Armchair Millionaire

To Buy or to Rent

Question of the week:I've been happily renting my place for years, but the low mortgage interest rates these days are starting to tempt me into buying. Do you think it's better to buy or to rent? --Lynne S.

Dear Lynne,

For many people, their home is not only their biggest investment; it's also a place of enormous emotional importance. So, your question needs to be considered beyond just the financial implications. When we posed your question to members of the Armchair Millionaire community, we heard many thoughtful responses that underscore how complicated the issue can be. Here are two examples from both sides of the fence:

Buy. "The only regret I have about home buying is that it took me so long to do it! Renting is just like throwing your money out the window. My mortgage payment is less than what I was paying in rent years ago. I want to have something to show for my hard work and a house is a great place to put your money. " --Danny

Rent. "I live in NYC and fortunately have a rent stabilized apartment. My rent is very low, my apartment is very nice. I can save and invest money and have enough left over for some goodies. I don't have to shovel snow, or cut grass, or repair plumbing. So, I don't get a tax break. I've done the math and I'm better off now. And I always know I can move, with very little notice to my landlord." --Mary

Obviously the best answer is going to depend entirely on your own situation. To help sort out all the factors to consider, I generally suggest that people look at the equation in two parts. The first takes your lifestyle into account. Is pride of ownership important to you? How would you feel about spending Saturday mornings mowing the lawn? Is the security of your own home important to you, or do you prefer the lack of ties that renting offers?

The second part of the equation looks at the finances of renting versus buying. This can be a little more complicated, so use my checklist to run down all the issues you should consider.

The Armchair Millionaire Checklist of Pros and Cons of Renting and Buying

• Equity. For renters: You won't get it. Once that rent money is gone, it's gone. For owners: Paying the principal amount of your mortgage each month is like "forced savings" and over time, you'll accumulate equity you can borrow from or convert to cash upon selling.

• Taxes. For renters: Sorry, your landlord will reap the tax breaks. For owners: Depending on whether you itemize, your tax savings can be significant.

• Interest costs. For renters: No worries here. For owners: You'll likely pay a huge amount of interest over the life of the mortgage-often much more than the amount of the loan itself.

• Investment value. For renters: You won't benefit from any increase in the value of the property you rent. For owners: It may go up or down, but given historical trends, you'll come out ahead.

• Flexibility. For renters: If you want out, just move when the lease is up. For owners: If you want out, you need to go through the time-consuming and expensive selling process. Given the costs of the transaction, you generally need to keep a home for a few years in order to avoid losing equity.

• Maintenance. For renters: Leaky pipe? The landlord is just a phone call away. For owners: Either you do the work yourself or pay someone else to do it.

• Monthly costs. For renters: These are fixed-aside from annual rent increases, you know what each month's outlay will be. For owners: Costs are variable, and there may be months when you have to shell out for repairs or maintenance.

THE BOTTOM LINE: Home ownership is called the American Dream because it is right for so many people, but that doesn't automatically mean it's right for you. Weigh the pros and cons carefully before taking the plunge.

Putting Your Home on the Line

Question of the week:I'd like to take out a home equity line of credit, but my wife hates the idea of going into more debt. What's your opinion about it?
--Tony C.

Dear Tony,

Plenty of people these days have the same idea. In fact, according to the Federal Reserve, homeowners' equity as a percentage of overall residential real estate value is now at an all-time low (about 56 percent), mostly due to the recent rush of mortgage refinancing and home equity loans and lines of credit.

But just because so many people are doing it doesn't automatically make it a good idea. When we asked Armchair Millionaire community members for their opinions, we heard arguments both for and against. Here are two examples:

No way. "A home is the best vehicle most Americans have for savings. By continuously extracting the equity in your home, you only perpetuate the attitude that cash is better than net worth." --Rick I.

Absolutely. "I always apply for one when I purchase a house as it can be done at the same time as the loan papers. I've used it for home improvements/repairs and bought my last car on it. When I sold the house, the car was also paid for, using cheap money!" --Jean

Home equity loans and lines of credit are popular for several very good reasons:

• They're usually tax deductible. Depending on your situation, the interest you pay on your line of credit may be deductible. (See your tax advisor).
• They have low interest rates. Because they are secured by your home, their interest rates are lower than for most other types of credit.
• They're fast and easy to get. You can typically obtain your line of credit in just a couple of weeks, and with low (or no) closing costs
• You can use them however you like. There are no restrictions on how you use the money. Make home improvements, vacation in the Caribbean, buy a boat--the choice is yours.

However, even though home equity loans and lines of credit can be used any way you choose, I still don't believe that they are right for every purpose. My guideline provides recommendations for when it's a good idea to tap your home's equity, and when it's not.

The Armchair Millionaire Guide to Using Your Home Equity

• Home improvements. I think this is the best possible use of home equity, because it puts the money right back into your house. Word of warning: Not all home improvements will result in an increase in your home's value. A kitchen or bath makeover probably will; new landscaping probably won't.

• Higher education. Home equity can be a great source of tuition funds if your child doesn't qualify for financial aid. Word of warning: If you're getting close to retirement and repaying the loan will severely impact retirement income, it's advisable to steer your child towards student loans, instead. The rates for student loans are often lower then those of home equity loans and lines of credit, and the interest may be tax deductible.

• To pay off debt with a higher interest rate. Paying down high-interest credit card debt with home equity can save you hundreds or even thousands in interest, as well as provide a nice tax break. Word of warning: Undertake this only if you have a concrete plan for changing your spending habits to stop incurring additional credit card debt. Otherwise, you'll just end up with more credit card debt and depleted home equity.

• Emergencies. A home equity line of credit is one alternative to an emergency fund of cold cash. (Remember that the time to arrange your line of credit is before you're faced with an emergency. If you've just lost your job, you may not get approved.) Word of warning: Having a line of credit is no excuse for not doing all you can to minimize the cost of emergencies--this means having the right kind of insurance, and enough of it.

• To pay for ordinary living expenses. This is an absolute no-no. If you feel you must use your home's equity to pay for day-to-day expenses, you need to re-evaluate your entire financial situation. Look at where you can cut spending or increase income, but don't risk losing your house in order to live beyond your means.

THE BOTTOM LINE: Your home is probably the biggest investment you have. Think very carefully before acting to deplete the value of that investment.

Ripped Off!

Question of the week:I just found out the closing costs I paid when I refinanced my mortgage were much higher than average. I had no way of realizing this before it was too late-what should I do in the future to make sure I know what I'm getting into when I deal with banks, brokers, etc.? --AB in Colorado Springs

Dear AB,

FROM ARMCHAIR MILLIONAIRE.COM Start Your Financial Future Today Name: Email:

As financial services have proliferated into every aspect of our lives, so too have the chances for us to pay too much for, or to get talked into buying financial services that we don't really need at all. When it comes to getting hit with unexpected financial services costs, you have plenty of company in your frustration. When we asked Armchair Millionaire community members about the surprise charges that get their goat, we got an earful. Here are a few examples:

ATM fees. "When I can't get to my bank and have to use another ATM machine, I have to pay that machine, plus pay my bank for the privilege of getting my own money." --Theresa

Mutual fund loads. "Fund loads don't improve fund performance, and have little bearing upon a fund manager's results." --Vito Z.

Biweekly mortgage payment programs. "Paying a bunch of money to have your mortgage payments put on a biweekly plan so you can pay it off sooner is crazy. Just make an extra payment yourself every year." --Kimmy

Some of the fees you pay are compensation for honest work by financial services providers, but others are hidden fees that simply pad their bottom line. My checklist will help you separate the reasonable from the outrageous.

The Armchair Millionaire Guide to Not Getting Fleeced

• Look closely at underlying costs. You will always pay some kind of fee or commission for every single financial service or product you ever buy, but often it will not be clearly spelled out for you. No load mutual funds can still carry significant costs, for example. Just because you can't easily see it doesn't mean it isn't there, so don't hesitate to ask about the fees that you will be paying.

• Take your time. People spend more time deciding which video to rent than they do hunting for the best deals on financing or insurance, even though careful shopping could save them thousands of dollars. Shop around and make sure you understand what you're getting in to. If you're feeling pressured, or if you're not getting the answers you need, delay your decision to another day.

• If you don't need it, don't buy it. More does not equal better. Children--and others without dependents or mortgages--probably don't need life insurance, plain and simple, no matter what your insurance salesman tells you. Don't buy credit card insurance when you pay your balance off every month. Likewise, don't buy insurance that will pay off your mortgage if you die when you already have life insurance.

• Understand how your financial services providers are paid. How much will your insurance salesperson make from selling life insurance to you? What about your broker? Are they paid a commission every time they make a change in your portfolio, or do you pay them a percentage of the assets they manage? Paying for advice is fair. Overpaying for advice isn't. Make sure you are comfortable with the price you're paying and what you are getting in return.

• Negotiate fees. Everything from "dealer prep charges" when you buy a car to "mortgage broker fees" when you finance a house may be negotiable. Understand them and ask for them to be lowered or removed. If the fees are not satisfactory to you, be prepared to take your business elsewhere.

THE BOTTOM LINE: Financial services pitfalls are so commonplace now that there is no way to even know about all of them. Your best route is to go slow with any decision, be skeptical of all fees and insist on completely understanding any product or service before you buy.

A Better Deal:Refinancing Your Mortgage

Question of the week:I want to refinance my mortgage before rates go up again, but there are a few different kinds of mortgages and I'm not sure which one is best. Any advice? --Ben G.

Dear Ben,

With mortgage interest rates at lows that haven't been seen in two generations, you've got plenty of company in your rush to refinance. When we asked members of the Armchair Millionaire community about how much money they're saving by refinancing, we could almost hear the glee. Here are a couple of examples:

"Just refinanced the house with a similar payment as in the past but we will save ten years of payments and tons of interest!" --de losangeles

"I refinanced two months ago, taking me from a 4-year adjustable to a 6.25% 30-year fixed with no points or pre-payment penalty. This saves me $140 per month after the cost of the refinance is recouped." --Kevin

There are several different reasons to refinance, and you should know exactly what you want to get from the refinance in order to choose your best loan option. These are main reasons people are refinancing:

• To reduce monthly payments. By lowering your interest rate, not only will your payment drop, you'll also build up equity a bit faster.
• To shorten the term. Many people are switching from a 30-year to a 15-year loan. Your monthly payment will go up, but you'll pay much less interest overall and be mortgage-free much sooner.
• To tap into equity. "Cash-out" refinances allow you to pay off the old mortgage, plus obtain cash. They're used by many people to pay for home improvement, college or other major expenses.
• To switch from an adjustable-rate to a fixed-rate. If you took out an adjustable rate mortgage when interest rates were higher, you might want to switch now to the predictability of a fixed-rate loan.

Once you decide which option is right for you, make sure you get the best deal. My quick guide tells you the key things you should know.

The Armchair Millionaire Guide to Refinancing Your Mortgage

• Know the terms. In a fixed-rate mortgage, the interest rate will not change-and your payments will remain constant-for the life of the loan, typically 30 or 15 years. They're a good idea when interest rates are low, or whenever you want the security of knowing exactly what your payments will be. In an adjustable-rate mortgage (ARM), the interest rate starts out lower than comparable fixed-rate loans, but is adjusted (either up or down) periodically as market interest rates change. ARMs are enticing when interest rates are high and people figure that rates are only likely to go down in the future.

• Know the APR. Lenders are required to tell you the APR (short for "annual percentage rate") to make it easier for you to compare two different loans. While the interest rate tells you only interest charged on the loan amount, the APR also takes into account many of the costs of the loan, such as points, lender fees and mortgage insurance. I regard the APR as a much more realistic number than the interest rate.

• Know the points. A point is simply a fee that is one percent of the loan amount. It can get confusing, however, because there are actually two kinds of points. Discount points are a fee you pay up -front in order to lower the interest rate of your loan. Origination points are a fee charged by the lender to help cover their costs. Avoid origination points if at all possible; consider discount points if they make sense for your situation.

• Know the costs. Some costs are unavoidable, such as title search and insurance, appraisal and recording fees. However, there are a slew of other fees that many lenders will try to charge, all of which go to their bottom lines. They can include "underwriting fees," "mortgage broker fees," "processing fees," and "application fees." Lenders are required to let you know these costs upfront as part of their Good Faith Estimate, so if they seem unreasonable, either negotiate them down or take your business elsewhere.

THE BOTTOM LINE: Refinancing can be expensive and time-consuming, so make sure you know what you want out of a loan before you start the process.

Burn the Mortgage?

Question of the week:I have a little extra money coming in each month, and I'm trying to decide what to do with it. Do you think I'm better off investing it or using it to pay down my mortgage faster? --Becka

Dear Becka,

This is an enduring question in personal finance, and like so many questions, there is no one right answer that works for everyone. Just take a look at some of the responses we received when we asked members of the Armchair Millionaire community about the wisdom of making additional mortgage payments versus investing:

Pay down mortgage. "Go to any online mortgage calculator and look at the dollar amount of interest you can save by increasing your mortgage payments just a little bit. Then look at the amounts you can save if you doubled or tripled your mortgage payment. That is all money you can put in your pocket (or into the stock market) after your mortgage is retired." --Don B.

Invest it. "Not only would I not pay off my mortgage early, I would take the biggest mortgage I could afford for 30 years in order to free up more to invest. A mortgage is some of the cheapest money around right now." --Richard

Do a bit of both. "Since I'm young with many years until retirement, I'd put more into the market and less into paying down the mortgage. The closer I got to retirement, the more I would put towards paying off the mortgage. --Brian F.

To understand which option is best for you, you'll need to do a bit of math and carefully assess your overall financial situation. The questions in my quick guide will help you make the best choice for your situation.

The Armchair Millionaire Guide for Deciding Whether to Pre-Pay Your Mortgage

• How much do you benefit from the mortgage interest deduction? To find out how much the mortgage interest deduction is saving you, look at how much you paid in mortgage interest last year, subtract the amount of the standardized deduction (in 2001, this was $4,550 for single filers and $7,600 for married couples filing jointly) and multiply this number by your combined federal and state tax rate.

  Here's an example: Say you paid $15,000 in interest and you and your spouse paid 32 percent in state and federal taxes. Subtract your standard deduction ($7,600) from your interest ($15,000) and multiply that number by .32. The answer is $2,368 in tax savings. Obviously, the benefit is higher if you're in a higher tax bracket, while many homeowners don't itemize at all, thus realizing no interest deduction benefit.

• What's your real interest rate? If you take your tax savings into account, it lowers the interest rate you're effectively paying for your mortgage. In the example above, your tax savings were about 15 percent of your total interest payment. If your mortgage interest rate is 7 percent, and you subtract 15 percent from that, you end up with an effective interest rate of just under 6 percent.

• Can you get a better return somewhere else? Once you know the real return from "investing" in your mortgage, look around to see if you can do better somewhere else. Historically, the stock market has enjoyed an average annual return of about 11 percent. (Although you would need to take taxes into account if your alternative is a taxable account.)

• Do you have a better use for the money? Are you well on track to achieving your other long-term financial goals, such as funding your retirement? If not, your extra money is probably better used taking care of those goals.

• How comfortable are you with debt? Despite all the number crunching they may do, some people still are simply uncomfortable carrying mortgage debt, and this feeling is only exacerbated during rocky economic times such as these. If you're one of these people, weigh these feelings against the numbers.

THE BOTTOM LINE: Run the numbers, look at your other financial goals, and then balance them out against how at ease you are with carrying your mortgage for its remaining term. And remember that your decision is not set in stone-as your situation changes, you can always start or stop making those extra payments.

For Sale By Owner?

Question of the week:We're planning to sell our house soon and are debating whether to list it with an agent or sell it ourselves. We're very tempted to go "For Sale By Owner" because we'd save over $35,000 in commissions. What's your advice about this? --Moving On in LA

Dear Moving On,

The "For Sale By Owner" route ("FSBO" in advertising lingo) is taken by plenty of home sellers these days. According to a survey by the National Association of Realtors, 13 percent of all homes were sold directly by their owners in 2001. The survey doesn't tell us, however, if those sellers were glad they did it.

For some insight into that, we asked Armchair Millionaire community members about their experiences in selling their homes themselves, and if they'd do it again. Here's a bit of what we heard:

Absolutely. "I sold my home myself and would do it again in a heartbeat! I spent $3 on two "For Sale" signs and because I set the asking price in the same range as similar houses being sold, I got to keep the equivalent of the real estate agent fees (4 to 6 percent of sale price) for myself." --Tony in CT

It depends. "I know from lots of personal experience that a slow housing market almost 100 percent requires a real estate agent, and even in some very strong markets it is very helpful to have one." --Will

No way. "We tried selling our home ourselves a year ago in order to save money. We experienced three months of people never showing up for an appointment, showing up early and showing up late. For us it was a pain-missed meals, changed plans, etc. We finally listed with an agent and it sold in 10 days." --Dave

Is FSBO right for you? It depends. What's the market like in your area? How quickly do you have to sell? Do you have the time and temperament to deal with hordes of perspective buyers tramping through your house? Balance all this out against the amount you would save by not paying a commission to an agent and you should have your answer.

Whether or not you choose go it alone, use my checklist of the key things you can do to make selling your home as profitable (and painless) as possible.

The Armchair Millionaire Checklist for Selling Your Home

Make it shine. Look at your house through the eyes of prospective buyers. Toss the junk, clear the clutter and make it sparkling clean. Make minor repairs so that your buyer's home inspection comes clean, but stay away from capital investments at this time, which you are unlikely to fully recoup when you sell. Your money is much better spent making cosmetic improvements.

Get real about the price. What you paid for the house or what need to make on the sale isn't relevant. The only thing that really matters is what buyers are willing to pay. To get a realistic idea of how you should price your house, look at what similar homes in your area are actually selling for, not the price they are listed for. You should also consider getting it appraised. If you do use an agent, he or she will be able to provide a fair price range.

Pick the best offer. If you receive multiple offers (and hopefully, you will), evaluate each on price, how prepared they are to finance the purchase, the terms offered and the type and number of contingencies placed on the offer. Remember that the offer with the highest price is not necessarily the best one.

Get legal help. Real estate transactions are complex affairs. A few hundred dollars spent on having a lawyer review your listing agreement, contract and closing documents can be money extremely well spent, ensuring that there are no surprises and you're getting a square deal. Choose one who specializes in real estate sales.

THE BOTTOM LINE: For most of us, our homes are the biggest investment of our lives. So when it comes to selling, be sure to either get professional help or to put a great deal of your own time and effort into ensuring that you get the best possible price and terms.

To Refinance or Not

Question of the week: With mortgage rates low, I'm thinking about refinancing. But I've heard that you have to reduce your interest rate by at least two points to make it worthwhile to refinance. Is that true?—Kim T.

Dear Kim,

These days, few things about mortgages are simple enough to be captured in any rule of thumb. Whether to refinance or not involves several things: How long do you plan to stay in your house? What's the length of time and interest rate on the new loan? How much will you pay in up-front costs? It all boils down to this: Will the savings from refinancing outweigh the cost of paying off your old mortgage and starting a new one?

It can be complicated. Fortunately, there are dozens of online calculators that will do the math for you. Check out different rate, fee and payoff scenarios to make sure you're getting the best deal. If your savings are greater than the up-front costs, refinancing can make sense.

Members of the Armchair Millionaire community have taken this trip before. Here's their advice on keeping your ventures into high finance as close to the ground as possible:

Check with your original lender first. "A lot of lenders have refinance programs for their own customers, so they require little or no documentation. Because my appraisal, income and credit information were already on file with my current lender, I didn't have to pay for these again."—James0111

Watch out for hidden penalties. "Be sure to check to make sure that your current mortgage doesn't have a pre-payment clause. Depending on how big it is, it could outweigh your savings from refinancing."—MariaH

If you decide to go for it, use my checklist to make refinancing as easy as possible.

The Armchair Millionaire Checklist for a Painless Refinance

• Get your paperwork in order. Have your most recent pay stubs, bank and investment statements and tax returns on hand.
• Be specific when shopping for the best rate. To be able to really compare two different loans, you have to know much more than just the rate. Also look at the term of the mortgage, discount points and the lock-up period.
• Understand the fees. These break out into three types: Lender fees (including charges for document preparation, underwriting and origination), third party fees (such as appraisal, title search and insurance, and credit report) and government fees (like recording taxes and other charges assessed by local or state agencies).
• Get a Good Faith Estimate of costs before committing to anything. Don't hesitate to question any fees that seem out of line. If a potential lender insists on sky-high fees, take your business elsewhere.

THE BOTTOM LINE: Interest rates are lower than they've been in a long time. Refinancing can save you thousands of dollars over the next few years. On the other hand, a bad deal can cost you more than you save. Do the math and you'll surely come out ahead no matter which path you choose.