Why you can’t afford to sell your house
If you’re thinking about upgrading to a newer house, don’t! I’ll show you why in just a few minutes. But first, I want to tell you a story about real estate. Real estate can be an amazing and powerful investment tool. A tool like buying a foreclosure and flipping it for profit, or buying a house, renting it and having rental income. On the other hand, though, real estate can also be a very real money pit, and does not always go up in value. In case you’re reading this and thinking that your house is a great investment, you are probably wrong. The reason is that most people assume that houses are appreciable assets, and will always go up in value.
If you don’t believe your house can be a bad “investment”, ask anyone who bought a house anywhere from 2006 – 2008 at the peak of the market. During that time banks were practically handing out loans like a bubble gum machine. Most likely, people that bought houses during that time with large mortgages lost equity in their homes in the upcoming years. As borrowers realized they couldn’t pay on their loans, and their house was “worth” less than what they paid, many people were foreclosed on. Just like Tom Hanks, many Americans felt the harsh reality that their “investment” was actually just a money pit.
Love the house you’re in
According to the U.S. Census Bureau, Americans will move about 12 times in their life. So, let’s say that you leave home after you turn eighteen, and you live to be 95 years old, you would move eleven more times. That’s an average of staying in any single home about 5 – 7 years. As I talked in this other post about amortization, it truly is your silent partner working against the average american. I’m going to go over some basic, but powerful, math that will demonstrate the power of your mortgage working against you. I want to challenge the notion that your house is a good “investment”, especially when you use other people’s money to “invest”.
Jonathan and Robert: Year 1
For this example, let’s say two brothers, Jonathan and Robert, went house hunting and found the house of their dreams! Jonathan lives in Texas and Robert lives in Florida (they both like to avoid state income tax). They each walk into their local banks and take out a loan for their dream house for $200,000, respectively. They each take out loans for $200,000 and agree to the terms of the mortgage, 30 years loan at 3.5% interest rate. Jonathan is excited to finally barbecue on his Texas sized grill and Robert loves to pick fresh Florida oranges.
Let’s take a look at the numbers for the first seven years in each of their houses.
Nothing fancy here, you can see that both Jonathan and Robert started with a loan amount of $200,000. At the end of their sixth year, they both had the same remaining loan balance of $174,000.
Jonathan and Robert: Year 7
After 7 years, Jonathan has a pretty routine life, he goes to work and pays his bills, and he’s happy in his house. Robert, however, decides that he wants to be closer to the beach. So, after 7 years Robert moves to another neighborhood that is closer to the beach. After putting it on the market, Robert sells his house for exactly what he bought it for, $200,000. Robert now has roughly $26,000 equity from the sale of his house ($200,000 – $174,000 = $26,000).
Robert buys another house for $200,000 and uses the $26,000 from the sale of his old house as a down payment towards his new house. That means he’s taking out a loan for $174,623, let’s assume he takes another 30 year mortgage at 3.5% interest rate.
Let’s look at the math behind each of their loans now!
Still, nothing shocking. After 7 more years (at year 13), Jonathan owes $137,574 on his house in Texas, and Robert owes $148,308. For the time being, Jonathan owes about $10,000 less on his mortgage than Robert. Not too bad, I mean Robert is closer to the beach.
Jonathan and Robert: Year 14
After 14 years in Texas, Jonathan is excited to know that he’s half way to paying off his mortgage! Robert, on the other hand, decides that he doesn’t want to live near the beach anymore, and wants to be near a better school district for his kids. So, of course, Robert lists and sells his house for $200,000, takes the equity ($200,000 – 148,000 = $52,000) and buys another $200,000 house. Roberts puts $52,000 as a down payment and takes a loan of $148,308 at 3.5% interest.
Let’s look at the math as Robert starts packing his boxes.
As you can see, the margin between Jonathan and Robert’s loan starts to get larger and larger. After 7 more years of being in his house (end of year 20), Jonathan only owes $90,437, while Robert owes $125,958 on his house. Hang on with me, we’re almost done looking at their mortgages, just 10 more years to go before Jonathan pays off his house!
Jonathan and Robert: Year 21
Here’s where the magic happens. Jonathan sees the light at the end of his mortgage tunnel and is getting closer to retirement. Unfortunately, Robert decides that now that his kids are off to college, he wants to move near the country club where he plays golf, so he can work on his swing.
So, Robert sells his house in the good school district for $200,000 and takes his $75,000 equity ($200,000 – $125,958 = $75,000) in the house and uses it as a down payment towards his retirement home on the golf course. Robert takes out a loan for $125,000 at a 3.5% interest rate.
Let’s bring this to a close as Robert works on his swing.
Here it is folks, what you’ve been waiting for! As you can see from the table above, as Jonathan nears the end of his 30 year loan, Robert is just getting started on his loan. At the end of year 30, Jonathan is enjoying his debt free house and can finally retire because his expenses are so low (lighthouse 1). Robert, however, will have an additional 20 years of mortgage payments. While Jonathan has a remaining balance of $0 for his mortgage, Robert has a $97,000 loan and continues to work to pay the mortgage each month, but his swing is getting better!
You can’t afford it!
So, can you afford to move? Probably not. I made a few assumptions in this simple example, but overall the principal and the numbers are the same. In this example, I assumed that each of Robert’s houses kept the same value. However, even if any of his houses did appreciate in value before selling them, he still would have had to pay closing costs and realtors fees to sell them.
When you’re looking to upgrade to a bigger house, or think you need to be in that neighborhood, think again. After Robert moved just three times, you can see the negative effects that taking out a fresh loan had after 30 years. That is the power of amortization and debt working against you.
You can also see the power and control Jonathan had over his life because he did not have to worry about a lot of factors that Robert did when he moved. Robert had to hope that his house value didn’t go down, he also had to pay closing costs when he sold and every time he bought there was uncertainty of varying interest rates every 7 years. Jonathan, on the other hand, didn’t have to worry about any of those factors. Instead of letting debt govern his life, Jonathan used money as a tool to pay off his mortgage and enter retirement, debt free. If you’re looking to take control, think about treating your 30 year mortgage like a 15 year mortgage. If you can’t be that aggressive, simply pay an extra $100 towards the principal each month and watch as you shave years off of your loan repayment schedule.
Of course, this whole example means nothing if you use CA$H! The power of using YOUR money far supersedes the “potential” to make money using OPM (other people’s money). Like I said when we started this example, there are a lot of ways people use mortgages with the potential to make money, whether it’s flipping houses or buying rental properties. Keep in mind that money is just a tool. If you don’t master your money and use it as a tool, money will surely become your master, dominate your life, and leave you with nothing when it finally leaves you.
Are you thinking about moving to a different house? Have you thought about the costs associated with selling your house? Can you afford it?