Home Sweet Home

derek-torsani-417294-unsplash

When I was about nine years old, I remember going to spend the night at a friend’s house, an activity that most adolescent children can relate to. My friend, Stuart, lived on the other side of town from me in a neighborhood with homes similar to what you think of when someone says “suburbs”. Brick homes, each one similar to the next with attractive lawns, sloped roofs, high ceilings and arched doorways. Nothing spectacular by today’s standards, but in 1981 these large, brick, ranch style homes epitomized upper middle class. I don’t necessarily remember anything special about Stuart’s house, but at the time, I did know it was different than mine.

My family would have most likely been categorized as working class–neither of my parents had a college education and my father worked as a repairman. The only similarity to my home and Stuart’s is that they were both ranch style. But unlike his newly built, expansive, brick Rancher with high ceilings and a big yard, our Rancher was older, smaller, with worn siding and an undersized front lawn that sloped downward so badly that having even the most informal game of baseball meant that making first base would require some downhill running expertise.

Honestly, living in that small, wooden house in a Hutchinson, Kansas neighborhood with friends down the street and my school four blocks away were by far my best memories as a child. Like many kids of that time, I remember staying gone all day on my bicycle only to come home long enough for lunch and then back out until the streetlights came on.  It was a great time to be a kid if you were lucky enough to live in a small town where you could roam all day, play ball with your buddies and explore the world on your bicycle.

alexander-shustov-73-unsplash

Interestingly, that is what a lot of international teachers love about being abroad. A lot of times, living overseas gives kids the opportunity to experience much of what it was like to grow up in the States decades ago.

For six years we lived in a compound in a Middle East capital. During this time my children had the luxury of safely being able to go outside and play with their friends, sometimes even unsupervised, whenever they liked. And as a parent I did not worry about them because I knew all my neighbors; they were my colleagues. I knew all the other kids; they were my colleagues’ kids. Unlike my childhood neighborhood, however, our compound was a highly-secured gated community where no one got in unless they lived there or knew someone who did. Everyone in the compound drove slowly because they knew, at any given time, children would be riding their bikes, scooters, and rollerblades in the street. Granted, this was an unusual way to live, in a secured compound, and for the adult, it can many times feels like a fishbowl, but for the kids, it has to be the best life ever. Much like those early years in Hutchinson, Kansas were for me. The square mile or two that I inhabited back then was my own personal little compound. It provided the opportunity to explore and discover in a relatively safe environment.

As I said, I don’t remember anything specific about Stuart’s house, nor do I remember much about what we did on that sleepover. What I do remember and what has always stuck with me happened when my mom picked me up from Stuart’s house the next morning. After I said my goodbyes and got in the car, my mom and I were driving through this new, housing edition with its large, brick homes with two car garages and manicured lawns. As we drove through the neighborhood in our green, 1976 Dodge Aspen station wagon, I commented to my mother how nice these homes were. Her response to me was,

“They’re nothing but a big mortgage if you ask me”.

At nine years old I didn’t have a clue what a mortgage was and wasn’t interested enough to ask my mom to explain. Furthermore, she didn’t seem too concerned about explaining to me what she meant or even what a mortgage was. Therefore, I was content to simply admire the homes and all their grandeur and she was seemingly content with the fact that she did not bear the responsibility of paying the mortgage that accompanied them.

Shortly after, my family moved from Hutchinson, Kansas. My dad lost his job and he decided to move us one state south to Oklahoma. He also decided to take his skills as a repairman and open his own business. The house we moved into was on the outskirts of Shawnee, Oklahoma. It was on a dead-end, dirt road and the nearest kid to play with was miles away. My world instantly shrunk to the acre of land that this house sat upon. The house, although now upgraded to a brick Rancher, was still nothing close to Stuart’s and my dad would eventually turn the garage into his office and work out of the house – adding a blue-collar stamp on the place.

I never liked that house, not because it was modest or housed Haggard Electronics, a TV & VCR repair business, but because it put an end to my childhood independence. I was no longer able to explore the city and socialize with my neighbors. It was, however, in my parent’s budget. They still live in that house today; thirty years later and most likely they never worried too much about making the mortgage. My parents were good with money in the sense that they knew how to live frugally. They may not have been too good at making money, but they sure could make it stretch. And part of that was because they never over-extended themselves. They were never fooled by the opulence of an object, but rather looked at it for what it represented – “nothing but a big mortgage if you ask me”.

Mortgages 101

During my undergraduate program at the university, I took a class called Financial Management. It was taught by Mr. Smith, an eccentric older professor with a 1970 MBA from the University of Oklahoma. I remember at one point in the class we were working on amortization schedules for mortgages. Basically, looking at mortgage time frames and their influence on the amount of interest you would pay for borrowing money to buy a property. A common example went something like this:

Suppose you want to buy a property, either as a home you will live in or as an investment. Let’s say that property has a price tag of $250,000. Let us also assume that you are able to put down 20% or $50,000. That would leave a balance of $200,000 that you would have to borrow from a lending institution. This is done every day all over the world. The numbers may change, but the concept is the same. An amortization schedule is nothing more than a table that shows each payment on a debt, in this case a mortgage, and shows where that money goes – how much of the monthly payment goes towards paying off the principal and how much goes towards interest. A typical amortization schedule or table would have all of the monthly mortgage payments from the beginning of the loan until it’s paid off. At each month you would see how much of your mortgage payment went towards the principle, or actually paying of the amount borrowed, and how much went to interest, or money charged to you for borrowing the money from the bank. As we will see with our example, the longer you borrow money, the more interest you end up paying. This actually makes sense. You would be more likely to let your friend borrow $100 if she paid you back a month later rather than a year later – banks are no different. If you are borrowing $200,000 and going to take 30 years to pay it back, the bank will want a higher return than if you paid that same $200,000 back in fifteen years.

Back to our example:

Let’s say the $200,000 you borrow for your dream home will be paid back over thirty years – a common time frame for mortgages. The following table will shed some light on just what that mortgage will really cost:

  • Principal borrowed:  $200,000
  • Annual interest rate:  5%
  • Total Payments:  360 (30 years)
  • Monthly payment amount:  $1,073
  • Total Repaid:  $386,510
  • Total Interest Paid: $186,510

We see here that the $200,000 loan is borrowed at a yearly rate of 5% and the time frame for paying off the house is 30 years. The monthly payment is a bit over a thousand dollars. Where it starts to get interesting is the total amount to be repaid; $386,510. To borrow $200,000 over 30 years, it will cost you $186,510 or almost twice the amount that you borrowed.  So in the end, the $250,000 house you bought will end up costing you $436,510 (the $50,000 down payment + the $386,510).

“But houses appreciate…..real estate goes up in value,” many people argue. My reply is that, IT BETTER! What if you would have taken the down payment of the house and invested it? And what if, instead of paying a $1,073 a month mortgage, you invested that? For the next 30 years, in a diversified fund earning a conservative 7% annual return?

  • Current Principal $50,000
  • Annual Addition $12,876 ($1,073 * 12 months)
  • Years to Grow 30
  • Interest Rate 7%

The value at the end of 30 years would be $1,682,029. Even if we adjust for an annual inflation rate of 3%, the value would still be $1,245,749. Would the house appreciate from $250,000 to $1.2 million in 30 year? Perhaps, but I doubt it.

Granted, buying a home has other financial advantages. You most likely will qualify for a deduction because of the home mortgage interest. However, this applies only if you itemize. And a tax deduction is only useful if you have tax exposure.  If you don’t owe Uncle Sam taxes, there is nothing to deduct. Also, if you are living in your house full-time, owning a home beats paying rent as the expenditure is actually going towards the purchase of an appreciating asset. But for the international teacher who is only going to reside in the home for a couple of months a year, the expenditure could be used for the purchase of a more lucrative appreciating asset, namely equities.

Still, there are other advantages of buying a home, but I would put these in the category of qualitative rather than quantitative. As an expat who returns to the states for two summer months a year, it would certainly be nice to have a place where the kids had their own room with their own things, where my wife and I had our own kitchen to cook and entertain and to simply have a physical structure to call “home”.

These are common themes international teachers reference when discussing and deciding on buying a house “back home” and if these are your reasons, then go for it. But don’t be misguided in believing it’s a great investment. Since housing is provided for the international teacher ten months a year, the financial upside to owning a home is simply not there. There are better appreciating assets to purchase. Nevertheless, if you are intent on buying the house, make sure and do it in the most financially beneficial way.

“If you remember nothing else from this class, never buy a house on a thirty year mortgage.” –Mr. Smith

It came during the lesson on mortgage amortization schedules. After we figured the interest payments on the thirty-year mortgage, we then looked at the same $200,000 borrowed on a 15-year mortgage.

Previous example given again for comparison:

30 Year Mortgage (from above)

  • Principal borrowed:  $200,000
  • Annual interest rate:  5%
  • Total Payments:  360 (30 years)
  • Monthly payment amount:  $1,073
  • Total Repaid:  $386,510
  • Total Interest Paid: $186,510

15 Year Mortgage

  • Principal borrowed:  $200,000
  • Annual interest rate:  5%
  • Total Payments:  180 (15 years)
  • Monthly payment amount:  $1,581
  • Total Repaid:  $284,686
  • Total Interest Paid:  $84,686

In this scenario, the principal borrowed remains the same, as does the interest rate. However, since the duration of time it would take to pay back the loan changed from thirty-years to fifteen-years, some interesting things happen. The monthly payment went up $500. A substantial amount you could argue, but considering the loan went from thirty years to fifteen, most likely not as much change as one would expect. The glaring difference is the amount of interest that will be paid on the fifteen year mortgage versus the thirty year. Almost a full $100,000 dollars in savings. This is why Mr. Smith thought it necessary to give such stern advice on the perils of the thirty-year mortgage. Why would you forgo $100,000 in the long term to lesson a monthly payment by $500? If you couldn’t afford the extra $500 a month, Mr. Smith surmised, you couldn’t afford the house.

And believe it or not it gets better. Since you are borrowing money for a shorter amount of time, lending institutions will give a better interest rate on the loan, many times at least a whole percentage point less. So looking again at our example, we may assume that now, because of our shorter term loan, we can secure 4% on the loan rather than the 5% assessed for the thirty-year loan. Let’s look at how this changes things:

15 Year Mortgage at 4%

  • Principal borrowed:  $200,000
  • Annual interest rate:  4%
  • Total Payments:  180 (15 years)
  • Monthly payment amount:  $1,479
  • Total Repaid:  $266,287
  • Total Interest Paid: $66,287

As you can see, at 4% our payment goes down $100, making it now only $400 more a month than the original thirty-year mortgage. Additionally, we will realize a savings of over $120,000 in interest over the course of the loan. Imagine that, $100 dollars extra a week will save you $120,000 and allow you to pay off your house fifteen years early.

So if you must buy a home by all means do it, but just remember Mr. Smith’s sage advice. And if you find that the monthly payment on that home is more than you can afford if financed for only fifteen years, then you have found a house that you cannot afford. This is the difficult part for would-be homebuyer – they fall in love with a house that is most likely more than their family needs or can afford and decide to make a poor financial decision (the 30 year mortgage) in order to get what they want. It is up to you to exercise the proper judgment and wisdom to not allow this to happen – “nothing but a big mortgage if you ask me”.

wesley-tingey-176386-unsplash.jpg

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s