People seem to go batty over the fact that the interest on your mortgage is deductible. They also seem to do the same thing over the the capital gains deferral for your primary residence. But just because you can sell your house, take a profit, and buy a bigger house to have *more* of a tax deduction, that is not necessarily a good thing.
Let’s say you have a $200,000 house. You put 20% down, so you have a $180,000, 30-year fixed mortgage at 5% (for the purpose of round numbers). Your payment is: $966.
Suddenly, your house appreciates. You can now sell it for $250,000. Rather than taking the capital gains and paying down a mortgage on a similar house, you decide to capitalize on this, sell your home, and trade up. After closing costs and fees, you have about $60,000 to put towards your next house. So you buy another home with 20% down, the new home being worth $300,000 with a 20% downpayment = a 30-year mortgage of $240,000.
At the same interest rate, your payment is now $1,395. You have just increased your overall debt by some $60,000, and your monthly cashflow has been stretched an additional $400/month. That is a 44% increase in your mortgage payment.
For what? A bigger house? Do you really need that much more room?
Let’s look at another scenario. Say you capitalized on your gains and rolled it into another, similar priced house. You take the $60,000 to pay down your mortgage, so your total mortgage on a $200,000 home is now $140,000. Your payment on a 30-year 5% fixed rate mortgage is now $751. That is a 22% decrease in your payment.
Now, here is why trading up really is dumb sometimes:
If you took that extra $200 per month and put it into a high-yield savings account at 5%, the compounding interest would give you $167,448 in 30 years! That is more than your new mortgage! And if you took the money you would be saving by not “trading up” to the bigger house ($1395 - $751 = $644) you would have $535,970 in 30 years. So, even if you can afford the bigger house, if you decide to save the money, rather than dump it into a bigger home (with higher costs of heating, etc.) you can have almost half a million dollars. Just see what you are giving up!
Why am I writing this blog? What do I hope to accomplish?
Well, lets start with my story. Girl goes through high school. Girl loves art, but is told
“nobody makes a living from art. You don’t want to be a starving artist.” She seems confused, and although she loves it, who wants to be a pauper the rest of their lives. So girl packs up belongings and goes to top 50 business school.
School is awesome, girl’s major, finance, is not. She does not want to work on Wall Street and look at Excel spreadsheets (as much fun as they can be) all day long. So she graduates early rather than continue hated classes. At graduation, only dependable finance-related jobs are available, so she takes a nice, reliable salary job.
Luckily, at this point, best friend from college decides he wants to date girl. She realizes that long distance relationships also stink, so she moves and quits the finance job. Next step is a sales position with a creative arts firm. If she can’t actually paint full-time, then at least she can sell them, right?
Wrong. Company makes several consecutive bad business decisions. Girl realizes ego is the only thing standing in between her and her dreams. So, she quits to go wait tables. Yes, the top 50 business school graduate is waiting tables.
To do what? Give girl time to start her own business and begin painting on a more full-time business.
Eventually, girl raises family, and retires to travel world painting and selling her art.
I work at a restaurant, serving (ie = waiting tables). I also have some little ventures on the side, like my eBay store, Squidoo, and a booth at a local antique mall. All in all, my goal is to make $400 per week between all of these ventures.
Normally, that is a no-brainer. But still, if I have to take a day off of work , or I’m sick, or something just doesn’t sell, I don’t have money. No *predictably* steady income stream yet.
For Example: I made $350 this weekend at the restaurant. And we happened to sell $265 worth of things in the antique mall, and we have had $85 come through advertising on Squidoo, for a grand total (and the week isn’t over) of: $700.
Not a bad payday this week, especially considering that was my bi-weekly payday at my old job. However, I know that in two weeks we will be going out of town and missing the $350 I would have made from the restaurant, and it has been almost two weeks since we have sold anything in the antique mall. We’ve been averaging $200-300 per month on Squidoo, but still, sometimes that is hit or miss.
So, I could wind up with one week (like the one before last) where I was sick and brought in only $200 total. How in the world do I manage this, and get ahead?
Well, in the past, I would think: “Hey I have extra money!” and go spend some (probably most) of it. But then I would forget I had spent it, and somehow spend it again in anticipation of it coming in. Then, because I had forgotten that I spent it the first time, I would get slammed when all the transactions cleared. My cashflow would be tight, so guess what? The credit cards come out. Well, now that I don’t use my credit cards, I had to find another way, a way to trick myself, if you will.
The trick: I don’t look at my bank account balance.
Instead, I use a budget, and Mvelopes Personal Budgeting Software to see how much I am allowed to spend in different categories.
Then, based on my budget, if I make $200 extra in one week, I’ll put it into savings for the week that I am down $250. I will still probably take $50 of the extra money and put it towards something fun every now and then, but this trick helps me not think I have extra money to blow, which is how I used to operate.
Now I have a cushion for the bad times, and I keep on paying off my debt!
