Afford Anything - Ask Paula: Is Upgrading Our Lifestyle Worth Mortgaging a More Expensive House?

Episode Date: December 15, 2020

#290: Sharon owns two condos that are worth $1.4M and has a cash cushion of $120,000 plus a $50,000 emergency fund. She’d like to move into a small house while keeping her cash cushion intact. Should she take out a home equity loan on her mortgage to essentially pay for her house in cash, or get a traditional mortgage and use her savings towards the downpayment? Jury and her partner are torn between two options: buying a condo, which would allow them to live off of one salary and invest the other, or buy a more expensive house – a much more attractive lifestyle option. Which should they purchase? Daine’s IRA balance is a result of 401k rollovers. He’s concerned that his lack of monthly contributions cause him to miss out on compound interest. What can he do to grow his retirement funds? Molly and her husband want to reach financial independence (FI) in 15 years, at age 50. They’re unsure of whether their rental property income will sustain their FI lifestyle. How can they plan for this? I answer these questions in today’s episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode290 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to how you spend any limited resource like your time, your energy, your attention. Saying yes to one thing implicitly means saying no to other alternatives. And that opens up two questions. First, what matters most to you? Not what to society tell you should, but what actually is a priority in your own life? And second, how do you align your decision-making on a daily week?

weekly, monthly, yearly basis to reflect that. Answering these two questions is a lifetime practice. And that is what this podcast is here to explore. My name is Paula Pan. I am the host of the Afford Anything podcast. Every other episode, we answer questions that come from you, the community. Today, here's what we'll be tackling. Dane has an IRA balance of about $140,000 that comes from 401K rollovers he's done

every time he switched jobs. He's concerned because he's not making any new contributions. into his IRA. So what can he do to better prepare himself for retirement? Molly and her husband want to reach financial independence in 15 years. They're 35 right now. They want to reach FI. by the time they're 50. They're not sure, though, if they're set up for that. They've got some rental properties. They've got traditional retirement accounts. Are they ready? What should they be doing? Jury and her partner are torn between two options, buying a condo, which would allow them to live on one salary and invest the other, or buy

a more expensive house, which is a much more attractive lifestyle option. What should they consider? And finally, Sharon owns two condos that are worth $1.4 million. She has a cash cushion of $120,000 plus an emergency fund of $50,000. She'd like to move into a small house while keeping her cash cushion intact. What's her next move? We're going to tackle all of these questions right now, starting with Dane. Hi, my name is Dane. I love your show. and I have been listening for a while. You provide great insights. The information helped me in my finances

and also confirm some of what I have been doing and have been thinking about. I have a question regarding IRA and 401K. Here's the background. I have an IRA account, and it has around 140K. Most of the money is from the rollover from 401Ks. In the last few years, I've changed jobs, and every time I change a job,

I roll over the balance into my IRA. My concern is that I'm not contributing monthly to my IRA, so the compounding interest benefit is not working for me. I do have a savings account of about 90K in addition to the IRAs in a full on case. I'd like to find out what are my options, if any, to grow my retirement amounts better and to the levels that I need based on all these calculators for the retirement. Thank you very much. You're doing a great job.

Dane, first of all, congratulations on three things. building an IRA balance of $140,000. Two, building an emergency fund, building a savings account balance of another $90,000. That's huge. And then three, congratulations on rolling over your 401k into an IRA every time you've switched jobs rather than depleting it. Unfortunately, there are so many people who, at the time that they switch jobs, they raid their 401k. They pay a penalty, they pay taxes and they empty out that account. What those other people are doing is exactly the wrong thing to do. So a big congratulations to you for doing the right thing when you've switched jobs by rolling over your 401k into an IRA and maintaining that money in a retirement account.

So there are two things that you said that I want to address. One is you said that you were worried that compounding isn't working in your favor. The good news is it is. The fact that you have this money invested already, the fact that that $140,000 already exists, it's already inside your IRA. I'm assuming it's in some types of investments, such as equity index funds or bond funds. I'm assuming that it's not just sitting there in cash inside of an IRA. Well, the great news is compounding is working for you with the money that you already have in there. So are you getting the benefit of compounding growth? Yes. Could you be getting even more? benefit by making regular recurring contributions to your IRA, by contributing more money,

yes, you could. So essentially, you're already getting the benefit of compounding, but now it's time to level up. And that leads to the second part of your question that I want to address, which is you mentioned retirement calculators. I love that, so let's start there. Google retirement calculators, there are a bunch of them online, and enter in all of the basic data that they're looking for, your age, the amount that you spend.

how aggressive or conservative your investment portfolio is, enter in all of that data, and the retirement calculator will give you some number that's going to seem like a very, very large, daunting number of how much you should have saved by the time that you retire. And most retirement calculators will then tell you how much you need to contribute every month in new retirement contributions in order to be able to reach that goal. So the first thing that you want to do is set that goal. Now, let me give a couple of disclaimers about retirement calculators. First of all, many of them, unfortunately, they don't ask what you spend.

They ask what you earn. And the reason that they do that is because they make the assumption that your retirement goal is to have an amount of money every year that is some percentage of what you currently earn. So, for example, there are a lot of retirement calculators out there that have baked into its formula that your retirement goal is. to live on 70% of your current income or 80% of your current income. Of course, there are many flaws with this type of setup. First of all, your current income might be temporary. It might not be a

reflection of how you typically live or how you hope to live. Second, the assumption that your spending is a percentage of your income, I mean a fixed percentage, a boilerplate, 70% or 80%. That's one heck of an assumption. And of course, it's not always a lot of correct. There are plenty of people who are listening to this podcast right now who live on 50% of their income, who live on 40% of their income. And of course, the percentage of your income that you live on is going to, in many cases, it's going to fluctuate based on how much you earn. If you're making $30,000 a year, you're probably spending the vast majority of your income. But if you're making $300,000 a year and you continue to commit to live frugally, well, then that percentage is going

to plummet. So when you are using these online retirement calculations, you're going to, you're and they ask that question about what your income is, the way that I work around their programming is that I will type in a level of income that is about 30% higher than the yearly amount that I want to live on in retirement expressed in today's dollars. So, for example, if I wanted to live on $70,000 a year in retirement, I would just type in that I made $100,000 a year because unfortunately so many retirement calculators are built. with these frankly dumb assumptions in mind. So figure out in today's dollars how much money you want to spend, how much money you want

to live on, go to an online retirement calculator, type in 130% of that into the online retirement calculator. And from there, you'll be able to construct a value of how much money you'll need in retirement. And then you can backdate that to how much you need to save every month between now and the date that you retire. The other thing that I do, because there are so many idiosyncrasies with the programming of each particular retirement calculator in terms of the assumptions that are baked in, I don't look at just one or two. I look at a bunch. So we'll link to a bunch of different retirement calculators in the show notes for this episode. The show notes are available at afford anything.com slash episode 290. That's afford anything.com slash episode 290. But what I have found is when I look at many online retirement calculators, I can get a range of the different outcomes that they're reporting to me.

And then I can read the fine print on each website in which they state their assumptions, and I can see what are the factors that influenced that range. So go through that exercise, and at the end of it, you'll know how much money you'll want to save every month in order to reach your retirement goal. Essentially, it's an exercise of first figuring out what the goal is and then breaking it down by month to figure out how to get there. And once you have that number, once you know what your monthly contribution goal is, well, then the question becomes, all right, how do you start to contribute that money to your IRA? Even if you're not currently in a job in which you have a 401k, you can still open a traditional IRA or a Roth IRA and contribute up to $6,000 based on 2020 contribution guidelines if you're age 49. under, you know, you can contribute up to that $6,000 per year. And if your trad IRA or Roth IRA is open by December 31st, which is coming up, because this episode is scheduled to air on December 14, 2020, but as long as you open, let's say, a Roth IRA account by December 31st, you have

until the tax deadline of next year, tax day 2021, to make contributions that can, quote, qualify towards your 2020 contribution limit, which means that if you hustle, you can create a budget between now and the tax deadline of next year, tax deadline 2021, that allows you to max out that $6,000 contribution into your 2020 IRA. And then starting in April of next year, you can do the same thing to max out 2021. And by the way, you can make contributions to a rollover IRA. So you don't, If you decide that you want the same tax treatment that your rollover IRA has, if your rollover IRA is tax deferred, meaning it's a traditional account, and you decide that you want that same type of tax treatment in new contributions, then you can just go ahead and make new contributions into your rollover IRA, assuming that you have at least that much in earned income for the tax year. So the only reason that you would open a new IRA account is if you wanted new contributions to go to a Roth account so that you get some diversification between tax deferred accounts and tax

exempt accounts. Otherwise, just go ahead and set up an automatic monthly contribution into your rollover IRA. Now, this leads us back to the bigger question of why is it that you haven't been able to make new contributions? Is it that you're not earning enough and you need a side hustle or you need a side hustle or you need to negotiate for a raise or a promotion, or you need some either enhanced stream of income or multiple streams of income that would then allow you to shovel more money into your IRA to start resuming those contributions. Is that the issue? Or is it more of a savings issue? Is it that you need to

take a look at how you're spending and trim back at least cut the low-hanging fruit? Figure out how you can reduce your expenses so that you can save an extra 200, 300, 400 a month. The why of why haven't you contributed more money into your IRA, that seems like the thing that needs to be addressed. And if it is an income issue, I'm a big fan of entrepreneurship, bootstrap solo entrepreneurship. I'm a big fan of side hustles because it's work from home, it's remote, it's flexible, you can make your own hours, the upside is unlimited, and it doesn't have to be your full-time gig. you can continue doing full-time work in whatever arena you do your full-time work in, but then have this side hustle that you work on five hours a week, 10 hours a week. And it takes a while to get going.

It's not instant money overnight. It's not like that's the benefit of getting a second job is like you get that paycheck right away. With a side hustle, you do put in some upfront hours that are unpaid or negatively paid because you're investing in it but not seeing any returns. But over time, the upside potential is a lot greater. So if that, and I don't know what the budgeting issue is, if it's more on the earned side or the spend side for you, but if it is an issue on the earned side of the equation, then particularly given the job market right now, given the pandemic conditions, that is particularly the route that I would recommend. We have a very comprehensive framework for deciding how to earn extra income and for getting started. You can read that online at afford anything.com slash extra income.

That's afford anything.com slash extra income. So, Dane, to summarize, first, use an online retirement calculator or actually use several of them to figure out what the goal is, what you want your monthly contribution to be, and second, figure out what's standing in between the zero monthly contribution of right now versus the goal monthly contribution. What's standing in the way of between present and goal? That's another way of saying first define the goal and second define the obstacles that are getting in the way of that goal. And once you do those two things, then you'll know how to proceed.

So thank you so much for asking that question. And best of luck. And call back. Share your success story. Let's hear from you again in 2021. Let's find out what happens. So please call us back and keep us posted. We'll come back to this episode after this word from our sponsors.

Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the fintech hustle that got them named one of America's most innovative companies by Fortune magazine. That's what being a fifth third better is all about. It's about not being just one thing. but many things for our customers. Big Bank Muscle, FinTech Hustle.

That's your commercial payments, a fifth-third better. The holidays are right around the corner, and if you're hosting, you're going to need to get prepared. Maybe you need bedding, sheets, linens. Maybe you need serveware and cookware. And, of course, holiday decor, all the stuff to make your home a great place to host during the holidays. You can get up to 70% off during Wayfair's Black Friday sale.

Wayfair has Can't Miss Blank Friday Sale. Black Friday deals all month long. I use Wayfair to get lots of storage type of items for my home, so I got tons of shelving that's in the entryway, in the bathroom, very space saving. I have a daybed from them that's multi-purpose. You can use it as a couch, but you can sleep on it as a bed. It's got shelving. It's got drawers underneath for storage. But you can get whatever it is you want, no matter your style, no matter your budget. Wayfair has something for everyone. Plus, they have a loyalty program, 5% back on every item across Wayfair's family of brands. free shipping, members-only sales, and more terms apply.

Don't miss out on early Black Friday deals. Head to Wayfair.com now to shop Wayfair's Black Friday deals for up to 70% off. That's W-A-Y-F-A-I-R.com. Sale ends December 7th. Our next question comes from Molly. Hi, Paula. This is Molly. Long-time listener and reader, first-time caller.

I could look through about four years blog posts. I cannot quite put together the answer to my question. So here it is. My husband and I are both 35 years old. Our plan is to reach five at some point. Our goal is by 50, but we're trying to figure out if we can reach it sooner. You're a combination of rental property, investments, as well as our traditional retirement funds. So here are our numbers.

Currently, our retirement investment is at two and insurance. So that's the current market value. We are maxing out every year and I am maxing out my Roth and we are both also contributing to an HSA. So the hope is to continue to do that if we can for the near future. We have two rental properties that are both renting at $1,100 a month and each of them have a balance of about $88,000 left. And they're on 30-year fixed. loans with a pretty good interest rate, three to four percent. We also have a primary residence that is on a 15-year fixed and has about $250,000 left on the mortgage balance. The reason why I'm including that is because our FI plan is that we will move from the area that we currently live in and probably rent as part of our FI life until we decide to settle somewhere else. So my question is a combination of, it's trying to figure out whether the combination of our hopefully paid off free and clear loans by the age of 50 or sooner can help us reach a lot sooner.

Also looking at supplementing that with our retirement income that we don't necessarily want to draw down on, but having that continue to grow would be obviously a really great strategy if we could draw on the rental income completely. So thank you so much for all that you do and really appreciate your answer to this question. Molly, thank you for calling in. Thank you so much for being part of this community. It's great to hear from you. It's great to hear your question. And congratulations on everything that you've built so far. You're 35 years old and you own three houses. plus you have more than a quarter of a million dollars stashed away for retirement in traditional retirement accounts. That is tremendous. So huge congratulations to you for setting everything up.

All right. So let's talk about your goal. You're 35. You want to reach FI. by the age of 50. And as I see it, you've got two buckets of money. There's the money that is currently in your retirement accounts. Right now, $280,000 and that amount will continue to grow for the next 15 years, both through new contributions as well as through market growth, that is a bucket of money mentally that I'm setting aside for after you are 59 and a half. There are ways to get at that money before you're 59 and a half. There are ways that you can get at that without having to pay the penalty. We did a very in-depth podcast episode about that.

We will link to that episode in the show notes. And again, show notes are available at afford anything.com slash episode 290. So we'll link to that episode in the show notes. But the long and short of it is, if you wanted to, you could get at that money prior to 59.5. But what I would like to do is design an FI plan for you in which you don't want to do that or don't need to do that. Because if you can hold out on accessing that money for the first 10 years or nine and a half years of your retirement, then you'll have the benefit of all the compounding growth that takes place during that decade. and with any compounding, that last doubling is the most important. You know, if your money doubles and then doubles again and then doubles again,

it's that very last one that really explodes into a big number. And so the longer that you can keep the balance of your tax-advantaged accounts invested in the market in an age-appropriate risk-adjusted way, the more that compounding works on your side. So as I see it, this question, in my head, the question, turns into, could you live on rental income for that first decade when you're between the ages of 50 to 59 and a half? Now, the good news is, I think it will be very straightforward to get a decently accurate estimate of how much cash flow your properties will net for you. And it's because you already own all three of those properties. You already own the two rental properties plus

your personal residence, which you will convert into a rental. So when you turn 50, you will have three fully paid off rental properties that you hold free and clear. And what's cool about your situation is that you know the actual operating costs of each property. You know repairs, maintenance, vacancies, any landlord paid utilities. You know how much that costs in the rental properties that you hold. You have, you're not just making an estimate of operating costs. You have actual data. And over the span of the next 15 years, as you get more and more of that data under your belt, you'll have some good years to offset the bad years and vice versa. You'll be able to get a pretty good, long-term perspective on the type of cash flow that you can expect. And you know

this about your personal residence as well. You know, you know how much you spend each year on repairs and maintenance. So what I would do is I would calculate out for all three of these properties, the gross monthly rent minus some subtraction for vacancies and then minus some subtraction for the operating costs of each property, repairs, maintenance, property management if you plan to hire a manager, which it sounds like you will since you'll be traveling, subtract all of that out and then arrive at an estimate of what each of these properties will net you once they are paid off free and clear, which they will be in 15 years. Now when you do that exercise, you will arrive at an amount that represents an average that you can expect. But when it comes to planning on

living off of rental property income, you also need to be prepared for the range, for the volatility. And there are two major ways that you can do that. One is to frontload any major capital expenditures that any of those three properties might need. So if there is a strong likelihood that one or two or all three of the properties is going to need a new water heater or a new roof or new windows or a bathroom remodel or new siding or a complete exterior paint job, any of that major capex handle it while you're still working. What a lot of investors do is they have spreadsheets in which they know, you know, they write down all of the major components of a home and then how long each component lasts and how many years they reasonably have left on each component

so that they can anticipate moving forward, all right, I've got approximately four years of life left on this roof. I've got approximately 20 years of life left in these windows. Once you break it down component by component, you can timeline out what those major capital expenditures might be and then create a plan or a budget for how you'll pay for each one. But to the greatest extent possible, front load as much CAPEX as you can into your,

working years so that that way there will be fewer demands on that rental property income at the time in which you yourself need to live on it. So that's one thing I would do. The second thing that I would do is to make sure that you have two different buckets of emergency funds. You want at the time in which you make any type of change in your career or job or any major change to your source of income, nine to five income, you want to make sure that you have at least 12 months' worth of living expenses stashed away. And in addition to that, you also want cash reserves for your rental properties, for your business. Just think of it as personal emergency fund, business emergency fund. And before you go into any major life changes, make sure that both of those

are secure. And over the span of the next 15 years, as you hold these properties, you'll be able to observe the, again, the range of net cash flow from the properties if you will. were to add the P&I portion of the mortgage payment back in, the true beauty of your plan is that you're going to have 15 years' worth of data arming you. So keep really good records of what your actual operating costs are. And then if you just add back in the P&I portion of the current mortgage payments that you're making, you'll have a pretty solid idea of how much each property is bringing in absent of its debt servicing every month, net after expenses. And again, doing this for 15 years, you'll be able to not only calculate the annual averages, but also see what type of volatility

you need to prepare for and then build the cash reserves necessary to be able to prepare for that volatility. So the answer truly lays in the spreadsheet. But I love this plan that you have. I love that you are thinking 15 years ahead. Best of luck as you gather data and continue along that path to FI. Our next question comes from jury. Hey Paula, I just had a quick question for you. My partner and I are looking to buy our first home. We have quite a big down payment. We have quite a big emergency savings fund set aside. We also have no existing debt. So we are in a really good place to buy at the moment. We are actually flip-flopping between buying a condo or buying a house. If we buy a condo, it's about, you know, a four-minute drive to my work. The mortgage payments are next to nothing, and we can invest one salary, and we can live off of another salary. I know this sounds like a no-brainer in the fire community, but I just don't know if I am a condo type of person. I am a very

loud person and also I don't like noise. I know that sounds so hilarious but I just don't know if I could do that. Also, I am a huge dog fan. I have a dog who is 75 pounds and there's not many places in the areas that I'm looking at near my work that allow dogs who are bigger than 50 pounds. And the ones that do are townhouses basically priced at the same amount as a house and therefore I would rather just buy a house. The other things I worry about are condo fees always going up and up and up and up and then special assessments and things like that. So don't know if a condo is for me. Also the condo market in Calgary is crashing. So if I even want to move after five years, I would probably end up losing money. Whereas a house, I could buy a house about 10, 15 minute drive from my work.

The mortgage payments would be doable, but we couldn't live off of one wage. But I would also be investing in that house and the equity of the house and hoping that it will go up after, you know, 20 years. So if I do buy a house, I am looking to stay in it for 10, 15 years. If I can, I know life happens and sometimes that's not possible, but I'm looking for a house that I can stay in for a very long time and have many dogs live in it. So I'm kind of stuck as to what to do, get a condo or buy a house. I just don't know. I am so lost. I need your help. Thank you so much. Thanks for the question. So here's what strikes me. It sounds as though this is a battle between the frugal option versus the option that you really want.

Essentially what I'm hearing you say is the condo makes sense on paper. The condo makes sense from an FI perspective, but it's not what I want. What I want is this house. Even though it's more expensive, even though my commute's going to be longer, this is the thing that I actually want. And so I say, get the thing you want. Get the thing, you're going to have to go to sleep there every night and wake up there every morning.

So get the home that you want to get. not the one that makes sense on paper. Now, I say that, of course, with the, there are the, this normal parameters of, don't overextend yourself, but you, in your particular situation, you're in no danger of doing that.

As you said, you have a huge down payment, you've got loads of emergency savings, you're debt-free, and the home that you want would not be a stretch. Sure, it means that you can't save as much as humanly possible. It means you couldn't save as much as you otherwise could if you had the condo,

but you would still have a high savings rate. This home would still be, it sounds to me, like, a relatively minor portion of your income. And so given that you have all of those parameters that makes it very doable, you know, that doesn't leave you house poor, that makes it a relatively small percentage of your overall income, you know, it sounds like the house that you're talking about is, despite the fact that you've characterized it as more expensive, it is still less house. than you qualify for. And so my recommendation would be, given that you are so well qualified, overqualified for that home, get it. Let the heart lead and the mind execute. Time and time again, the biggest mistake that I have made is doing the thing that seems

frugal, doing the thing that makes sense on paper, even though my heart wasn't in it. Because ultimately what happens is that I try to talk myself into enjoying it, I don't, and eventually I have to undo the situation. And every time that I undo that situation, it ends up ultimately, over the long term, being more expensive than if I had just done the thing I wanted in the first place. And particularly, if you don't like where you live, you know how a lot of people cope with not liking where they live?

In non-pandemic times, they travel. My friend and I were just having a conversation about this, where she was saying, yeah, you know, my rent is so cheap, but I'm never there. I don't like being there, so I always find excuses to go somewhere else. You know, and my response was, well, is the rent really cheap then? And of course, you know, that can be chicken and egg. Sometimes people have the desire to travel and they rent a cheap place so that they can minimize that line item in their budget so that they have more money for travel.

That's one situation. But it's a totally separate situation where somebody doesn't like where they're living but stays there because it's cheap and then ends up booking a whole bunch of travel just in order to get away, right? You could have what on the outside seem like identical scenarios, but the motivations behind each one, the motivation behind scenario A versus scenario B that I just outlined, that is what makes all the difference. And I tell that story to illustrate that sometimes the cheap option can end up being the expensive one. there are hidden costs and additional spending and emotional spending that you do when you don't like the situation that you're in. That's one way in which cheap can be more expensive. And then the second way

is that you ultimately end up undoing it and ultimately that ends up costing more. Now, in your question, you talked about all of these, I think, housing prices in Calgary. I have some speculation about that, the way that's going to go in the future and what if they raise the HOA. You know what? drop the rationalizations. That's the other thing that I would say. If you want something, you want something, you don't need to rationalize it, you don't need to justify it, you don't need to speculate on what housing prices in Calgary may or may not do five years into the future. You don't need to speculate about whether or not condo assessments might go up. We can deceive ourselves when we rationalize what it is that we really want. We can trick ourselves into

thinking that we're making the logical decision? The truth of it is, the only reason you need is that you want it and you can afford it. You don't need reams of data about average annual condo assessment increases dating back for the last 40 years. If you were an investor, that would be data that you might want to use, but you're not. You're buying something for your own personal enjoyment, so buy the thing that you will personally enjoy. That was a relatively quick answer. And, you know, it's unusual for me to take a position. Typically, I weigh the pros and cons of both sides. But, you know, the thing is, if you had called and said, hey, I really want to live in a condo, but I just have a few hesitations about it. I would like to live in this condo, but I'm worried about the noise and I'm worried about my dog.

All right, if what you want is to live in the condo, we can find solutions to the noise in the dog. You know, we can look for different types of condom. When newer construction, more insulated walls, there are ways to solve problems around the thing that you want to do. But it was clear to me from your question that the issue is not the noise, the issue is not the dog. The issue is that you just don't want to live there, which is an important thing to recognize. Like, that's the self-awareness that is pivotal to good financial management. the type of life that you want to lead, your wants, your desires, those are not a hurdle to overcome. Those are, in part, the reason you have money in the first place.

All savings is deferred spending. So what are you deferring it for? The core of managing money is the core of deciding what kind of life you want to live. And maybe I'm, I suppose it's possible that I'm missing. understanding your question, but from what I heard, it sounds like you're pretty clear about exactly where you want to live. You're just looking for permission to do it. So I want to give you that permission, even though you don't need it from me. If it's helpful, you have it. So thank you so much for calling in with that question. And enjoy your new home. We'll return to the show in just a

moment. It's week two of Canadian Tires early Black Friday sale. These prices won't go lower. So you're lying on the floor? Save up the 50% November 13th to 20th. Conditions apply, details online. Our final question today comes from Sharon. Hi, Paula. I absolutely love your podcast, and I've been a listener for over a year. Thank you so much for everything you do and all the knowledge and wisdom you share.

I just signed up for your VIP list for the first rental property course. I think it's the perfect course for me, but I'm calling today because I've been obsessing over a question I have. Some background information. I'm 48 years old and I became an accidental landlord about two years ago. I have no debt at all, no mortgage, no credit card debt, no school loans. I have an emergency fund of $50,000 in a cash savings account and a separate cash savings account of about $120,000 that earns about 1.3% interest. I have $6,000 in a Roth IRA in VT, S-AX at Vanguard. I work in healthcare and after getting burned out, at an intense hospital position, I left and took a part-time position of 20 hours per week at a prestigious hospital in Manhattan in New York City. I make about $80,000 gross annually from that 20-hour

position. I receive rental income, which I'll tell you about in a minute. I have two additional income streams that I'm working on, a per diem position at the hospital where I work, which hasn't started yet because of the pandemic. I also just opened my private practice last month. month that I plan to grow over the next few years. In terms of property, I own two condominiums in Westchester County, which is on the outskirts of Manhattan and is a very high cost of living area. The condos are worth a total of about $1.4 million. I live in one of the properties and rent out the other for an annual gross income of about $63,000. So right now my annual income is about $140,000 from the 20-hour job, which is basically my bread and butter and income from the rent.

unit. I've lived in an apartment my entire adult life and I'm really over it. The main reasons are that I'm just sick of a board telling me what I can and can't do and when I can and can't do it. I just long for really simple things like a hose to wash off my large dog when we come home from the park, which by the way I have petitioned the board for and have been repeatedly rejected. I'm also just really sick of having neighbors and dormen. I totally get why other people love them and maybe I'll change my mind one day, but I'm just really sick of it right now. I don't have anything to hide, but I just don't want people watching my every move, and I just want peace and quiet and privacy. So I've been salivating over buying a little house. I don't want to buy a lot of house, but I would like as much land as possible

around the house for privacy, peace and quiet. The thing is, I've never owned a house. I've never had a mortgage, and I'm not handy at all. Also, my father, who is a real estate investor himself, and I'm has some very outdated ideas about a woman owning her own house and believes that I should wait to get married to buy a house. Now, I do not share that point of view, but after hearing it over and over throughout my life, I think I've internalized it and now I'm really terrified, and I feel like I'm incapable of owning a house on my own. I realize how silly this sounds, but I'm just being honest. I'm also a little reluctant to go back into debt, since I've really felt a huge stress relief from having no debt. I messed up my credit score with student

loans a while ago, but for the last five years, I've been diligently working at it. And now it's about 780 according to TransUnion and Equifax, but it's still around 680, according to Experian. I don't really get that discrepancy, but maybe that's a question for another time. I want to rent out the condo I'm living in, which would bring my annual gross income to $210,000 just from a 20-hour part-time job and renting out the two condos, not even including two additional jobs of the per diem position and my private practice. So my question is, what would be the safest way financially to buy my little house? I'd really like to keep the 120,000 of savings that I have just because it gives me such great peace of mind. So I'm wondering

if it's possible to get a home equity loan on one of my condos and pay in cash for the house. I read that I can possibly get up to 85% of the value of the property. So 85% of the property, So 85% of one of the condos would be about 595K. And I would be looking at properties between 500 and 600K, though, of course, I'd like to get a great deal for less. Or should I try for a traditional mortgage? And would that mean that I would have to use my cash cushion as a down payment? I'm concerned that my credit score will not yield a great interest rate on a mortgage. So I'm wondering if a home equity loan makes more sense than a traditional mortgage.

Is it wrong to think that I can keep my cash savings account and be able to use the money from a home equity loan to pay the down payment, inspections and closing costs in addition to the price of the house, in effect paying for the home in cash? I'm just obsessing over this right now, and I'm wondering if you can help ease my mind. And I absolutely love you, Paula, and I thank you so, so much for everything that you do. Sharon, first of all, thank you for being part of this community, and congratulations on everything that you've done, you've built. You have a great career which allows you to work 20 hours a week and still

make a great living. You're debt-free. You have $170,000 saved in cash in cash reserves and an emergency fund. You're in an amazing position. So big congratulations. Now, to address your question, first, let's talk about the fact that Equifax is so much lower than the other two than TransUnion and Experian. What I would encourage you to do is not just look at the score, but actually look at the full report. Grab the full credit report. You can get it for free once a year at annual credit report.com. Once a year at that website, you can get your full report from Equifax, Experian, and TransUnion for free. Take a look at all three reports and make sure that there isn't something that's false or erroneous that's printed on the Equifax report because it shouldn't

be the case that there is so much divergence between one of the the scores and the other two. They should all be relatively close to one another. And so when you see something that's an outlier like that, it may be an indicator that there is some false information on that particular report, which you can then dispute. So once you have a copy of the report, you can then use their website to dispute any inaccuracies that you find on that report. So that's the first thing that I would say. Now, to your question, fundamentally your question is what type of mortgage should you take out, given the desire to balance competing objectives. So let's talk through your different mortgage options.

First of all, in your question, you used the phrase traditional mortgage, which I assume means that you were referencing a mortgage that comes from a lending institution, like a bank or a credit union. In the world of mortgages, there are loans that are referred to as conventional loans and loans that are referred to as non-conventional loans. A conventional loan is a loan that is not backed by any federal entity. It's not a federally guaranteed loan. That can include a conventional primary residence mortgage that you take out from a bank, or that could actually even include a private loan. Those all fall under the umbrella of what's referred to as conventional loans. Now, in terms of non-conventional loans, those are loans that are backed by the federal

government, such as FHA loans, VA loans, USDA loans. Those are all examples of non-conventional loans. You would obtain these through an accredited institution, a bank or a credit union, but because of that federal guarantee, they are not conventional. And also, thanks to that federal guarantee, you can, if you qualify, you could be able to put a very, very small down payment on this property that you're buying. You mentioned that your hesitation around what you referred to as a traditional loan was that you didn't want to dig too deep into your cash reserves. You wanted to be able to preserve those cash reserves. If you were to take out an FHA loan, you could make a down payment that is as low as 3.5% or some other options would include a down payment of 5%, 10%, you could make a lower down payment and therefore be able to preserve the cash that you've built.

Now, if you take out an FHA loan with less than 20% down, then you'll have to pay something that's called MIP. MIP stands for a mortgage insurance premium. This will add a little bit to the cost of your loan, but essentially you can look at that as the additional payment that you're making in order to be able to preserve your cash. Also, once time goes by and you reach 20% equity in that home, you can remove MIP from a FHA loan by refinancing into another mortgage program. Now, I should note that FHA loans are not your only option if what you want is an institutional loan with less than a 20% down payment. You can also get a conventional loan, meaning a not federally back loan from a bank or a credit

union with less than 20% down. And if you do this, you'll pay something called PMI, which is essentially the conventional loan equivalent of MIP. And again, you'll only need to pay PMI until you reach 20% equity. But either of those options, whether you go the conventional loan route or the FHA loan route, either of those options would allow you to take out a loan from an institution like a bank at today's rates, which are some of the lowest in our lifetimes. Today's mortgage rates are excellent.

So you would be able to take advantage of that while simultaneously preserving the cash that you have. If I were in your shoes, that's probably the first route that I would pursue, given that this is going to be your primary residence, and given that you have, have so many options when it comes to institutional lending. Now, let's talk about the other alternative route that you could take, which is borrowing against the equity in the condos. There are a few different ways that you could do this. You could either take out a home equity loan, as you mentioned in your message, or you could do a cash out refinance. Let's talk through the differences. Now, a home equity loan is a loan for a fixed amount of money that's secured by a residence

that you own, such in your case a condo. With a home equity loan, you'll repay this loan with equal monthly payments over a fixed term, just like your original mortgage, just like a standard mortgage. And as you mentioned in your voicemail, the amount that you can borrow is all the way up to 85% of the equity in the home that you own, in the condo, in your case. Now, a home equity loan, and I'm saying this for the benefit of everybody who's listening, to be clear, a home equity loan is different than a home equity line of credit. to get conflated often. A home equity line of credit, which is also known as a heloc, is a revolving

line of credit, similar to a credit card, in which you can take out what you need when you need it by writing a check or by using a credit card that's connected to the account. You can take out what you need when you need it as up to your credit limit. But unlike a home equity loan, a helock is not an installment loan. You don't make fixed monthly payments. It is really the credit card is the good analogy. Like in the world of loans, there are installment loans and revolving loans. So an installment loan is anything in which you make that fixed monthly periodic payment. And a revolving loan is a revolving line of credit is like a credit card. And so the home equity loan is that installment loan. And the HELOC, the home equity line of credit, is that credit card.

It's a revolving line of credit that's secured by a home. Now, your other option is to do a cash-out refinance. So typically, if a person, has a mortgage on their home, and they want to close out that mortgage and obtain a brand new loan with better terms, and they also want to pull some cash out at that same time, they will take out what's referred to as a cash out refinance. Now, if you own a fully paid off free and clear property, as you do with your condos, when you take out a new mortgage on a property that you hold free and clear, it is still referred to as a cash out refinance, even though technically you're not refinancing it, you're financing it. It's still referred to as a cash out

refinance. So under this scenario, you would take out a mortgage against the condo. You would pull some cash out. If you pulled out more than 80% of the equity in your home, the lender could require you to purchase PMI. But the benefit of a cash out refinance is similar to a home equity loan. It is an installment loan with fixed payments. And that makes it easier to budget for than something like a HELOC where you'd have a variable interest rate. Now, a cash out refinance and a home equity loan are both likely to have a higher interest rate than if you were to simply go to a bank and apply for a standard primary residence mortgage. So here's what I would recommend doing.

I would go to a mortgage banker and say that you're considering four options. You're considering a conventional loan, an institutional conventional loan with less than 20% down, perhaps 10% down. That's one option. You're also considering an FHA loan with less than 20% down, perhaps as low as 3.5. That's your second option. And you also hold these condos free and clear, and you are considering either taking out a home equity loan or a cash out refinance against one of these condos. Those are options number three and number four. So I would go to a banker. I would say that these are the four options that you're considering. And then I would find out what are the interest rates and the payment terms? What are the details of all of these options? How much money

will you have to put down? What interest rate will you have? And when you have that information in front of you, once your mortgage banker presents you with a sheet of paper that says, all right, here are the array of choices in front of you. And here's how adjusting variable X impacts your interest rate. Here's how adjusting variable Y impacts your interest rate. Once you have all of that data in front of you, you'll be able to make a comparison between these four options and decide which type of mortgage is best for you. But without knowing the specifics of what your down payment requirements would be, what your interest rate would be, what amount of PMI or MIP you would have to pay, without knowing those specifics and those specifics are going to be based on the market, they're going to be

based on your credit score and your credit history, they're going to fluctuate day to day. in the way that interest rates fluctuate at banks day to day. So once you know what those specifics are, then you'll be able to see which option is best for you. So thank you for asking that question, Sharon, and best of luck with whatever you decide. That is our show for today. Thank you so much for tuning in.

My name is Paula Pant. This is the Afford Anything podcast. If you enjoyed today's episode, subscribe to the show notes. You will get a synopsis of, of every episode delivered directly to you, including timestamps of all of the questions. So if there's ever anything that you want to search for, if one day you're thinking like, hey, didn't we discuss a question about XYZ somewhere in the past, you can quickly search

through your archive of show notes and pull up the question, the timestamp, you can pull up exactly what you want. You'll also get links to all the resources that we mention. You'll get write-ups about the interviews that we do. All of that is available to you for free just by subscribing to the show notes, and you can do that at afford anything.com slash show notes. That's affordanything.com slash show notes. Thank you so much for tuning in. If you enjoy today's episode, please share it with a friend or a family member. It's a single most important thing that you can do to spread the word about financial independence and personal financial management. And about life management. I mean, really money is a vehicle through which we

think about what is most important. It's a vehicle through which we assess our values and our priorities and then decide how to live our best life. So if you believe in that message, if you want to share it, share today's episode or any of our other awesome episodes with a friend, a family member, someone who you think would really enjoy this and really benefit from this message. You can find links to share any of our previous episodes at afford anything.com slash podcast. Thanks again for tuning in. My name is Paula Pant. This is the Afford Anything podcast, and I will catch you in the next episode.

Here is an important disclaimer. There's a distinction between financial media and financial advice. Financial media includes everything that you read on the internet, hear on a podcast, see on social media that relates to finance. All of this is financial media. That includes the Afford Anything podcast, this podcast, as well as everything Afford Anything produces. And financial media is not a regulated industry. There are no licensure requirements. There are no mandatory credentials.

There's no oversight board or review board. The financial media, including this show, is fundamentally part of the media. And the media is never a substitute for professional advice. That means any time you make a financial decision or a tax decision or a business decision, anytime you make any type of decision, you should be consult. with licensed credential experts, including but not limited to attorneys, tax professionals, certified financial planners or certified financial advisors, always, always, always, always consult with them before you make any decision.

Never use anything in the financial media, and that includes this show, and that includes everything that I say and do, never use the financial media as a substitute for actual professional advice. All right, there's your disclaimer. Have a great day.