036 – Four things you need to know about your home (financially)


For most of us our home is the biggest ‘asset’ we own – so these are four things you need to know about your home financially. Make sure you don’t fall into these traps to ensure that you have a greater chance of being financially free. I’ve made ALL of these mistakes, and learnt painful expensive lessons.

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Transcript

Speaker 1:           00:00     Welcome to Working Women’s Wealth where we discuss what it takes to build real wealth in a way normal humans can understand. Here’s your host, Lisa Linfield.

Lisa Linfield:       00:21     Hello everybody and welcome to today’s episode of Working Women’s Wealth. We’re going to be chatting about the house you live in. So for many of us it’s a home. It’s where our family gathers and it’s where our memories are made, but it’s also for a lot of us, one of the biggest expenses that is part of our monthly bill. And so it’s really important that we understand that it is one of the cornerstones of our financial wealth and as such I get asked a lot of questions about the house we live in and what we should do about it.

And the first one that many times comes into being is when people think of their house as an asset. Now for many of us it is the biggest thing we own, but it doesn’t go towards helping you pay for your retirement and in investing terms, we look at assets as things we invest in that generate income. So it doesn’t generate income because we’re living in it, we’re making it our home, but we’re not generating any revenue from it, obviously unless there’s a piece of it that you rent out. And so the first thing that you need to know about your home is not to think of it as a revenue generating asset and to understand that in actual fact it’s an expense. So when people say to me, “Should I pay off my mortgage or should I invest the money if I have a little bit of extra money or if I get a bonus or something.” It’s quite an interesting question because there are many nuances and I can’t advise you for you individually, but what I can give you is a framework on how to think of it.

The first thing is that you should definitely be paying off at least one extra home loan payment a year. So if your mortgage payment is 1200 grand or $1,200, you need to make sure that you divide it by 12 months and pay an extra amount every single year. So should you pay off more? You should definitely pay off at least one extra home loan payment a year. In South Africa, you will finish paying off your home six and a half years earlier because of our high interest rates, and if you’re listening in America, it’s between two and four years early. You have low interest rates there. So the first thing is that you should definitely pay off one extra home loan payment a year and then when you finish paying off your home, keep that money and invest it directly. Don’t even let it come back into your budget.

The second thing that you need to bear in mind when it comes to paying more or not is whether or not you use that facility as what we call an access bond, where you put extra money in, in the thought that it helps to pay it off quicker, but then when you need money, you take it out. So this is something that I became conscious with regards to myself before I even became a financial advisor is that we, like many people, had used the logic that it’s better to kind of stash your cash in your home and your mortgage and when you need the money, take it out because it’s got a higher interest rate than some of the short term money market or savings accounts. And one of the challenges with that is that I have yet to find one person who has the discipline to keep track of what they’re taking out versus what they’ve put in.

And I know for ourselves that it was one of my biggest awakening moments when I worked out that we had for three years taken more money out than we had actually put in. Because you put a little bit this month and a little bit that month and then you put a big wad in if you get a bonus and then what happens is you pull it out to use it for stuff, but you actually end up going backwards. So one of the things I’m very much believe strongly is that you should rather have three months worth of finances put aside into an high interest money market account, than you should in your home loan, because what is a few percent that you save versus the much more money that you pull out.

So it becomes a discipline. That money that goes into home loan stays in the home loan because remember one of the things that we’ve learned is that you should never use capital to fund expenses. If your expenses are challenged, you need to cut back and have the discipline to cut back. Do not use the money that is inside your house, which is capital to fund your daily overriding expenses. If you do use your money that’s in that bond, you should use it in extreme circumstances only and really extreme circumstances.

It’s what I always say, managing people’s money is 90% behavior and 10% kind of technical knowledge. It really is that 90% behavior, protecting ourselves from ourselves. So if you put your money in and out, in and out, and in and out, then I would not suggest that you put extra money into a home loan because you are more than likely able to access that than you are to an actual investment.

In episode 34, we discussed the fact that you should set up a cash flow account, which is like a savings account. Where basically in times like Christmas when you’re going to spend more, you draw from that account, but in times when you’re not spending as much that you should stash the cash for those Christmas or expensive periods. And that secondly, you should put it in a money market account linked to your bank account where you have three months of emergency savings at least. What you want to do is make sure that your money stays invasive, that your capital stays as capital and not get used as expenses.

The next thing that you need to consider when it comes to paying off your home loan or investing is that over the long run, equities have outperformed what you would be paying on your bond. So if you have a longterm view, then actually it is better to invest because you will get a better return over the long term. It doesn’t mean that any little bit of extra cash, and when I mean little I’m meaning the smallest amount of cash that you can put into your mortgage, doesn’t make a huge difference.

It does and my view is that the quicker you can kill that mortgage, the better. It is countered by the fact that from an investment perspective, you will over a longterm get a better return in the markets and that even when the markets are flat and not really performing, that’s the time to be buying shares that will rise when the market rises.

So it’s a very difficult question to answer for you personally, but bear in mind those things. First of all, definitely pay an extra home loan payment a year and secondly, don’t use it as an access bond, and thirdly, over the long run your investments should perform better.

So then the third big thing in terms of the things that you should and shouldn’t think about when it comes to your home loan, is that the most important decision you can possibly make is to not upgrade your house. I love this quote from a journalist called Mark Ford and he said that, “In order to stop the spending spiral, you need to stay in the house you have.” And it hugely echoes one of my favorite books, which is The Millionaire Next Door, which is just a really good book in understanding that it’s normal, average people who become millionaires, not the exceptional. And one of the things that the authors of Millionaire Next Door make you aware of is that upgrading your house, remember that your house is an expense. It’s not an asset, it just adds to that level of expenses.

First of all, in terms of the actual transaction itself, you have to take into consideration, you’re both going to pay a transfer tax and you’re going to pay the sale of your existing house. But that’s only the start. One of the things you have to bear in mind is that the bigger the house, the bigger the ongoing expenses. So for example, your cost of debt, so the actual mortgage that you are going to get to fund this bigger house. That debt in itself can often take the cost of your house to double, so if it’s a small amount, you’re going to pay a small amount extra in terms of interest, but if you pay a big amount, you’re going to pay a big amount extra in terms of interest. So that’s one of the expenses and it’s one that often many of us sit down and we go to a mortgage broker or the bank and we do the sums and we think, “Okay, we can afford that.”

But what we don’t think about is that there are many other ongoing expenses. Now that you’ve got a bigger house and a bigger property, the council tax or the city tax that you pay is going to be higher. Your water and electricity is going to be higher because now you’ve got more rooms that need to be air conditioned, more rooms that needs lights. So suddenly your water and electricity bill goes higher. You have a bigger garden or you have more cleaning and suddenly your cleaning and gardening costs go up.

And then there’s also those crazy things when you first move into the house that your furniture doesn’t fit or your curtains don’t fit. Now you need more furniture, ’cause suddenly you’ve got rooms that you need to furnish. So there’s a huge amount of added expenses that come when you upgrade your house and the challenge with that is that it locks up free capital.

So I remember when I was starting my business, we thought that we would sell the house we lived in. To be fair, we should have stayed in our first house, but like what happens to most people, we had upgraded and when we looked at our ongoing costs, we just knew that we could have just as wonderful a life in a smaller home and then we tried to sell it. And the problem is the market is not in a position at the moment where we can realize the capital value that we’ve put into it. So we have ended up not selling, but what that’s done is it means that we’ve got this capital locked up in this house and more importantly the monthly expenses. That is an opportunity cost we’re investing in our business.

So it’s one of the things that we don’t think about. We always think that a bigger, bigger house would be better for us, but in actual fact there are huge amounts of expenses and one are the stats that I love from the Millionaire Next Door is that millionaires on average have six and a half times the assets of their next door neighbors. And if you live in a suburb and you look around and you think to yourself, “Do I have six and a half times the assets of my next door neighbors?” Well firstly, obviously you’ll never know, but I can tell you something. Just the cost of our house versus our next door neighbor’s, I think there’s less than no chance that we have six and a half times the assets of our next door neighbors and it really is something that one should bear in mind. That after you move to that big house, will you still have six and a half times the assets.

And the point that they’re basically making is that because your house is an expense, it’s money that is tied up that can’t be invested to generate an income. So instead of upgrading your house, put that money, that extra bond, that extra water lights and electricity payments, put those into an investment and they can generate money. Having it sit inside your home means that it’s money that’s not working for you.

And lastly, one of the biggest mistakes that comes when people think of their home is that they say, “Don’t worry, I have the big house, but what we’re going to do is we’re going to downsize and release that money when it comes to retirement.” And one of the things that I’ve seen for sure is that houses in retirement villages are very expensive. Why? Because you pay for all of the infrastructure that comes with high care or frail care. Nurses, et cetera, and that it doesn’t end up releasing the money that you’d like to release and I think that that’s one of the major challenges is this assumption that we will be able to release a substantial amount of money that can go towards our retirement expenses. Only for people to find out that actually it’s too expensive to move into a retirement village.

So to wrap up, let’s go through that. The first thing is that your house is not a revenue generating asset. It is an expense and it is an expense that uses up very precious money that you could be investing in. When it comes to whether you should pay off more money or invest the money if you have some spare cash, you must definitely pay one extra home loan a year. That should be a discipline that each of us get into but, that you should not use your home to stash extra cash. That you should rather invest it and make sure that you have three months of emergency funding so that that would be where you dip in and depart. At least that way you keep capital capital and expenses expenses.

The next thing is that you should not upgrade your home. One of the worst things that people do is that they upgrade their homes and they get bigger houses, but with that they forget that comes bigger cleaning and other expenses. And lastly that you should not think of your house as being able to downsize it and release money for your retirement. More often than not, little places in retirement villages cost as much if not more than the place that you live in.

I’m Lisa Linfield and this is Working Women’s Wealth and we’d love it if you would subscribe to the podcast and keep downloading it and share it with other people so that many other women around the world can learn more about what it takes to become wealthy and to look after their money. Take care and have a great week.

 

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  1. Pingback: 46 - Investing vs. paying off debt - Working Women's Wealth

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