How to Rebuild from Rock Bottom: 2 Powerful Financial Lessons

Have you ever found yourself drifting through life without direction or purpose?  Drifting is how you get nowhere, fast.  When you’re drifting, directionless and without goals or a plan, you can fall, unprepared, right off a cliff.  This happened to me.  In my mid-twenties, I fell off a financial cliff and hit my financial rock bottom – HARD.  This is an abbreviated version of my story and the 2 powerful financial lessons that I learned the hard way.

Experience is mistakes Quote

My Rock Bottom

I hit rock bottom in 2011.  I was a single mom to a baby boy, living in a tiny efficiency studio apartment, drowning in medical bills, credit card and student loan debt, and unable to pay my bills.  One night, after I put my son to sleep, I sat down on the couch to pay bills.  I had avoided opening my mail because I knew bills were overdue and, yet again, I didn’t have enough money to make the minimum payments on all the bills.

My credit cards were maxed out and the credit card companies lowered my credit limit each time I made a payment, so I never had any available credit.  I was alone, living far from my family.  I received no child support payments and received no government assistance.  My dad was not employed, my siblings had no money, and my mom had passed away several years earlier.  I didn’t know what to do and had no one to turn to.  I didn’t know how I was going to buy groceries or gas to get us through the week until payday.  A friend had bought me diapers that week or I wouldn’t have even had a clean diaper for my baby.

I slowly opened the dreaded credit card statement.  I noticed, for the first time, the box that said something like, “If you only make the minimum payment, it will take you 26 years to pay this off.”  In shock and horror, I dropped the bill.  26 years!!!!  I could not imagine my life staying the same for 26 years and having this debt hanging over my head for that long.  In despair, I broke down crying.  This stressful moment was my financial rock bottom moment.  After lots of tears, tantrums and some theatrics, I committed to getting serious about my financial situation.

How did I end up at rock bottom?

I had graduated from the University of Washington at age 22 and immediately got my first full-time “real” job.  Most of my college friends were moving away because they got new jobs, were attending graduate school or were getting married.  I had no clear idea of what career I wanted, so even my job was just a placeholder – it was a vehicle to a paycheck, nothing more.  I drifted financially.  I contributed a small amount to a retirement account, just enough to receive the full employer match.  I had no credit card debt and made more than the minimum payment on my student loans.  I had a small savings account, paid my bills, and avoided taking on debt, but I lacked a financial plan.  I had no strategy for paying off my loans and had no future financial plans beyond just paying my bills.

“Experience is a hard teacher Quote

About 15 months after my college graduation, my mom suddenly and unexpectedly passed away.  We were very close and her death threw me for a loop.  My emotional and mental health suffered.  What followed were three exceedingly difficult years.  During this time, I decided to go back to school to be an elementary school teacher.  I was accepted to a Masters in Teaching program at the University of Washington.  However, I ended up needing surgery shortly after beginning the program.  After surgery, I received the devastating news that it was unlikely I would ever be able to get pregnant without significant fertility assistance – if I was able to conceive at all.  As I had always wanted a family, this news was hard to bear.  Still emotionally fragile from the loss of my mom, I went into an emotional tailspin.

Graduate school was very expensive and added significantly to my student loan debt.  Although I was working part-time, medical bills began piling up and I found myself ignoring my financial situation.  The credit card was the easiest way to make my problems disappear while I desperately tried to focus on school.  After about 6 months, I realized it was not financially feasible for me to remain in school at that time.  I was granted a one-year leave of absence from school and returned to working full-time.  Although I had not technically dropped out, I felt like a drop-out and a failure.  (I have a streak of perfectionism and very high expectations of myself!)

My emotional and mental health were completely eroded at this point.  Between feeling like a failure and dealing with my mom’s death as well as the news of likely fertility problems, I was a mess.  I found out that I am an emotional spender.  I never splurged on really expensive things, but I made a lot of little purchases that added up over time.  My uncontrolled spending and apathy towards handling my finances combined into a perfect financial storm.  I racked up close to $20,000 in credit card debt in a very short period of time.

I was not making smart choices in any area of my life.  In early 2010, I found out I was pregnant with my medical miracle baby boy.  By late 2010, I found myself homeless with a newborn baby and staying with friends and relatives.  When I had found out I was pregnant, I began making changes.  After returning to work from an unpaid maternity leave, I managed to rent a small efficiency studio apartment.  The efficiency studio consisted of one room, a bathroom, and a teeny-tiny kitchen with a small sink, a two-burner stove, and a mini fridge.  Three months later, I had my rock bottom moment.

Mistakes Best Lessons Dale Turner QuoteLesson 1:  Don’t be an Ostrich

Ignoring your financial problems and acting like an ostrich putting its head in the sand will only make your situation worse.  Wishful thinking is not a money management strategy.  I know from experience that it is so easy to ignore the rising balances on credit cards, the dwindling (or non-existent) savings account, and the cash that disappears faster than you can stash it in your wallet.  However, ignoring your money management and debt problems will not magically make them go away.  In fact, ignoring the problem is guaranteed to cost you additional money as you thoughtlessly spend, squandering money on consumerism and on interest payments.  It can be overwhelming and seriously intimidating to take charge of your finances, but the rewards are worth it!  The hardest part is getting started – from there you take it one step at a time.

 

 

Lesson 2:  Take Baby Steps

My biggest lesson in money management has been that I need to take baby steps.  I did not overcome my financial mess through making just one change.  I could not change my spending and money management habits overnight – I had to take it one step at a time and I recommend this approach to anyone just getting started.  Begin by organizing your financial papers and getting an overview of your current accounts, balances, interest rates, and recurring bills.  Set up a system to track your spending and then create a budget.  If you are like me and find budgeting overwhelming at first, then don’t focus as much on long term goals or try to change cold turkey.  Instead, set multiple short-term goals.  Maybe put $100 extra per month towards your debt, or start transferring $25 every paycheck straight into savings.  Go from eating out three times a week to eating out only twice a week.  Every couple of months reevaluate where you are and where you want to be.

When setting your goals, really get to know yourself.  Maybe you could go cold turkey and switch from buying your lunch every day to brown bagging it daily.  But, maybe you can’t resist the latest bestseller or are a compulsive clothes shopper.  Allow yourself some small luxuries, but slowly rein them in until they are in line with a spending level that fits within your income and financial goals.  It will be easier to stick to your changes long-term if they are made gradually and realistically.

Rock Bottom JK Rowling Quote

Fast Forward to Now

It has been almost 6 years since my rock bottom moment.  I am still a single mom and have a wonderfully funny and happy little boy who is the light of my life.  I paid off all of my credit card debt, bought and paid off a car, and bought a house.  I also returned to school and earned my MBA.  I do still have some student loan debt.  As a single income household living on one modest salary and paying the high cost of childcare, I still have to manage my money carefully, but I am able to meet my current needs and am planning for the future.

I am glad that I experienced my rock bottom moment and had a serious financial wake-up call.  If I had not hit rock bottom, I may have continued drifting financially.  The benefit of getting serious about my finances is that I now have a financial plan.  I still create a monthly budget and track my spending.  I believe in being intentional with my finances.  I have a limited supply of money and unlimited choices of how to use that money.  Each choice I make involves trade-offs.  My philosophy is to find the way to maximize my money such that I use money in ways that add real value to my life and limit using money in ways that do not add value to my life.  My emergency savings account adds value to my life because it provides security and peace of mind.  Saving money for retirement adds value to my life because it also provides peace of mind and allows me to dream of the day that I can retire.  I don’t spend a lot of money on clothes or electronics because I prefer to spend money on travel and restaurants.  My financial plan provides security and direction for my financial life.

 

Have you experienced a financial rock bottom moment?  What financial lessons did you learn?  If you have a financial plan, do you think it has saved you from having a rock bottom moment?

I’d love to hear your experiences and lessons.  Please share in the comments section.

 

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Why is the Seattle Real Estate Market So Crazy?

A Conversation with a Mortgage Broker

Seattle may not be the absolute most expensive real estate market, but the prices are increasing at a breathtaking pace.  For each of the past 7 months, Seattle home prices rose at the fastest rate in the nation.  Seattle home values have doubled in the last 5 years, according to a recent article in the Seattle Times.

Last week I wrote about the upside, downside, and danger of rapidly rising home values.  This week, I indulge my curiosity and analyze the factors behind the rising Seattle home values.  As I am not a real estate expert, I interviewed a mortgage broker friend, Keane Ng, who is the branch manager for Cross Country Mortgages (www.keaneloans.com).

Why is the Seattle area experiencing such a rapid rise in home prices?

The answer to this question takes us back to Economics 101 – it’s supply and demand.  According to Keane, the job market and median income fuel the demand, while the inventory (new home starts and months of selling inventory) determine the supply.  King County, and Seattle specifically, has a growing population.  The tech sector has strong job growth and there are a lot of highly paid jobs, which is driving up the median income, leading to more demand.

As you may remember from Econ 101, the price and the quantity demanded have an inverse relationship – as the price increases, the quantity demanded falls.  The increasing home prices do lower demand, but because the jobs are still growing and median income is also still rising, the higher prices are not having a noticeable impact on the demand.  The other factors driving the increasing demand outweigh the dampening effect of the higher prices.  Keane described the factors affecting the real estate market as:

“Jobs and median income are the first main factors, inventory is next, lastly rates tend to be a ‘headwind’ or ‘tailwind’ on whatever the market is doing, speeding up a good market if rates are low and vice versa, slowing down a good market if rates are moving up.”

Is Seattle in a bubble?  How does the current real estate market compare to the mid-2000’s before the Great Recession?

I was especially interested in this question!  Keane responded to this question by House Bubbleinvoking two comparisons.  The first is comparing the cost of renting to the cost of owning.  In 2006-2007, rental costs were decreasing and vacancies were increasing — all while home prices were rising.   The cost of owning in comparison to the cost of renting made renting more and more attractive, and made home ownership harder to justify at the prices of that time.  However, in the current market, the job growth has squeezed the housing market for renting AND owning.  Rental rates have also been rapidly rising (interesting articles about this found on the Seattle Times and Business Insider).

Not only are rents going up, but vacancies are at all-time low.  Keane said:

“Most of my landlord clients currently receive more than double the rent they received in 2006 and 2007 and the time they’re on the market is shorter.”

This indicates that the current rise in housing prices is not out of sync with the general rise in the cost of housing, whether it be renting or owning.

The second interesting comparison is Seattle and San Francisco, both of which have a lot of tech jobs – and we have a lot of people moving to Seattle from San Francisco.  Keane’s comparison of Seattle & San Francisco is as follows:

“Seattle currently operates at 55% the cost of San Francisco for the median home cost.  The same jobs pay approximately 90% the cost of the same job in San Francisco but California has an approximate 10% state income tax that doesn’t exist in WA state, while their sales tax is only 1% different than ours.  Knowing it’s considered more desirable to live in CA if all things are equal, it’s not out of the question that the Seattle area can grow another 40-50%, taking us between 70-90% the cost of the Bay area before we hit a value ceiling.  This is, of course, if we don’t have a major tech bubble or Amazon doesn’t fall on their face with their growth plans.”

 

What could stop the growth in housing prices?

In Keane’s analysis, he mentioned that while the Bay area also is also heavily tech related, the jobs are high paying, and they also have very limited inventory, the Bay area home prices haven’t gone up for over a year. Their incomes have hit the cap of cost and affordability is limited.  Simply put, prices have risen to the point where people won’t be able to afford to buy them if the prices go up much more.  Seattle will likely continue to rise until it has a change in the job market, median income, inventory, or it hits a similar value ceiling.

Advice for potential home buyers?

First, Keane says that people should:

“Pay close attention to real estate by the city, not nationally.  Cities like Cupertino, CA (where Apple is located) didn’t lose more than about 10% of their value before they rebounded and skyrocketed in value when the rest of the country was still in a deep recession.  Compare that to Detroit, where they haven’t begun a strong effort to rebound values since hitting their bottom several years ago.  You can use this link to see how values have varied in different areas in the country:  https://www.zillow.com/home-values/”

For Seattle specifically, Keane says that buyers need to formulate their own opinion of what the market will do.  As far as inventory is concerned, Keane says that King County has operated with less than a month of housing inventory for 2 consecutive years.  The King County demand is 4,000 – 5,000 homes per month, so it will take a lot to fix the inventory problem that is helping fuel prices.  Keane suggests:

“Unless there’s a tech bubble coming, I see rapid price growth in Seattle of 8-15% a year until we reach approximately 80-90% of the Bay area’s value for similar jobs.  A home buyer can almost house door key in lock
exclusively come up with their opinion of Amazon, Microsoft, and Boeing and use that as their analysis if they should buy or not.  If they believe Amazon will do well for the next couple of years and Boeing/Microsoft will maintain, they should expect the pressure to continue.  That means they should buy soon.  If they think Amazon is growing at a risky rate and no growth from the other two, you can guess we may have a local value correction.”

Final thoughts for potential home buyers?

From Keane:

“First-time buyers are being squeezed for sure as the median income continues to rise in our area.  More than ever, the assistance of affordable housing programs is needed to assist first time buyers.  Prices are moving faster than most can save which is why IF you believe the market trends will continue, getting in with a reduced down payment is likely a better move than waiting.”

 

Conclusion

First, a big shout out to Keane Ng (www.keaneloans.com) for taking the time to so thoughtfully and thoroughly answer my questions!

The Seattle real estate market is fascinating to me, especially since I bought a home a few years ago.  I am not in the city of Seattle, but rather I live in a smaller suburb.  Prices in my area are increasing as well, especially as folks get priced out of Seattle and must move further north, east or south to find more affordable housing (interesting article on this in the Seattle Times).

My Advice

If you are looking to purchase a home, my advice is to make sure you have a good budget in place and know what you can afford.  Rapidly rising home values can create a sense of urgency to get in now before prices rise more, but it is important to remember that buying a home involves real risk.  If home values fall, and you are unable to sell or refinance, will you be able to afford your mortgage?  Do you have room in your budget to handle increasing property taxes as your home appreciates?  Have you built in saving for maintenance and repairs?  If the answer is yes, then happy shopping and good luck!!  In addition to the rapidly rising prices, most buyers face a bidding war out there.  When I bought my home a few years ago, when I put an offer on a home, I was bidding against 7-14 other people on houses that had only been on the market for a matter of days.  Now, it’s even a crazier market out there!  Best of luck to you!

 

Do you have an opinion on the Seattle real estate market?  Do you have a story about buying or selling your house?  I’d love to hear from you in the comments section.

The Upside, Downside, and Danger of Rising Home Values

Did you know the median home price in Seattle is now $700,000?  That is double the median price just 5 years ago! I recently read an article in the Seattle Times  that said Seattle had the fastest rising home prices in the country for the 7th straight month.  Wow!

That article got me thinking about the impact of rising home values.  Read on to find out more about the upside, downside, and danger of rapidly rising home values.

The Upside

Happy Home

Increased profit when selling

If you bought a house in Seattle 5 years ago for $350,000 and sold it this summer for $700,000, you would walk away having made a $350,000 profit.  Home ownership is the main driver of wealth accumulation for American households.

Less likely to be underwater on mortgage

When home prices crashed in the Great Recession after the housing bubble burst, millions of Americans ended up underwater on their homes, meaning the amount they owed exceeded the value of the home.  As of March 2012, four years after the market crash, approximately 11 million homeowners were still underwater.  As home prices rise, people are less likely to be underwater.

Home equity

For 60% of Americans, home equity makes up 67% of total net worth.  If you own a home, rising home values mean you have greater home equity.  This equity can become a source of cash when needed through a home equity line of credit or home equity loan.

Eliminate PMI

When you purchase a home with less than a 20% down payment, you generally have to pay private mortgage insurance (PMI).  If you pay down your mortgage to 80% of the purchase price you can have the PMI canceled – saving you the monthly fee.  If your home value rises quickly, you may be able to have the PMI canceled based on the new home value.

 

The Downside

Money Down Arrow

First-time buyers feel the squeeze

As home prices increase, the amount needed for a home down payment also rises.  Generally, 20% is a rule of thumb for a down payment.  However, prices are moving faster than many people can save.  In Seattle, a home that sold for $350,000 in 2012 (requiring a $70,000 down payment) would sell for around $700,000 in 2017 (requiring a whopping $140,000 down payment!).  A family would have to save at least $1,167 per month just to keep up with the rise in the home price.  First-time home buyer programs that have a reduced down payment requirement can help more people achieve home ownership by lessening the burden of the down payment.

Increased property taxes

As home values go up, so too do property taxes.  Property taxes are only a fraction of the home value (around 1% – 1.5%), but for lower-income households and those on a fixed-income, the property tax increase can feel substantial.  In Seattle, a home worth $350,000 would have a tax bill of roughly $3,500 per year (at a 1% tax rate).  If the home value increases to $700,000, the tax bill increases to roughly $7,000 per year – that’s about $292 more per month.  It may not sound like a lot, but for someone on a fixed income, that is a significant rise.

 

The Danger

Caution

Increased ability and temptation to cash in on home equity

In the section on the upside, I discussed how homeowners have increased home equity with rising home values.  This can be good if the homeowner is looking for a cheap way to finance a home repair or is looking to eventually sell their house.  However, rising home equity can tempt many people to borrow against their home without considering the potential consequences.  If home values fall, you may end up underwater on your home.  This will limit your ability to sell or refinance.  Also, be wary of using home equity to finance consumer purchases and vacations.  If you run into any issues paying back your loan, your home is at risk.  I urge people to be cautious when considering using a home equity loan to repay credit card debt for this reason.  Credit card debt is unsecured – meaning that the debt is not tied to an asset.  Examples of secured debt are mortgages, home equity loans, and car loans.  For secured debt, if you do not make payments, you risk losing the asset.  If you use a home equity loan to repay credit cards, and then become unable to make the payment on your home equity loan, your home is now at risk.

Using home equity to repay credit card debt or for other purposes is not always a bad idea, but be very, very cautious when considering this idea.  It becomes less risky (but still a risk!) in the following situations:

  • Your credit card debt is the result of a one-time situation such as a temporary job loss or serious injury/illness and not the result of an ongoing, chronic problem with debt or employment.
  • Including the amount you plan to borrow, you will still have a relatively low loan-to-value (LTV) ratio for your home.  For example, suppose your house is currently worth $250,000, your mortgage balance is $140,000, and you want to borrow $22,500.  If you add your mortgage balance ($140,000) plus the home equity loan ($22,500), that brings the total debt on your home to $162,500 – exactly 65% of the value of your home.  This is probably a relatively “safe” risk (but still a risk!) because it allows for your home to potentially drop in value 20% – 30% and still likely be able to sell and at least break even on the home debt in the event that you are no longer able to afford payments.

Home values do not always go up

As many learned the hard way after the real estate bubble burst in 2008, home values do not always go up.  You can mitigate the risk of falling home values by paying as large a down payment as you can afford and avoid tapping into your home equity unless necessary.  Be sure when selecting a home and a mortgage that you can comfortably make the payments.  Homes can be a great forced savings plan and a source of long-term wealth that is valuable in retirement planning.  However, homes come with risk and obligations for maintenance and repair.  Within 5 years of purchasing my home, I will have paid for a furnace replacement and a new roof – two of the most expensive repairs faced by homeowners!  Be sure there is room in your budget to make the both the mortgage payment (and insurance payment, HOA dues, if necessary, and taxes), as well as save for the inevitable home repairs and maintenance issues that will confront you when you least expect it.

 

Advice for First-Time Home Buyers

Home Key

If you are looking to buy a home in an area with rapidly rising prices, you may want to consider buying sooner rather than later.  With prices rising as fast (or faster) than you can save, it can be difficult to wait and break into the market later.  HOWEVER, there is no guarantee that prices will continue to go up, or that prices will not fall back down after you buy.  Trying to buy sooner may mean that you have a smaller down payment percentage, or that you buy at the peak of a market and end up underwater on your mortgage.  The riskiness of this plan is mitigated somewhat if you are looking for a long-term home (10+ years).  With a longer time horizon, you have more time to wait that will allow you to either pay off more of your mortgage or wait for home prices to rebound.  Be sure to check out first-time home buyer programs in your area as there may be down payment assistance programs or specialized loans available.  In Washington State, the Washington State Housing and Finance Commission has information on their website (http://wshfc.org/buyers/index.htm).

 

Are you a homeowner excited about the rising values?  Are you a first-time buyer getting squeezed out of the market?  Do you have a story about buying at the peak in 2006 and ending up underwater for a number of years?

Share in the comments!