Diversification In Action, Another Plug For Tracking Net Worth

Posted By Paul

Long time readers of Frugalize will know that I watch my net worth very closely. (see a posting from 3 years ago tracking your net worth)

One thing I didn't mention in that article was that another advantage of tracking your net worth is that you automatically get an idea of how diversified you are (or aren't), and how that's working out.

About 7 years ago I started noticing that A LOT of my net worth was in real estate (i.e. my house). That was to be expected in that my house (like many houses at the time) was growing in value quickly. As my house became more valuable it became a bigger and bigger part of my total net worth. My other investments were doing fine as well, but they just couldn't keep pace with the crazy real estate market.

My reaction to this was to make it a point to focus more on OTHER types of savings. I wasn't someone who thought that real estate was going to just keep going up forever, so I decided I didn't want to have too much of my net worth tied up in real estate. Instead I focused on my emergency fund, and other types of investments. They weren't quite as exciting as the real estate market at the time, but I figured that since I'd already gotten a piece of that I didn't need to put all of my eggs in that one basket.

So today I realized one consequence of this choice was that in the last year or so my net worth has been tracking steadily up, even though the value of my home has been steadily trending down (Of course knowing the value of your home is always tricky, but I just use zillow for simplicity, and figure it is at least in the ballpark).

So even though my house is losing value, overall my net worth is continuing to grow. This is a direct consequence of having made other investments years back that offset the cooling real estate market now.

It's nice to know that my net worth isn't completely driven by the value of my home.

I think I'm going to stick with this strategy of always trying to stay diversified. I get a piece of every boom, and of course every bust as well. Thanks to the fact that I track my net worth I can honestly say that so far the strategy is working for me and overall I'm coming out ahead.

The Hunt For The Perfect House

Posted By Paul

My wife and I have been in our current house (which was our first house) for about seven years and we recently started talking about moving. Having been in our place for a while we've learned a lot about what we would like in our next house.

So now we were faced with some really tough questions:
-Should we move?
-Can we move?
-What can we afford to move into?

I now appreciate what people mean when they say that buying your first house is the simplest since you don't have to deal with selling your OLD house as well. We decided to take it step-by-step.

We started off by browsing properties on the internet. We wanted to see if properties existed in the area that met our criteria to get an idea of what they cost.

That ended up being pretty easy. We discovered several properties that met the basic criteria of what we wanted. That told us that properties like we hoped for did exist (we wanted a little bit of land) and what they cost.

We then did some research to get an idea of what we could get for our house if we sold it. We tried to factor in a cushion to cover what we would do if there was a long gap between selling our old house and finding a new one.

We quickly end up with a spreadsheet where a lot of the numbers were guesses, but at least they were hopefully guesses grounded in the fact.

Based on a general idea of cost and a guess of what we could get for our current house it was simple math to figure out the mortgage payment we would need to swing in order to make it happen (based on the current mortgage rates).

Unfortunately that is where the process ended. The way the numbers worked out it looked like the mortgage payment for our dream house would be much bigger than we wanted to take on.

So now what? Well we're going to do three things:

1) Keep browsing the web for properties. You never know, maybe some amazing bargain will pop up.

2) Get our current house in shape for selling. This just means that any projects we decide to bite off will be based on the idea that we'll be selling this house in the semi-near future (so projects that help the resale value of the house get priority).

3) Save, save, save! Just because we can't afford our dream house now doesn't mean we can't get there. Towards that end we're focusing on paying down the mortgage (giving us more equity to put towards the next house) as quickly as we can without sacrificing our other "required" savings vehicles (rainy day fund, college fund, retirement, etc.).

It was tough looking at all of these cool properties and trying to figure out a way to get the numbers to work. Phrases like: "Well that mortgage payment wouldn't be TOO bad." keep going through your head. Luckily with a quickly growing toddler in the house it was easy to remember that unexpected expenses come up and that even if we COULD manage a bigger payment every month, it doesn't mean that we SHOULD.

Our hope is that if we stick to our plan that eventually we'll be able to afford our dream house and we won't be stuck in that "house poor" mode where we have a great house but we struggle to make the payment every month.

We'll keep you posted!

Article: 7 New Rules of Financial Security

Posted By Paul

A great article listing new rules for financial security.

You can read the full article at:
The 7 new rules of financial security

I also thought I'd summarize them here:

Rule 1: Risk
It essentially says that you need to be very careful to make sure that invested money is available when you need it. There have been many stories of people with college or retirement funds invested in high-risk stocks that collapsed right when they needed the money.

Rule 2: Cash
This talks about having a nice rainy day fund of cash available quickly when you need it. Matt and I talk about this all the time.

Rule 3: Human capital
This was interesting, the article suggests that you not only look at risk but also the stability of your job when considering investment risk.

Rule 4: Borrowing
It essentially says to borrow cautiously. View debt as a necessary evil.

Rule 5: Housing
Says to not fall into the trap of viewing your house as a no-risk investment.

Rule 6: Diversification
Suggest a really close look at diversification.

Rule 7: Retirement
Retiring early is NOT easy to do.

3.875 on a 30 year fixed? What's the catch?

Posted By Paul

This weekend I was looking in the paper and saw several ads offering 3.875% on a 30 year fixed mortgage.

Having just refinanced I was confused...since I know that at their best the banks were offering 4.3% for a 30 year fixed. I figured there had to be a catch.

Well after some research it looks like there is a catch....sort of.

This is called a 'builder buy down' loan. As with all mortgages there are all different types of builder buy down loans, but the basic idea is this:

Are you familiar with mortgage points? The idea is that a bank will lower your mortgage rate if you are willing to pay some money up front as a fee (1 point just means once percent of the loan as a fee).

So let's say your bank is offering a 30 year fixed loan at 5%, and you need to borrow $200k to buy your house. When a bank says they offer you 4.5% with one point, it just means that you pay 1% of the mortgage up front as a fee to get the better rate. So in this case you'd have pay $2k in fees to get the 4.5% rate.

So basically a builder buy down mortgage is where the builder pays the point(s) for you. Think of it from the standpoint of the builder.

Let's say you just built a house that you are trying to sell for $500,000. Maybe by paying $10,000 (two points) you might be able to offer a rate that will entice buyers. From the standpoint of the builder:

1) It gets the house sold - if real estate prices are falling then the builder probably want to unload the house before the value falls any more. Paying the $10k now is probably a no brainer if the builder is worried that in a few months the house will be worth $490k or less anyway.

2) The house is sold at its list price - you see this in the fine print of these loans. This is important because often the builder isn't just trying to sell one house, but many houses all in the same neighborhood. By paying the $10k to get you the lower rate, the house still goes on record as selling for $500k. This means that it will hopefully keep the appraised values of the other homes in the neighborhood higher. If instead of giving the bank the $10k to get the better rate the builder instead just knocked it off the price, and sold it to you for $490k then now every other similar house in the neighborhood could be viewed as being worth $490k. If you are the builder and you have 20 of these homes to sell a hit like that is something you'd like to avoid. It's much better to pay the points to the bank and keep the value high. It's kind of a sneaky way to make the value of the home SEEM higher than it is, but from the builder's standpoint it's a smart move.

So overall, a builder buy down is a sign that the builder is REALLY motivated to sell the property (this is no surprise in today's market). IF you want to get the house anyway then there's no harm in taking advantage of it, just keep in mind that:

1) A builder buy down of a mortgage is a sign that waiting could result in lower house prices.

2) The higher appraised value of the house could affect your property taxes.

3) There are all kinds of builder buy down loans some only lower the rate temporarily (like for the first few years) so make sure you understand the terms of the loan.

There is a great detailed article on builder buy down loans here:

Builder Buy-Down at Lendingtree

I thought that the article did a great job of summarizing how to view these offers so I thought I would quote the final paragraph of the article here:

"A buy-down can be very attractive, but it shouldn’t be the decisive factor in your home purchase. Regardless of the buy-down, you should shop around, compare loan products from different lenders and take care not to overextend your ability to make your mortgage payments after the buy-down expires."

Some House Hunting Tips

Posted By Paul

I recently saw a show on the Home and Garden Network called 'My First Place'. Where they follow a person or family through the process of buying their first home.

In the one episode I saw, the young couple found a house they really liked with a price they were comfortable with, so they go to the mortgage company and discover that they don't qualify for as good of a rate as they had hoped, which means the price they were comfortable with is now quite UN-comfortable.

So they spent some time agonizing over whether or not they could swing the bigger payment by cutting costs in other ways. The end result is that they had to pass on the house and keep looking. It had a happy ending in that they found a smaller place that they liked AND could afford, but I think the episode really accentuated some lessens for house shopping:

1) Research the mortgage first. To me this seems like an obvious choice, but many people don't do this. I shopped for a mortgage first, checked rates and saw how a specific interest rate + house price translated into a monthly payment. I was then able to see how coming up with a little more down payment lowered my monthly payment and so on. Once I was comfortable with the numbers, the mortgage company "pre-approved" me for a loan of a specific amount. I had heard that there was a time where being pre-approved for a mortgage was a big plus to the seller when you make an offer, though I didn't really experience that. However, it did give me a chance to house hunt with a sense of what I could comfortably afford.

2) Don't even look at a place you can't afford. If you already know what you can afford, why look at a house that you can't? It will just make the houses you CAN afford seem smaller and shabbier in comparison, so in my opinion you just shouldn't bother.

3) Don't let yourself tip toe into something you can't afford. I experienced this a little when I went house hunting. I had my target price that I was comfortable with, but I also knew that I could go up a little more if I really wanted to. It was sooo easy to look at a house that was a few thousand above my target price, and then look at a house just a little above that, and then a little above that, and the next thing I knew I was looking at places that were well over 20% out of my price range. I had to force myself back into the range I was comfortable with.

So what happens if during your house hunt interest rates change dramatically? Well first of all in my experience interest rates don't change THAT much in a few months and if they do then you can always go back and run the numbers.

This way you won't be caught in the sad situation where you've fallen in love with a house that you can't afford.

What you can learn from the banks.

Posted By Paul

I am always interested when a business article makes the front page of the paper, so I couldn't pass up reading an article about how banks in the northwest were on shaky ground.

What intrigued me most was how several points made in the article were mistakes that the banks made that people could learn from:

Banks' Mistake 1: Jumped into the housing boom like it would never end
I know that the current housing boom is over, but this lesson applies to any investment boom. I learned this lesson from my experiences in the dot-com boom. During that time you were hearing stories every day from people becoming overnight millionaires by pouring all of their money into the dot-com company that was the next big thing. You seldom heard the stories about the people who put all of their money into an IPO, only to have the company go nowhere. There was so much fervor about getting rich and so much certainty that the investments couldn't fail that people got carried away. Whenever there is an explosive boom like this I try to keep in mind that super accelerated growth can't last forever, and when a boom ends it usually ends quickly and dramatically. There is no harm in trying to get your piece of the dot-com boom, or the housing boom, but if you go in too deep you could lose it all when the boom finally ends.

Banks' Mistake 2: Too much debt, not enough cash.
In the banks' case this was from approving crazy no down payment mortgages to people who couldn't afford them, but the people who signed up for these mortgages aren't without blame. When I was shopping for my first house the mortgage company wanted to sign me up for a BIG mortgage with a monthly payment that I could swing as long as I never lost my job and never had a financial emergency. Don't let yourself be one of those people living in a big beautiful house but eating peanut butter and jelly three meals a day because you can't afford anything else.

Banks' Mistake 3: Went too deep into a single investment.
When the housing market cooled the banks that had all of their money invested in crazy mortgages and property development loans were hit the hardest. This is no different from putting all of your financial eggs in one basket. I don't just mean tying up all your money in your house, but in ANY single investment. Just think of the people from Enron who lost most of their nest eggs when the scandal broke.

It just goes to show that financial institutions are susceptible to the same greed and poor judgement that people are when faced with a financial boom.

The Housing Crisis And My First Podcast Recommendation

Posted By Paul

I've recommended quite a few articles but this is my first podcast recommendation.

There is this show I really like on National Public Radio called "This American Life". Each week is a different topic and there is usually 3 or 4 stories relating to the topic.

Last week the episode was called "The Giant Pool of Money" and it's all about the housing crisis. They do a great job of explaining the events that led up to the current housing crisis. They do it in really personal and understandable terms so you don't have to be an economist to follow it. One of my favorite parts of the show is that they first play an excerpt from one of Alan Greenspan's speeches and then summarize Greenspan's statement as:

"Central banker, speak for 'Hey Global pool of money, screw you!'"

It goes on to talk about mortgages, mortgage backed securities, and essentially how all of this came together to create what is being referred to as the housing crisis.

I admit that I'm only half way through it (I listen to it a piece at a time during my morning commute), but so far it's really interesting, and I wanted to let people know about it because I think for the first week or so you can download the entire mp3 for free.

I think it's really worth listening to, here is the link to the episode:

The Giant Pool Of Money

"Fixed" Mortgage, Be Careful

Posted By Paul

I was listening to a story where people are getting mailings for fixed mortgages at a great rate. They get excited and quickly do the paperwork, and feel like they got a great deal, and then 6 months later their interest rate shoots up.

Why? Apparently mortgage companies can to refer to a rate as "fixed" and call a mortgage a "Fixed Mortgage" even if they mean that the rate is fixed for the first 6 months and then adjusts. If you're not careful and don't read the fine print, then you could accidentally sign up for an adjustable mortgage when you THOUGHT you were getting a fixed mortgage.

I actually received one of these mailing recently that had big letters declaring a fixed mortgage rate that was low enough that I got pretty excited. Once I read the mailing closely it was easy to find the part where it said that the rate will adjust, but I could see a situation where someone might get the mailing, see the phrase "Fixed mortgage" and the rate and immediately call to take advantage of it without actually reading all the info.

What's the moral? READ THE FINE PRINT, and be wary of anything that seems too good to be true.

Article: 6 Money Dilemmas

Posted By Paul

Found a cool article on CNN Money today that listed some of the classic "which should I do" scenarios and gave suggestions and information.

The six scenarios the article talks about are:

1) Pay off a credit card OR fund your 401(k)

2) Save in a Roth 401(k) OR a regular 401(k)

3) Lease a car OR buy a car

4) Prepay your mortgage OR invest

5) Buy a home OR rent a home

6) Take Social Security early OR late

Here is the link to the article:

Six Money Dilemmas

Article: Roadbloack to a subprime solution.

Posted By Paul

Hi Everyone,

On CNN Money today was an article about the subprime lending crisis and the search for a way to help people keep their homes.

Here is a link to the article:

Roadblock to a subprime solution.

Since I recently wrote an article about mortgage backed securities, I was especially interested in the part of the article that mentions them:

"A large part of that plan, it's been widely reported, is to broadly rework adjustable rate mortgages (ARMs) for all borrowers who qualify and freeze their interest rates before they jump to unaffordable levels.

But investors in mortgage-backed securities, who buy the loans wholesale from lenders, aren't exactly jumping on board."

So it sounds like investors in mortgage backed securities are VERY interested in the current state of the real estate market.

I'm trying to learn more about MBS investments, so it was interesting to read about them relative to the current market.

I'm still hoping that among our readers that there are some first hand accounts of investing in mortgage backed securitues that people would be willing to share.

Property tax discounts and refunds

Posted by Matt

I read an article in the Oregonian over the weekend suggesting that I take another look at my property tax statement(s). The author suggested that the county assessor's office does occasionally make a mistake, and it might be worth a little quick math. In our area, the assessed value of a home is not allowed to increase by more than 3% per year unless something has happened to obviously increase the value (like a remodel).

So, I hauled out the page full of numbers and got the calculator going. Here's how the numbers crunched:

Land value: +5%
Structure value: +29.7%
Total Real Market Value: 17.5%
Taxable Assessed Value: +9.2%

I almost let myself start getting excited about the possibility of an overpayment and refund, as was mentioned in the article. I called up the tax office for an explanation only to hear that the numbers were correct. The assessments actually take place in January, so our 2006 numbers were determined when our house was only 90% finished. (We moved in at the beginning of February.) Their other reminder was that property taxes increase for more than just assessed value (as was mentioned in the article). Most of the increase we saw this year came from extras like bond measures.

The article offered us one other bit of consolation:

The only sure-deal way to shave your property taxes is an easy one that's been around for years: Pay the whole bill by Nov. 15 and you'll get a 3 percent discount, guaranteed. If you pay in installments, you lose out.

Our property tax payment is made out of the escrow account for our mortgage, and the title company made the payment in plenty of time to save us the $132.22.

One other side note on property taxes: there are situations where it makes sense to pay your property taxes yourself instead of through escrow. If you hang onto the tax money until it becomes due and put it into a safe investment, you can earn a return on it all year long. However, most lenders require tax escrow until you reach a threshold level of equity or payment history. This is fine for most people anyway, as it helps to level out their budget and makes the tax payment (and discount) automatic.

One View On Paying Off The Mortgage Early

Posted By Paul

Matt posted an article called The mortgage prepayment conundrum, but I wanted to share one other viewpoint I heard when talking to a friend.

The idea was this:

The main arguments against taking extra money and applying it to the mortgage are:

1) Any money you put towards paying off your mortgage early can only be accessed by a home equity loan or by selling the house. It can't be accessed easily in case of emergency.

2) Any money you put towards paying off your mortgage early could be put in an investment that can beat the interest rate you're paying on your mortgage. (You can make a greater amount of money by investing a dollar than you can save by applying that dollar to your mortgage). This argument also includes the fact that mortgage interest can be deducted from your taxes so your interest rate is effectively less.

The view I heard addressed both of these arguments by saying:

1) If you have an emergency fund built up, the need to access money you put towards your mortgage becomes less important (you won't need the money you gave the mortgage, that's what your emergency fund is for).

2) Yes you can POSSIBLY make more money investing that dollar than you save by applying it to your mortgage, but that generally assumes some sort of investment that involves some risk (like a mutual fund or stocks). The super safe investments (like Savings Bonds, CD's, savings accounts) give you smaller returns, but a dollar put towards paying down the mortgage is guaranteed to save you money.

I thought these were both valid points which made me think about my own finances. As I mentioned in the article A Simple System For Saving Money I periodically transfer money from my checking account to savings. My wife and I decided that for the next few months we're going to try transferring half of the money into savings and the other half to our mortgage, and see how that works out for us.

Your home is not an investment

Posted by Matt
I used to be a big believer in real estate as an investment (two weeks from now, my wife and I will be closing on our third house in less than 4 years), mainly because of the concept of leverage.

For those of you who aren't familiar with the term leverage, it just means that we get the benefits of appreciation on the entire value of the house even though we only "invest" the down payment. This is great, and it does actually work. The Portland area has seen great appreciation over the last few years and real estate has been pretty good to us overall. But:

1. We're tired of moving.


2. We're tired of making decisions about our house with prospective buyers in mind.


3. We want stability for our son.


4. We found our dream house in a great school district.


5. Every time we make money on a house, we end up putting it into the next house we buy.

I think the last point is probably the most compelling financial one for me. Yes, we can still technically count the home equity as an asset, but I no longer really think of it as an investment because we'd have to sell again to access it and we have NO desire to do that. We want the new house to be the last house we ever buy.

The good news is that, even if we don't consider our home equity an investment, it is still there in case of emergency (via HELOC) or if we decide to implement a reverse mortgage in retirement.

Overall, I'm happy with our choices over the last few years as all the moving, shopping and building (the last two houses were new construction) really helped us decide on and locate exactly what we wanted.