Author Topic: Case Study: Can we afford to move?  (Read 3084 times)

toby2

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Case Study: Can we afford to move?
« on: June 12, 2017, 08:12:29 AM »
Life Situation: Married with two young kids (4yo and 6 mo.)

Gross Salary/Wages: 130k total between wife and I

Individual amounts of each Pre-tax deductions: $700 401k, $300 health insurance, $150 stock purchase

Adjusted Gross Income: Monthly, this equates to about $6500 per month take home (I withhold a lot and get paid bi-weekly, so there are two additional checks that are like 'free' checks. Otherwise this monthly total would be a good bit higher).

Current expenses: Oh boy. Here are the big ticket items.
  • Current mortgage: $1270 total
  • Student loans: $600
  • Home Improvement Loan: $450 (two years left @ 4%)
  • Car loan: $275 (fours years left @ 1%
  • Daycare: ~$1800 (in one year this will drop to
  • Phones - $75 total
  • Internet $80
  • Car Insurance: $150
  • Electric/Gas/Water: $200

Assets: House, value equal to current balance (bought at a bad time) ($175k). $25k cash in savings. $75k in 401k.

Liabilities: See above student loans, car loan and personal home improvement loan)

Specific Question(s): Its time for us to move! Our space is busting at the seams in a 975 sq ft townhouse, and with school on the horizon for our oldest, the schools here are terrible. The challenge is that anywhere nearby with a decent school system is substantially more expensive. We're planning to rent out our current house since we could probably cash flow a hundred bucks or so a month and use that a a long term hold investment. Once PMI comes off in a year or two, our margin will go up to about $300. It's in a very rental-heavy part of town, so I expect that a young person or couple would rent it quickly regardless of the school situation.

Where we are really stuck right now is that with daycare and our debts, we would be really squeezed if we were to buy a house that meets all of our needs for the foreseeable future. Specifically, we found a place that is $330k, which would amount to $2150 including taxes, insurance and PMI. It has great school, is three minutes from my wife's work (no clown commutes!) and is a forever home. And comparable houses are in the 400k range. Anything less gets you sketchy schools. In a year one of our daycare payments will drop off ($800) and in two years a personal loan will drop off ($450). But for at least a year money would be really tight.

I feel that our salaries are enough to justify this house price, but with our current expenses we would be in a risky spot for a year. Our jobs are fairly stable and I receive decent bonuses every year (~10k, not factored into income above). So my real question is what should we do? Should we knuckle down and scrape by for a year or two in our forever home? I'm afraid that if we wait too long, rates and price will go up, not to mention the fact that we're psychologically miserable right now in our very cramped current space. Would love any thoughts on this!
« Last Edit: June 12, 2017, 11:48:36 AM by toby2 »

Timmm

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Re: Case Study: Can we afford to move?
« Reply #1 on: June 12, 2017, 10:18:07 AM »
That mortgage includes HOA costs? If so, it looks like you currently have about $1500/mo extra.

I'm not sure holding the townhouse is what I'd do - in my area, those have not been a very good investment. Price appreciation lags SFH here, so holding would mostly be about cash flow and your $100/mo seems like a narrow margin to me. Landlording is a job and there will be spikes in expenses and vacancies to deal with even when it goes very smoothly. You may also find getting a mortgage for a new place is a challenge if you keep it. Conventional lenders won't consider future rent income at all, your income will have to meet their DTI limits for both mortgages plus your other loans.

But aside from that, it seems like a workable stretch to me. You're looking at a property about 2.5x gross income, and don't claim too much in other expenses. You've apparently spent more on a car than I would, but maybe the short commute will help reign that in for the future. Your internet cost seems very high too - is there some special situation there?

Thanks for posting your case study - I'm new here and collecting budget info to post my own soon. I've been reading through most of the active ones to pick up ideas and make comparisons, it's been informative.

Another Reader

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Re: Case Study: Can we afford to move?
« Reply #2 on: June 12, 2017, 10:31:13 AM »
If your cash flow calculation is rent less mortgage and HOA, you don't understand rentals.  You will have close to 50 percent expenses over the long haul, including the HOA, repairs, maintenance, replacements, vacancy and collection losses, taxes and insurance.  If taxes and insurance are included in the mortgage payment, you subtract less, but this will be a negative cash flow investment.  I understand not wanting to sell it, but it will be a drag on your finances for years to come.  Owning a rental with bad schools is generally a bad idea, as you don't attract good tenants.  Unless the location and the unit appeal to pre-kid 20 somethings, your tenants will be people that don't value good schools.

Finally, as the previous poster mentions, the income from the townhouse will not be counted towards the new mortgage DTI.  You may not be able to qualify for the new mortgage, especially with the minimal down payment you have in cash.


Dicey

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Re: Case Study: Can we afford to move?
« Reply #3 on: June 12, 2017, 10:55:59 AM »
I'm fine with you doing this, provided that you get rid of the townhouse! Do not keep it. It will be a long term ball and chain.

FWIW, Another Reader and I are both fans of owning real estate and have multiple rental properties.

Laura33

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Re: Case Study: Can we afford to move?
« Reply #4 on: June 12, 2017, 11:51:11 AM »
I'd do some hard math first.  Where will your downpayment come from?  What closing costs can you expect?  What kinds of costs are you going to have when you move in -- immediate fix-ups, new carpet, new blinds/drapes, etc.?  How about moving costs?  It looks like you have $25K of accessible cash.  That is not a lot to cover all of the cash needs that come along with buying a new house -- at least, not if you want to have any kind of EF left. 

I'm also going to assume that you want to rent your current house because you'd need to bring cash to the table to sell (you say it's worth what you owe -- does that mean mortgage balance, or mortgage balance + home improvement loan?  In either case, selling means writing a check for closing costs, realtor fees, etc.).  The problem is that, as others have said, renting is NOT a good idea.  You will have maintenance costs, vacancies, periodic repairs/cleaning between tenants, costs in finding/vetting tenants, etc. -- my very first tenant went so far as to take all of the light bulbs with him!  If you put a chunk of your $25K towards the new house, how much will be left?  How many months could you carry the mortgage and bills if you had a vacancy? 

The good news is that, unless your kid is developing slowly, early elementary school is basically irrelevant.  If your kid is already reading, it is a waste of time, as the class will focus on the kids who aren't reading yet.  Even if your kid is just learning letters and starting to sound a few things out, they will do just fine in even a bad school -- it's really the kids who are behind for whom early intervention is the most helpful.

So if I were you, I would have a two-year plan.  Pay off the home improvement loan aggressively.  Get the daycare costs down.  Then use the cash that you free up to significantly build up your free cash.  Then when you are ready to move, you will be at worst cash-neutral and may even have positive equity in the existing house that you can roll into the new house, and you will have plenty of other cash to cover the necessary expenses and still have a cushion left.

Tl;dr:  You appear to have a history of letting your "need" for stuff get ahead of your ability to afford said stuff.  As a result, you now have multiple debts that are stressing your budget and that have limited your ability to save the cash you must have for your newest "need" (the new house).  The solution is not to take on even more debt so you can have what you want right now.  It's time to break the cycle.  Live on less, save more, figure out how to be happy with what you already have -- at least until you have sufficient cash in hand to afford the next step.

toby2

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Re: Case Study: Can we afford to move?
« Reply #5 on: June 12, 2017, 11:57:41 AM »
Thanks for the replies so far! I edited my original post to make the rental part more clear, but figured I'd address that here since it's generated a few opinions.

Normally, I would not purchase this house at this price with the explicit purpose of renting it out. But given the amount I have invested in it already with the original down payment, numerous upgrades and what not, I see those as sunk costs. So looking forward, if I can eke by with someone paying down the principal over time, that becomes a long term investment. This is sort of a common strategy in the neighborhood I live in, and seems to work ok for everyone who goes this route. I live in an area where rentals are in demand from younger folks - it's more of a city rowhouse than what you might think of as a suburban, new construction townhouse.

Also one factor is I currently pay PMI, which will come in a year or two - this will drop the mortgage to ~1050 or so and make it much more palatable. My concern with trying to sell it is with realtor fees, concessions, repairs to meet a buyer's demands and paying off the home improvement loan, I could actually have to bring money to closing. I'm comfortable with trying out the rental thing for a few years and will happily bail if it proves to be unsustainable.

ysette9

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Re: Case Study: Can we afford to move?
« Reply #6 on: June 12, 2017, 05:50:32 PM »
Quote
Normally, I would not purchase this house at this price with the explicit purpose of renting it out. But given the amount I have invested in it already with the original down payment, numerous upgrades and what not, I see those as sunk costs.

You are falling into a textbook definition of Sunk Cost Fallacy. I'd recommend checking out the common investing mistakes page on the Bogleheads wiki and reading about sunk cost fallacy. In short, if you wouldn't buy it today for a rental then you should not keep it as a rental. How much money and work you put into it in the past is completely irrelevant to the decision-making process going forward. Look at the asset you have now and the cash-flow scenario and then ask yourself if you have a better use for those dollars. If the money would work better for you as a new down payment or invested in the stock market, sell the condo.

Also, don't treat this situation as a need for you to buy. You may need to move but that does not mean you need to buy. Rent if necessary until your financial house is in order. There will be other houses out there.

toby2

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Re: Case Study: Can we afford to move?
« Reply #7 on: June 12, 2017, 08:06:18 PM »
Quote
Normally, I would not purchase this house at this price with the explicit purpose of renting it out. But given the amount I have invested in it already with the original down payment, numerous upgrades and what not, I see those as sunk costs.

You are falling into a textbook definition of Sunk Cost Fallacy.

Possibly, but I think there's a slight difference. If I were to purchase my current home, today, with the purpose of using it as a rental property, I'd have to put ~35k down. In that instance this money would of course be terribly appropriated. But the reality is that I've already invested a (much smaller) down payment, as well money on several needed upgrades. So I don't have nearly the same opportunity cost that would be involved in a new purchase of this sort.

Now, I totally concede that it's not ideal and might not work out. Just trying to find the best outcome. But with a 3.25% rate and a reduced mortgage when PMI comes off in a year, I feel like I can do ok just on principal pay down. I'm also in year 5 of this mortgage, so starting to enter more of the payment going to principal vs interest. The other option is to sell it for a loss, which is not really too appealing.

Where will your downpayment come from? What closing costs can you expect?
$17 down payment, closing costs from a seller's assist and money back from an employee loan program. DP would come from savings.


The good news is that, unless your kid is developing slowly, early elementary school is basically irrelevant.  If your kid is already reading, it is a waste of time, as the class will focus on the kids who aren't reading yet.  Even if your kid is just learning letters and starting to sound a few things out, they will do just fine in even a bad school -- it's really the kids who are behind for whom early intervention is the most helpful.


Sorry, but I think I respectfully disagree with this assessment. Not saying your take on it is wrong, we just might see this differently.

So if I were you, I would have a two-year plan.  Pay off the home improvement loan aggressively.  Get the daycare costs down.  Then use the cash that you free up to significantly build up your free cash.  Then when you are ready to move, you will be at worst cash-neutral and may even have positive equity in the existing house that you can roll into the new house, and you will have plenty of other cash to cover the necessary expenses and still have a cushion left.

Tl;dr:  You appear to have a history of letting your "need" for stuff get ahead of your ability to afford said stuff.  As a result, you now have multiple debts that are stressing your budget and that have limited your ability to save the cash you must have for your newest "need" (the new house).  The solution is not to take on even more debt so you can have what you want right now.  It's time to break the cycle.  Live on less, save more, figure out how to be happy with what you already have -- at least until you have sufficient cash in hand to afford the next step.

There's a lot of great insight here, I appreciate you taking the time to write this! And I think you're probably right. I will say though that I have had a pretty frugal mindset over the years - up until two months ago I hadn't had a car payment for 5 years. My very mustachian Yaris got stolen recently and the insurance payout was so far below the value the car had to us, that we basically had to obtain a new (to us) vehicle. I opted to instead buy a used Prius with a 1% interest rate. And the kitchen loan was to fix and remodel a kitchen in which the cabinets were literally falling apart. Normally both of these purchases would be paid for in cash, but I didn't want to drain my savings knowing that we needed to move soon.

Sorry if this comes off as defensive, I just figured some context might help.

Tuskalusa

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Re: Case Study: Can we afford to move?
« Reply #8 on: June 13, 2017, 12:32:27 AM »
I totally hear you on needing the space. A small house can totally close in on you with kids and family stuff. In my book though, the only thing worse than lack of space is lack of cash flow. I see this move as severely curtailing your cash flow. So, if something random comes up (car breaks, new house needs repairs, unexpected medical expenses creep in, etc.), you could have a stressful money situation.

While this current new property sounds good, perhaps it's worth looking at some others? Maybe there's something out there for a little less money that can give you the space you need. If you could find an alternative that didn't stretch your cashflow quite as much, that could help solve space and cashflow challenges.

YoungGranny

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Re: Case Study: Can we afford to move?
« Reply #9 on: June 13, 2017, 10:35:46 AM »
Yes you can afford to move if you rent but I do not think you should buy a house right away. I know you said you were mustachian at one point but your assets and debts accumulated don't necessarily align with that statement. I think you should sell the TH if you absolutely cannot stay and find a place that fits your needs to rent for 2-3 years as you figure out your next steps. Ideally, I'd stay for at least a year and get finances in order before making a big move like that. While you might get approved the new mortgage having almost nothing down and jumping into something without a solid long-term plan will likely land you back on these forums asking for advice.

Plus, just because they'll approve you for an amount doesn't mean that's how much you should actually be spenidng. $330k is ALOT of money and a mortgage of over $2k is quite high especially with a car loan, student loans and a home improvement loan. I'd really recommend taking control of all of your debts before accruing more.

 

Wow, a phone plan for fifteen bucks!