House purchasing economies of scale

This one is a quick reminder for those attracted to investment properties. The right home to have for the purpose of renting out will be around the price median for a given area. Too expensive of a home, and it will be hard to get what is needed in monthly rent. The exceptions being vacation homes, and the luxury market.

The other end of the spectrum is even more problematic. A $40k house will have many cost items that are the same as a $160k house. Here is a list for example:

Appraisal: $200-$400. The house size can influence price, but not by much.

Home Inspection: $200-$500 depending on tests performed. It is similar to appraisal, but can vary a little more with house size. Most of the inspection will be a fixed cost.

Plumbing: Trip fees and simple fixes will be the same. Toilets will be the same.

Mortgages and titling fees generally disregard house size.

Cable TV, and utility service fees will be the same

Evictions will cost the same

Liability issues will be roughly the same

While this list has exceptions, its purpose is to provoke thought about the “good deals” to be had in low cost houses. Always make sure to do your own due diligence before making any kind of investment, and if unsure…consult a local professional advisor.

How a monthly mortgage works

Most people are now stuck with getting fixed rate mortgages with terms up to 30 years. The time of adjustable rate and other specialized home loan products is over. Today, FPO answers the question of what determines your monthly house payment. The first factor is your home loan amount. This amount will be some percentage of what you bought your house for, depending on how much money was paid down. A standard situation may look like this: A house was purchased for $125,000. The loan company required 20% of the house value to be paid immediately in the form of a down payment. This results in a loan amount of $100,000. With a term of 30 years, this amount will be paid at the end of the term as long as all payments are on time and there are no other changes to the loan. The loan contract will have interest on the amount borrowed from the bank, which is the reward for the bank risking it’s money   with you. Presently an interest rate of 3.5% is reasonable (and average). This rate will be compounded daily and payments made on the loan monthly.The monthly payment consists of money that is directed to service the interest on the debt and money that is paid towards the principle of the loan, reducing the amount currently being borrowed. For most all loans in the U.S., this monthly payments remains the same for the life of the loan.  Keep in mind that this does not include taxes, insurance, home owners’ association, or late fees; that’s extra.

Since the payment is the same for each month, the portion of money that is applied to the principle of the loan will subsequently   reduce the portion of the payment that covers interest for the next and each subsequent month. This process of repayment in called amortization.

Retirement savings modeling

The retirement scenario generated by FPO (we’ll randomly post different retirement scenarios) shows the importance of the cash flow concept mentioned in the previous post.  This is also the bread and butter for FPO; growing your income, shrinking your expenditures, and maintaining/grow your quality of life.

Here’s an example of what would be a working solution based on FPOs model for figuring out how much money is needed to retire.

Year: 2012

Age: 47, Spouse: 46

Earned income before taxes: $60,000/yr

Taxes on earned income: $6000/yr

Earned income related expenses = $6000/yr

Last year of mortgage. Payment = $12,500/yr

Other expenses: $17,500/yr

Saving rate: $18000/yr

Starting in 2013: Primary residence is paid off.

Assets: $500000 rental property, $500000 high dividend and master limited partnership (think oil+gas income)

After tax income: $27500 real estate, $27500 high divident, etc. total: $55000

Note that $1000000 is assets completely replaces the earned income in transistion. These assets were building up over several decades prior to 2013. The result is cutting income by half in 2012 if there is no more earned income, but the assets still generate $55000 in income. There are only the normal expenses of $17500 year. The only unknowns would be health insurance and long term care insurance. even budgeting $12500/year for these two categories still leave $25,000 in savings rate per year. Take some of that for vacation and fun. An added plus is that someone following this example will likely figure out in some spare time to make some extra money at a high rate per hour, but that parts optional.

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