The other day in the gym, as we pedaled madly on the stationary bike, this investment banker who comes to work out regularly was saying how he had visited this breathtaking, sprawling house in the outskirts of the city. He said it could be anyone’s dream house, a piece of jewel that could definitely grace the front cover of Town and Country. “It was post-card perfect”, he said, “and the garden and the lawn made you feel like you were in the stomping grounds of the well-to-do. I was eager to look inside. I went in through the front door and the first thing I saw was this very graceful, winding staircase fit for royalty. I was in awe. The architecture was top of the line. You could smell the hefty price tag right away. But then as I made my way in…I was…I was…”
“You were what”? We got curious, thinking that he was going to say that he saw a sinister-looking lady in black at the top of the stairway who had her fangs out ready to suck his blood dry.
“Well…I went in and the house was screaming empty. There was one piece of furniture in the living room, a scraggly sofa that had seen better days and absolutely nothing on the walls. It was the bare minimum. It felt like someone with a lot of cash just bought it to use as a hideaway.”
“Know what we think?” We offered an opinion without being asked.
He looked at us. “We think it’s a case of being house-rich but cash-poor. People have the tendency to buy way too much house either because they want to keep up with the Joneses or they don’t know anything about managing their liquidity position. They have zilch knowledge about money.”
He agreed with us. Of course - he’s an investment banker. He’s used to seeing people spend their money like there’s no tomorrow.
Mortgages: After you Sign the Papers
No one will argue that a mortgage is good debt. It’s a debt in the guise of an investment for the future. Getting into a mortgage is an exciting stage of one’s life. It opens up new vistas and forces individuals to re-adjust their spending habits to accommodate this new event.
Financial advisers say that a mortgage is the equivalent of building equity. You won’t get very far as a renter; in fact lenders don’t consider you attractive enough as a client the way they do homeowners. Banks and other lending institutions are aware that if a homeowner defaults on a loan, they have their house as collateral. And it’s excellent collateral. This is the reason why lenders run after you and offer you all kinds of tempting deals - to get you further into debt.
We immediately realized this when we purchased a home four years ago. Before then, we were a perpetual tenant. We pooh-pooh’d buying a house, thinking that it ate a lot into cash flow. Just the thought of carrying out periodic maintenance work made us gun-shy. Every time we spotted a homeowner during weekends raking the yard, clearing the gutters up on the roof, installing windows and tinkering with the sump pump in the basement, we’d gleefully thank our stars above that we didn’t have to do that kind of work.
But then the housing boom happened and mortgage rates went down, down down. It seemed foolish not to jump in the bandwagon and join the crowd of people who took on mortgages that were larger than life. So we signed the mortgage documents and whispered, “there goes our freedom.”
Mind you, something wonderful happened. We actually learned to fall in love with our little piece of real estate and then we started receiving offers - offers for money that people wanted to give away practically for free. Those letters would say, “you need a much-needed vacation. Why don’t we credit your account right now with $5,000.00 so you can go anywhere your heart pleases? Just call this number and we’ll credit the funds without delay.” And that was not the only offer. There have been dozens since then.
When we were a tenant, we had to knock at the doors of banks to apply for a loan. Now as a homeowner, the bankers are knocking at our door. They suddenly think you’re a solid asset that’s worth all their time and attention.
That’s the upside of mortgages. You’re saving for a real asset that will pay handsome dividends in the future. You’re building equity so you can face your retirement years with confidence. You’re improving your financial credibility because you have one of the best collateral to offer should you need to take out a loan. You’re making lenders fall head over heels in love with you.
Mortgages, however, can be a blithering, bulldozer of a burden if we’re not careful.
Mortgages: Best to Postpone if…
Despite the praises heaped on home ownership, getting into a mortgage has to be executed with perfect timing. We’ll explain what we mean by this.
You’ve just graduated from university and you’re carrying some $20,000 worth of student loans. You land a job but because this is your first job, the bosses upstairs don’t think you’re worth the extra zeros yet in your paycheck because you’re well…a little wet behind the ears. As a young upwardly mobile individual, you have to get out of the house on Saturday nights, meet a few people and socialize, refresh your wardrobe and get an expensive gym membership – just to – you know – rub elbows with the mighty and powerful who can crank up those weights and crank up corporate sales at the same time. So what’s next? Credit card debt begins to pile up.
A year passes. Cupid comes by and one of his arrows lands in your heart. You fall in love, propose, and guess what, you’re both planning for a huge wedding with about 300 attendees. Your future bride also wants a big house to come home to after the honeymoon, complete with a pool and back garden large enough to accommodate a barbecue party of 200 people.
Hold your horses.
Stop and think. Can you afford a mortgage at this time of your life? What will your debt profile look like when you take on a mortgage on top of those student loans and credit card charges? Assuming you buy the house with your parents’ help going towards the downpayment, your future kids will need braces…and measles shots…and summer camp. Have you done any adding or subtracting lately?
Perhaps you should.
Like we said, the desire to buy a house is a financially sound decision. But temper that desire for the time being if you’re swimming in debt at the moment. You may be young – in your early 30s – and not thinking of your debt burden as something to agonize over. But getting into debt is truly habit forming.
A house in the suburbs with a white picket fence, an apple tree in the backyard and a kidney-shaped pool is the idyllic setting, but wait until you can afford it. And you WILL be able to afford it, provided you do debt-diligence.
Mortgages: and when it’s time…
You’ll know when it’s time. It usually comes after the decision to marry and have children. When you negotiate the terms of your mortgage, your financial adviser should be able to tell you how much house you can afford.
If you and your partner are planning to have 2.5 kids, you don’t need a house with 8 bedrooms just because it sounds impressive. Your financial adviser will want to look at both your incomes, the kind of house and neighborhood you’re considering, your debt load and your lifestyles. Your financial adviser will also enquire into your savings and other assets, whether or not you have registered retirement funds, the outstanding payments on your cars and other such information that will help her determine how much mortgage you can afford.
You have the option, of course, to keep up with the Joneses, but think of what our gym friend said earlier. Can you sit on a run-down sofa for the next three years?