Thursday, October 19, 2017

Burn Your Mortgage

Many people are familiar with Sean Cooper’s story of living extremely frugally for a few years while he saved up a large down payment, bought a home, and paid off his mortgage by age 30. Cooper built on the interest in his story by writing a book called Burn Your Mortgage. I expected to like this book because I believe paying off your mortgage and any other debts is a good idea (I paid off my first mortgage by age 28). However, despite many good parts of the book, there is too much cheerleading for home ownership for me to recommend it.

A common theme throughout this book is treating rising housing prices as a permanent reality. “The last thing you want is to find yourself priced out of the market.” “It’s probably wise, if you’re in the financial position to do so, to buy now while you can still afford to.” Even though this book came out in 2017, it already has a dated feel now that home prices have been dropping in Vancouver and Toronto.

Another part of this theme of rising house prices is the claim that real estate has been a better investment than stocks. See my recent post on cheerleading for home ownership for one example. Another is a chart of home sale prices from 1980 to 2015 with the caption “Canadian real estate prices have been trending upward over the past 25 years. That’s more than we can say about the stock market over this same time.” I can’t do better than John Robertson’s image of the S&P 500 total return superimposed on Cooper’s home price chart.

The early chapters of the book cover advice on basic personal finances building up to how to save up for a down payment. One quote I particularly liked is “It’s not how much you make; it’s how much you save.” The more I see of other people’s finances, the more I realize that overspending can happen at any income level.

One section offers “25 Ways to Save Big.” This is a decent list of things that many people buy mindlessly, but each item includes a suggested amount of annual savings that just seems random. This attempt to quantify savings marred an otherwise interesting list.

Some of the advice is too superficial for readers to follow without a lot more knowledge. One example is “Carefully weigh the pros and cons of a car loan versus leasing to see what makes the most sense.” This ignores the best option: save up and pay cash for a car. Another problem is that those who just compare monthly payments might think they’re following this advice.

There are advantages and disadvantage to using the Home-Buyer’s Plan (HBP) to use RRSP assets for a down payment, but Cooper’s justification is pure FOMO: “in this crazy real estate market where home prices are rising a lot faster than wages, it’s hard to turn down a 30% risk-free return.” To start with, the HBP allows you to increase the size of your down payment with money you’ll have to pay back later; this is not the same as a 30% return. Further, it’s dangerous to make big financial decisions based on the belief that house prices will keep rising.

The second part of the book contains a lot of useful advice on the details of buying a house. Cooper even allows that “sometimes it makes sense to rent until you’re financially ready to buy a home.” More excellent advice is to “Love They Neighbour.” It’s difficult to understand how important it is to work at getting along with neighbours until you’ve had a bad neighbour. “A good neighbour can make your time at home pleasant; a bad one can make it a living nightmare.”

I was suspicious of a quote Cooper attributes to Warren Buffett: “To build true long-term wealth, you must buy and hold real estate.” This turns out to be from a list of 13 Buffett quotes that were “translated” for real estate investors. The actual Buffett quote is “Our favorite holding period is forever.” But Buffett is referring to the businesses his company owns, not real estate. This is another example of true believers in some investment approach trying to recruit Buffett as one of their own.

In a section listing the pros and cons of buying a home, one of the pros is “forced savings.” There is some truth in the idea that forced savings helps people, but as Rob Carrick once said, a home comes with “forced spending” as well. Curiously, Cooper says forced saving is good because “Most people put their mortgage ahead of all other debts.” If you’re paying off your mortgage and allowing other debts to grow, that’s not forced savings. You’re not saving anything if your net worth isn’t growing.

One section contains some good, detailed advice on choosing a real estate agent. However, along with several good ideas is the advice to “Visit their website to read testimonials.” That’s not a good idea. For some reason humans are wired to be influenced by stories, even when they are deliberately misleading. In Ontario, regulated health professionals aren’t even permitted to publish testimonials.

In a discussion of mortgages and how much you can borrow, Cooper discusses the two main debt ratios. For the gross debt service ratio, he recommends that we “aim for a GDS ratio 30% or below (up to 35% in pricey real estate markets).” For the total debt service ratio, he recommends that we “aim for a TDS ratio of 37% or below (up to 42% in high-cost cities).” This idea that it’s okay to borrow more in hot markets is nonsense. You can’t suddenly handle more debt just because houses are expensive. And hoping to get bailed out by prices continuing to rise after you buy is a bad plan.

In a section discussing the pros and cons of mortgage brokers, Cooper says they have “No cost.” This is just wrong. The broker’s fee is baked into the rate you get. Now, it could be that a mortgage broker can still get a better rate than you could negotiate yourself from a lender, but that doesn’t mean the broker has no cost. Any time it seems like someone is working for you for free, you’re probably missing something.

A good section on breaking a fixed mortgage explains how expensive this can be. Many people would be shocked to learn that it could cost $20,000 or more to break their mortgage. A statistic that surprised me is that “70% of people change their mortgage before the end of its term.” Presumably, this doesn’t always involve a huge penalty, but such penalties are common enough that home-buyers should understand this potential cost.

The book’s last section covers topics that come after you’ve bought your home such as insurance, wills, and becoming a landlord. Becoming a landlord isn’t for everyone, but those who choose this path get some useful advice from Cooper on pitfalls and good practices.

“A rental property is the ultimate solution to building long-term wealth and achieving financial freedom.” I disagree. I’ve known too many people who tried to make money this way and ended up losing a lot of time and money. It takes a certain personality type to be able to deal effectively with tenants and to negotiate with various types of contractors for repairs and upgrades. You also need to develop a keen sense of the value of real estate to buy and sell at good prices. Only a small minority of people seem to do well at being a landlord. It’s much easier to build wealth with passive investments in the stock market.

An appendix lists a number of “side hustles” to make some extra money. This list of ideas can be a good starting point for an energetic person seeking ideas. One that made me cringe, though, is “If you’re healthy, get paid to test out new drugs.” Yikes!

The best parts of the book discuss frugal living and the advice on important details of the house-buying process and becoming a landlord. However, if asked whether I’d recommend this book to my sons, I’d have to say no; they are bombarded with enough messages to buy now while they still can. I think they’re better off using price-to-rent ratios to decide when to rent and when to own.

1 comment:

  1. I stopped (never started?) taking Cooper seriously when he admitted to falsifying details (i.e. lying) in order to obtain an on-camera interview. He then when on to publish unsubstantiated financial claims on another popular Canadian personal finance blog.

    His whole trajectory seems based on two things: supporting his ego/becoming popular, and tapping into the Canadian mentality of loving housing/hating mortgages.

    There's been many analyses done on the long-term returns of residential real estate, almost all of them arrive at the same conclusion -- it's not a great "investment", with common returns in the very low single-digits. Taking into account ALL costs, most residential real estate will experience negative returns over the long haul; even more so if bought at ridiculously high valuations and/or compared to alternative investments such as public equity.

    But, as Robertson puts it, "a marketable story" (Note that his book is self-published). And in the end, in a Capitalist society, money is the ultimate measuring stick. Cooper invented a story that capitalized on the current public mindset -- it's this that's a much better story than his flawed homeownership experience ("Cooper's Folly"). He's a much better marketer than he is investor.