Learning the financial language will save you money

Proficiency in "Financialish" equals money and empowerment

According to one urban legend the score in tennis matches was meant to confuse the common bystander, safely maintaining it within the confines of aristocracy. Other explanations include a clock face used in medieval French for scoring the game moving a quarter each time and the different gun calibers of English naval ships (15-pound guns on main deck, 30 pound guns on middle deck and 40 pound lower gun deck).

I've also encountered a similar explanation as to the reason why the French language holds so many "redundant" vowels. According to this myth the French royalty added a bunch of complicated phonetic rules the French writing to make it harder for the commoners to develop reading and writing skills.

It doesn't really matter whether the aforementioned is true or false. The point of these arguments, as we all know, is that knowledge is power.

Proficiency in the financial language is directly translated to money saved or earned

Language is a form of skill and knowledge which empowers the ones proficient in it.
The current crisis, for example, has everything to do with ignorance or lack of proficiency in the more complicated aspects of the financial world. Complicated derivatives and structured products drove the world crazy, making regulatory financial reporting such as financial reports completely useless for investors.

Warren buffet had identified the problem with derivatives as early as 2002: "I view derivatives as time bombs, both for the parties that deal in them and the economic system… derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts… ".

We don't have to as far as derivatives in order to demonstrate the importance of proficiency in the financial lingo. Many of us are completely puzzled with even the most basic conversation with our banker. The terminology is perplexing and no one really likes to admit one doesn't understand.

Be sure enough banks and financial institutions are quick to exploit on this tendency. A less known fact is that most of the bankers we meet in banks are really marketing personnel "in disguise". It's very simple really. The bank's goal is to sell financial products (loans, credit etc.) in high prices (interest). In order to be smart consumers we must first understand what this guy in a suit is talking about before we are able to be more confident in our negotiations.

It's really not that hard. Much like any other technical terminology the financial language may seem, at first, to be complex and full of subtleties and innuendos. At its higher level this is definitely the case but as with other things in life you can get a good comprehension of about 80% of the subject matter with 20% of the required investment (read this post on the 80%/20% rule). Just be confident enough and you'll be surprised of the results.

When one is proficient in a language one is confident. Suddenly bankers will start mumbling around you and will be turning much more to their manager when suddenly explanations and deviations from the standard pitch are required. This is literally worth money.

Where to start? Or is there a dictionary?

My idea for this post sprang to mind when Oxford university press were kind enough to send me a copy of "The Finish Rich Dictionary" by David Bach, an author of many other personal finance guidebooks.

While I'm less fond of the ever-promising title I did actually find the idea behind the book to be quite helpful. Much like any other language we need a "Finance to English" dictionary which will help in learning Financilsih.

David Bach has cleverly constructed this dictionary 1001 financial words "you need to know" are alphabetically organized and explained. The book is intertwined with helpful personal finance essays which discuss the issues at the very core of our personal finances including: Credit card problems, compound interest, the workings of the Federal Reserve, insurance, buying a home, money mistakes, financial plans, retirement, financial advisors and others.

The book also includes good references to other helpful resources and a interest rate risk calculator to complete the package.

I do feel the added value of this book should be articulated carefully since lack of financial resources is not something the internet is characterized by. This book is helpful as a glossary of words, combined under one roof, which maps the very basics of the financial language. If you don't know where to start this book may very well start you off in the right direction in an easy manner.

The interest offers much more diverse and deep knowledge resources of several kinds I highly recommend to anyone, no matter how proficient in the financial world:

• Wikipedia is without a doubt one of the best knowledge resources available to us, free of charge. Most of the entries are very comprehensive and well articulated. I often turn to Wikipedia first to find out more on a certain subject matter.
• Another helpful online dictionary is Investopedia which is centered around finance and investments.
• Finance blogs are great resources for financial knowledge. Blogs, such as my modest Personal Financier, aim at expanding financial literacy and discussion and are home to many good articles and advice. My link section has many helpful blogs listed. Some of my favorites include The Digerati Life, The Financial Blogger, The Simple Dollar and other more I apologize for not being able to list here.
• MSN money, Yahoo! Finance, NY Times (Your money section) and many other offer invaluable knowledge on personal finance. The problem is usually where to start from.

Whether you prefer a book to the internet or vice versa don't neglect your financial education. It's worth money.

Related posts:

• Behavioral Finance in Everyday Life – The Lottery as a Case Study
• Review: The Gone Fishin' Portfolio by Alex Green
• The 80/20 Rule - Let Pareto Do Most of the Work

Is It Better to Buy or Rent?

Another look at this timeless question. Now better explained with a great tool by NY Times.

The NY Times has one of a few calculators that actually get the comparison between rent or buy right. I strongly recommend visiting Is it Better to Buy or Rent @ NY Times to get a feel of it.

This post is essentially an improved older post in which I've explained my approach to the buy or rent question, the same approach taken by this simulator.

There are many psychological aspects to the question of rent or buy. While these may be debated in length it is important to get the financial part of the question right (A deeper look into the psychological aspects is available related posts further down the page).

In this article I will examine the financial aspects of the decisions in the form of the alternative 'loss' in each option (Rent Vs. Buy). We are not always aware of the entire financial picture.

When addressing a financial question we should isolate those variables which can be measured and compared. We should regard a house as every other asset and ask ourselves which way to purchase the asset is most desirable financially.

In order to compare the two options we must first have a common basis for comparison. Evaluating rent or buy, financially can only be made by considering the same asset, of course. Thus, we shall look at two alternative paths to own a house in a certain period of time:

Option A: Buy the house today and live in it for that period: The Buy Option.

Option B: Rent the house today and buy it in the end of the period: The Rent Option.


Option A: The Buy Option

Let's assume our future home owner buys a house with the common combination of equity and mortgage. His 'losses' would include:

1. Interest paid on mortgage - The most obvious would be the interest paid monthly as a part of the mortgage payment. This is essentially 'throwing' money away much like rent.
   
2. ROI on equity - A bit less obvious would be the optional return on investment on his equity. Our home owner would have invested his money instead of using it as a down payment for the house. This alternative investment could have potentially yielded significant return which is lost when invested in a house (to be gained, possibly, by a rise in house prices)
   
3. Deal costs - The costs of deal itself that include taxes, real estate agent's commission, lawyers etc.
   
4. Home maintenance and improvement costs - House ownership often means maintenance and home improvements otherwise avoided.

What about potential gain? In the buy option our home owner has a great potential gain as his investment in the house is a leveraged investment (An investment made with a combination of equity and debt).

The possible gain extends to funds he didn't have in the first place. Here's an example: Our home owner has invested his equity of 100K US$ in a portfolio which yielded a 5% return of 5,000$. Assuming his house has yielded the same return (5%) but was purchased with the same combination of equity and mortgage (say another 100K US$) his return on investment is now 10,000 US$ (with some paid as mortgage interest but with a relatively low interest rate).

Notice the return on his house is gained also on the debt or mortgage part of it (Higher absolute return).It is important to note that this potential gain is also a source for potentially greater loss since in the case of loss on his investment our home owner is left with mortgage payments unaffected by the devaluation of his property.

Option B: The Rent Option

Let us now examine the 'losses' in the rent option:

1. The monthly rent - Self explanatory.
   
2. The potential gain on the house as an asset - While renting housing prices may rise significantly without any benefit for the one renting (the renter will eventually have to pay more).

The potential gains for the rent option are

1. Return on equity - Return on equity not invested in a house but alternatively invested in a portfolio.
   
2. Return on monthly savings - Not having to pay a mortgage leaves the renter with the ability and duty of saving the principal part of the monthly payment so that he or she may buy the house at the end of the period. These funds generate return on investment as well.

When comparing the two alternatives we should always compare them for the same asset and for a set period of time in order to achieve a true comparison.

After getting the financial part out of the way we must make room for the psychological aspects of house ownership vs. periodical rent. I'd like to dwell on one unique psychological aspect: The motivation to save. In the buy option our home owner is forced to save in the form of timely mortgage payments. In the rent option our home owner needs some discipline in order to save the money for future house ownership. As available money always has its uses the mandatory part of the mortgage is an excellent motivator for the less disciplined savers.

Related Posts:

• Why A Mortgage Is An Opportunity And Why We Shouldn’t Fear Mortgages
• The Perfect Home is a Financial Nightmare - Don’t Get Caught Up In the Costly Race
• Why Buying a Home is More Important than You Think
• How to Make Sure this is your Dream Home: 7 Practical Tips
• Buying a Home – an In-Depth Look at the Process
• Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons

Why A Mortgage Is An Opportunity And Why We Shouldn’t Fear Mortgages

If I was a potential home buyer I’d start browsing for opportunities

Even the mere mention of a mortgage is sometimes enough to send some people running for their lives. Mortgages have a bad rep and are associated with debt, dubious financial logic and the recent sub-prime crisis.

The truth, as always, lies in the middle. Mortgages are probably the cheapest available loan and usually the only way a family can afford their first home. As any financial tool mortgages are neither good nor evil. When used properly mortgages can really leverage your life (literally).

Mortgages tend to be regarded as complicated financial tools. They certainly are for the financially illiterate but with a small effort and some will you’ll be able to figure them out quickly enough.

Housing starts are at a slump and so are housing sales and prices. The market is slowly correcting its way back to normal price levels. Some might say even overshooting down as markets that experience corrections often do.

Low interest rates, combined with what might possibly turn out to be reasonable housing prices, can create a good opportunity for potential home buyers.


So why a mortgage is an opportunity and why we shouldn’t fear mortgages?

Many people regard mortgages as a tremendous obligation weighting heavily on their backs for many years. An unsound mortgage just might do that. However, properly thought out mortgages present as much an opportunity as bad ones present a threat.

Mortgages are opportunities because they are essentially relatively cheap debt. As aforementioned a mortgage is a loan against the property bought. The property essentially serves as a sort of insurance which enables the lender to offer a significantly lower rate on a very big loan.

By taking on a mortgage you are leveraging yourself. You are making an investment with both your equity and relatively cheap debt. Your investment is your house thus enabling you to enjoy an increase in housing prices on both your equity and debt. As mortgages are considered relatively cheap debt and since buying a house is usually a long term investment chances are you’ll see solid returns on your investment. Keep in mind Leverage works both ways – losing on your investment leaves you with debt yet to pay. There are always risks involved (more on leverage and mortgage can be found here).

There are always exceptions such as the recent crisis. Keep in mind, though, that had sub-prime lenders had the ability to actually afford their mortgages they wouldn’t have lost their houses. This is where sound mortgage planning and risk management take place.

Avoiding a mortgage will save you interest payments and the necessity of making payments. However, you might also find yourself buying a relatively cheaper house which might not suite your future needs. In this case, you’ll pay more in deal costs buying a more suitable home in the future.

Related Posts:

• The Perfect Home is a Financial Nightmare - Don’t Get Caught Up In the Costly Race
• Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons
• Why Taking a Mortgage Is Leveraging Your Equity: Understanding the Potential Risks and Benefits
• How to Make Sure this is your Dream Home: 7 Practical Tips
• Should you Rent or Buy a Home?
• Buying a Home – an In-Depth Look at the Process

The Perfect Home is a Financial Nightmare - Don’t Get Caught Up In the Costly Race

It is very easy to get sucked in a terribly expensive effort which never really ends

My wife and I just returned from our 203th visit to IKEA with some interesting insights I’d like to share. Since we’ve bought our apartment and renovated it we’ve been caught up in a continuing effort to furnish and design it into our perfect little home. All this time a very obvious yet elusive insight eluded us: There’s no end to this effort, no finish line to the race.

It starts very early on. You decide to buy a house, maybe even decide on a budget but all the plans and all the decisions soon fade away when you start shopping for a one. It’s understandable. Some locations, architecture and design, extra rooms and more may be well worth the extra money but have you ever heard of anyone buying a cheaper house than they initially planned on?

It continues with massive, endless renovations trying to shape reality to dreams with multi-million homes as our inspiration. Even the world’s best interior designer can’t create that much space in a two bed room apartment.

Naturally, our quest goes on even after we’ve moved in. Furniture, appliances, designs and adjustments all continue to trouble us. I’ve heard the sentence “we’ve got to replace that couch” from everyone of my friends (and they bought the couch just a couple of years ago).

Our house is a major factor in our lives. It’s our home, it’s where we spend most of our lives (after work), it’s where our children grow up and it also reflects on us as people. Aiming for the perfect home is very understandable but is it wise? Is it financially sound? Is it at all possible?

I’ll show you that even billionaires can’t really attain the perfect home and are constantly busy searching, buying, designing and eventually selling their homes.

My case against the race for the perfect home is built on the following:

#1 It’s Endless

Stop and think about it. When will you tell yourself you’ve got it made? Chances are you’re not even living in your perfect home just yet. Most of have dreams, be they a park view apartment in Manhattan, a mansion in the English countryside or whatever else comes to mind. It could also be just two more rooms, or just a pool and that’s it.

Don’t delude yourself. We can’t really be happy and content with what we’ve got. It’s a human curse and a blessing. We adjust too quickly to both good and bad and always fail to appreciate the present and what we’ve got. It’s a sort of hedonistic fallacy. We always want more and better. It’s fantastic because it drives humanity forward (supposedly) but we must understand this basic psychological concept and how it affects us so powerfully.

#2 It’s terribly expensive

When it comes to our homes it’s always expensive. Forget about buying or renovating one. Those costs are astronomical and the point is easily made. Instead think about that $2,000 designer sofa you just saw on “sale”.

Designers of any sort have it made. They can price their products as they like since “inspiration” cannot be measured. The only measure is whether people buy it and surprisingly they do. You don’t need me to tell you there’s no practical difference between a $200 sofa to a $20,000 sofa. It’s whether someone is willing to pay that price (and keep mentioning it in our ears to justify the purchase).

The same goes for tiles, baths, showerheads, dining rooms and everything else you can think of. Nothing is too good for our home, and the retailers know it.

#3 It’s time consuming

I’ve personally spent (or invested some might say) at least 50 hours searching for an apartment, 200 hours renovating one and at least 50 hours shopping for my home. It’s not wasted time but that time has many alternative uses. Every time you go looking for a set of cups think about the alternatives.

As the quest never ends so the shopping, browsing, designing and adjusting never cease.

#4 Fashions change

Fashions change and we have to start everything from scratch. This means yet another trip to the handy store for that oceanic-pearl wall color to replace our previous wall color of tomato-orange mix or whatever name they came up with to justify paying an additional 20% for that color.

We obviously have to re-design everything else to fit that new wall color and so on and so forth.

The National Association of Home Builders (NAHB) cites interesting numbers for first year spending in a new home (the numbers are for 2003 but the ratio’s are ever more relevant):



Another interesting view point is how these expenses divide up the first year. The following pie charts speaks for itself:



Remember I promised you I’d prove how even billionaires take part in the race? Well, Russian billionaire Roman Abramovich just bought a $36M Colorado ranch. The 1,300-square-meter, split-level home is set on a secluded 81 hectares in Snowmass, near Aspen, The Wall Street Journal reported Friday. The house, built by surgical-equipment magnate Leon Hirsch, has 11 bedrooms, 12 bathrooms, a media room, a climate-controlled wine room, a hot tub and a spa, the report said.

I’m sure you don’t find this at all surprising. But did you also know Roman Abramovich intends to create a super mansion in the heart of London which will become the most expensive private residence in England and that it will cost approximately $300M? Apparently Abramovich owns dozens of houses around the world, all unique, beautiful and terribly expensive.

I guess it really never ends.

Image by: Lincolnian

How I Saved Over 3,000$ In One Hour

I admit the headline is a bit catchy but the amazing thing is that it’s absolutely true. I was literally amazed at how easy it was. I was even more astounded to discover that had I not been aware and acted promptly no one would have bothered telling me anything.

Yesterday, by leaving work for one hour, I managed to save 3,000$ in interest payments and a year and a half (!) of mortgage payments.

How was this miracle performed? Simply by being aware to falling interest levels and by snooping around at current interest rates offered on mortgages. The loan officer knew exactly what I came for the minute I sat down and was suddenly very eager to match and best any offer I had received elsewhere.

A simple discount of 0.5% on my mortgage rate was enough to save me 3,000$ on interest payments and a whole year and half of payments while leaving my monthly payments the same as it was.

The source of this financial miracle is obviously a combination of two powerful financial tools:
1. Compound interest
2. Long term

There have been so many words written on these two but nothing compares to watching them do their magic for you.

Still a troubling thought crosses my mind. What would have happened had I not been aware of the economy and of current financial developments? What would have happened had I not been financially literate and had the understanding and opportunity to refinance my mortgage as I just had?

The obvious answer is that many of us are probably throwing money away daily. I’m not a “frugal” person, as I often bother to mention. For me the everyday effort of saving pennies is just not worth it. I strongly believe saving real money lies elsewhere. It lies in loans, interest rates and smart saving and investing. It’s how we buy our homes, how we save for mid and long term and how we manage our home economics that matters. That is also why “The Personal Financier” is more about these subject matters.

With interest rates dropping sharply I believe every one of us who carries a mortgage should very diligently look into the possibility of refinancing it and saving big.

The thumb rules regarding mortgage refinancing are usually lower interest rates compared to the costs of originating a new mortgage. I’m not very proficient when it comes to mortgages and I suggest, as always, you consult with a mortgage consultant. Bankrate.com offers this calculator.

How to Successfully Navigate Your Way through Home Renovations: 10 Practical Tips

For a while now I’ve been writing about my recent experience with purchasing and renovating my home, a small apartment in bustling city center.

One of the more difficult steps in this process was renovating our home. Home renovations have some characteristics which make them extra difficult to plan and execute:

1. Uncertainty is high
2. The professional knowledge at our disposal is scarce
3. Our experience is very limited while the contractor is well versed
4. The costs of a single mistake can be relatively high
5. The work takes place at our home thus creating more pressure on us

Understanding these crucial elements is essential to a managing a successful renovation. While the following advice I provide from my own recent experience won’t assure surprises won’t happen they will greatly reduce the risk associated with them.

This is my list of 15 practical tips for successfully navigating your way through home renovations:

#1 Get professional help

My readers probably recognize by now how strongly I feel about this particular advice. Architects and interior designers get paid because they have added value. Professional help is crucial in any field which requires a level of expertise and experience which is unavailable to us.

Our architect saved us from many mistakes and helped us greatly in deciding which of our plans is feasible and within out budget limits and which plans will never leave the drawing board.

As in all aspects of life pricy designers and architects are abundant and pretend to offer greater value in various forms: from feng-shui interior designs to spiritually designed homes. If that’s your cup of tea it’s ok, just be aware of the price you’re paying for this. A good proficient architect and interior designer will save you 80% of the headache with significantly lowers costs (as always, it’s all about marketing).

#2 Have an agreed bill of material and work

I was surprised when I heard how many people get into home renovations without a proper summation of the scope of the work. This is absurd and is the worst thing you can do when renovating. This is obviously a clear and sure way into early arguments with the contractor on what is included and what was left out in the initial agreement which will usually end in you constantly paying more and more (remember the pressure part?).

Another aspect is properly pricing your renovation. You have no way of comparing two offers if you don’t have one defined and finite scope of work and bill of materials. Each contractor will make an offer based on his assumptions and understandings which will eventually change after the work begins.

A bill of material and work should be a tabled document providing information in very high resolution which will enable the pricing of each work and material unit.

#3 Shop around and let them know you do

Use your bill of material to shop around. The high resolution pricing will enable you to negotiate better with each contractor as you’ll know exactly how much each material and work unit should cost.

The most beautiful part of this process is that the contractors themselves will provide you with that information.

#4 Don’t hire the cheapest contractor or a rouge contractor

I personally never buy the cheapest available. It ensures getting lower quality 99.9% of the times. I agree expansive doesn’t mean better but the correlation exists without a doubt.

A cheap contractor might prove to be very costly. Remember, no one works for free. If the offer is cheap something is paying the price: work quality, material quality or he might have future plans of sticking in some ‘unexpected’ costs.

Make sure your contractor is a professional with the required certifications. Cheap is costly! Just imagine getting stuck midway into the renovation. You’re at his mercy.

#5 Sign a contract

Contracts sound scary. Who needs all that legal lingo? A handshake is as good as a contract. Right? Wrong! You definitely need to sign a contract with your contractor. This binding and legally anchored document is your assurance if things go wrong. Better yet, it’s an excellent measure towards making sure things don’t go wrong. A contract is your leverage on the contractor. Remember, we are the weak party here and we need all the help we can get.

If a contractor doesn’t want to sign a contract or tries to convince you it is unnecessary, take that as a bright red flag and think three times before you hire him.

Make sure your contract includes all the following:

a. Agreed dead line and penalties or rewards – No renovation ends in time. You will get a more realistic time estimate if the proper motivators are set in the contract. This, in turn, will help you plan better for things to come.
b. Agreed price per bill of work and material – Naturally your contract should include the agreed upon work and the agreed upon price.
c. Agreed payment milestones – Payment milestones are a very important aspect of planning a project. Don’t agree to pay too much too early. Payments are the main motivator for the contractor to keep on working.

#6 Plan to overspend by at least 20% and don’t be surprised by surprises

Even if you’ve agreed on a price you should plan for surprises. The initial décor you thought would work seems plausible. You suddenly discover some bad wiring, etc.

We’ve already noted the level of uncertainty renovations hold. Plan in advance to spend 20% over your agreed price for the work (this might mean lowering the work down a bit if you’ve planned on your entire budget).

#7 Coordinate your expectations

Are you a perfectionist? Let your contractor know. In such negotiations and price offers people plan and price considering reasonable circumstances. Do you simply must have each tile spaced exactly 2.1 mm apart? Let him know in order to price accordingly and remove future arguments and conflicts.

Remember each expectation comes with a price. The more you communicate your wishful thinking and expectations to your contractor the better the chance you’ll make them happen with a lot less conflict but with higher costs.

#8 Perfectionism should be leveled

I believe there is little room for perfectionism in construction unless you’re willing to pay a very high price for the best workmanship and materials. Don’t expect to get something you didn’t pay for. If a 2 degree deviation in the bath tub prevents you from sleeping consider renovating very carefully.

#9 Be there

You can’t replace good overseeing and inspection. Your presence will greatly increase the chances of better workmanship and schedule. Don’t hesitate to ask and comment, probe and touch. Most of it isn’t rocket science.

Make sure you drop by often and sometimes unexpectedly. There is no other way to make sure you’re getting what you want.

#10 Have boundaries

The contractor is a person too. Keep your demands at a reasonable level. I’ve heard from many contractors (that didn’t have a contract and a bill of materials and work by the way) how frustrated they were by unreasonable and pricy demands from their customers. Guess it works both ways.

Reader Green Pastures suggested hiring a local contractor which has a reputation to maintain. I strongly support his advice. They hold all the cards and we must strive to maximize our bargaining power which way we can.

Images by eye of einstein, Wolfcreeker

Why Buying a Home is More Important than You Think

Rent vs. buy comparisons are abundant. I’ve wrote quite a bit on the matter trying to illuminate the less obvious parts of it. In this post I’ll concentrate on a few fundamental financial advantages of home ownership which are too often painfully overlooked.

Buying a home is indeed a great undertaking which requires maturity and an ability to commit (not to mention available funds). However, it also presents several significant financial advantages to the home owner.

#1 Your home is a solid long term investment

In financial planning a portfolio consists of the household’s entire asset allocation, including real estate investments. Buying a home is, in essence, investing in a relatively solid asset for the long term.

Furthermore, as your home is usually your primary asset it automatically creates a significant allocation of solid investments.

#2 Your home hedges your financial risk

As a result your home helps you hedge your financial risk. Even if your investment portfolio is invested in very risky financial assets your entire financial portfolio gets its risk balanced whether you like it or not.

This kind of hedging will prove very useful in difficult times when risky investments tend to drop sharply together. In financial theory (and practice) there is no way to diversify the market risk which might hit all the financial markets (we got a pretty good demonstration lately).

#3 Your home is a great tool for disciplined saving

Being able to save money while renting takes strong character and self discipline. I’ve tried and failed. When you rent you automatically live in a higher standard of living than the one you can actually afford.

Taking on a mortgage is forcing yourself to save. Economically, renting a home can sometimes prove more profitable. But the question remains. Can you rent and save enough to buy the property at the end? (as a good financial comparison of rent vs. buy should be).

Related Posts:

• Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons
• Why Taking a Mortgage Is Leveraging Your Equity: Understanding the Potential Risks and Benefits
• How to Make Sure this is your Dream Home: 7 Practical Tips
• Should you Rent or Buy a Home?
• Buying a Home – an In-Depth Look at the Process
  

How to Make Sure this is your Dream Home: 7 Practical Tips

As promised I’ll be writing a bit more on real estate. In this post I’ll discuss some practical tips on how to properly research a property before buying it. Since I’m writing for you, my readers, and I usually focus more on investments, I’ll be very happy to hear your thoughts and your level of interest in the subject in it, if any. As always if you would like me to focus more on one of the other topics I write about please let me know at:
dorian.wales@gmail.com

I consider myself a diligent person. Before I buy I usually read consumer reviews, compare prices, ask for a trial periods, consult with experts, consider recommendations and more.

Surprisingly, I wasn’t as diligent when I bought my apartment. I did my research, and very thoroughly so, but I didn’t get a trial period (yes, there is a way) or a house inspection, for example.

Buying a home, as we always say, is probably going to be a major financial deal for most of us. Therefore, we must demand it from ourselves be as diligent as is humanely possible.

How can make sure the property we’re about to buy is the home of our dreams (for the next decade, at least):

#1 Rent before you buy

It might sound odd at first but this tip has a lot of sense. It doesn’t have to be the exact same property but it would be more helpful if it is. When buying a property you have to get a very intimate knowledge of its surroundings starting from morning and afternoon traffic to public services, parks and entertainment. Get to know the neighborhood, the schools, the business areas and everything that might make a difference.

If you have the option to rent a property and buy it later on take it. Get to know the property’s quirks, advantages and disadvantages. You would have asked for a 14 day money back guarantee if it was a stereo, wouldn’t you?

#2 Have a chat with the neighbors

From my experience this is an excellent tip. It is a bit embarrassing at first but your neighbors a vast resource of information, especially when you’re buying with no previous knowledge of the area. Your neighbors will be able to tell you almost everything I listed before. How good the municipal and public services are, how bad is traffic, how are the other neighbors and the neighborhood. They may also tell you how price levels have progressed over the years and what are their thoughts on what future potential the area and property have.

#3 Get a house inspection

Though I myself have my reservations on this one it sure can’t hurt. The problem with house inspections is that they are very limited to what may be observed. They won’t go around drilling holes and cutting pipes. Still, a good, thorough inspection might save you from buying a property in a worse condition that you were bargaining for.

#4 Don’t bite off more than you can chew

Usually, as with every project, expanses outweigh the initial budget. However, this is no excuse to go spending over your abilities. The rule of thumb is not to spend over 30% of your income on housing and not borrow over 70% of the property’s value. Plan ahead and try your best to stick to your budget. Remember your current financial situation might change, for good or bad (plan conservatively).

#5 Consider future potential

Buying a property should also be regarded as an investment. You are paying too much good money to see it just stay at its present value with no return on investment (a huge alternative lose as you could have rented and invested the rest). How do you research potential? Consult with professional real estate agents; consider the future development possibilities, future growth of the area, location (location, location…) and much more.

#6 Make sure it suits your needs

Are you planning on getting married? Having a kid or two? More importantly, what’s your wife planning? It is important to buy a home which will also suit your future needs. I believe a newly bought home should last at least 10 years. Otherwise the deal costs are too significant to ignore and it is more economically sound to rent. Consider the future possibilities and keep them in mind when comparing properties.

#7 Make sure you can afford the maintenance

Many people have dream homes with huge lawns and gardens, maybe a fountain or two. Big homes with many rooms and outdoor space are also expansive on maintenance. Since you are probably able to afford the property, maintaining it should be relatively easier. However, are you willing to spend so much money on it? Are you aware of all the costs?

Taking the time to research a property properly can help make the difference between a successful investment which suits your need and a poor one which you will have to replace soon enough. More ideas and comments are always appreciated.

... Kristin, from The Financial Engineer, posted a very good comment on the need to take a trip to city hall and thoroughly research future development plans for the area. This advice is priceless. Simply imagine that beautiful garden you have across the street changing into a garage...

Buying a Home – an In-Depth Look at the Process

Buying a home is probably one of the more major decisions in our lives. I’ve decided to buy a home about a year ago. After a long and tedious year I can gladly say I’m writing this post from my new home. The process of buying a home is tedious, long and difficult both physically and mentally. It can be a bit easier with experience but I don’t think it changes much when you buy your second home later in life. It’s just the way it is.


A year ago my wife and I decided we had enough of renting. We sat down and looked at our options and the process we’re about to go through. We had little knowledge and experience but we compensated for it with common sense and hard work (as everything in life).

You can find your dream home in a short period of time and maybe even get a good deal on an asset with future potential but this is definitely not the case most of the times. That’s why hard work is so important and cannot be replaced.

We eventually bought a 3 bedroom apartment in the heart of the city in a very central location. We renovated it and now live happily in it completely at peace with the choices we’ve made. We had our differences and difficult moments but I can truly say it was worth it.

In order to write a useful post on buying a home I’ve looked back and examined the process we went through phase by phase. I’ve tried to emphasize the more important aspects of it and what could be my added value to you as readers.

The following breakdown of the process is what I came up with eventually:

#1 Considering your personal status

This very basic first step is usually intuitive and happens whether you’re aware of it or not. Buying a home has a lot to do with your personal status and plans for the future. No use buying a 3 bedroom apartment if you’re expecting your family to grow in the next 6-9 years. Buying a home is a major decision usually taken by couple that reached a certain level of commitment in their relationship. My advice in the matter is to carefully examine your current and future personal situation. There is no need to rush into buying a home if you are unsure of anything.

When buying a home your expenses are never ending and will amount to much more than the price of the asset itself. You won’t get the money back if you decide to sell the house after 1 year. Actually you’ll have to pay to close another deal. Think carefully on how ready you are to go through with the process.

As I’ve already written this happens intuitively and most of the times on an unaware level. Being aware is always better and taking 5 more minutes to think things over might save you a lot of money in the future. You could always rent for a couple more months before you commit.

#2 Getting a good grasp of your budget and financial capabilities

you’re dream home will always be one you can’t afford (well, almost always). Deal and closing costs can amount to 3%-5% of the price of your home (Real-estate agents, lawyers, taxes, paperwork and more). Renovation is another bottomless pit. When I finished work on my home and moved in I was over my budget by approx. 10,000$ which took me 5 months to recuperate from. I don’t really think you can stick to your initial budget, much like any project. However, it is important to keep track and monitor your financial ability at all times.

Consider your ability to pay back mortgage payments carefully. How fixed is your income? How much can you afford to pay back each month? Mortgage payments, in general, should not be more than 30% of your monthly income. Avoid biting on more than you can chew.

Buying a home is a complicated financial deal which requires leverage (mortgage and loans) with many implications (Read more about leveraging risks and benefits here). Plan your budget carefully and leave room for error. You will end up buying a more expansive house than you hoped for. It’s natural since you’ll be looking at the better part of homes you’ll be able to afford. Just be aware of your limits and capabilities.

#3 Rent or Buy?

The eternal question of rent or buy has been discussed in length. I’ve personally written two detailed posts on the matter:
1) Should you Rent or Buy a Home ?
2) Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons

Many rent vs. buy comparisons are simply wrong. The financial comparison is not a simple matter at all. The subject of rent or buy deserves some attention and you should get knowledgeable in the financial reason behind it. Two thumb rules to satisfy any immediate appetites:
1) The more equity you have the more financially reasonable it is to buy a house (not always, naturally).
2) The real difference in the comparison comes from your expectations on the future value of your home. As buying with a mortgage is leveraging you will make a decent profit on money you didn’t have to begin with should the house price rise significantly (again, more details in the posts I linked to).

#4 Location, location... location

Location probably affects the value of your home more than any other variable, either real and current or potential. Location cannot be over emphasized. Location is affected by many other considerations such as closeness to family members, public services, personal preferences and more.

Sit down and think about your preferences. Consider your current and future personal status as always. If you plan on having kids soon you might want to consider a property closer to your parents or good schools for example. Are you a city or country person? Do you mind traffic? And so on and so forth.

If you’re buying a house with a partner agree on your mutual preferences together.

#5 Research

Once you’ve decided on location preferences you need to start researching. Usually several areas (neighbourhoods, districts, cities etc.) will fit your preferences. In order to be a smart buyer you really need to start researching each and slowly yet surely narrow down your search.

Each housing market is different. Properties within several miles can have different price behaviour and different characteristics you need to be aware of. Be familiar with price levels, future potential, trends and even the branding of the environment.

Needless to say research should also include all the aspects of living: public services, neighbours, crime, traffic, taxes, comfort, available leisure activities and much more. Don’t be afraid to ask around. People will be eager to help and answer questions. Sometimes small talk with a future potential neighbour can expose crucial information.

#6 Footwork

Good old fashioned footwork (or car work) cannot be replaced. Take the time to compliment your research and choices with thorough explorations of potential properties and areas. I’ve visited over 20 properties in 3 cities before I decided on buying one.

Footwork is required in order reach a level of readiness to buy a property. I’ve never heard of someone who bought the first property he saw. As human beings we will always consider what we are missing on.

The process will often yield surprising results and end in new revelations on your earlier preferences. Seeing many properties adjusts your expectations and your wants and wishes. You’ll realize what you find really important and what you only thought you like but really is just redundant.

#7 Making your choice

After setting your preferences, researching and exploring it is time to narrow and zoom in on: an area, a type of property, personal preferences and more. This will happen naturally it helps to make a conscious decision. Only by narrowing the scope of your search scope will you be able to really be familiar with the property or properties you are about to bid on. It is impossible to get to know 30 properties in 3 different cities each with its own characteristics and housing market.

Without focusing and making a choice you’ll probably continue drifting through the endless amount of properties out there.

#8 Getting professional assistance

I can’t stress enough how important it is to get professional assistance when buying a home. Real estate agents, lawyers, accountants and more are called professionals for a reason. The real estate world is complicated and requires expertise.

Real estate agents can save precious time and help with locating the best assets for your budget. They live and breathe the market and exist because such professionalism is required. A good lawyer can help complete a deal quickly and without risks. You really need the best protection you can get when dealing with a huge expanse such as buying a home.

#9 Negotiating

Negotiating is a very valuable skill. I seriously doubt it can be taught (I myself am a lousy negotiator) but understanding some truths can really help you. Each percent in this deal is significant and well worth the effort.

First of all, be aware the seller has one advantage from the start. He named the price. When you think of it we, as buyers, often treat the seller’s price as a point of reference other then deciding for ourselves what the right price to pay for a property is. Shake off the seller’s price and get a good idea of what the real value of the property is to you. Getting 5% off a property priced at 110% isn’t a good deal.

A significant portion of the negotiations gets done through professional real estate agents. Be aware of their interest in getting the deal closed and use their skills to your advantage while not letting them pressure you into raising your offer “just a bit more” for the 5th time.

There are always other properties. While you should be ready and able to spot a good opportunity and act fast don’t act out of pressure and fear of the property being sold to someone else. The only way to get a good deal is to be patient and ready.

#10 Renovating

To me this step was the hardest of all. Entire libraries can be written on the subject of renovations with more to follow. What makes this step really hard is a combination of the following, in my opinion:

1. Renovating on a tight budget – Usually, renovating after purchasing the property is done under a tight budget as we’ve already spend what we could on buying the property. Each surprise is more crucial and has more impact on your decision making.

2. The uncertain nature of renovation, our relative ignorance and your average contractor – Renovating a home is painful enough without having to learn your electricity needs to be re-wired or that there is a termite infestation in your home. Most of the times we don’t even know what the contractor is talking about, and certainly don’t know why he’s charging what he does and for what? On top of this many contractors are not, let’s put it mildly, easy to get along with. They have a tough profession with tough clients and they will usually outwit you when it comes to money or work.

3. The enormous varieties of designs of all kinds and the length between expectations and reality – When buying a home you have a concept of how it is going to look like and how you will design it. Often reality has other plans. Designing is a high premium market with varying price levels and never ending supply of ideas and designs. Starting from tiles and flooring, bath and showers, furniture, appliances and what not. When renovating painful decisions and compromises are an everyday matter.

Many of the stages and tips I detailed earlier are valuable when renovating. Planning the budget carefully, researching and understanding your wishes and wants, getting professional assistance such as designer and architect can really help (that’s what I did), negotiating with several contractors and choosing a good one is crucial to the success of the renovation.

#11 Moving and making it a home

The final step takes work as well. After completing a renovation you’d probably feel this is the easiest thing you’ve ever did. You will find out soon enough how many things are still missing, how much more money is needed to get everything just perfect, how you’d like to change some things already... and more.

Take a deep breath and relax. Let your new home sink in (and your financial situation as well with seemingly endless payments and loans). Take the time to think of the process you’ve just been through and plan ahead.

You’ll always want another couch, a better oven or TV, a new bedroom and more. Housing expanses are some of the highest there are and there is no need to go crazy over living space. Plan a monthly budget for home purchases and improvements and try to stick with it. The first month or two will be the hardest but you’ll get used to it soon enough.

This concludes my post on the process of buying a home from my recent experience. In the near future I hope to focus more on the major steps and elaborate more on each with more tips and ideas. Your thoughts, questions, comments and more are always welcome and are greatly appreciated.

Images by SantaRosa OLD SKOOL, TroyM, FotoDawg

A Case of Too Much Information? Real Estate and Stock Investments Compared

Try to imagine what would happen if there was a market price available for your home at any given moment, which was set by supply and demand. In short, imagine your house was traded in a house exchange. Scary thought, isn't it?

I can picture myself rushing to the computer every other moment hoping prices went up. Even a small fraction of percent would be significant when real estate is at stake.

This kind of behaviour would obviously not constitute smart investing. We always preach to ignore the noise in the short term and invest for the long term. Why is it so difficult to do when it comes to stocks and easily performed when it comes to real estate?



This is all the more baffling as the huge amounts of money we invest in real estate, or our home, make the money we trade in stocks pale in comparison. Why are we so anxious and stressed when it comes to a couple thousand dollar invested in stocks and so relaxed when it's hundred of thousands invested in a home? This is an obvious exaggeration but it does holds some truth.

First and foremost, we are not rational beings. Homo-economicus has yet to make an appearance. But this explanation is too easy.

The more probable explanation is that our real estate is usually also our home and we can make good use of it by living in it or any other similar psychological explanation. Theses uses do not depend on its current market value. But what about real estate investments then? Why are these considered less stressing or safer then investing in stocks?

Actually I find there is all the more reason to be worried when it comes to real estate investments as these investments are usually of very significant volume, they are not diversified and they carry significant specific risks (a risk which can be eliminated in stock investments - for more information see here).

I believe the availability of information when it comes to investing in stocks actually throws us off balance. Warren buffet once said only invest in a company you'd like to own even if the market closed for the next 10 years. This is the basics of long term investments. The noise in the short term is enormous. We are constantly presented with prices, trends, analysis and valuations. Our exposure to the stock market is often and frantic. If we could separate the business behind the stock from the price in which it is traded then we would make some progress.

Another argument might be that when it comes to real estate identifying potential is easier then in the stock market. I highly disagree. Real estate requires no less expertise then stock investments and it is riskier.

Image by Martiniko

Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons

This article, a third in a series, is about the softer side of rent vs. buy. These comparisons have become very popular and can easily be made using one of the many online calculators available. However, the psychological aspects of this comparison have yet to receive their deserved attention. (I still recommend reading this post about how to properly compare rent vs. buy financially as many calculators don’t make the correct comparison).

As you may remember a correct comparison of rent vs. buy should be made for the same property in the same time frame where the two options are:
1. Buy the property today and repay it through out the period.
2. Rent the property today and buy it at the end of the period.

The problem with the rent vs. buy comparison is, as always, the human factor. In order to compare rent vs. buy correctly some assumptions need to be made which are not at all easy to meet up with in real life.

These assumptions are:

1. We’re talking about the same property to either rent or buy
2. By choosing to rent through out the period you commit to save regularly:
a. You commit to saving your initial equity throughout the period
b. You commit to monthly savings instead of monthly mortgage payments

What are the difficulties with these assumptions then? It is a well known fact that when one rents one is able to afford a much more expansive property. This is also usually the case. Think about it. Have you considered buying the property you currently rent? Can you afford it? For a true rent vs. buy you compare for the property you’re thinking of buying.

Another problem is with the human inability to postpone pleasures or basically put: consumption. We all know available cash flows and moneys have a tendency to be consumed rather then saved. Think of the rent option where you’re not repaying regular mortgage payments but saving them instead. Doesn’t that ski trip look inviting? By committing to monthly mortgage payments you’re avoiding temptations.

Many corporations make use of debt in order to educate general managers. Think of a CEO with a huge cash surplus. This is obviously unhealthy as CEO’s will usually use those moneys to build “empires”. Shareholder use debt as a tool to discipline managers. If you lack the self discipline to save monthly instead of repaying a mortgage then taking a mortgage as a disciplining tool for saving is recommended.

There are more psychological aspects to rent vs. buy such as ownership and confidence but these have been discussed at length in many other places. Understanding the psychological assumptions of the rent vs. buy comparison is as necessary as understanding its financials.

Relevant Posts:

1. Why Taking a Mortgage Is Leveraging Your Equity: Understanding the Potential Risks and Benefits

2. Rent vs. Buy: Some Assumptions May Have a Significant Impact on Your Decision

3. Should you Rent or Buy a Home

image by mrbill

Why Taking a Mortgage Is Leveraging Your Equity: Understanding the Potential Risks and Benefits

Buying a property with a combination of equity and mortgage is actually leveraging your own equity. Leverage is essentially the use of borrowed funds to complete a transaction. Leveraged transactions hold significant potential benefits and, more importantly, significant potential risks. It is important to understand why leverage is the source of these risks and benefits.

In order to simplify matters let’s look at the following example:

1. John has 1,000$ he wants to invest in ABC Inc. (ABC).

2. We’ll assume two scenarios:
a. One where ABC goes up by 10 and John gains 100$.
b. One where ABC goes down by 10% and John loses 100$.

Investing his 1,000$ John has either gained or lost 100$.

Reading a blog post about leveraging John has decided to loan an additional 1,000$ at 5% from GoodWill-NoSoul Bank (GWNS). John now has 2,000$ to invest but he also has a loan to repay with interest. Let’s examine the results of the two possible scenarios:

1. ABC goes up by 10%: John now gains 200$, repays 1,050$ and is left with a net gain of 150$
50% more then he had gained without leveraging

2. ABC goes down by 10%: John has lost 200$, repays 1,050$ and is left with a net loss of 250$
150% more then he had lost without leveraging

This outcome is due to the loan taken which is repaid in all scenarios. This fixed loan payment causes the results of the scenario’s to vary greatly thus increasing the inherent risk in the transaction (measured usually by the statistical variance of possibilities).

It should be clear by now why buying a property with a combination of equity and mortgage is leveraging. In the case of sudden drops in housing prices, much like the current market situation, a borrower might find himself (or herself) in a very difficult spot, having not only lost on his equity but on the debt as well. The mortgage is to be repaid in all scenarios.

This result of leveraging equity with mortgages is also behind the current sub-prime crisis. This crisis is essentially a sharp drop in housing prices which caused sub-prime lenders immense losses on both equity and mortgage and left them with no ability to repay the loan taken.

Image by D'Arcy Norman

Rent vs. Buy: Some Assumptions May Have a Significant Impact on Your Decision

Rent vs. buy comparisons are very common and have been already discussed in length. However, the impact of several common assumptions on costs and opportunities has yet to be fully uncovered and explained. I’ve recently compared the two alternatives and have decided to share my experience.

We all know that in rent vs. buy the alternative cost of each option should be compared. When deciding to rent the primary cost is the rent itself. When buying a property the primary cost is the interest paid on the mortgage.

However, there are no less significant costs and opportunities to consider. We usually refer to these as alternative costs or opportunity costs. When considering these costs and opportunities we usually make assumptions and let the internet calculator do its thing. You must be aware your assumptions greatly affect the end result. One must use sensitivity analysis in order to examine the impact of these assumptions on the comparison as a whole.

When considering buying a property the most significant assumptions, other then interest rate on mortgages, are:
1. The alternative return on investment – Consider your equity invested in alternative financial assets. Assuming a 4% or 8% annual return rate on equity invested elsewhere amounts an ROI of 48% vs. and ROI of 115% respectively.
2. The prospected return on investment on the property bought – The assumption on the rate of return on your property is crucial. This is due to the fact buying a home with a mortgage is actually a leveraged buy which makes use of the bank’s money. Every percent returned is gained on the bank’s money as well. Thus a 0.5 % or 2% annual return rate on your house amounts to 5% or 25% increase in your entire property’s worth.

When considering renting a property the most significant assumptions, other then monthly rent payments, are respectively:
1. The return on equity (that was not used to buy the property)
2. The return on monthly savings generated by not buying the property

The significant affect these assumptions have on the end results is due to the following:
1. The nature of compound interest (The strongest force on earth according to Einstein)
2. The length of the prospective period examined in rent vs. buy (which actually kicks in

For a more detailed analysis of how to financially compare rent vs. buy correctly have a look at: Should you Rent or Buy a Home

Image by sufinawaz

The Carnival of Personal Finance #127 - Hosted by Moolanomy

I'd like to take the opportunity and thank Moolanomy for hosting The Carnival of Personal Finance #127 and choosing to include my article on Investing mistakes to avoid.
I've personally found the following posts very interesting:

1. The Dough Roller presents Slow Motion Retirement (or Retire Early, Retire Often)
2. Home Finance Freedom presents Payoff Mortgage v. Invest Stocks: Housing Myths Part 12
3. Advanced Personal Finance presents The Most Misunderstood Tax - The Estate Tax

Pros and cons of reverse mortgages

The significant advantage of reverse mortgages is clear. This financial tool enables seniors to make use of their home equity in order to increase their standards of living in their senior years which are often characterized by a shortage of liquidated financial resources. This is especially valuable when other family members are unable or refuse to aid the senior with his financial situation.

A reverse mortgage requires no guarantees on the side of the borrower aside from the property itself.

Another advantage of reverse mortgages is that it enables seniors to support other family members today instead of as an heirloom. It enables seniors to decide how and when to aid the potential heirs and is especially valuable when seniors still support their families.
A reverse mortgage might also assist financing required payments for health care or nursing and also help finance the move to a retirement home.

Last but not least a reverse mortgage is a great solution to avoid taxes on payments made to the borrower.

Although reverse mortgages have many advantages considering and understanding the disadvantages of a reverse mortgage is highly important as they are no less significant.

One of the primary disadvantages is that family members might often requires financial assistance with either buying a house, college funds or more. In case of a lump sum reverse mortgage the senior might find himself spending the money unwisely as one might not be accustomed to receiving a large sum of money at once.

As the debt compounds with time it is more then possible that at repayment most of the property's value will be used to repay the loan leaving only a fraction of the original value to the heirs.

Generally, reverse mortgages tend to be more costly then regular ones as they are rising debt loans with interest added to the principal loan balance each month.

There are other alternatives then reverse mortgages. Some might be more financially sound. A senior should consider selling the property himself and rent an apartment instead and by doing so save the compounding interest and make his decisions regardless of a loan to be repaid. This is quite difficult; however, as most seniors would prefer to remain in what has been their home for many years.

One should also consider the relatively high rates paid for closing a reverse mortgages, often a percent of the property's value. As a result a reverse mortgage is not suitable for seniors who intend to leave their home in the near future (3 years being the rule of thumb).

Should you Rent or Buy a Home ?

There are many psychological aspects to the question of rent or buy. While these may be debated in length it is important to get the financial part of the question right.

In this article I will examine the financial aspects of the decisions in the form of the alternative 'loss' in each option (Rent Vs. Buy). We are not always aware of the entire financial picture. There is also one more very unique psychological motivation that I think should be discussed.
When addressing a financial question we should isolate those variables which can be measured and compared. We should regard a house as every other asset and ask ourselves which way to purchase the asset is most desirable financially.

In order to compare the two options we must first have a basis of comparison. Evaluating rent or buy, financially can only be made by considering the same asset, of course. Thus, we shall look at two alternative paths to own a house in a certain period of time":

Option A: Buy the house today and live in it for that period. Henceforth the BUY option.
Option B: Rent the house today and buy it in the end of the period. Henceforth the RENT option.

Option A:
Let us look at the expenses at the BUY option or option A. Let's assume our future home owner buys a house with the common combination of equity and mortgage. His 'losses' would include:

1) The most obvious would be the interest part of the monthly mortgage payment which is 'throwing' money away the same as when paying rent.
2) A bit less obvious would be the optional return on investment on his equity. Say our home owner would have invested his money in stock. This alternative investment could have potentially yielded return which is lost when invested in a house (to be gained, possibly, by a rise in house prices).
3) The costs of the house purchase deal itself (Real estate agent's commission, lawyer etc.)
4) Home maintenance and improvement expanses during the period in which he lives in the house.

What about his potential gain ? In the BUY option our home owner has a great potential gain as his investment in the house is a leveraged investment (An investment made with a combination of equity and debt). His possible gain extends to funds he didn't have in the first place. Lets look at an example: Say our home owner had invested his equity of 100K US$ in stock which yielded a 5% return of 5,000$. Now let us assume his house has yielded the same return (5%) but was purchased with a combination of equity (the same 100K US$ as before) and mortgage (say another 100K US$). His return on investment is now 10,000 US$ (with some paid as mortgage interest but in a relatively low interest rate). Notice the return on his house is gained also on the debt or mortgage part of it (Higher absolute return).

It is important to note that this potential gain is also a source for potentially greater loss since in the case of loss on his investment our home owner is left with mortgage payments unaffected by the devaluation of his property.

Option B:
Let us now examine the 'losses' in the rent option: In this case there is the obvious 'loss' of the rent paid each month. But there is also the 'loss' of the potential gain on the house as an asset. The potential gains for the rent option are:
1) Return on equity not invested in a house but in stock or bond.
2) Return on funds not paid as mortgage payments (Balance part of the payment) and saved to purchase the house at the end of the period.

When comparing the two alternative we should always compare them for the same asset and for a set period of time in order to achieve true comparison.
Finally we should always take into account the psychological aspects of house ownership vs. periodical rent. I'd like to dwell on one unique psychological aspect: The motivation to save. In the buy option our home owner is forced to save in the form of timely mortgage payments. In the rent option our home owner needs some discipline in order to save the money for future house ownership. As available money always has its uses the mandatory part of the mortgage is an excellent motivator for the less disciplined savers.