Overextending Yourself and Facing Reality

Recently I had a call from a friend who is trying to buy his first home. He is currently buying into a very hot real estate market and has so far had no luck getting a house. The major reason he hasn't got a a house is the market is so hot he has to overbidding the asking price by at least $20,000 with no conditions just to get a shot at a house.

During the discussion it came out that he is trying to get a house near the top of his range given to him by the bank. He knows that he would end up house poor if he did it, but he is still shopping in that range. Why would anyone over extend themselves like that? Simple, he thinks he deserves a single detached house regardless of the consequences.

At times like these I hate to do it, but at the same time someone has to point out what he wants and what he can really afford at this time are two different things. It is time to face reality that overextending yourself is never a good idea. Your cash flow situation ends up so tight that you end up frustrated and often tempted by credit to buy all those things you need for your first house like a lawnmower and appliances. I know this can happen because I ran the numbers myself when I bought my first home. I could afford the over $250,000 the bank approved me for, but I wouldn't have money for anything else. I've seen the pain this causes for people when they get into this situation a few times now, it isn't very nice.

So what's the solution? If the plan isn't working perhaps it is time to change the plan. Perhaps my friend should start out in an apartment condo and keep saving for a few more years. Then when the market isn't so hot go shopping for want he really wants with a larger down payment and hopefully a larger income.

Shopping in a hot real estate market is a brutal thing to have to go through and I don't wish it on anyone. Yet markets like that tend to produce bad decisions based on emotion rather than facts. If you are in a hot market take care to avoid overextending yourself otherwise you might find yourself selling your beloved house when interest rates go up because you can no longer afford it.

Parents Influence Over Their Kid's Money

Over at Get Rich Slowly, the author had an interesting post on how parents influences a child's view on money and how that carries over to their adult life. I have to admit this got me thinking a bit about my own family's views on money.

I grew up in the middle class so I never felt deprived of anything, yet at the same time I wasn't spoiled. Now as I can see my parent's over spending habits, I have to wonder why I don't overspend at all. I know that I'm their son (actually I was the only baby in the hospital, so I couldn't have even been switched at birth), but when it comes to money genetics I might as well be a different species. I always have lived below my means, saved money and avoided debt before I even knew those were good things to do.

Perhaps the two events that shaped me most weren't even noticed by my parents. The first was one day I was taken to the bank to buy some Canada Savings Bonds. Upon getting to the bank I was informed that I had enough to get a term deposit instead and get a higher interest rate. In that moment I learned something important: Having more money give you even more choices to make your money work for you. So $100 to invest is good, but $10,000 is better.

Then other thing my parents did for me that really hit home was during my second year of university they stopped paying the bills. They had decided to buy a cottage instead of funding the remainder of my education. So they co-signed some loans and I was now living off debt to pay my school. I hated it, but it taught me to pay attention to my spending. Needless to say I reduced my spending at school by 10% the next year and I started paying down the debt with every dollar I could after leaving school. So I learned, debt can be good tool, but don't depend on or think for a second it is your friend. Debt truly is a master/slave relationship, you get to pick which one you will be.

So what's your story, did you pick up terrible spending habits from your parents or did you learn to save early on? If you feel like sharing leave a comment or send me an email (candian.dream.free.at.45@gmail.com).

RRSP or Mortgage: Moneysense Reviewed

Check your mail box today to see if you have the latest edition of Moneysense magazine. If so jump to p.14 and Duncan Hood's column on RRSP or Mortgage? If you don't have the magazine, I'll do a quick summary.

Mr. Hood suggests that the 'debate' about paying off the mortgage vs the adding to your RRSP is over for a few good reasons. First he explains the misconception that your RRSP is tax sheltered while your RRSP is. Obviously if you put money in the RRSP you get a cheque back from the government, but if you pay off the mortgage you pay less interest. So all those future payments will have less interest paid with after tax dollars, so in effect your not only saving the interest, but the tax on all that interest too.

Then Mr. Hood goes on to say it's about risk. A mortgage at 6% is a guaranteed returned, while a 8% mutal fund after the average 2% MER (management expense ratio) gives you the same return, but your exposed to the market risk. So obviously then we should pay down our mortgages first and then contribute to our RRSP.

Ok, I agree with his first point. Saving lots of interest on the mortgage is a good thing. It's the numbers in the second point I'm having problems with. First off most intelligent investors are not paying a 2% MER on anything. If you even use the basic couch potato portfolio you would have got a return last year close to 12% with a MER around 0.5% (or less), for a net return of 11.5%. I locked in my mortgage back in the very low interest days and blended in my new portion when I moved, so I'm only at just over 5%. So my RRSP is 6.5% higher than my mortgage, which in my mind is worth some risk.

The problem with these little articles is they make assumptions. The reality is the answer of paying off the mortgage or save for retirement depends on your own numbers and your comfort level with risk. If your like me a higher RRSP return makes me more likely to save for retirement, but I'm also aware that your mortgage is a reverse compounding curve. So any payments in the first five years really drops your interest payments over the life of the mortgage. So my answer is do both. I've increased my mortgage payments by 15% to assist on the pay down, while still putting a fair amount into my RRSP's. Then any left over cash is getting saved for a big payoff to the mortgage in another year, because if I want to retire at 45 I need to get rid of my mortgage a bit faster than normal. So in the end, do want's right for you.

The Emotional Part of Paying Off Debt

I recent had a conversation with a friend who had a nice problem. He had a big cheque coming to him for retro pay for a raise that he got. The amount was several thousand dollars and he had decided to pay off some debt (Great idea!). The question was which debt would he pay off first. He has a car loan for about $20K (5.9%), the mortgage for over $100K (6%) or a student loan at $5K (8.5%). He was concerned about paying off the student loan since he can use the interest as a tax deduction.

My personal thought was screw the tax write off and get rid of that student loan because the satisfaction of finally paying off your loan is a great emotional high which can be used to inspire you get rid of more debt. I think people tend to get so tied up in the numbers that they forget that money is a very emotional topic.

So next time you get a windfall, try to remember that some emotion in your money decisions can be a good thing.