I Did the Math

This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA

photo: surfboards on beach

My son went surfing several times off the Narragansett Beach on the Rhode Island Shore this year.  He went with a couple of his buddies for the day. They would rent surfboards and then go out all day.

Recently he told me there would be a charge on my credit card for $690.  On this trip he said he bought a surfboard and he would pay me back. Before I could get another word out he said,  “Dad, I did the math.” Ouch. We are all good at some things. Other things, well, not so much. Math is not his strong point. He then explained to me that by buying the surfboard he wouldn’t have to pay to rent them. By his ninth time out, the surfboard would be paid for.  He really had done the math.

The Sharing (And) Rental Economy

This got me thinking about the millennials, those between age 18 and 34. As a group they clearly appear to want to rent over own. This includes housing and transportation.  Uber, the ride sharing service has an estimated private valuation of approximately $66 billion. Yes, that’s with a “B.” Urban millennials clearly prefer this mode of transportation over taxis, buses and subways.

I think there are a few reasons for their preference of renting their housing over owning.  First, many have student debt. This affects their ability to borrow more money to purchase a house.  The total student debt in 2016 was a record $1.2 trillion and climbing.  And yes, that’s with a “T.”  The average student debt for 2016 graduates is expected to be $37,172. (1) With the cost of college skyrocketing everyone needs to know the 5 Reasons to Fund a 529 College Savings Plan.

Second, one of their main reference points when it comes to homeownership is the Great Recession of 2008-2009.  Many saw their parents and grandparents struggle to stay in their home. This recession left a lasting economic and psychological mark on many. Finally, if you are living in your parents’ basement you might not be paying any rent at all. This should allow you save some money.  If you moved out and got an apartment you would quickly find out that Things are More Expensive When You Pay for Them Yourself.

Renting per say is not bad.  I’ve done it myself, many times. Coming out of Bryant College I just didn’t have any money. I did have some relatively small student loans that I had to pay off. Renting an apartment was the only way to go for me. I moved around a bit depending on my job.  Finally I had an opportunity to buy into half of a two family house. As this appeared to be the only way for me to get into the housing market I jumped on it. I only stayed a few years and sold and moved on to our next house. Our next house quickly became too small after our son was born.  We tried selling it and it just wasn’t moving. My wife and my realtor wanted me to cut the price by $10,000.  I wasn’t so sure. I sat down and did the math.  I called up our realtor and told her I wanted to rip up the contract we had.  She paused and asked, “Why.”  I told her I wanted a new contract and I wanted to INCREASE her commission from 6% to 7%.  She said she would be right over with the paperwork.  What should have taken her half an hour to get to our house took her about fifteen minutes.  We signed the paperwork and she was on her way. Two days later the house sold for almost what we were asking for. All of the other real estate agents saw the 7% commission and jumped on it!

After selling this house we rented a condominium. The price was right and the place was beautiful. Our children were young and I didn’t have to do any yard work. Time when by quickly and we stayed there six years then moved into our current house.

Good Debt and Bad Debt

To purchase a home you will need to have enough saved for a down payment. One of the key factors in your ability to save is your income. However income isn’t the only factor that impacts your ability to save. One of the primary factors in your monthly cash flow is your debt service. Are your debts under control and therefore there is cash flow available to save? Or are you strapped trying to keep up with your payments? When considering taking on debt, there are essentially two types of debt, “good” debt and “bad” debt.  What is good debt?  Generally, its debt associated with buying your home. Why is this good debt?  First, the mortgage interest paid on your primary residence is generally tax deductible. There are two limits however with the mortgage interest deduction:

  • So-called ‘acquisition indebtedness’, which is the mortgage placed on your home when buying it.  The mortgage interest deduction is limited to the interest paid on up to $1,000,000 of mortgage debt.
  • Interest on a home equity line of credit is limited to the interest paid on up to $100,000 of debt.

Second, this is good debt because a home generally tends to be a good investment.  Notice I didn’t say owning a home is always a great investment. It’s not. Face it; everyone has to live somewhere… hopefully not with your in-laws. The choice is to own a home or rent. The primary advantage to owning a home is not paying rent. Sure, homeowners might be paying a mortgage, perhaps for many years. On the other hand renters just have a cigar box full of rent receipts at the end the year. Clearly, this isn’t the way to build your net-worth.  In the mobile society we live in now it might be necessary to rent for a while.  People that are moving might want to get familiar with the area before buying a home.  In this case renting for a short period of time might be appropriate. Long-term however, homeownership should be a goal.

Keep in mind real estate prices are cyclical. This means that real estate prices go up and down. Sorry I put that in italics.  Some folks have just experienced declining real estate prices. They do decline, and when they do, watch out.  If you buy a house when prices are at the peak, it could be a long time before “breaking even” again.

Homeowners, unlike renters, will have other expenses. Even if you don’t have a mortgage, there are still operating expenses. These expenses include property taxes, insurance, utilities and repairs and maintenance and they add up quickly. This doesn’t even count the time and sweat required to keep your home in good condition.

Higher Education

Another potential type of good debt is to help finance a college education.  Unfortunately, I have to say potential here because sometimes it just doesn’t work out as planned.  Sure, it can be tough to go into debt to get a college education.  Generally, college is often a very good investment.  The earning capacity of a college graduate tends to be significantly higher than someone without one.  Remember, you’ll probably be working a long time.  If you start working somewhere around age 20 and retire around age 65, that’s about 45 years of working.  You’d probably want to be earning the most amount of income (while still being reasonably happy, of course) you could.  Competition for good jobs seems to only intensify every year.  Sure, when the economy is humming along everyone is working.  Let the good times roll, signing bonuses and stock options galore.  Its rock and roll time.  You (should) also know the good times don’t go on forever.  So what’s the deciding factor when employers are looking to hire new employees?  First, they’re typically looking for employees that have experience for a particular position.  Second is a prospective employee’s educational background.  So, getting an education is a good thing.  I know, I know, Bill Gates, Former Chairman of Microsoft, and one of the richest men in the world, doesn’t have a college degree.  What does he always say; he’s on sabbatical from Harvard.  I’m curious, how long, exactly; can someone be on sabbatical from college?  Anyway, there will always be exceptions.  Remember, there’s only one Bill Gates.  I’m sure there are plenty of other people on “sabbatical” from college who, perhaps, aren’t as financially successful as Mr. Gates.  With that said, college certainly isn’t for everyone and a college degree doesn’t assure success.

For some high school graduates and their parents they should consider something other than the traditional four year college degree.  When our son was a senior in college we didn’t think that having him go off to college for a four year degree would potentially be a ‘win’ for him.   We saw our nephew attend a community college at a fraction of the cost of a traditional four year school.  We made an offer to our son that he could attended (and graduate in two years) from the local community college or attend trade school.  He likes to work with his hands and the trades, well; those jobs are just not going to get outsourced to India.  He chose to go to Manchester Community College and got his associates degree.  And he did it in two years.  The value for what you invest and what you get is awesome.

Our daughter has taken the more traditional path and is attending the University of New Hampshire.  Don’t worry; she doesn’t have a free ride from her parents.  Here are 3 Ways My Daughter Financially Contributes to Her College Education.

(1) Wall Street Journal 5/2/2016

The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon and not necessarily those of Raymond James.

Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James.  All opinions are as of this date and are subject to change without notice. The information contained herein is based on current tax laws which may change in the future. You should discuss any tax or legal matters with the appropriate professional.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This article includes hypothetical examples for illustration purpose only and does not represent an actual investment.  Actual investor results will vary. Past performance is not a guarantee of future results.