Welcome to Pension Attention, the best show for first responders who want to take control of their finances.
After advising Los Angeles city firefighters for over 12 years, financial advisor, Brad Barrett now shares how you can grow your wealth, build your legacy and enjoy a life of freedom. And now here's your host, Brad Barrett. [00:19.9]
Brad: Welcome to Pension Attention, the show for you, first responders who want more out of their deferred compensation and pension plan. My goal with this podcast is to reach you where you are. At whatever stage in your career, you are in, in order to provide my nearly 15 years of experience working exclusively with both active and retired service members on their investment and retirement planning. My team of fiduciary advisors here at One Capital Management are dedicated to ensuring you take control of your finances and build the life you deserve. To find out more about me or any one of our advisors here at One Capital Management, you can go to our website at PensionAttention.com or give us a call. You can call us at (805) 409-8150. And before we get started on this week's episode, I want to send a big shout out to each of you listening each week. And if you haven't already done so you can go to our website, which again is PensionAttention.com. And there you can click on the media tab and there you can download and subscribe the Pension Attention podcast. But remember, you can also download the podcast on any other platform you would otherwise download a podcast. Lately, I've been getting a lot of responses from people who are listening on Spotify. You can also listen to it on SoundCloud or the apple app on your phone, just type in Pension Attention and it'll pop right up. You can also do it on Google podcasts as well. And if you're on there, leave us a message, leave us a comment, let us know what we're doing, it's always good to get feedback. And as always, if you like the podcast, share with someone you like, and I guess if you don't like the podcast share with someone you don't like, but today we're going to be talking about an interesting topic around our home, specifically the house that we choose to live in and when we look at that, many of you listening here are probably a lot like me. [02:10.2]
When you buy a house, you buy, you get a mortgage and when you get a mortgage, you want to pay that mortgage off. I heard that from my parents, my parents heard that from their parents and their parents are in that from their parents, you see where, I'm going with this. So, I want to go through the philosophy and maybe even the psychology around mortgages first and foremost, and they get into three specific questions that I think are really important when it comes to a lot of the clients that we meet with here at One Capital Management around the topic of their home or real estate in general, is around paying the home off. What's the right principal and interest payment? How much can I afford? There's a lot of questions we're going to talk about. I'm going to name three today that I think are really important, but first let's start with a little history when it comes to mortgages. [02:57.9]
And many of you listening here are probably thinking, you know, I have read and heard everyone from a Dave Ramsey to maybe even a Susie Orman, talk about mortgages. And they have very polarizing opinions on whether or not it's right or wrong to pay off a mortgage or keep the mortgage. And again, this show today, and this as advisors is really important to make sure that we fit the goal and objective within the plan for each of our clients, that's really important. When you're looking at something, reading something, listening to someone, remember to bring it into context for you. It's not a one size fits all. I think that's one of the most important things to mention when it comes to pure fiduciary advice, something we take to heart here at One Capital Management. So, as you're listening to me here, remember I'm going to bring in some more context around your specific plan as it relates to your goals and objectives, but also your tolerance levels. Some people don't mind carrying debt, and some people literally lose sleep over carrying a $1,000 of credit card debt and everywhere in between. So, remember to filter and to put into context what it is that you see around debt and around home purchases. [04:09.8]
Because as I mentioned on one of our podcasts a couple of weeks ago, in fact, it might've been a couple of months ago around debt and how to pay off that debt. Again, plenty of strategies out there, everything from the snowball effect to two other items you can do when it comes to debt management. And today's not so much about debt, but rather the other side of that, because debt can be a good thing if you use it right, but it also needs to be a managed item within the portfolio and within the plan itself. Now, again, as all things, I think it's important to start at the Genesis of everything. [04:41.7]
In the 1920s when mortgages first started coming around, because prior to that, and just around the turn of the century, any kind of debt or leverage was actually done still within the family. It wasn't until the end of World War I and into the 1920s, where all of a sudden you had banks becoming the lender. And in those time periods in the 20’s, mortgages were actually callable. And what that means is at any point, if you owed money on your home, the bank could come in and say, you are due to have this loan paid off in the next 30 days, or we'll have to displace you from the home essentially. Now, furthermore, at that point, mortgages were only five years long, there weren't 30-year mortgages or so. So, you had to redo your mortgage again, if you did pay it off, you'd have to redo it every five years. There weren’t these long mortgages. So as always in something I know I bring my own background into this. I really liked talking about the psychology and the philosophy around where these things start. These notions of paying your house off. [05:44.8]
Now in the 1920s currently we're in 2021, that is a 100 years, that is two generations. So, anyone listening right now is probably in one of those two or three generations, I should say. You're listening here, your 20’s, 30’s, or 40’s and have been told this by your parents who were born in the fifties, sixties or seventies or vice versa you were born in the fifties, sixties or seventies. And you heard this information from those who were born in the early 1900’s. So, you can see how we created this culture of people that believe that the only way we could truly have security was be, by having our mortgage paid off. And obviously over the years and over the decades, a lot of change has happened with regards to the laws surrounding mortgages, as they are no longer callable anymore. So, you cannot be displaced in a residential mortgage as you once were. We've also been conditioned to believe for many, many years that we have security. And the only way to do that is to have our house paid off. And I'm going to challenge over the next 10 or 15 minutes as to why that may not be a good idea. Again, context is important. I'm not saying it's the wrong idea, but it's interesting to look at how the laws have changed and what it means to you and why a mortgage on a home may or may not be of interest to you depending on your situation, which leads us into the three questions I think are important when it comes to a mortgage and your home. [07:08.0]
The first question I want to attack right away is how much of a percentage of my income should be going towards my home. Is there a net worth or income multiple that is a good rule of thumb? Okay, the question becomes more relevant by the day, honestly and especially nowadays this year, as we see housing prices are skyrocketing. Housing is probably the biggest line item in the budget of the majority of households that we oversee here at One Capital Management. And for many of you listening, but it is hard to know exactly how much you should spend. Let's reinvent the question here, is how much is too much, cause that's really the fear question that people are asking. How much is too much? When does it make sense to stretch to the high end of your range? And what have you spent too much and you become house poor? What if you don't spend enough and you regret your decision? ringing a bell for anyone. [08:03.0]
There's some financial rules of thumb when it comes to this stuff, but like most financial decisions there, these rules always require some context. As I mentioned before. There's the old 50, 30, 20 rule that states you should allocate your budget as follows, again, rule of thumb, 50% on necessities, basically housing, transportation, health care food, et cetera, 30% on once that's dining out, travel, entertainment, clothes, things like that. And then 20% on saving, saving for retirement emergencies, debt repayment. So, depending on where you live, this budget might sound reasonable or it might sound frankly impossible. So, if you're in the high cost of living areas like maybe here in California, you could be spending that entire 50% on housing alone versus necessities or more in some cases actually. And I've seen personal finance people recommend believe it or not, no more than 30% of gross income towards housing costs. The certified financial planning board of which I'm a member as a certificant, it states the 28 to 35% of your gross income goes towards housing costs, again, another rule of thumb. [09:14.7]
The problem with rules of thumb though, is they don't take into account your personal circumstances. This decision involves math emotions, circumstances, and trade-offs, I mean, it's encompassing, wouldn't you agree? Now, before we get into some qualifiers about how to think about this question, I have to state upfront that you don't have to buy a house. I think in 10 minutes into this episode, as we're talking here and we're going through owning a home. Remember, owning a home is not for everyone. I know there's a ton of FOMO, fear of missing out, out there right now because home prices are rising at such a fast clip, but there are downsides to buying a home, especially as a young person. You lose some flexibility, if you wish to pack up and move somewhere else in a hurry for a new job, a love interest or, or a new start. I mean, there is some flexibility issues to discuss. And it's expensive to own a home. Remember, we're just talking about principle and interest here, for the most part, you have to pay property taxes, furnished the home landscape, it maintain it, insure it and pay interest on the mortgage just the same. [10:15.8]
So, there are frictions involved when buying and selling as well. There are closing costs, realtor fees, moving costs, and the headaches involved in buying and selling a home. I mean, it's more of a tangible asset, so it just doesn't trade on a dime, like maybe say you can move in and out of a stock as an example. And most people, if I'm being completely honest, have no idea what the actual return on their home is because no one bothers to calculate the all-in costs involved. We do that for our clients. And it's important for you to consider that, but don't buy a house just because you feel pressure or an obligation to do so. [10:46.8]
Do you know how much you should be contributing to your deferred compensation plan? Are you getting the most out of your current investment options? Looking at entering or about to exit the DROP program? Go to www.pensionattention.com to find out how we can help. [11:02.6]
As you hear me each and every week, you know, I speak heavily around the topic of the psychology of money and why that's so important. It's really interesting to debunk those myths that may or may not have come from our parents or our relatives or people in our inner circle, but it's important about the nurture in nature and what we've been used to and what we feel is necessary. A lot of times I meet with younger clients that just feel so strongly, I should say, around buying a home. And it's important, I'm not saying that's wrong by any means, but it's really important to go through that's what they want versus that's what they think they want based on someone else's perception. [11:39.8]
Now, with that disclaimer, out of the way, here are some questions I would ask myself as a 20 something year, old years ago, thinking about this decision and thinking through this decision. So, question number one, how much should I be spending on my mortgage? The 50, 30, 20 rule is a good baseline to start 50% on necessities, 30% on wants 20% on savings. And then breaking that down into the CFP standard, which I actually kind of agree with, I think is kind of more in line of 28 to 35% should be what's called PITI, Principal, Interest, Taxes and Insurance when it comes to your home. So, use those as a frame of reference if you will, when it comes to buying it. But I'm going to go into a couple other questions here about home person that I think are important. So, number one, again was how much should I be spending on the home? And these other two are going to be more around once you buy the house. [12:34.4]
Number two, how long do I plan on living in this home? That's kind of important. No different than the car conversation we had a couple of episodes ago, around should I buy, or should I lease. The tenure or the timeframe in your home actually has a lot to do with the purchase itself. But the question around how long do I plan on living in this home that you've purchased? This is probably one of the first questions all potential homeowners should ask themselves once they get into the home. Home ownership can be a profitable venture under the right circumstances, but rarely if you live in the house for a short period of time. And I say rarely only because that has a lot to do with market fluctuations. The majority of your payment goes towards interest costs in the two to three years of paying down your mortgage. So, the 7 to 10 years is a good starting point for the minimum length of time in a home. And further to that math, if you will, the first, let's say 10 to 12 or 13 years of a 30-year mortgage, 30-year fixed mortgage in particular, the majority of those years are largely interest it's right after those years that you start inverting the scenario to it being largely principal reduction versus interest. So, 7 to 10 years is a good starting point. Now, anything less than that, and you open yourself up to the possibility of selling into a bad market or eating up any equity with switching costs from the selling to the buying of a new home. [14:03.1]
And the third question is, could I see myself or my family being in this home forever? You know, a few friends who bought a home when they were bachelors, before they settled down and got married. None of them ended up staying in the house they bought myself included. You may think you have great taste in neighborhoods or homes and maybe even decor, but until you go through the process with another person, you know, it can be entirely a different story. So, there's nothing wrong with buying a starter home. One of the questions we get asked a lot is about starter homes or home for long-term, but there is nothing wrong with buying a starter home. It just tends to be what I would call more of an investment property than it is your home. And just to understand that buying a home when you're single could be, and it is, its a, could be a mistake if you eventually end up in a relationship with someone who has different ideas of what a home should look like, the you live in a home, the better your odds are of seeing positive outcomes of returns that I have mentioned before, and when I mean longer live in a home, I mean, right around seven or 10 years give or take, but it's hard to know ahead of time, the curveballs of life, you know, getting thrown your way. So, it's fully expected that you might make some mistakes here, but just know the parameters and put it all into context. And you might expect to live in the same home for life for that matter and until it gets away and you know, my wife and I thought our first home could be a forever home, but like many of you and many of our clients, our life evolved, we had kids and we somewhat grew out of the house. [15:24.9]
And I’ll add another question at the end of this too, is how much am I comfortable spending on housing? And I want to touch on that question and I'm only bringing it back up on my notes here as I was writing this episode this week to question number one, which is how much I should be spending on the home? And I mentioned the parameters and the guidelines or the rule of thumb around that. But there's also a psychological question, an emotional question, maybe you should ask yourself is how much am I comfortable spending on housing? The down payment, alone can be a problem in certain housing markets, but for most people, the monthly outlay is the biggest determinant of how much you can spend on a home. Again, that monthly payment includes not only your mortgage payment, but also insurance property taxes, potentially PMI. If you don't put 20% down. So in terms of figuring out a price range, it might be a good way to think about it this way. And I found this article actually, and a wealth of common sense. The article was written by a guy named Ben Carlson and he put it this way and I tend to agree it kind of falls in line with my scenario as well. [16:23.1]
So, in terms again, a figure on a price rains, every $10,000 in price is an extra $40 or so in monthly payments. This is again based on a 30-year fixed and we use an example of 3%. So, let's say your range is $250,000 to 400,000. The monthly mortgage payment range for these prices is between $1,054 to 1,686, again, this is before accounting for a down payment. That's a difference of more than $630 a month or nearly $7,600 a year. You have to think through, I think the opportunity cost of those payments. If you don't have a good grasp on your budget or time horizon, or maybe even your current financial status and local real estate market in particular, when buying into this market, it's going to be difficult to figure out how much to spend on a home, which is by the way, where you can rest on the laurels on maybe the guidelines or the rule of thumb. But if you think you found your forever home, you know, look for my clients, I really don't have a problem with them looking at homes in the higher end of their range. The wonderful thing about fixed rate mortgages is they don't change. [17:26.6]
And by the way, I think now more than ever, it's important to take a look at our interest rates right now we are historical lows, but I do believe I'll be honest with you, I do believe in fixing the rate. I think right now, variables in particular are going to go up, I think we all can agree with that. rates are going to go up by the way, when a rate increases, it doesn't mean your mortgage is going to increase dollar for dollar the same way, or I should say percentage point to percentage point. So, you need to look into that. A lot of times I've seen clients psychologically when the fed raises rates by let's say half a percent, they in their mind think their mortgage rates going to double and all of a sudden, they can't afford their mortgage. And I'm like, wait a minute, you're on a fixed rate, you're fine. But on a variable, it's still not the case. It's still going to go up relative to the fed funds rate or the overnight discount rate and how the bank that you're choosing to have the mortgage through appropriates that. So again, it's just an important aspect to think about when you're going into your home. So, the first question I mentioned is how much you should be spending in our home, which is the largest question we get asked. The subsequent questions I think that are really important to kind of look through, right, is how long you plan on living in the home as well as do I actually see myself in this home forever. [18:31.0]
So, I hope that provided some good context around some of the questions we get asked. And I think a lot of you that are listening right now are probably thinking those things. So, if you have any further questions, please feel free to reach out. As I mentioned before, you can reach out to us at (805) 409-8150. Again, you can also go to our website at PensionAttention.com and there you can actually set some time with myself or Toby Rodriguez or any one of our advisors here at the firm to go through your retirement, your goals and objectives, especially heading into or out of hopefully the pandemic and really taking a look at what your road ahead looks like. [19:06.6]
I want to thank you for listening to this week's episode of pension attention before acting on anything discussed today, remember speak with a financial advisor near you about your specific situation, or again like our help visit us at PensionAttention.com or give us a call (805) 409-8150. And until next week stay safe. [19:27.3]
The information in this podcast is educational and general in nature and does not take into consideration the listeners personal circumstances. Therefore, it is not intended to be a substitute for specific individualized, financial, legal, or tax advice.
To determine which strategies or investments may be suitable for you consult the appropriate qualified professional prior to making a final decision. [19:50.6]
