[...] Reader Mail: Buried in Debt, Help! (21 comments) [...]

We used to ask the question: Do we keep investing our savings, or do we buy a home? It didn’t occur to us until reading about readvanceable mortgages that we could do both. By being careful about what we bought, and the mortgage terms used to buy it, we didn’t need to take on additional jobs. I think that might qualify as an example of “scale”, if I understand the use of the word here.

We don’t have to move/sell to realize a gain in property value; we simply reappraise, then reinvest. The gain is translated into additional power to generate wealth. It’s a long-term plan, so the gains are realized indirectly, deferred so that they can compound. Using the purchase of increasingly valuable real estate to also further our investments elsewhere seems to me a valid example of getting the best value for our investing dollars.

And today’s post seems to harken back to my suggestion of multiple income streams; become a landlord, operate a small business, etc. This blog is about one person’s journey to becoming a millionaire, and getting value for your dollar is one part of that.

I’m also curious to learn of the savings that you would expect if I had rented my current house instead of buying it. I can see some expenditures such as cosmetic painting, landscaping, and other improvements increasing my costs, however, I expect that my utilities would be the same, the landlord would flow the taxes through, and of course, take his profit. The only way I can see the rent being cheaper than the mortgage interest, is if the landlord acquired the dwelling at a MUCH lower price than I, and therefore can get his return based on that investment cost, rather than mine.

In addition, my mortgage cost remains static for the term. My landlord can increase my rent annually, or in some jurisdictions make increases on a whim. SOME cities are seeing tenants evicted, and their dwelling space sold to another. The purchase of a home insulates me from all these negatives, and also keeps my housing value current. As I stated in my earlier post, I could not have found an investment that would match the increase in value of my home. As such, I see no easier way to protect myself from the increases in the housing market than to be directly involved in it.

As an investment in my future financial well-being, home ownership has some very positive aspects.

DAvid

But statements like this one: there is no possibility that any investment I would have considered would have doubled in three years are just misleading b/c you can’t actually realize your gain without moving. So it’s like your favorite job of all-time offering you double your stock options to leave.

The car is also a lifestyle decision (often tied to the house lifestyle decision). But the car does not appreciate in value, instead, owning “a car” is the single most expensive way to get around.

If you look around, this site is all about working smarter NOT harder. Take a look at today’s post: Dividend Analysis. We’re talking about getting the best value for your investing dollars here, not about taking on a second job so that you can have more dollars to invest. We all know about the second job method, but it simply doesn’t scale, b/c I can’t just take on a third and fourth. But when we talk about dividends we talk about stuff that does scale, if I triple my investment, I can reasonably triple my return.

I guess it’s obvious why you might advocate owning a home (seeing your home double its value in 3 years!) whereas I might swing to the other side (having seen my home value decrease since our purchase 3 years ago). ;)

Hindsight is 20/20 and we can’t predict the future so I tend to look at home ownership as a purchase, not an investment. If it turns out to be, more power to me, but if I don’t sell and am not receiving any dividends then it wasn’t an investment in the true sense of the word after all.

BTW, it’s possible to rent a house, not just an apartment.

Ah, but therein lies the rub — you need the wisdom, and to adopt the responsibility to invest the difference! There are also other issues that arise, including do you rent an equivalent dwelling to the one you would buy; are suitable rentals available; and if you are moving, do you build enough equity to afford to enter the market at a later time. In the situation that I see in my community, the rapid increase in housing prices has made home acquisition nearly impossible for the average working joe. Rentals are effectively unavailable. Fortunately we were able to buy into the market during a relative low, and are able to use that equity should we move to another location. Had I rented, and invested the difference (an opportunity I have used in the past), there is no possibility that any investment I would have considered would have doubled in three years.

Yes, there are some additional costs associated with owning, mostly related to maintenance, but utilities, etc would be the same if I own or rent a house. However, I also have an opportunity to pursue hobbies that would not be possible in an apartment.

DAvid

Basically Curtis, in your situation, keep doing what you’re doing and you’ll be debt free in no time. Watching your spending, and putting all excess income into your debt will accelerate your debt elimination. But overall, looks like you’re on the right track!

Curtis, you mention that you have $30k in equity in your home and the value keeps rising. Is the $30k built up through downpayments (not including the HBP amount you have owing) and prepayments or is much of that a result of increased value since you bought? If it’s through prepayments, I would obviously suggest reducing those.

I guess my adivce to Curtis would be: don’t worry about savings yet. Take care of the loans (it sounds like you’ve been doing a good job so far), make sure you have either an emergency fund or line of credit, contribute to your RRSPs enough to get the match and pay back the HBP and keep plugging away, increasing your loan payments with any salary increases and tax refunds you may get. Soon enough you’ll be done with the loans and all that money can start going to savings.

In my town in rural BC, a ‘modest’ house now costs $300,000, double what it did 3 to 4 years ago. I believe this to be within the range of much Real Estate in Canada currently.

A ‘modest’ car is in the ballpark of $30,000 these days.

An average Canadian family income is a bit over $75,000 per annum.

You now indicate that you have (by most Canadian standards) a very inexpensive home, a compact car, a modest income, and have paid over 10% of your net income against your student loans over each of the past 5 years. This is a very different story than contained in the original quote. Based on this information, you are doing quite well financially.

Based on the original information, which suggested that you were recent graduates, owned a recently purchased home, a car that was purchased new, and student loans with no information about repayment, I stick by my original comments. For new grads, etc., your description is of a costly lifestyle. As suggested in other posts to this blog, given the information you provided, there are other avenues to financial security, that could be chosen.

GatesVP,
The benefits of the ‘expensive lifestyle’ refers to the forced savings that purchasing a home early rather than later usually causes, building home equity that may be used in a number of ways, and the acquisition of a vehicle that should be able to be kept for a decade or more. It also frequently causes that home owner to make expenditures that increase the value of that holding, rather than spending it in other directions. the ‘dividends’ accrue from the investment in home equity, rather than an expenditure in rent.

Yes, my solution, if you want to reduce debt in a hurry is to work harder. MOST of the wealthy folk I am aware of worked hard for their wealth — running small businesses with untold hours of labour to generate their wealth. While their lifestyles are not ostentatious, they do not live what I would call a frugal lifestyle. The folk I am speaking of are the working wealthy — the independent plumber or electrical contractor, the corner druggist, the realtor; the ‘millionaire next door’. Each of these folks can generate a fair bit of wealth, but it comes at the cost of additional work; being there when your customer needs your services, so they recommend your services to others. Doing the books after hours, to ensure you get paid; meeting customers at their time schedule, etc. While I agree that one will not become wealthy if they spend their income, few will become wealthy simply by reducing spending on an already small income.

DAvid

That won’t work. In order to pay off one credit card with another, you have to get a cash advance on it. The interest starts accruing immediately then (no 21 day grace period). So in fact, you’d have a high interest loan (whatever the cash advance interest rate is). You’d be better off just using the 10K line of credit and paying the interest on that.

1) RRSP contributions are only made as part of an employer matching program and the RRSP was used to provide a downpayment on our home. Thus stopping the RRSP contributions would not make sense for us as they have to be repaid under the home buyers program.

2) Myself and my wife are not recent grads, we have been working for about five years. We originally had about 70,000 in student debt and have managed to pay down about 25 – 30,000 along with paying for our wedding out of pocket.

3) I do have to take issue with David’s comments “Curtis & partner have entered into an expensive lifestyle (home, car, etc.)”. I don’t see buying a modest $120,000 home and small compact car as living an expensive lifestyle. We already have about $30,000 of equity build into our home after two years and the value is rising each year.

I really like the advice of financial blogger and we have already begun to implement some of his ideas in getting rid of higher interest debt first. I am not so worried about the overall amount of student debt as the interest is not high. We just want to get rid of as much debt as we can without going to extremes like selling our house and car.

Thanks again for all the great information. We are learning so much through the advice given here.

From here on just continue to pay off the credit cards with each other (As was done in March and April). This entire time you have $10,000 sitting in your personal account gaining interest just waiting to be invested or used to accumulate growth. Sounds simple doesn’t it. That’s because it is
Warning: Make sure to pay each balance full every month and you will never incur any interest charges on this loan.

The richest people I know, all tend (or tended) to live very frugal lifestyles in their 20s. Despite any illusions to the contrary, unless you are renting out rooms for a really good chunk, your home does not generate income.

Your solution is work harder, where most of us are suggesting live smarter (and then work harder).

Curtis & partner have entered into an expensive lifestyle (home, car, etc.) that should pay dividends in the future, especially if they do not move, and are able to retain their home & car for the longer term.

My recommendation would be they find some extra sources of income (part-time job, etc.) and place ALL of that income against the debt. If this additional income is not used for consumption, it should stand them in good stead for the future.

DAvid

If however, you can’t take this debt load for 4-5 more years (which is probably what it’s going to be), then here’s my drastic 2-year solution:

1. Sell the house and the car.
2. Move into an apartment that’s walking, cycling or bussing distance from the office(s). Find one that’s close to amenities like Safeway, Drug Store, Post office, convenience, etc. This is usually pretty easy, b/c apartments tend to cluster so you’ll get a Safeway and two bus stops that basically service one community of apartments.
3. Sell the extra furniture and anything that doesn’t fit into the apartment comfortably.
4. Stop your RRSP pay-outs and throw your tax returns for the next couple of years, as well as all of the “extra” income at the student loan debt. If you just graduated from Uni, you likely have student deductions rolled over from the year you graduated, so use these directly towards your student debt.
5. Parcel out “spending cash” into envelopes every 2 or 4 weeks to help keep on the budget. You may also need some for groceries. The point is to make everything else pre-paid so that you can focus on your cash flow instead of your debt.

At the end of the day, that last point is the biggest thing that you can do towards debt repayment. Budget off the debt monies and start focusing on other stuff. Psychologically, thinking about debt tends to attract debt. Make your debt repayment “automatic” and then focus on the positive aspects of money. Oh yeah, and do this together with your wife :)

This is, of course, the very drastic solution. Many people have dug out of your situation w/o selling the house or the car, some of them even wander these boards :)

We really don’t have enough information about the couple to know what’s best. It’s possible that between RRSP contributions (which are savings) and student loan payments (also savings) and mortgage principal reduction (savings) the couple might already be saving quite a bit and maybe there isn’t really a problem.

Mike

I’m not sure how their salaries are distributed but if they are fairly even and each is making ~$40k (31% bracket assuming Ontario) then maybe they should hold off on the RRSP contributions for a couple years. Since they are both recent graduates, it’s likley their salary will increase over the coming years and they can start contributing more when they are in higher tax brackets (by saving their contribution room).

My husband and I didn’t make many contributions in the early years. We concentrated on getting rid of the car & student loans first and foremost. I think it worked out quite well. We’re making catch up contributions (we have lots of contribution room now) in a higher bracket than when we first graduated.

Just a thought.