Here’s a clever idea I never thought about (mostly because I don’t have kids): Children perform chores in return for computer or video game time, not allowances. That’s the idea behind an article in the New York Times today in which children earn “screen time” as opposed to dollars and cents for good behavior.

I really like this idea because it’s a lot like carbon credits (please bear with me). So a company does something bad for the environment, like pumping more CO2 into the air, in order to offset that they can do something good, like planing more trees. Well, this is the same idea as earning “screen time” because playing video games is “bad” whereas studying, reading a book, doing chores, is “good.” You can even throw in wrinkles like trading your chores for screen time with siblings, sort of like a secondary market for screen time!

Now, some parents might say that chores should be part of one’s duties and children shouldn’t feel like they should be rewarded for the things they should be doing. It’s the same argument as not tying allowances with chores but if you can get over that then this is a pretty solid idea. It’ll be a few more years before we’ll have a chance to implement it but it’s always good to be prepared.

This morning I did a bit of an apples to oranges comparison of a 401(k) and a high yield savings account, showing that the two would meet two years and two months out given a set of probably unreasonable assumptions. It was apples to oranges because the risk involved in investing in the stock market simply isn’t anywhere near the risk involved in saving money in a high yield savings account. So, I took Anne’s suggestion and compared a pre-tax account, in this case the 401(k) again, and a post-tax account.

Results? 401(k) never catches up. Despite starting with more money, $133 vs $100, 401(k) can never get over 25% the marginal tax rate + 10% penalty hit that it takes when you extract funds from it (not a loan, a straight up withdrawal). If you plan on pulling out your 401(k) funds to buy a house, don’t put them in there in the first place. Make the minimum contribution to get your match, then put the rest somewhere else.

Assumptions

• Better is defined as the approach that ends up with the most amount of gain.
• You are in the 25% marginal tax bracket.
• Both accounts return 11% a year, or 0.8735% each month, compounded monthly.
• There is no 401(k) contribution match by your employer. An employer match will bring in the breakeven point and raise the value of the 401(k).

Pretty Charts!

The chart below plots the growth of the brokerage account versus the 401(k) account. The value shown is the final extracted value, but growth is based on the non-extracted value. For example, with the 401(k), it’s the pre-tax dollar amount that is being compounded but the graph is showing that value reduced by 35% (25% tax, 10% penalty). The brokerage account line is growing based on its unrealized gains but the value shown is the realized gain, minus long term or short term capital gains. If you’ll notice the little hitch in the purple line at around month 12, that’s because the brokerage account tax rate fell from 25% (short term capital gains) to 15% (long term capital gains).

If you’re interested in the Excel spreadsheet I played with to reach these simplistic conclusions, I’ve made them available here. Please check it out and let me know if you see any mistakes I may have made.

When it comes to saving for a house, is it better to contribute pre-tax into a 401(k) and withdrawing it (taking the 10% penalty) or contribute it post-tax into a high yield savings account? The trade off is that a 401(k) will grow more, start with a bigger pot, but take an extra 10% hit on the way out. A high yield savings account starts with a smaller balance, takes an earnings tax each year, but doesn’t face a 10% penalty at the end. According to my analysis, after three years of growth, contributing to a 401(k) comes out 6% ahead compared to a high yield savings account (my assumptions and an explanation of my analysis to follow). The break-even point is at around two years and two months.

What does this mean? If your sole concern is saving and earning the most to put down towards a house, with no consideration towards retirement, then contribute to your 401(k) if your target date is at least two years and two months into the future. I believe that to be short-sighted because retirement is far more important than whether you own or rent, but that’s a decision you have to make. *One other option to consider is that you can contribute to a 401(k) and then borrow from it at prime + 1-2%, so these are by no means the only two options you have.

Assumptions

• Better is defined as the approach that ends up with the most amount of short term gain, this analysis gives no consideration towards retirement goals, which I believe is far more important than buying a home.
• You are in the 25% marginal tax bracket.
• The 401(k) would return 11% a year, or 0.8735% each month, compounded monthly.
• The High Yield Savings would return 4.75% a year, or 0.3875% each month, compounded monthly.
• There is no 401(k) contribution match by your employer. An employer match will bring in the breakeven point and raise the value of the 401(k).

Explanation of Approach & Spreadsheet

I assumed that you would contribute $100 in the beginning of January (once) to your high yield savings account and you would contribute $133.33 to your 401(k), that’s the pre-tax equivalent of $100 if you are in the 25% marginal tax bracket.

Pretty Charts!

The chart below compares the growth between the high yield savings account and the 401(k). You’ll notice the dips at the end of each year in the HYS, that’s when income tax is levied on the interest earnings. The 401(k) line reflects the post-tax value of the 401(k) balance, that is after a 25%+10% reduction (25% marginal tax rate, 10% penalty). The 401(k) growth is calculated using its pre-tax value but the chart is charting it’s post-tax and post-penalty value. You can see that the lines intersect around the 2 year, 2 month point (X-axis 25 or 26), when income tax is levied on the HYS.

If you’re interested in the Excel spreadsheet I played with to reach these simplistic conclusions, I’ve made them available here. Please check it out and let me know if you see any mistakes I may have made.

My friend sent out an article today about how Baltimore is predicted to see its housing prices fall 27.8% in the next five years. 27.8% over five years is approximately 5% each year for five years… that’s the prediction. I think predictions like that are worthless and why I generally ignore them.

Reason 1: Where Were You Four Years Ago?

If you can predict the future with absolute certainty, why couldn’t you predict we were going to enter a slowdown in 2006 back in 2003? The market’s been somewhat slow for over a year now, so why didn’t we get some advance warning? The reason why is because you can’t predict the future. You can make an educated guess about what will happen next year, maybe the year after, but five years? C’mon now.

Reason 2: Experts Say What Is Popular

Wouldn’t you like to get one TV? What about see your name in the newspaper or magazine? Of course you would and so do experts. That’s why they will look at the data and why a lot of them will come to the same conclusions. When the market’s hot, it’s blazing hot. When the market’s cold, it’s sub-zero. Experts are likely to say those things because that’s what will get them on television or into magazines and newspapers.

Reason 3: Experts Are Never Called Out

Do you have any idea who said the housing market was sizzling hot right before it tanked? Probably not, that’s because no one keeps track and no experts are ever called out when they’re wrong. When things go sour, some CEO gets canned. I bet they wished they had these experts tell them that subprime was going to go into the toilet and their SIV’s were going to get them axed (though they both received handsome paydays).

What do you think of all the housing doomsday experts? (the ones that do scare me are the experts talking about the dollar and the exchange rates, so I can’t claim total rationality, I mean the Canadian dollar is worth more than the US Dollar! Insanity!)

A recent article on Wall Street Journal talks about how some people are glad they rented instead of bought because of the recent housing slowdown. What I want to know is why timing the housing market is okay, but timing the stock market is the greatest sin in all of personal finance (it’s not, but sometimes people make it seem that way). The argument against market timing in the stock market is that the market is random, that it trends upward, and your horizon should be far enough away to handle any hiccups. The idea is that with it being random, trying to sell at peaks, buy at valleys, and all that mumbo jumbo is a losing proposition, especially after fees.

Real Estate Timing!

So why is timing in the real estate market any different? The prices aren’t random and don’t move quite so much, but they’re difficult to predict. Here in my neighborhood, five houses have sold in the last twelve months (of the six listed) and each sold within a week to two weeks of being listed. Each sold for about 7%-10% than what I bought my house for two years ago, which shows some year over year growth (not the crazy growth of a few years ago, but healthy reasonable growth). The lone house that sat wanted a good 20% more, which was clearly over-priced. If you waited to buy a house in this neighborhood, it wouldn’t have mattered.

However, in the city, where newly renovated rowhomes and brand new condos were being build and listed with ridiculous prices; those prices sank like a rock. Homes that were once listed around $500k are now at $400k. The only difference was that those homes were newer, being purchased by people with more money than ability to recognize value, but the same geographic area (Baltimore, MD). So, why did those fall more than other areas? Who knows. It’s difficult to predict when supply will outpace demand.

I’d Probably Be Renting

That being said, I hate unyielding adherence to conventional wisdom (which says you should always buy and not rent because rent is throwing away money). Conventional wisdom works if you’re conventional, except most people aren’t conventional and even if they are conventional, they’re usually not in a conventional environment. If I didn’t own a house, I’d probably be renting right now only because I don’t like putting myself into long term relationships (mortgage) in an uncertain environment (housing).

What about you? Renter? Buyer? Glad you did either? What are your future plans?

I asked a few friends of mine why they didn’t maximize the contributions to their 401(k) each year and the number one reason was that they were saving up money for a downpayment on a home. All of my friends are young professionals with good salaries but with your typical rowhouse in the area costing around $200,000 to $350,000, with many far more, it’s extremely difficult for someone to come up with the $40,000 to $70,000 required for 20% down. What’s adding to the difficulty is that it doesn’t even consider the closing costs which can get up to $10,000. So, what are some strategies you can use to come up with the 20%?

First, How Much Will You Need?

This is step one, calculating how much you’ll need to save in order to reach your goal of a 20% downpayment. After you have this target number, you can start employing the strategies below to figure out how you’ll get there. Let’s say you want to buy $300,000 of house in 2 years, so that means you have 24 months to save up the $60,000 downpayment. I think you can use a conservative estimate of 4% for the appreciation of your money in savings (let’s ignore inflation because the estimates for inflation and its effects over two years are too variable to use historical numbers).

Now, calculate how much you’ll need to save over 24 months to reach $60,000. Here’s a savings calculator (you will need Java installed, but it should ask if you don’t have it) that you can play with to reach your answer (I used a business calculator). Enter in $60k for the savings goal, 2 for the years to save, and all the other pertinent data. If the graphs aren’t updated, click on the Calculate button. The answer is $2,375 (the white boxes). You can enter in your current savings to see how far away you are, but $2,375 is your target number each month if you want $60k in 2 years at 5% appreciation. So, how do you get there?

Find A Smaller House, Different Location

Now that you have the target number, it’s time to play with it. While this sounds like a no-brainer, it isn’t that clear when you’re searching around for homes that you should settle for less house. What used to be a “starter home” in an area ten years ago is no longer a starter home as home prices, even after the recent slipping, have vastly outpaced inflation and wages. In your mind’s eye you have an image of what you’re first home was going to be, I know I had an image of a first home that looked like the home I grew up in (my parents still live there and have done so for the last 27 years). The problem was that home is at least half a million dollars in the nicer areas of Maryland, if not more depending on the home’s age and specific location, so it wasn’t within reach.

Next step? Think townhouse. Single family home on my salary was an impossibility unless I was willing to sacrifice other factors such as the location, which I wasn’t, so a townhouse was my next option. If you’re a handyman or handywoman, consider getting a fixer-upper. If you’re not picky about the location, pick a less desirable location. Ultimately the first step is finding out how little you’re willing to pay for a home and how much you’d be willing to pay and check out your options.

So, let’s say you are now willing to live in $200k worth of house and thus need only $40k in a downpayment in two years. $1,583 is now your target savings per month, a difference of $792 each month.

Ask Your Parents (Relatives, Grandparents, Etc)

This is how I was able to come up with any type of downpayment (I was only about to get around 10%, even with my parent’s help) and it’s something that requires a little of preplanning because of gift taxes. The donor must pay gift tax on any gift over $12,000 in 2007, so if your parents can help then it will help their tax situation to spread the gift out over the years. If you do this, keep this sample gift letter template in your back pocket because you’ll need to send a version to your lender when you request a mortgage.

Let’s say you’re back to a $300,000 house and your parents (or benefactor) gives you $10k right now. Enter that as your “Amount currently saved” in the tool and you’ll find that your magic number per month has fallen from $2,375 to $1,939, or a difference of $436 of savings each month.

Cut Back On Retirement Savings

This is another option that I and many of my friends did to help save a little extra. I still put in my maximum Roth IRA contribution and the minimum needed to get the employer match for my 401(k), but I didn’t contribute any more to retirement outside of what I consider the bare minimum. Some might not even contribute to a Roth IRA, but I would consider that a mistake. At this point you’ve stopped reducing the magic number and started focusing on increasing your savings, so it doesn’t make much sense to look at the calculator anymore.

Cut Back On Discretionary Spending

Start finding trimmables in your budget so you can get your savings up to your target savings rate to achieve your goal. The trimmables post I wrote back in October of 2005 still applies today and it was motivated by my own savings plan when I bought a house. It’s easy to cut something back when you think it’s only temporary and when you have a goal in mind.

I hope that with a little bit of math and some suggestions I’ve been able help some prospective homebuyers wrap their heads around where they can look to get that 20% downpayment, it was the approach I took and it ended up working for me so I hope it works for you. If you have any suggestions or ideas that I’ve missed, please let me know and I’ll add them to the list. I hope that this helps people understand that while getting 20% is difficult, it’s not impossible if you’re diligent.

If you haven’t been reading about the “subprime lending meltdown” lately, you’ve had your head in the sand because this thing has pervaded every corner of the financial world and chances are it has touched you in some way. In fact, the other day I was talking to someone and it turns out that American Home Mortgage held his mortgage loan (AHM recently laid off 90% of its workers) so the subprime lending meltdown certainly touched them in a very palpable way (In fact, they were one of the folks who had their escrow check bounce when paying their taxes) Another friend had to jump through hoops in terms of documentation, specifically the gift letter, and even had one lender pull their loan offer when they were looking for a home. We’re talking financially responsible, high credit score individuals here; not what you would associate with a subprime lender. The tentacles of this thing have spread everywhere and everyone is spooked.

Here’s another impact… If you were looking to get a jumbo mortgage loan, a loan greater than $417,000, then you’ve been affected too because those rates have spiked since Fannie Mae and Fannie Mac don’t buy jumbo loans. Instead of paying something like 6% you’re talking about paying a minimum of 7.5% to 8% - that’s a significant impact especially considering it only affects the more expensive loans. The reason for this is simply because you would be getting a loan that Fannie Mae and Fannie Mac won’t buy, so lenders are scared (but not so scared they won’t lend you money of course).

Personally, it hasn’t really impacted me because my mortgage has been pretty vanilla, a 30 year fixed mortgage at around $230k. The only noticeable impact has been in my retirement assets because they’re mostly in index funds and those funds gave a little something back last week.

So I’m interested to know, has the subprime meltdown affected you or someone you know? I’m curious to hear how widespread this has truly become.

On my post warning against overpaying on rent, James poses this question:

Is it better to rent an apartment or buy a manufactured home? I found a good location where they are selling a 2 bedroom manufactured home for $170K. The mortgage calculator says, for a no downpayment for 30 years at 6.12% interest, I pay $1,032.39 monthly.

Today, Im renting a studio at $1,000 a month. So I thought would the mobile home be better? I mean in 3 years, I would have paid out 36,000 (more if the rent goes up). That money goes away. But I buy that mobile home, I can sell it in 3 years for a super discounted deal, say, 80,000. I would not be only be able to regain the 36,000 but also would have made money.

First, I think you’re getting too exotic by thinking about saving money by purchasing a mobile home and reselling it, recouping some of the equity and thus paying out less in rent. It’s certainly a very interesting decision and analysis but ultimately I think your assumptions are going to be your undoing on this one.

If all your assumptions go through, that you can purchase the mobile home and resell it at the stated prices, it sounds like your plan will work. Your assumptions, however, are very difficult to support and I am clearly not qualified to give you an advice on that. All I know is that there is a social stigma associated with mobile homes and I have no experience selling one, either first hand or anecdotally. What I do know is that you’ll have to put that mobile home somewhere and generally mobile home parks charge some sort of land usage fee that you didn’t figure into your calculation. You also have closing costs and selling costs that you haven’t factored into your equation which may make the decision less financially attractive. Then again, your extra low price of $80k may have accounted for all of this in its fudge factor, who knows.

All that being said, I go back to the beginning where I said this is probably making it too complicated and potentially putting yourself in a bad spot, especially if you experience difficulty selling it and have on your hands a depreciating asset that you can’t sell. Would I do this? Probably not. I don’t like committing myself to debt larger than my fist unless it’s a pretty sure thing and I don’t think your trade off necessarily is. It’s definitely an interesting question though.

Anyone else care to weigh in?

“When banks compete, you win” is a slogan you’ve probably heard recently but is that really true or is that just a clever slogan wrapped around some somewhat clever advertisements? In summary, I think LendingTree offers you a quick, free, easy way to determine what the ballpark rates should be for someone with your credit profile. The fact that it’s free makes their offer compelling, why not enter in your information so you can figure out whether you can get a good rate or just an OK rate.

When I was looking at houses over two years ago, I signed up to LendingTree because of all the advertisements I saw on the television and because I felt that it was a useful resource. It’s essentially a search engine for mortgage loans and while the banks don’t necessarily “compete” in the sense that they are scrambling to beat one another for a loan, it certainly aggregates all the offers in one place so you can compare them easily.

Easily Compare Offers
I think that everyone should use LendingTree because getting those offers is free and because it gives you a general idea of the rates you can probably expect. See, Bankrate is nice with their rate listings but they’re not terribly accurate; getting a series of rate quotes based on your personal information and geographic area will give you a better sense of what’s a “good” rate and what’s a “bad” rate.

Pre-Approval Letter
Another benefit to using LendingTree was that they processed me for a pre-approval letter and I was able to print that out within hours (I want to even say within minutes since in a previous post I talked about how LendingTree called me a little after I submitted a quote). A pre-approval letter is crucial whenever you’re bidding on a home because it shows that you are a qualified bidder (that you’re good for the amount that you bid) and, given how hot the market was in two years ago, so it was definitely a bonus to using LendingTree (even though my loan wasn’t originated by a LendingTree lender).

Lots and Lots Of Offers
This can be a good or a bad thing depending on your perspective but within minutes of applying, I was deluged with mortgage related emails from all sorts of lenders from local banks and credit unions to big national banks that had a presence in my geographic area. Some of the offers included sample rate quotes based on my information, some were just cold call type “hey we’re here, call us,” but in general it was good.

Why Am I Pimping LendingTree?
I’m compensated for each signup but also because I had an email asking me whether I thought LendingTree was worth using and whether it resulted in any spam. I don’t think I’ve gotten any spam as a result of using LendingTree but you can never be certain with those sorts of things. Since it’s a major company and fairly reputable, I’m inclined to think that they don’t sell the lists or do anything questionable. However, considering your information is forwarded to a bunch of banks and lenders, you could perhaps get spammed if those institutions sell your information. Ultimately, who knows… use a good spam filter and you should fine.

Has anyone had a good or bad experience with LendingTree?

Given the popularity of the last searcher questions on 401K and Roth IRA, I figured I’d poke through the logs and pull out some mortgage loan related questions. Some of these are very good questions and I invite you to share your own opinions if they differ on my own (or even if they’re the same).

Should I pay the closing cost or roll them into the new loan?
This is a tricky question and it’ll take a few minutes to explain why but the answer is - it doesn’t matter. Most experts will claim that you shouldn’t roll your closing costs into the new loan because when they are capitalized (integrated into the principal of the loan), because you will pay for those closing costs for the next X years (your loan terms). The problem with that logic is that if you assume you have a finite amount you can afford to put towards a down payment for the loan, then it makes no difference whether the dollar goes towards the purchase price or it goes towards the closing costs. Either way the loan amount is going to be the same so it doesn’t matter.

How to get your PMI (private mortgage insurance) off at CitiMortgage?
This one is best answered by the experience of a reader who had CitiMortgage cancel his PMI payments. Essentially, this is possible only when your home value has increased such that the principal on the mortgage is less than 80% of the value of the home. If your home value has increased, call up your mortgage lender to have them hire an appraiser (this will cost you money) and hope that the appraisal comes back high enough. If the principal has fallen under 80% of the value of the home as a result of your payments, The Homeowner’s Protection Act of 1998 has mandated that your lender is required to remove the PMI.

Are mortgage interest rates negotiable?
Your mortgage interest rate is not going to be negotiable with your current lender because they calculate based on your characteristics but you should be able to get the lenders to “compete” through brokerage services (like LendingTree) or comparison shopping (which is basically what places like LendingTree does anyway).

What is on a mortgage gift letter?
I used the following mortgage gift letter when I applied for my mortgage and it was accepted by the lender. The major components that the lender looks for are: who is giving who money, that it is a gift, and that there is no expectation that the gift will be repaid.

Should I use home equity to pay off credit card debt?
I just wrote an article on this exact topic a few days ago because of a NYTimes article about folks losing their home because they can’t make the payments after a refinance. When you shift the loan from an unsecured credit card or a car note, you risk your home if you can’t make the payments. If you can’t make the payments on a credit card or a car note, you might lose the card and the car but you won’t lose your home.