Jump start your financial future

According to a recent study, Millennials between the ages of 22 and 30 spend 45% of their income towards rent or almost $93,000 during that time period. This is the highest percentage any group has ever spent on rent. Millennials tend to have a preference to live in Urban centers where rents are very high (and most likely means they are going out to the bars and restaurants on a consistent basis). Combining the high rent with student loan debt, car loans, credit cards, etc., it is no wonder the savings rates for this group is -1.8%. ¼ of all millennials spend more on coffee on a monthly basis than on retirement. 

The problem with many people, not just the millennial generation is that they tend to think in the now, not the future. Immediate gratification is what motivates people, not delayed sacrifice. Why would someone want to cut their $250 per month cable bill? Its only $250? Yes, but if that $250 per month was compounded over 20 years at 6% annually, that $250 is $111,204. This is a significant sum.

Now lets take a look at real estate. I truly believe real estate is one of the greatest wealth generators, especially for those who start young. I personally believe that the best financial move someone can make is buying a multi-family home (duplex, tri-plex or four-plex), live in one of the units and rent out the others. Someone can utilize an FHA loan and get into the home for as little as 3.5% down. I originate over 100 loans a year, and over the last 5 years, I bet I have had only one or two clients take advantage of this type of financing. Lets take a look at the math in this scenario:

A buyer finds a duplex for $300,000. Utilizing FHA financing at 3.5% down, their total payment is $2,135 per month (principal and interest of $1491, mortgage insurance of $210, taxes of $300 and insurance at $134). This would be comparable to the rent someone is paying who makes $5,000 per month using the 45% number quoted in the article. To me, it is hard to grasp someone paying this amount in rent when bringing in $5,000 per month, so I am going to bring this down to a more tangible number of $1500 per month. Of course, the person buying the duplex will be renting out the other unit (and the borrower can use this income to help qualify for the mortgage). Lets say that number is $1200 per month. I am going to take this scenario over a 5 year period and show the net worth comparison between Millennial buyer A and Millennial renter B:

Buyer A: Total initial investment: $10,500 down payment and $6,000 closing costs: $16,500

Total payments (net of rental income or $935 per month): $56,100

Total value of asset: $331,225 (assuming 2% appreciation) minus mortgage balance of $269,004 or $62,221

Renter B: Total initial investment: $0

Total payments: $90,000

Total value of asset: $0

In the scenario above, the buyer pays $33,900 less in payments and has an asset with $62,221 of value so the buyer is just over $100,000 better off. This is using just a 5 year period. The savings grows exponentially the longer we drag this out. We are not even taking into consideration the tax benefits of home ownership (interest and tax deduction, depreciation, repairs, etc). What a great way to start building wealth at a young age. Taking this a step further, lets say that the buyer was smart and saved the rent income the duplex brought it. After 5 years, they would have enough money to put 20% down on a new home to move into while renting out the departing unit and starts this process again. One can see the snowball effect this has on someone’s net worth.

I am certainly not telling one how to live their life. I made and still make a lot of decisions that are not fiscally responsible. There is a lot of appeal to living in a nice place in a great location. I merely want to point out the benefits of delayed gratification and the effect it can have on someone’s balance sheet. It certainly isn’t sexy living outside the city in a duplex while your friends are living the high life in a loft downtown. Sometimes certain sacrifices have to be made for financial stability and advancement. I am not saying one way is right or wrong, I just know I would sleep better at night knowing I had an extra $100,000 in my pocket 5 years from now.