Wednesday, May 19, 2010

I'll Just Sell

In my work, coming face to face with hundreds of people each year, discussing finances and attitudes about finances, I find it very interesting how people approach potential financial pitfalls and opportunities.


One situation I have often come across quite often is the approach toward real estate ownership and financial risk management. The risks I speak of are common to all people: Death, Divorce, and / or a Loss of Income. One of these things can happen unexpectedly at any time and how you prepare for these events is of critical importance in your and your family's long term financial health. Relating specifically to real estate ownership, what happens to the family home when one of these risks turns into reality. How will the mortgage, taxes, maintenance, fees get paid?


Death - a common answer with a couple is "I'll just sell if Bill dies." or "We'll find a way to make it work." - a poor strategy to be sure and one frought with risks. What if the sale price is below what you need? What if it takes 6, 12, 18 months to sell? Where will you live? Will you be in any state to move and uproot in a time of emotional turmoil? Will you have the financial capacity and physical capability to make the necessary payments are do the necessary maintenance? Life insurance is a more appropriate strategy and the costs of that insurance should be added to the monthly budget.


Divorce - this clearly never happens to anyone and certainly isn't going to happen to the couple in front of me! "We'd just sell and split the proceeds." is the typical answer but this is also full of pitfalls. What if one person is emotionally attached to the property? What if one person wants to sell for much more than the other person and there is a stalemate about the sale strategy (very common)? Will you be in any state to move and uproot in a time of emotional turmoil? The key to managing this risk probably lies in the mate selection process but more practical advice would be that couples shouldn't overextend themselves beyond what either of them is comfortable taking on by themselves if it became necessary.

Loss of Income - Job loss or a disability can happen any time as well and despite the loss of income, the bank, strata, government still wants to be paid all at a time of diminished capacity to meet these demands. The common answer here again is "I'll just sell." but again will you be able to sell? Or more appropriately, will you be able to sell it quickly at the price you want? This is really the key question, since you can always sell your home if price isn't a consideration, but it always is. If you lose your job or become disabled, do you have enough of a financial cushion to make all of the necessary payments for 12 - 18 months or longer? Again, disability insurance can be helpful here but it is no solution for job loss. The best advice to to have a large cushion of savings that you can draw on if necessary. Retirement savings withdrawals are possible as long as you commit to replacing the funds as soon as possible so that you do not derail your long term retirement plans.


My impression is that people are very comfortable with the fact that in the past few years real estate has been an asset with good liquidity and rising prices so these concerns seem unfounded when coming from their financial planner, especially when their friends and family are able to sell their houses quickly and for more than they were asking. The question is, was that normal? Should we expect a much different market in the future with dramatic implications for personal risk management? Many people wonder how they can build up an emergency fund, savings or pay insurance premiums when they are stretched to the limit with mortgage payments. My advice is that you should get out of that situation as fast as possible because you may not be able to sell at the price you need.

17 comments:

Robert Reynolds - GBA said...

Mo, I see this stuff all the time as well. Another that is just as common, is the plan to have the mortgage paid off at age 65 and retire the next day.

I am constantly baffled by people, with no money in the bank, think they will be financially stable in retirement as long as their house is paid for.

mohican said...

Yes, I see the same thing Robert. Somehow the house is going to put food on the table or gas in the car.

Additionally, more and more retirees are going into retirement with a mortgage or large outstanding HELOC. It is not uncommon to see retirees with liabilities in excess of $100,000 and investments of less than $200,000. Luckily, for many of them, they have a pension but it is still an unattractive retirement strategy. The problem is that these people have no control over their spending and feel entitled to own 2 harleys, a big motorhome, a big house for two people, and take 3-4 expensive vacations per year.

patriotz said...

If you have a paid for house you can get by on CPP/OAS/GIC and the property tax deferral if necessary. Just barely. You can also sell and buy something smaller or just rent.

It's the people who are carrying (or will carry) 6 figure mortgages past age 65 who have me scratching my head.

buff_butler said...

"is the plan to have the mortgage paid off at age 65 and retire the next day."

I laughed pretty hard at this. Awsome comment.

jesse said...

I equate financial planning sans saving to a "reverse lottery" -- 99% of such people don't lose but 1% of the time they are wiped clean.

david said...

Ahhh if only everyone thought that way.

Then house prices might be, you know, rational.

So many people are in (what I would consider) danger. They bought way to much house with not enough cash.

How anyone can consider buying something like a house with less than 10% down is beyond me. Personally I wont do it with less than 20% but I am a reasonably safe person when it comes to money.

jesse said...

"Ahhh if only everyone thought that way."

The same logic that has people buying lottery tickets is the same logic that allows people to avoid planning for bad fortune. Bad luck usually happens to other people.

North America has combined a culture that enjoys and promotes gambling with a state that provides a level of welfare that limits absolute despair when things go wrong. It's not surprising the savings rate is low in such circumstances.

patriotz said...

...with a state that provides a level of welfare that limits absolute despair when things go wrong.

I think you mean "starvation" not "absolute despair". I think most people have little idea what it's really like to live on welfare, CPP disability, or CPP/OAS/GIS.

I think quite a few people are going to see a lot of despair ahead of them, quite soon.

BTW I put 40% down on my first house and that was without any help.

jesse said...

Living on welfare/OAS is hard. What's harder is getting sick mentally or physically and having nobody to help you navigate the system.

Still, abject poverty in Canada is contained and uncommon enough to keep its consequences out of the vision of most of the populous. Not so in other parts of the world where I believe savings rates are higher as a direct result.

The higher savings rates in many parts of Europe are a different matter altogether.

RentingSucks said...

BTW I put 40% down on my first house and that was without any help.

Downpayment isn't worth much these days with a 35 year mortgage and low interest rates even significant downpayments aren't worth more than a few hundred a month.

E.g.
Assumming a 5 percent fixed rate:

$300,000 25 year loan + $100,000 down payment $1744 a month.

$380,000 35 year loan + $20,000 down has payments of $1905 a month.

Note that for the 35 year loan your interests costs for the life of the loan (assuming no increase in interest rates) is $420,000 as opposed to $223,000.

Downpayments just ain't what they used to be.

patriotz said...

But if higher down payments were required prices would have to go down because so many people would be unable to buy. Ditto if amortization was reduced.

The introduction of the 0/40 was no accident.

jesse said...

"...because so many people would be unable to buy."

True here because savings rates are low. Would the same sensitivity exist if savings rates were markedly higher and would a high savings rate have prevented, or at least muted, an asset bubble?

david said...

Note that for the 35 year loan your interests costs for the life of the loan (assuming no increase in interest rates) is $420,000 as opposed to $223,000.

Exactly! The longer the mortgage the more the downpayment actually saves you in the long run. An extra 10K down is like taking 10K off the very end of the mortgage.

500K mortgage 4.59% (assumed for length or mortgage)

Monthly payment = 2792.44

490K mortgage 4.59% (assumed for length of mortgage)

Monthly payment = 2736.59

Not a huge difference right? But if you still pay the 2792.44 per month with the extra 10K down you can pay off the mortgage almost a year sooner. Saving you almost 33K over the life of the mortgage. And you still end up with the same house.

Paying a little more up front and/or accelerating your payments a little bit makes a big difference when it is all said and done.

That being said the difference would be much bigger if interest rates were higher. So I do see your point about the low interest rates mitigating the importance of down payment.

RentingSucks said...

Not a huge difference right? But if you still pay the 2792.44 per month with the extra 10K down you can pay off the mortgage almost a year sooner. Saving you almost 33K over the life of the mortgage. And you still end up with the same house.

I know! I think like that but I don't think most people get much past "want shiny house", "bank give money", "buy buy buy". You would hope the insanity will end sometime but it's been a good long time. Only bright point on the horizon is the current rapid rise in inventory.

RentingSucks said...
This comment has been removed by the author.
ιŸ‹δΊŽε€«ζˆ said...

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Mark and Danielle said...

mohican, thanks as always for your rational post

I've been trying to send you an email at the address you provide, and I get an email back saying your email address doesn't exist.

Please send me an email at chibidani at gmail dot com

Thanks!