Investing V – Buying a home

In my previous posts about investing I’ve mentioned more than once that buying a home is almost always a great investment. From my own experience I can say without equivocation that buying homes has had more positive economic impact on my life than any other investment I’ve made.

I’m talking about buying a home, here. I’m not talking about buying an investment property. These are two different things.

That being said, the first home I ever bought turned into an investment property, pretty much by accident.

I lost my job in 2000. The company I was working in was going under, and I had plenty of warning. But the only reason I lived where I did was because of the job.

If the job was going away then I wanted to move away.

But I'd just bought a condo 4 months prior.

I had thought that I'd be working and living in the city in question for years, and so buying a home made sense. But with joblessness on the horizon and no great love for the city in question, then buying a home there was looking like NOT my best decision ever.

I could turn around and sell it for what I'd paid for it, but there are closing costs that have to be paid when you're buying or selling, and I didn't want to pay them each time without realizing an offsetting profit.

It was every first-time-homebuyer's nightmare.

I rented it out. Rather, I found a property manager who would rent it out for me. At the price for which it was rented I didn't make a profit, but I didn't lose money, either.

So suddenly I no longer owned a home. Instead I had an investment property.

What’s interesting is that if you have a rental property and can provide a copy of the rental contract to a lender – proving that your costs on your original loan are being met – then you can go out and buy another property in which to live.

I did exactly that. I moved back to my metropolitan area of choice and was able to buy a second condo – this one as my primary residence.

Now each time I purchased a condo – in 2000 and 2001 – I did it using a 30-year-fixed loan from my bank. This was, as far as I was concerned, the only way to buy a home.

Then in 2004 I bought a house. And evidently the rules had changed. My realtor and my finance officer offered me “creative financing.”

I was skeptical, but I read the fine print and asked lots of questions. It was a little iffy, but it was doable. In the end I bought a house using the types of loans that have come under a lot more scrutiny in the last couple years. But I had a plan, and in retrospect it actually appears that I might have known what I was doing.

80% of the purchase price of my house was financed using a 3 year ARM – an Adjustable Rate Mortgage. This gave me a really, really great interest rate – less than 4%, I think – for 3 years. After the 3 years it would begin to fluctuate and almost certainly to trend upward.

The plan was to refinance before the 3 years were up, and this is exactly what I did.

Another 15% of the purchase price of my home was financed using an Interest Only loan. This was the scariest piece, to me. This is a loan that is designed NOT TO BE PAID OFF. You don’t have to pay anything toward the principal of the loan. You just have to pay the interest. Every month. Forever. At the end of each month you would the bank the same amount as the previous month. It’s the debt that never ends.

The plan was to end it. To pay off the principal on that loan as soon as possible, and this is exactly what I did. About 5 months after I bought the house, that interest-only loan was gone, thanks to the sale of my investment property – my first condo – and a bit of money from Savings.

And let me say at this point that my first condo – to which I referred earlier as “every first-time-homebuyer's nightmare” – really worked out well for me. I had not intended to own an investment property, but it paid for its own mortgage each month, and then when I sold it less than 5 years later, I did so at a 23% profit (minus closing costs and some sales-prep work I had done. It was probably a 14% or 15% net profit).

Oh, the remaining 5% of my house was financed using some of the proceeds of the sale of my second condo. And that turned out to be another great investment. I sold it at a 37% profit (minus closing costs, etc. It was probably at least a 30% net profit, though).

Since refinancing a year ago I have also made an effort to pay down additional principal on my new 30-year-fixed mortgage whenever possible. As of this writing I stand to get somewhere between $40,000 and $55,000 out of my home if I were to sell it today.

I got lucky. Or I was the right combination of lucky and careful and attentive.

If I had not been careful and attentive – and didn’t really understand or care that I had a 3 year ARM and an Interest Only Loan – then this would have gone badly for me. I would have had a mountain of debt and rising monthly payments. I would have metaphorically drowned.

So is Creative Financing a bad thing? Are banks to blame for offering these kinds of loans?

I have to say no. My situation is proof that one can use these kinds of loans to one’s own advantage and come out ahead.

But you have to have a plan that involves GETTING RID OF THOSE LOANS. And in retrospect it looks like a lot of people got those types of loans without having a plan to get rid of them.

That being said, a lot of the people who are now defaulting on these types of loans are people who had bad credit. Banks gave these types of loans to people who had a bad track record of dealing with money.

Most disturbing of all, the banks were able to bundle these somewhat-iffy-loans-to-people-with-less-than-perfect-credit into investment securities. And the ratings agencies – for-profit companies whose job it is to rate investment securities – rated these investment securities as really good and really safe investments: Triple-A rated securities.

And so a lot of investment companies, banks, and even countries put money into these securities.

Thus the mortgage crisis was born. When homebuyers’ ARMs started adjusting upward and the homebuyers in question started defaulting on payments then these triple-A rated securities started producing less-than-triple-A results. And because so many entities had invested in these securities, the repercussions have been felt everywhere.

I’ve gone pretty far afield, here. I intended to write a little piece using my own story to illustrate why owning a home is the best real estate investment one can make. Instead I've tried to explain the mortgage crisis while I'm at it. Let's get back to the point:

I could have been renting for the last 8 years, but by owning (and buying and selling with a bit of luck) I find myself with $40,000 to $55,000 in home equity.

That’s if I sold the home today, though. And because of the mortgage crisis I have no plans to sell my home today. It’s not a good time to sell.

But it’s a great time to buy! Buying a home is a great investment, as I hope I’ve demonstrated. And thanks to the mortgage crisis home prices have been driven down. If you don’t already own a home then I strongly suggest you look into it.

Investing I - Gambling: not an Investment Strategy

Like most everyone, I have my dream of what I will do someday when my ship comes in. When I win the lottery. When I find that stock that's goes through the roof. When a hermit uncle that I never knew existed dies and leaves me several million dollars for no readily apparent reason. When I invent something simple that everyone wants and needs. When I write the great 21st-century novel and Hollywood throws money at me for the film rights. When I strike it rich at the casino...

What I find interesting is that we all have these dreams.

Some people with these dreams are busy actively pursuing them. They're writing their novels. They're inventing their gizmos. They're trying out for American Idol.

Me? I'm investing.

Mostly I'm investing in my house. I own my own home. It's in a relatively urban area, so the property values aren't declining like they are in the suburbs. I'm doing okay.

Real Estate - Real Estate in which I live - has been good to me.

And really, I'm just saying to you what any investment advisor would say:

• Work to get out of debt, especially credit card debt.
• When you've paid your credit cards off then put some money - several months worth of living expenses - into savings.
• Buy a home (and pay it off as quickly as you comfortably can).
• Start a retirement account.

Well, see, I've done all those things. And the economic advisors are right. These are the right things to do, absolutely.

But then what? What do we do to attain our unreasonable dreams of wealth?

Well, I'm not writing my novel. Nor am I trying out for Idol anytime soon. Instead I'm investing.

Here's the point where other authors tell you how they struck it rich on the stock market and you can too! Just follow these simple rules!

No. Because I haven't struck it rich on the stock market, and I may never strike it rich.

And you don't have to buy my book to learn what I've learned. This blog is free to all to read.

But when I write about investing then that's what I'll be telling you: What I've learned so far.

So what have I learned so far?

Well, first and foremost don't invest any money you can't afford to lose, because you might lose it. Make sure you've taken care of the bullet-points above, and are continuing to take care of the bullet-points above, before you invest any additional money anywhere else.

Second, the lottery is a losing investment. Duh. I mean, this is not a revelation.

That being said, I do play the lottery a little. It's stupid, I know. The lottery is a tax on people who are bad at math or are overly optimistic.

Well, I'm pretty good at math. I play the lottery because - you guessed it - I'm overly optimistic, and because I actively engage in a certain amount of magical thinking: If I play the lottery and lose then maybe I'll be lucky in other parts of my life.

And it appears to be working. I seem to be lucky in all the ways that matter. I'm not rich but I'm happy, and that's what matters. Enough is as good as a feast.

Still, let's dispense with magical thinking for a moment and look at the lottery with the semi-critical eye of one who plays it. From my experience, I can tell you this: I have lost more money than I have won on the lottery.

That's okay, because I've stuck to my first rule of investing; Don't invest any money you can't afford to lose (which is good because I've lost almost all of it).

When you invest in the lottery, you're almost certainly not going to benefit from it monetarily. May it bring you joy in other ways, but I can pretty much guarantee you it will not bring you riches.

It brings me some kind of joy when I lose, because of the magical thinking of which I've spoken. Also, there's a kind of anticipation at finding out the results of the next drawing. There's always the very minor possibility that I might win this time. A feeling that maybe today is the day! And then I pull up the lottery's website and see that, in fact, today is not the day. But that's okay, too.

If you think of the lottery as an entertainment experience - like going to a movie, say - and you get some kind of enjoyment out of the experience then good for you. Stick to the first rule of investing, though. Don't spend money you can't afford to spend.

The same thing goes for horse-racing, casinos, poker tournaments, etc. In all of these situations the odds are against you, and when you lose you will have nothing to show for it. As long as it's all money from your entertainment budget and not from your retirement or your kids' college fund then you're fine. Gambling can be an entertaining and enjoyable activity, but it's not an investment strategy.

The stock market is different. Theoretically when you invest in a stock then you're investing in something real. Even if it turns out to be a losing bet - let's say the stock you buy loses 50% of it's value - then you still have something to show for your money. In the case I just mentioned you can sell the stock and still have 50% of the money with which you started. That's not great, but it's infinitely more money than you'll walk away with if you lose at the lottery, at the track, at the casino...

So we'll talk about the stock market. Next time.