Buying a first home means not buying the sports car

The explosive growth of the Internet brought a lot of money to the San Francisco Bay Area and the Silicon Valley in the late 1990s. Many of my work colleagues and friends cashed in their stock options and bought high-end cars or lived BIG in San Francisco during those go-go years. Many of us younger employees did not know the difference between paper wealth and actual wealth. Unfortunately, the paper wealth quickly disappeared as pro-forma balance sheets fell out of fashion and stocks plummeted. Easy come, easy go.

Fortunately for me I did not get sucked into the craze of buying a BMW M5 and renting an apartment in the Marina. My Mid-West style upbringing made me far too frugal (or cheap!) for such “extravagance.” Fortunately I was able to same-day sell a chunk of my ISO options and chose to just sit on the cash. I continued to drive the 1988 Toyota Carolla I owned in college and rented with a roommate a two-bedroom apartment in less than trendy Sunnyvale. I was also able to have my company pay for a good portion of the MBA program I attended to avoid taking on massive student loan debt.

Yes, I experienced a ton of peer pressure for not living in the city. “Come on, Dunstan! Move up to the Marina with us. You won’t have to make the long drive home to Sunnyvale late at night…and “Social Safeway” is just crawling with honeys.” Many a tale has been told about love found in the produce aisle.

Why didn’t I cave to the peer pressure or buy-in to the spendy trends at that time? I wanted to buy a house. That was my goal. Even back then, living in San Francisco was expensive and many of my friends there lived paycheck to paycheck. Several work colleagues graduated with an MBA and $100K+ in student debt. I graduated with no debt. Shortly after I started my first job after business school I was able to purchase my first house. Goal accomplished.

The San Francisco Bay Area housing market is even more competitive (read “expensive”) now than it was in the early 2000s. Buying a home or condo takes a significant cash down payment to meet the more stringent lending requirements. A hefty monthly cash flow is also required to take care of the trappings of ownership…namely property taxes, insurance and then basic living expenses. Home ownership gets expensive. Fast. But I think it’s SO worth it!

First time home ownership is still possible in the Bay Area despite the gloom and doom affordability market data. Sacrifices have to be made and savings goals have to be achieved. Life style choices have to be made too. The process of saving for the first home may take some time and may require renting with a roommate in a less fashionable area to amass cash. Building a monthly and annual budget is a great tool to help analyze where the monthly paycheck goes and decide what changes are to be made to funnel more cash to savings. I highly recommend Alexa von Tobel’s book, “Financially Fearless” to help with building a budget and savings plan.

Buying what type of house and in what neighborhood will also be defined by company stock performance and salary compensation. People make a lot of money in the Bay Area. However, how well one manages money will play a key role in the home purchasing power of the individual. Keep in mind that most first time home buyers will NOT be able to buy a home in a top neighborhood. Be OK with that. Buy what you can afford in the best neighborhood possible. How this is done will be discussed in future posts. Start small and gain equity to then move up to the next house/neighborhood. This is all very possible. It takes time, commitment and money management. I did it. So can you.

Please send me a note on Twitter (@ericdunstan) if you have any questions.

Does it make sense to remodel or buy another home?

Our Memorial Day weekend was filled with get togethers and barbecues . As with most social events in the San Francisco Bay Are, real estate was the most popular conversation topic beyond, “So how are the kids doing?” Talking about real estate makes sense given the impact it has on many aspects of our lives including monthly budgets, savings and education. This great weather in California is expensive.

I find it disheartening to hear the advise from financial planners that roughly 50% of a monthly income should be spent on fixed costs including rent or a mortgage. Sigh…given the conversations I’m having, it sounds like families are spend a far greater percentage of their income to live in tiny 1,300 sq ft houses or tiny 1bd/1bth condos. It’s an unfortunately reality in the San Francisco Bay Area.

A friend, Dan, and his wife and two kids are living in a 1,300 sq ft home in a fairly middle range neighborhood close to a decent elementary school in Campbell, CA. He shared with me that the family is busting at the seams with limited space with growing boys. Dan and his wife would like to move, but is wrestling with the decision of staying put and remodeling OR buying another house and moving. This decision is a TOUGH ONE given how much the real estate market has increased in pricing over the past 5 years…even in the last 1 year! Dan shared he has a mortgage of $475K and a similar home down the street sold for $950K. I know, a 1,300 sq ft home sold for $950K! That is INSANITY, but is what people are willing to pay.

Clearly there are many considerations here including the family’s long-term goals, quality of neighborhood, financial situation and quality of education. One of the biggest hurdles that came to my friend’s mind is the increase amount of annual property taxes and increased mortgage should the family move. Given the high property prices now, these are big considerations.

I have fixed and flipped and built homes and shared a point of view on how best to evaluate the remodel vs. buy a new home decision. When I remodeled my home, I came at $200 sq/ft, which is very low. My wife and I were our own general contractors and got “family rates” from the sub-contractors doing the work. A healthy rate to consider that includes middle range building materials is $350 – $400 sq/ft. Ish.

My friend shared they would like to add on 750 – 1000 sq ft. Given these rates, the estimated ROUGH cost translates into $262, 500 – $350,000 not including the disruption to family life that needs to be factored in.   Yikes, this quick remodel project is not cheap even with the costs running on the LOW end of the range. Is it better to take that $262,500 to be spend on a remodel and put it into a mortgage on a new house for the family in a better area? Hmm…how should Dan evaluate this?

Dan shared with me that he roughly has $500K in equity in his current house if he sold today. Now, assuming the remodel is paid for in cash, Dan and his family will have on the low end $762,500 in cash ($500K from house sale + $262,500 from remodel) to purchase a new home. If Dan wanted to keep his mortgage at $475K, the purchase amount for the new home will be roughly $1.23M. Given this purchasing power, there are quality neighborhoods to buy into in the South San Francisco Bay Area.

Now, how does Dan buy the right house in the right neighborhood for his family? Buy the worst house in the best neighborhood that Dan can qualify for with a $762,500 down payment. With interest rates so low, Dan may be able to afford a mortgage above his self-determined $475K amount. The BIG key here is to buy a house that needs work, but is livable in the short term. Once the family is moved in and settled, a remodel plan can be developed and implemented in phases. Yes, the complete project could take time, but Dan’s family will continue to build equity and pay for the remodel over time with cash coming in from his business. The end result will be spectacular with the right property. The family will be in a stronger financial position, a better house, in a better neighborhood than taking that same $262,500 and using it to remodel Dan’s current house.

These decisions, of course, are very emotional. Based on the numbers, I think there is a strong case to sell the current house and remodel a new house. However, many other family, emotional, financial factors come into play here that makes these decisions not easy.

When does it make sense to refinance?

Several friends of mine have asked me when does it make sense to refinance their home loan. These questions were very timely for my wife and I are in the process of refinancing our 30 year fixed rate conforming loan now.

There are two general rules of thumb (or whatever finger you chose) to guide the refinance decision. The first rule focuses on the difference in the current interest rate and the rate of the current loan. If the difference is equal to or greater than .5% then it makes sense to EXPLORE the option of refinancing. Keep in mind that there are other factors to consider when refinancing a loan including closing costs, points and credit history. For example, if a borrower has a short sale within the past 4 years, lenders will not loan money. Or, because a borrower’s credit score is below a certain number, a lender may require the borrow to pay a point above the rate quoted…which may push the refinance rate difference below the .5% threshold.

The second rule of thumb, and this comes from my father in law who has done a TON of loan transactions as a general contractor, requires a little quick math and is a GREAT litmus test. If the amount saved on each monthly payment over one year is equal to or greater than the total cost of the loan (closing costs + points etc) then it makes sense to refinance.

The refinance process is NOT quick and easy and will take roughly a month to complete. The borrowers will need to submit a lot of paper work including W2s, tax returns, bank account information, credit reports, etc. The lender will also need to send out an appraiser to evaluate the home which creates other challenges. Given the strict lending rules these days, lenders may ask for additional detail that may seem irrelevant and nit picky…but that is the new normal. For example, we were asked to explain why we recently opened a new credit card and what the minimum monthly payment is…and we both have very good credit scores.

The stringent refinance process brings to mind the question, “Is it worth it!?” We ALL have crazy insane schedules…and the refinance process makes it even more hectic. I take the perspective from our refinance process as someone handing me each moth the cash saved ($200) from our refinance. To some, $200 a month savings is NOT worth the time and energy. However, that $200 a month savings equates to roughly $70K over the lifetime of the loan. Yikes, $70K equates to a 5 series BMW or Tesla, a few years of college, the down payment on a vacation home (outside of California of course!). From our perspective, the refinance is well worth it given we plan to live in the property for many years.

So, how does one find the best interest rates? Interest rates are readily available on most financial websites including Markwatch. We check those rates regularly and evaluate what to do. However, to find the rate best available for each borrower, I recommend using a mortgage broker. Brokers are typically paid a “finders fee” fby the lender for brining in new borrowers and do not charge the borrower directly. If the broker does charge the borrower, find another broker! Seriously.

Additional detail and pithy commentary about the refinance process is available in my video:

Please send me a note on Twitter (@dunstanprop) if you’d like a broker referral or have any questions.