Cash Flow Leak?

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I think I’ve left the best to last (no offense to the other MITs) … Diane says that she is in a ‘rent free’ situation … but, there’s no such thing as a ‘free lunch’ from purely financial perspective … and, even though this post is primarily about housing I am also interested in exploring the 401k ‘draw down’ … these are some of the financial issues that I hope to explore with Diane through this – and, future – posts …In the meantime, I would be interested to see what questions and advice Diane gets from the 7m7y Community …


Adrian’s challenge this month is to compare our “present state” against his theories and see where we fall and how we can mimic what he did, which is to align ourselves within the two rules of 25% and 20%.

I’m in an interesting state – once again doing something that doesn’t really fall into a real category.

  • Theoretically I have no income, but truthfully I’m living on deferred income from my years working – money I put into a 401k to get 50% matching on 8%, 100% vested, which was a really good return.  Even with 10% penalty, the matching was a good deal.
  • I’m not living in the house I own, and pay no rent/mortgage payment for where I am living.

I am withdrawing about $5000 in cash per month.  Allowing a 10% penalty and 30% taxes means that my income is about $8340 per month before taxes.  Subtracting taxes leaves $5838 net income per month.  25% of that is $1451 which exceeds my monthly mortgage payments.  I prefer to use $5000 as my net, allowing some for the 10% penalty, and because it is “golden,” also to reduce that number by subtracting a monthly obligation to support my children (another $1000).  Using $5005 as my net gives a 25% allowance of $1251 for rent/mortgage; using   $4000 allows only $1000.

I have 2 monthly mortgage payments which equal 100% financing.  I got a conventional 30-year 80% loan at 6.375% and a fixed 20% loan at about 8% that comes in 10 years, as a balloon loan.  It was pretty much a no-money-down deal (except for closing costs).  The 80% mortgage requires an escrow account.  Even with that added to both mortgages, the total is less than $1251.  It exceeds the $1000 threshold (using a $4000 net income.)

I’m not living in that house anymore.  I rent it.  The rent does not cover both mortgages.  If I had paid 20% down, it would cover the 80% mortgage, without the escrow for insurance and property taxes.  It comes short with them added.  I bought the house 3 years ago (Jan 2006).

Based on my net worth in Nov 2008, and the 20% equity rule, I should have no more than $3609 equity in my house.  Currently I have $1,202.  So I am below 20% on that.

So, let’s look at this from different angles:

  • Using either net income ($5005 or $4000), I am paying less than 25% ($1251-1000) on my mortgages, depending how you count property taxes and insurance.  If we look only at the house I am currently living in (not renting), I am paying zero, but I am not building equity here either.
  • Using active income, I am exceeding and breaking all rules, yes?  Unless you use “where I live.”

So, I guess I am okay on these rules, but need to look at my situation a little bit different.

  • Particularly, should I pay off the 20% balloon loan now so that the rent is a positive cash flow related to the remaining (80%) mortgage (not counting the property taxes and insurance)?
  • Or should I continue to “go with the flow” of an 8% loan with tax-deductible interest and use the money for other investments?

The last is what I’m thinking, but since I have gone a bit unconventional on the mortgages, it’s a negative cash flow (I still need to add money to cover the mortgage payments each month).  This reminds me of how different RE investors go with .8% or 1% of a purchase price in determining rent.  Perhaps that has to do with how much cash they have invested in the property?  A different topic (“for another post”), Adrian would say I think (smile, behind dark glasses and a hat).

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Reader Comments

Not sure it’s the “best,” Adrian, certainly it’s the screwiest, so perhaps it best represents the general populous who hasn’t been clearly following all the financial standards and can’t figure out how to muddle their way out of their own situation? I’m certainly open to hearing what my fellow 7MITs have to say; they’ve been very smart for everyone else. I hope they have some wisdom to share with me now, too!

Great Post Diane.
Am I reading it right that you will have depleted your retirement account by the end of this year? If so, what will you be doing to replace that income?
How much negative cashflow do you have on the rental, and how much positive cashflow would you have if you paid of the balloon now? What would you use to pay off the balloon?

@ Diane – I have a recommendation right off the bat:

Unless you keep your finances TOTALLY separate from your partner, you need to look at your personal finances as a household – I presume that SOMEBODY is paying for the house that you’re living in?!

The same with your ‘deferred income’ (which we’ll come back to in a later post) … does this cover ALL of your living expenses, or do you and your partner share: food, transport, travel, accomm., etc.?

I think your situations is just a little unorthodox right now Diane because of big changes your going through. A big move, a change of pace, and on track to live your life’s purpose. I think Adrian is right about your situation. I would tend to look at it from the standpoint that you are in a relationship and your financial situations are kind of ‘melting’ together, particularly if the relationship is serious.

By doing this, I think you get a clearer picture of where you are financially with the rules and can get a better picture of your future.

@Ryan – thanks for the ideas, Ryan – I will run the numbers on those privately and see how it actually plays out.

I will only run out the retirement account if I pay off all the credit card debt rather than paying it down. Right now, I have a hefty loan with one that is at zero percent. However, that changes in July. So, my options (looking at July as a huge fork in the road for me) are to either pay it off or transfer it to another instrument. Right now, the other instruments are not attractive, but if the CC ups the percent then (which it had planned to), I will not want to pay that off. Historically, however, I am usually given offers by other CCs to transfer. These days, that may or may not come with a 3% charge. So, I weigh the options using the “pay off worse % debt first” method, knowing that I have a few debts I want paid off before then (another CC I am paying off now and will finish them month so I can delete some finance charges on it.)

@Adrian – right now our finances are completely separated, but my fiance is covering all the living expenses, except health insurance and medical charges right now, my child support payments, and my debt reduction. The debt reduction is a personal issue that we both want to be clear on – it’s mine and not his.

Back to the income issue – we could live on his salary, but in wanting to pursue Life’s Purposes, it’s really not going to help both of us with a life-after-work life. I am considering getting a position with a company locally and with another farther away. I’m qualified for both (oddly for the local one as what I do is not prevalent around this area), but the one farther away puts me closer to family AND gives me back a retirement that I once had (I can buy back into it). With 11 years with that employer (kinda) in the past, I would only need 9 more years to qualify for a (very reduced) retirement package. Yet, it is in a locale where my fiance also used to work (as a consultant) and could find work again, if need be. This would be a huge change for both of us, but perhaps a needed one as we deal with putting households together at our age and after having both lived alone for six years.

@Scott – I agree with what you are saying, that my fiance and I are going to have to pool resources to see where we both truly are in this regards. I have worked some of the questions with him over the year, but we have not really sat down and said this is where we are and how we are going to get there. At our ages, there is a bit of the independence in both of us and the need for legal advice on how to deal with some of my issues (e.g., child support) since that is also something that is non-traditional.

If I don’t end up with a job by July, there are options on some of my debt (the student loan and the child support, which is an obligation not a debt per se – it’s a debt when the obligation is not met (and causes all kinds of fun with state and federal governments) to alleviate the issue until I regain a suitable income. However, my way is to continue to pay my part as long as I am able and not to seek relief even tho I can (on the student debt). [Deferring debt doesn’t help really at this point.]

In other words, Scott, I think you are saying we need to see where my fiance is on the 20/25 rules? Right now he does have some money to invest and may have more equity in the house than is needed. When I find the right investment, I have options besides him as well for funding as I know some of my family members are seeking MM301 options as well as MM201.

Adrian however keeps saying THINK BIGGER…and I am not sure I have the picture yet for that. I think I feel more confident asking for a smaller venture to start out and prove to others what my abilities would be in choosing/creating/selecting/managing and building an enterprise first. I also think my fiance’s skills, abilities, etc., can add a lot to the value of the enterprise as well, but his “regular” job is a bit too important for anything to trump it, so this is a huge consideration as well (i.e., I can’t in any way put a 2nd job over his 1st job, tho I can change the 1st job (if that makes sense – SMILE). Sorry for being discrete here, he has a very public job.

@ Diane – You are touching on a number of issues here relating to how to deal with co-habitation situations; worthy of a post on methinks. In the meantime, some things to consider:

– Scott is right, it is in your interests to ensure that your partner complies with the ‘rules’ as well … how to do this sensitively? Hmmm …

– You can keep your debts and finances as together or separate as you desire, the trick is to ‘backfill’ any notional expenses; for example, what would it cost to live if you DIDN’T split expenses, or if partner were not around?

– The advantage of having a Number, Date, and required Annual Compound Growth Rate (and, a mighty strong Life Purpose ‘reason’) is that it helps you to put these decisions in perspective; for example:

>> Where to live / which job to take? Well, which one is likely to help you meet your required Annual Compound Growth Rate? If only one, then how important is your Life’s Purpose, again? 😉 If either, then … well … choose either 🙂 … but, doesn’t this help to show how important knowing your [Number, Date, Annual Compound Growth Rate and, Life’s Purpose] really is?!

>> To start big or small? Starting small is better than not starting at all … just make sure that you understand what the role of this business is: to take you directly to your Life’s Purpose (can it grow to meet your required Annual Compound Growth Rate?) OR to help clear the decks (i.e. pay down debt) and/or build up some capital to start the business/investments that WILL take you there? Be VERY honest with yourself …

@ Adrian – Right now, any of them will do. Their purpose would be to allow me to continue supporting my sons financially and allow me to pay off my student loans, independent of having someone else actually pay the off you understand. It’s acceptable for my fiance to support me (as he would a traditional wife), but not for me to bring in a massive amount of debt. And as I alluded to earlier, we are working out details on how everything is going to work, even to trying to figure out what 2 people have the equivalent of stuff for a 7-bedroom, 2-dining rooms, 2 living rooms, 2 offices and an exercise room, house. It’s a little cramped in the garage right now, let’s say, and I skinnied down a lot moving here. There’s still more to go, so we are even looking at moving to a smaller place – with a fenced yard for the Bailey-meister – as a way of forcing us to relinquish more and more (simply move in only what we must have). A garage sale is planned for the spring and I have a beautiful diamond for sale if anyone’s getting married. I ought to post it before Valentine’s Day, but I’ve also been looking at going back to work while I work on the investments – RE or a business or both, depending on what comes first and meets the needs, still being defined in terms of “one level down” from Life’s Purpose. In other words, placing a foot down between here and there and making sure it’s not just placed anywhere.

I’m not going to run numbers on what it would cost if we didn’t split expenses (we don’t really – he pays them) or if he weren’t around, because it was a conscious decision on our part to reduce my living expenses (and thereby the COUPLE’s living expenses) by doing this. I had hoped my employer would be open to my telecommuting to work, but they weren’t, so I no longer work for them and have sent out resumes recently. It’s been nice being at home and learning things, but I can’t see how RE investing in the next six months is going to cover the amount of income I want by then so that I can pay off the CC debt, continue paying child support, and continue paying off my student loans. But, I’m willing to do the math on each property I look at and be proven wrong 🙂

Adrian, you never answered a question I had before on how you chose the two businesses you had (with their $30k in debt) when you started your own journey to $7M7Y. If I recall correctly, one was a call center. Exactly how does one create and/or buy a call center? How does one decide this is the business for them? Is it merely seeing a need and going about trying to fill it?

@ Diane – One business was a defunct family business (all I really had was a customer list), and the other a semi-related idea that just ‘popped’ into my head one day. I get very few original ideas, but this one turned our to be a goodie 🙂

… my business journey might be the subject of a non-personal-finance “Amazing Stories” book one day: it was the second part of my journey … the one that took me well past the 7m7y mark.

As to your situation: I recommend that you combine finances as far as these exercises go and add in your debt (of course). Again, this is only for the purposes of moving you to your Life’s Purpose.

When we come to income and debt reduction, we’ll have to play with your “household rules” around the Cash Cascade to see who’s paying for what – and, how – but for now, we’re just looking at ‘your’ house …

… so why don’t you share your combined numbers per the questions and we’ll take a ‘look see’ … also recommend that you update your NWiQ profile to NOTIONALLY combine assets (again, in ‘real life’ the liability side and the assets etc. will actually be split however the two of you decide) … OK?

No can do, Adrian; my fiance didn’t sign up for the 7m7y public journey here, and he and I don’t have financial obligations for each other. If/when that changes, then it will be looked at at that time.

For now, consider me as a child living at home with his parents – didn’t we have someone else living at home? – and subsequently not paying rent, utilities, food, some extras, etc.

Currently my income is like retirement income, tho I am looking for a job again as I write this, so we may move if I find one in an acceptable locale that is not here. I am not sure how to record that even with the state, but will learn as I do my taxes as it is all taxeable income.

I’ll just dog-ear this for an on-going thing (like updating the Networth IQ from time to time). Like everything else financial,these things should always be examined from time-to-time. Nothing is static, is it?

@ Diane – A child living with parents it is! How much pocket money / allowance do you get a week? 🙂

All kidding aside, from memory, I think that your Number assumes a full set of costs, right?