housing-related financial problem: what to do when you break the 25% Rule (the one that lets you know how much of your income to spend on rent/mortgage payments)?

Panic is always a good first option …

… before we do that, let’s hear Alexandria’s ‘problem’:

Ok… after reading the above I want some options on my situation. Married, three school aged kids. Currently own a home with a high mortgage that is worth just about $50K more then we owe. Not the home of our dreams. We are not in foreclosure. I am self emplyed and my husband is a Police Officer. We can make our monthly mortgage but it eats up about 60% of our monthly income. We have no savings, a mininal 401 plan, no large other debt. We are both in our mid thrities. We can rent a much nicer home in our area for about $1k less then our mortgage a month. If you were us, would you sell and rent or keep the house?

OK indeed!

My first piece of financial advice would be to dump the copper and marry some rich bloke (I’ve seen your photo) who looks like me … but, marriage proposals aside, I can’t offer you any better advice than that, because I am NOT you …

… that’s why I struggle to answer specific “what would you do if …” questions on this blog, because I rarely have enough information to know how to deal with YOUR Life’s most difficult financial decisions.

BUT, it’s not all doom-and-gloom, because I can use wonderful readers’ questions, such as this one, to inspire some general points: just don’t construe it as direct personal advice, even though I may liberally intersperse “you” and “should” in my posts to make them more readable.

Disclaimer out of the way

Even though I can’t really give you the answer that you can ‘take to the bank’, I can ask why you would consider keeping a home that you don’t like, when you can sell it and rent a nicer one and save/invest an extra $12k a year?

Better yet, what would it do for you financially (balanced against family ‘needs’ … not keeping up with the Jones’ … hence, the image at the top of this post) if you sold this place and used the freed up equity as a deposit against a smaller/cheaper place that fits closer to the 25% income Rule, and then used the money saved on mortgage payments (100% of it!) to finally start to build your financial future?

Remember, given that this is effectively your first home (i.e. you have not built up any housing equity yet) the answer – for you – maybe somewhere between the two …

Nice house v fewer financial headaches … what a trade-off to have to make

What to do when you are upside-down on your mortgage …

Ryan – one of our Millionaires … In Training! – is upside down on his mortgage; if you can’t afford the payments (and, I have some guidelines to help you decide when that point has been reached), then I would generally suggest that no matter whether you are right-side up, upside down, or sideways, that you should get out!

But, Ryan is a high-income earner and high-saver already so he has decided to … well … I’ll let him tell you:

If I could wave a magic wand, I would not be upside-down on my mortgage, but that will correct itself over time as we are not planning on moving soon. While we could short sell the house and rent, we will not likely do that. We are emotionally tied to the house and would not, in my opinion have much upside with a rental because we would have to either float the note on our mortgage or pay the taxes on the difference on a short sale, all to pay MAYBE $1000/month less and not have the mortgage interest to write off come april 15th. An appreciation of our home of around 5%/year, starting in 2010, [should help by] bringing us back to an equity position around 2012.

A home performs two functions: housing and investment.

Like most dual-purpose things, owning your own home is probably a poor compromise on both …

… in my experience, you can usually rent a better house than you can afford to buy AND can usually find much better returning investments.

Yet, I recommend that one does own their own home, for a number of reasons:

1. Often it can turn out to be a person’s only investment,

2. It is a ’safety net’ in case all else goes wrong,

3. You have continuity of tenure (the ‘landlord’ won’t kick you out, as long as you keep up with the payments)

4. Over time, you may build up equity that you can ‘release’ to kick-start other investing activities.

For me, it was always 3. (and, the associated ‘emotional attachment’ that comes with calling your house your ‘home’) that held the most sway as I always expected to make my ‘fortune’ elsewhere. And, I have never actually used the equity for investing (except for my brief HELOC-fueled stock speculation experiment of 2007/2008).

So, I would suggest that you ask yourself the following TWO questions:

i) Can afford the payments? If so,

ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?

If the answer to both questions is YES, then stay. If the answer is NO, then sell/move … be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).

This is a question that we all need to ask ourselves at least once per year (or, whenever the market and/or our financial position changes), as – in effect – we are ‘buying’ our house every year (by missing the opportunity of selling and putting the money to work elsewhere).

Given the size of our ‘investment’, we should never take the rent/own – buy/sell decision for granted

Tax implications of converting your home to a rental …

This is your last chance to take part in a foolproof money-making scheme … even if you have NEVER bet on a horse in your life, I personally GUARANTEE that this System (previously known as ‘Lay Formula’) WILL work for you! If you do want to take part in this once in a lifetime opportunity, read yesterday’s post here and register your interest NOW.

Expressions of interest close in 24 Hours!
___________________________________________

Despite the length of this title, today’s post will be really short … because I have NOTHING to add on the subject of taxes. They are something to be paid – or not paid – depending on the advice of a QUALIFIED tax practitioner (accountant and/or attorney) in the area that you are interested.

Personally, I have only a slight hiccup in signing tax checks for over $1 Million (as I have for the last 2 tax years in a row) because it means that I have made a TON more money

… and, I rely totally on good advice; but, I pay for conservative, specialist opinion where necessary.

However, I have noticed that I number of my readers (and contributors) have recently converted their own residences into rentals, so I thought that I should perform a Reader Service by pointing you directly towards the excellent Tax Tips Blog so that you can read some excellent advice, straight from the “horse’s mouth”:

http://glgcpa.com/blog/2009/02/18/convert-personal-residence-to-rental/

Disclaimer: I have NO IDEA whether this is good, bad or indifferent advice … that’s what your accountant is for!

But, I would like your opinion …

Contrary to popular opinion, paying off your mortgage is the dumbest move you can make …

I wrote a post a long while ago … actually, it was my 5th-ever post - some say that I should have stopped there – about the classic Rent or Buy dilemma for your own home … and, I just (!) received an interesting comment to that Post from Joy:

That’s the silliest thing I’ve ever heard – borrow against your house (aquire more debt) to invest??? Paying off your house early and being debt-free allows you to do whatever you want with your income, THAT’s truly the way to wealth.

Now, Joy is not alone: I recently read a post by Boston Gal on her blog that talks about Suze Orman’s  advice which also is to pay off your home loan early:

Believe me, I have thought about trying to pay off my mortgage early. But since I have an investment condo which is mortgage free (yeah! paid that one off in 2007) I have been a bit hesitant to use my current excess cash to pay extra toward my primary home’s principal.

 Now, this sparked a whole series of comments, including this comment from ‘Chris in Boston’ who said:

This is interesting. Usually you hear from personal finance people that its best to take on the longest fixed rate mortgage you can afford. This allows you to tie up as little cash in a non liquid asset as possible (slowly building equity). Also allows you to protect that pile of cash from the effects of inflation. The house is bought in today’s dollars and paid off over 30 years in today’s dollars.

Sure, when you own a property you have to compare it to owning any other investment – cost/benefit; risk/reward; all the usual stuff. You also need to compare the costs of holding it (including interest) against the costs of investing elsewhere.

But, this last piece in Chris’ comment is THE critical point: “the house is bought in today’s dollars and paid off over 30 years in today’s dollars”.

You see, the one thing that makes owing a property, even your own home, very different to any other investment is that it can be easily financed … almost completely (remember the sub-prime crisis?).

This leads to a whole swag of benefits that I don’t think that you can get anywhere else … benefits that simply cannot be ignored by the typical saver / investor.

Here’s why …

When you mortgage a house, you and the bank enter into a partnership (typically the bank is an 80% partner and you are a 20% partner going in), but you are not in the same position:

1. You have access to ALL of the upside … so as inflation and market conditions push the value of the property upward over time, you gain 100% of the increase, the bank gets none of it.

Let’s say you buy a property for $100,000 today; you put in $20,000 deposit and the bank puts in $80,000 as an interest-only loan (forget closing costs for now) … in 20 years, if it doubles to $200,000, your share of the ‘partnership’ is now $120,000 and the bank’s is still $80,000.

You are now 60/40 majority owner of the real-estate venture! In fact, even as 20% ‘owner’ you have total control over all the decisions related to the real-estate – as long as you pay the bank on time.

2. Sure you pay the bank interest on their $80,000 share … but this is fixed (you did take out a fixed interest rate, didn’t you?!).

At 8% interest rate that’s approximately $6,400 per year … this year.

Why only this year? Because the same inflation that is increasing the value of the house (and you get to keep 100% of that increase) also decreases the effective amount that you pay to the bank; as each year goes by, the bank gets less and less in real dollars and your salary goes up.

The price of bread, milk and gas may go up, but the bank’s interest rate never will because it’s fixed!

3. You either get 100% of the value for the payments that you make to the bank (call it ‘rent avoidance’ if you live in the property) or you take 100% of the income if you decide to rent it out … all as 20% minority ‘partner’ going in. The bank on the other hand, gets their $6,400 and ONLY their $6,400.

4. The government gives you tax breaks and incentives to do all of this!

Here is my advice …

Look at everything that you own as a business: if it’s your own home, separate the ownership of the property in your mind from it’s use …

… for example, even if it’s your own home, treat yourself as your own tenant and figure the rent that you would otherwise had to pay when doing the sums.

Then evaluate the investment against any other investment or ‘business’ … and ask yourself:

- What ‘business’ gives you pretty damn close to 100% control for only 20% initial investment?

- What ‘business’ lets you in for only 20% initial investment, but then gives you all of the upside?

- What ‘business’ gives you only one-time multiplier on your initial investment on the downside but a five-time multiplier on the upside?

- What ‘business’ grows in your favor (and not your “partner’s” favor) merely by the effects of inflation?

By all means, pay off you mortgage and your lines of credit as you reach your financial goals and are set to retire …. you have plenty of money and just don’t need the stress, right?

But, if you’re still trying to get rich(er) quick(er)?

If you own a home, don’t pay it off … use the upside to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ’businesses’ …

If you have other sources of income (businesses, investments) don’t spend it or reinvest all of it … use some of the spare cash to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ’businesses’ …

That’s my advice to you, and to Joy, but only take it if you want to be rich!

Applying the 20% Rule – Part I ( Your House)

Since my early post How Much To Spend On A House is still one of the most visited posts on this site, I thought that I should write a little follow-up piece that gives some examples on how to apply this important ‘rule’.

First a recap:

You should have no more than 20% of your Net Worth ‘invested’ in your house at any one time; you should also have no more than 5% of your Net Worth invested in other non-income-producing possessions (e.g. car/s, furniture, ’stuff’). Why?

This ‘forces’ you to keep the bulk of your Net Worth in investments i.e. real assets (stuff that puts money into your pocket … not stuff that drains your finances)!

Warning: most people think of their house as an asset, but by this definition, it most definitely is not … let this be a warning to all those ‘house rich … asset poor’ people out there who think they can retire just from their house.

For those mathematically minded, as a formula, this can easily be represented as:

20% (max.) for your house + 5% (max.) for all the other stuff that you own = 75% (min.) of your Net Worth always in Investments! Simple, huh?

Also, for those who have been tracking my posts, the difference between your Notional Net Worth and your Investment Net Worth will be the Current Market Value of Your House + the Current Market Value of Your Possessions; if you’ve been following my advice this should be no more than 25% of your Notional Net Worth.

Now, you may have noticed something interesting:

The Current Market Value of Your House will usually go up over time (current market conditions aside!)

The Current Market Value of Your Possessions will usually go down over time (collectibles aside!).

Houses generally appreciate … possessions generally depreciate.

This sets up some interesting situations that we should discuss … by no means an exhaustive list:

1. Aspiring Home Owner – The chances are that you have debt (particularly if you were recently a student), little income, some possessions, virtually no savings or investments. You will probably never be able to buy a house at all – or, if you can it may never be bigger than a cardboard box - if you follow the 20% Rule …

… My advice is to buy the house anyway IF you can afford a decent down payment (ideally 20+%) and can afford the monthly payments (lock in the interest rates for the max. period that your bank will allow, ideally 30+ years).

A lot of financial mumbo-jumbo has been written in the press, books, and blogosphere about this … ignore what you may have read: for most people, it’s the only way you will ever get financially free.

2. Already A Home Owner – Revalue your home (be conservative … don’t wear ‘rose-colored glasses’ … check what other houses around you have actually sold for … don’t rely on any realtor’s advice – they may ‘talk’ up the price to convince you to sell – we don’t want to do that, yet!). Do this every 3 – 5 years (yearly is better).

If the conservative value of your house puts the equity in your home (Your Equity = What the Home is Conservatively Worth – Today’s Payout Figure On Your Home Loan) at greater than 20% of your Current Net Worth (you will need to redo this calculation at the same time as you revalue your house), then it is time to extract that ’excess equity’.

What to do with this excess equity? Invest it of course! For example, you could buy a long-term, buy-and-hold, income-producing (get the picture!) rental property … or you could buy stocks … or you could take some risk and buy / start a business … or it’s up to you!

But, if you locked in your home mortgage at a cheap interest rate, you probably don’t want to refinance it, so be sure to ask a professional about suitable options for you (second mortgage; use your home’s equity to ‘guarantee’ the loan on another, etc.) … just be sure that you can afford the loans on both your house and your investment/s … make sure you have a cash [AJC: better yet, a Line of Credit] buffer against emergencies (loss of job, loss of tenant, etc.).

 3. Right-Sizing Home Owner – Again, revalue your home … but, of course you can down-grade (let’s say that you are retiring or the kids have moved out) – but just because you have freed up some equity and can easily fit into the 20% Rule doesn’t mean that you can slack off on your Investments.

ADD the freed up amount of equity to your Investment Plan … it will help you retire earlier and/or better!

Remember, your Investments should be a minimum of 75% of your Net Worth … you can and should invest more wherever and whenever possible! 

Again, if your original house is rent-able, and you have locked in a cheap interest rate (like I told you), you may want to keep it as an investment … consider doing so!

Now, buying houses isn’t always about making the right investment choice; there will be times in your life when you have to consider changing houses whether it fits within the 20% Rule or not (one obvious example was our First Home Purchase) …

… most likely, this will be at major life changes (marriage, divorce, babies). So be it!

Remember our Prime Directive: Our Money is there to support Our Life … Our Life isn’t there to support our Money (that would be just plain sick)!

Just make sure to revalue every year at first, then every 3 – 5 years min. and try not to get off-track, but if you do, simply realize if you are off-track financially and that you just have to get on-track at the first opportunity …

AJC.

PS You may want to bookmark this post (using the convenient links below) and review at every major ‘house change’ decision!