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Why Your Home Isn't a Retirement Goldmine
By Kris Sayce
Recently we asked whether it was still possible for homeowners to treat their current home as "retirement savings."
In other words, can you live in it now and then sell up when you reach retirement in order to buy something smaller and use the remaining cash to live off?
We received quite a response from Money Morning readers.
In true Obama style the answer was... "Yes you can... sort of!"
Hmmm. It wasn't exactly an overwhelming affirmation of the idea. Sure, there were a few readers with stunning stories of buying in the early 1970s or 1980s and selling with a 1,000 or 2,000 per cent profit after ten or twenty years.
That is surely proof enough that it is possible.
And it is. But as with anything, it isn't always quite as simple as that.
Although all the reader experiences were unique to their own situation they had one thing in common...
They started off with a big deposit, and even more than that, the average loan size compared to household income was much lower too.
So why is that relevant to whether you can retire on the value of your home?
It's relevant because of the amount of interest you pay over the term of the loan. One thing we've found when talking to property owners and investors is that they only ever talk about the price they bought the property for and the price they sold it at.
They never mention the cost of holding the property. Not once have I ever heard a property owner say, "we bought the house for $300,000 and paid $50,000 in interest over five years and then sold it for $400,000. Plus we had a few other costs such as stamp duty, agents fees, maintenance etc. So really we just broke even on the deal."
Instead we always hear, "we made 100 grand on the house in just five years, try doing that on the stockmarket."
You see, for every dollar you spend on interest payments today is $1 less you can invest in something else. That's why we've been so keen to encourage mortgage-owners to keep making extra payments on the mortgage even though interest rates have fallen.
That may sound like a contradiction based on the previous sentence. But another thing to remember is that for every extra dollar you pay off the principle amount of the mortgage that's less interest you'll be charged.
And naturally we always hear the argument that capital gains on the profit from your home is tax free. True. But they also forget to mention that the mortgage repayments are made with after-tax money.
So $1 in interest on your home means you have to earn about $1.30 to cover it - depending on your tax rate.
That's why the best time to pay off extra is now when interest rates are low. And boy, do we get frustrated when we read comments from some financial planning 'experts' who say now is a good time to take 'repayment' holidays on your mortgage.
That's just madness. If you're mortgaged up to the hilt then you need to pay as much off as you can now, because even a small 1% or 2% rise in interest costs next year or the year after will add thousands onto the interest bill of even the average mortgage.
But usually they say it based on the common belief that house prices always go up. Only yesterday we were reading info sent to us by a Money Morning reader that stated real estate investors rely on capital gains for 75% of the return and only 25% for income.
That's why landlords are prepared to rent out property for less than the cost of servicing the mortgage! Again, more madness.
But, to get back to the point. Having extra non-home investments is crucial as you go into retirement. Reducing your interest expense on your home mortgage as quickly as you can makes more sense than paying it off over 25 or 30 years.
You see, a house is a depreciating asset. It's no different to a car. It really isn't. If you live in a home for 30 years, even if you update the fixtures, it's still an old house. That means you'll only receive for it what someone is prepared to pay for an old house.
In many cases, the actual home is worth little more than the value of the land it's standing on.
Yet when you come to downsize is it really likely that you'll choose to move to a similarly aged home? No. Very few people will want to spend their 'autumn years' renovating and spending thousands on doing-up a renovators delight.
More likely is that you'll want to move into a new town house, or something similar. And unless you're looking for a complete change you'll probably move to a place in an area you know.
That means property valuations will be similar.
But let's also not forget there is no guarantee house prices will continue to rise. There have been so many distortions propping up house prices that eventually the whole thing will pop.
For those that don't own a property then it will be rich-pickings. But for most it will mean many home owners imprisoned in their homes thanks to negative equity. They'll find it impossible to move due to the value of their home being significantly less than the amount of the loan.
The dream of retiring in luxury on the 'equity' built up in one's home may still be possible, but we're afraid to say that based on the current state of the over-inflated housing market it's more likely to be the exception rather than the rule.
Money Weekend
Saturday, 11 July 2009
Melbourne, Australia
By Kris Sayce
Recently we asked whether it was still possible for homeowners to treat their current home as "retirement savings."
In other words, can you live in it now and then sell up when you reach retirement in order to buy something smaller and use the remaining cash to live off?
We received quite a response from Money Morning readers.
In true Obama style the answer was... "Yes you can... sort of!"
Hmmm. It wasn't exactly an overwhelming affirmation of the idea. Sure, there were a few readers with stunning stories of buying in the early 1970s or 1980s and selling with a 1,000 or 2,000 per cent profit after ten or twenty years.
That is surely proof enough that it is possible.
And it is. But as with anything, it isn't always quite as simple as that.
Although all the reader experiences were unique to their own situation they had one thing in common...
They started off with a big deposit, and even more than that, the average loan size compared to household income was much lower too.
So why is that relevant to whether you can retire on the value of your home?
It's relevant because of the amount of interest you pay over the term of the loan. One thing we've found when talking to property owners and investors is that they only ever talk about the price they bought the property for and the price they sold it at.
They never mention the cost of holding the property. Not once have I ever heard a property owner say, "we bought the house for $300,000 and paid $50,000 in interest over five years and then sold it for $400,000. Plus we had a few other costs such as stamp duty, agents fees, maintenance etc. So really we just broke even on the deal."
Instead we always hear, "we made 100 grand on the house in just five years, try doing that on the stockmarket."
You see, for every dollar you spend on interest payments today is $1 less you can invest in something else. That's why we've been so keen to encourage mortgage-owners to keep making extra payments on the mortgage even though interest rates have fallen.
That may sound like a contradiction based on the previous sentence. But another thing to remember is that for every extra dollar you pay off the principle amount of the mortgage that's less interest you'll be charged.
And naturally we always hear the argument that capital gains on the profit from your home is tax free. True. But they also forget to mention that the mortgage repayments are made with after-tax money.
So $1 in interest on your home means you have to earn about $1.30 to cover it - depending on your tax rate.
That's why the best time to pay off extra is now when interest rates are low. And boy, do we get frustrated when we read comments from some financial planning 'experts' who say now is a good time to take 'repayment' holidays on your mortgage.
That's just madness. If you're mortgaged up to the hilt then you need to pay as much off as you can now, because even a small 1% or 2% rise in interest costs next year or the year after will add thousands onto the interest bill of even the average mortgage.
But usually they say it based on the common belief that house prices always go up. Only yesterday we were reading info sent to us by a Money Morning reader that stated real estate investors rely on capital gains for 75% of the return and only 25% for income.
That's why landlords are prepared to rent out property for less than the cost of servicing the mortgage! Again, more madness.
But, to get back to the point. Having extra non-home investments is crucial as you go into retirement. Reducing your interest expense on your home mortgage as quickly as you can makes more sense than paying it off over 25 or 30 years.
You see, a house is a depreciating asset. It's no different to a car. It really isn't. If you live in a home for 30 years, even if you update the fixtures, it's still an old house. That means you'll only receive for it what someone is prepared to pay for an old house.
In many cases, the actual home is worth little more than the value of the land it's standing on.
Yet when you come to downsize is it really likely that you'll choose to move to a similarly aged home? No. Very few people will want to spend their 'autumn years' renovating and spending thousands on doing-up a renovators delight.
More likely is that you'll want to move into a new town house, or something similar. And unless you're looking for a complete change you'll probably move to a place in an area you know.
That means property valuations will be similar.
But let's also not forget there is no guarantee house prices will continue to rise. There have been so many distortions propping up house prices that eventually the whole thing will pop.
For those that don't own a property then it will be rich-pickings. But for most it will mean many home owners imprisoned in their homes thanks to negative equity. They'll find it impossible to move due to the value of their home being significantly less than the amount of the loan.
The dream of retiring in luxury on the 'equity' built up in one's home may still be possible, but we're afraid to say that based on the current state of the over-inflated housing market it's more likely to be the exception rather than the rule.
Money Weekend
Saturday, 11 July 2009
Melbourne, Australia
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