Home Sweet Home
By Rob Wrubel CFP® AIF®
Our homes are sources of pride and centers of family activity. We spend most of our free time in and around our homes—making meals, planting gardens, watching sports, and hanging out with family.
Our homes also lead to some of our biggest life decisions. Families with children locate their homes to be near the best schools and safest neighborhoods. New grads look for homes near vibrant, downtown areas for nightlife. Seniors look for homes with simple maintenance and easy mobility.
The home is a key asset we consider when sitting down with clients to review lifetime ambitions and create financial plans. This column explores a few ways to think about your home and mortgage in your financial life.
How do you value your house?
Four years ago, the average American homeowner looked brilliant. Buy a house. Wait three years (three months in Florida, Nevada, Arizona and California). Boom. The house you just bought was now up 10%, 20% or doubled. Easy money for all.
We live in a different world today. Home prices in some markets have recovered but overall there are still too many homes for sale and too many people underwater. It is expected that home values will not return to 2007 levels for a long time.
The first step in deciding how to use your home in the financial planning process is to get something close to a current market valuation. Most of us have a pretty good idea of that valuation in our heads as we watch homes in the neighborhood change hands.
The price I recommend using for today’s value is that which you would get if you had to sell your house in the next 90 days, not what similar houses are listed for currently but have not sold in six months or a year.
How long will you live in your current home?
Next, and this may be the hardest part, is to make some decisions about what your future housing needs and wants will be. Is the current house the one you will stay in for two years, 10 or 30? Will this be your retirement home? Will you moving into something different as you age?
My clients have a huge range of opinions and dreams about this. Some live in the “big” house now while they have kids at home and in college. Others need to have a separate entrance or apartment over the garage as they will need to have a child at home for a long time due to special needs or are planning to care for a parent. Still others are looking to the time when they can pick up and move to a beach condo when their careers are winding down and enjoy the sand and surf.
Planning requires some thought on the time horizon of the house. Of course, plans change and we adapt as they do but it does help to start with a sketch today. The plan will help decide many financial issues—like what type of mortgage to use, whether to buy or rent, how quickly to pay off the mortgage and how to title the home and other assets to best transfer to the next generation or to charities.
Mortgage or Retirement Fund?
The common question I have received from clients over the last few weeks has been, “Do I put extra money I save each month towards retirement or to pay down my mortgage?” Great question. Like most great questions, there is not one perfect answer.
Many of my clients do not have a mortgage. They have less stress caused by financial fluctuations. They can raise cash by selling their home if needed. They can use the payments they were making earlier to fund savings and retirement goals or spend to enhance their current lifestyles.
Financially, there are a few factors that make a huge difference in deciding where to put the extra money.
First, the mortgage rate. Some people I work with have had high mortgages—over 7%. The true cost of this money might be anywhere from 4.55% (in the 35% tax bracket) to 5.95% (in the 15% bracket). This is the payments made less the tax benefit of the deduction if the mortgage interest is deductible.
A 4.5% mortgage, more realistic over the past few years, might have a true cost of between 2.93% and 3.83%.
Second, you have to decide if can you do better than the after tax cost of your mortgage with other investments. Assume you have 15 years left on the mortgage. Do you think that a diversified portfolio of stocks and bonds will deliver more than you pay for the mortgage? You can buy blue chip names like McDonald’s and Coca-Cola that pay dividends around 3%. This cash flow alone may make the investment decision for you.
Third, appreciation. US home values have had a nominal (before inflation) return of 4.49% over the last 30 years. US large stocks have had a nominal return of 11.24% (data supplied by Thornburg Investment Management). You have to make some educated decisions about your investment return over time.
Fourth, are you willing to take additional risk? The mortgage payment is a guaranteed return the day you make it. Investments in stocks and bonds will fluctuate over time.
There are two main ways to access capital from your home—selling and a reverse mortgage. The reason we like to plan for your future living space has to do with selling. If there is no plan to sell and access capital then you will need money in more liquid accounts—like IRAs and investment accounts. This may be the most important driver of whether to pay down the mortgage or fund and maintain other accounts. Reverse mortgages are becoming more common but many choose not to use this tool due to the complexity and fees.
Personally, I love my house. My family creates memories there and it suits our needs. We have been there almost nine years and gone through the spike, drop and near recovery of value. I prefer the slow build of wealth and look at my home as the one piece of the financial picture that I can use every day, enjoy in my free time and not think about each month when the statement comes in.
We look forward to having more conversations with you about your home, your financial plans and how we can be of service. We are happy to sit down with you to review your current situation and enjoy working with the referrals you have sent us.
Rob Wrubel, CFP® is a Senior Investment Consultant with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.