Best way to budget for mortgage payment?

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jason
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Best way to budget for mortgage payment?

Post by jason » Thu Apr 04, 2019 9:00 pm

I am 47 years old and retired because I sold my business a few years ago. Not counting my mortgage payment, which includes taxes and insurance, my annual budget is under the safe withdrawal rate of 4%. My mortgage payment, however, puts me at around a 5% withdrawal rate. Obviously, building equity in a house is a different type of expense than taking lavish vacations, going out to dinner, throwing big parties, and so on where the money is just spent and gone forever. Am I taking too much risk? I know that, historically, a house leveraged with a mortgage is a pretty solid investment long-term. But I also know that there have been extended periods where real estate has done poorly. But it doesn't make sense to me to classify a mortgage payment that builds equity in the same category as taking a vacation when planning an annual budget. Any advice on this?
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Re: Best way to budget for mortgage payment?

Post by sophie » Thu Apr 04, 2019 9:48 pm

Not enough info from your post to really know, but it sounds like you may be cutting things a bit close.

I suggest using the retirement simulation tool at http://www.cfiresim.com/. It can account for time-limited, fixed expenses like mortgages, and will tell you % success of historical retirement years. If it's below ~90%, you might want to think about a part time job or some other source of income.
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Re: Best way to budget for mortgage payment?

Post by jacksonM » Fri Apr 05, 2019 10:27 am

I don't know why you wouldn't include the mortgage payment as part of your annual budgeting. What you say about it when comparing it with other expenses like vacations may be true but it's also true that unlike those expenses it isn't discretionary. It will remain a fixed part of your budget for as long as you hold it.

(BTW, I am also holding a mortgage in retirement and DO include it in my budgeting. Right now my SS + 3.5% would meet our budget but my wife is still working so the withdrawal rate as actually negative right now and will get even more negative when the SS checks start coming in July. I think when the figure gets down to 2.5% it will be time to work even harder at convincing my wife to retire.)

And thanks to Sophie for that link. Never saw that website before. All of the planners I've used in the past say my plan looks good but it's nice to have more confirmation.
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Re: Best way to budget for mortgage payment?

Post by ochotona » Fri Apr 05, 2019 11:09 am

jason wrote:
Thu Apr 04, 2019 9:00 pm
I am 47 years old and retired because I sold my business a few years ago. Not counting my mortgage payment, which includes taxes and insurance, my annual budget is under the safe withdrawal rate of 4%. My mortgage payment, however, puts me at around a 5% withdrawal rate. Obviously, building equity in a house is a different type of expense than taking lavish vacations, going out to dinner, throwing big parties, and so on where the money is just spent and gone forever. Am I taking too much risk? I know that, historically, a house leveraged with a mortgage is a pretty solid investment long-term. But I also know that there have been extended periods where real estate has done poorly. But it doesn't make sense to me to classify a mortgage payment that builds equity in the same category as taking a vacation when planning an annual budget. Any advice on this?
Jason, you've gotten some unexamined assumptions that you need to take a look at, like immediately and urgently.

4% retirement withdrawal rule, original work by Bill Bengen... was NEVER NOT EVER designed to support a 47 year old to the end of their life. It was, if I recall, a 30 year retirement calculation. If you intend to be compost by 77, then fine, otherwise you're going to run out of money in your 80s. You need to look at PortfolioCharts.com and pursue the Perpetual Withdrawal Rate for your type of allocation, not the Safe Withdrawal Rate. From a retirement point of view, 50 years (your lifespan which remains for planning purposes) is practically Perpetual.

Also, what is your allocation? Some people think, "Oh I have my money at Bank of America earning 0.01%, I can use the 4% Safe Withdrawal Rule". You''ll be Safe Withdrawing your way to poverty.
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Re: Best way to budget for mortgage payment?

Post by jason » Sat Apr 06, 2019 7:16 am

ochotona wrote:
Fri Apr 05, 2019 11:09 am
jason wrote:
Thu Apr 04, 2019 9:00 pm
I am 47 years old and retired because I sold my business a few years ago. Not counting my mortgage payment, which includes taxes and insurance, my annual budget is under the safe withdrawal rate of 4%. My mortgage payment, however, puts me at around a 5% withdrawal rate. Obviously, building equity in a house is a different type of expense than taking lavish vacations, going out to dinner, throwing big parties, and so on where the money is just spent and gone forever. Am I taking too much risk? I know that, historically, a house leveraged with a mortgage is a pretty solid investment long-term. But I also know that there have been extended periods where real estate has done poorly. But it doesn't make sense to me to classify a mortgage payment that builds equity in the same category as taking a vacation when planning an annual budget. Any advice on this?
Jason, you've gotten some unexamined assumptions that you need to take a look at, like immediately and urgently.

4% retirement withdrawal rule, original work by Bill Bengen... was NEVER NOT EVER designed to support a 47 year old to the end of their life. It was, if I recall, a 30 year retirement calculation. If you intend to be compost by 77, then fine, otherwise you're going to run out of money in your 80s. You need to look at PortfolioCharts.com and pursue the Perpetual Withdrawal Rate for your type of allocation, not the Safe Withdrawal Rate. From a retirement point of view, 50 years (your lifespan which remains for planning purposes) is practically Perpetual.

Also, what is your allocation? Some people think, "Oh I have my money at Bank of America earning 0.01%, I can use the 4% Safe Withdrawal Rule". You''ll be Safe Withdrawing your way to poverty.
Thanks for the info! All of my savings are in a standard 25/25/25/25 HBPP. I have a hard time wrapping my mind around the concept that, for example, budgeting for $3,000 per month for a mortgage, or budgeting $3,000 per month for a rented home, or budgeting $3,000 per month to send a kid to fancy private school should all be treated the same when planning a budget. Unlike paying rent or private school tuition, the mortgage payments are building equity so, at last in theory, I will be able to get all that money back someday,, plus some profit. When my kids are older and move out of the house, I could potentially sell the house (hopefully for a profit) and downsize to a small condo, for example. So I think of a house as more of a Variable Portfolio than a regular expense line item where money is just spent and gone forever. Why can't my house be considered a VP with moderate risk? And if it is OK for my house to be classified as a VP, what's the best way to calculate potential returns and calculate the risk I am taking, and include the home equity in my retirement calculations?
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Re: Best way to budget for mortgage payment?

Post by sophie » Sat Apr 06, 2019 7:58 am

I don't think you should assume that you'll profit from selling your house. Generally, housing prices keep up with inflation but don't do more than that, absent a housing bubble.

What most of us do is regard the house as a consumption item. Your home equity figures as part of your net worth, but it does you no good unless you plan to tap it using a home equity line of credit or reverse mortgage. You might reasonably do these things late in your life, but I'd regard as an emergency measure only. Personally, I'm reserving home equity as a form of long term care insurance.

If you plan to sell your house and downsize in the near future, you can figure that into your retirement calculator as a one-time income event (home equity minus costs of the selling and moving process and purchase price of the condo) followed by reduced annual housing costs. That's why I like cfiresim, it makes it easy to do that.
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Re: Best way to budget for mortgage payment?

Post by Kriegsspiel » Sat Apr 06, 2019 8:13 am

jason wrote:
Sat Apr 06, 2019 7:16 am
ochotona wrote:
Fri Apr 05, 2019 11:09 am
jason wrote:
Thu Apr 04, 2019 9:00 pm
I am 47 years old and retired because I sold my business a few years ago. Not counting my mortgage payment, which includes taxes and insurance, my annual budget is under the safe withdrawal rate of 4%. My mortgage payment, however, puts me at around a 5% withdrawal rate. Obviously, building equity in a house is a different type of expense than taking lavish vacations, going out to dinner, throwing big parties, and so on where the money is just spent and gone forever. Am I taking too much risk? I know that, historically, a house leveraged with a mortgage is a pretty solid investment long-term. But I also know that there have been extended periods where real estate has done poorly. But it doesn't make sense to me to classify a mortgage payment that builds equity in the same category as taking a vacation when planning an annual budget. Any advice on this?
Jason, you've gotten some unexamined assumptions that you need to take a look at, like immediately and urgently.

4% retirement withdrawal rule, original work by Bill Bengen... was NEVER NOT EVER designed to support a 47 year old to the end of their life. It was, if I recall, a 30 year retirement calculation. If you intend to be compost by 77, then fine, otherwise you're going to run out of money in your 80s. You need to look at PortfolioCharts.com and pursue the Perpetual Withdrawal Rate for your type of allocation, not the Safe Withdrawal Rate. From a retirement point of view, 50 years (your lifespan which remains for planning purposes) is practically Perpetual.

Also, what is your allocation? Some people think, "Oh I have my money at Bank of America earning 0.01%, I can use the 4% Safe Withdrawal Rule". You''ll be Safe Withdrawing your way to poverty.
Thanks for the info! All of my savings are in a standard 25/25/25/25 HBPP. I have a hard time wrapping my mind around the concept that, for example, budgeting for $3,000 per month for a mortgage, or budgeting $3,000 per month for a rented home, or budgeting $3,000 per month to send a kid to fancy private school should all be treated the same when planning a budget. Unlike paying rent or private school tuition, the mortgage payments are building equity so, at last in theory, I will be able to get all that money back someday,, plus some profit. When my kids are older and move out of the house, I could potentially sell the house (hopefully for a profit) and downsize to a small condo, for example. So I think of a house as more of a Variable Portfolio than a regular expense line item where money is just spent and gone forever. Why can't my house be considered a VP with moderate risk? And if it is OK for my house to be classified as a VP, what's the best way to calculate potential returns and calculate the risk I am taking, and include the home equity in my retirement calculations?
It looks like you're asking more about how to classify a mortgage payment, not how to budget for it.

I track my house value on the VP sheet, and I count it in my net worth, but I don't count it as part of my invested assets. Are you including your home equity in your withdrawal rate calculations? Owning a house is just a way to decrease housing expenses. It doesn't make sense to compare a mortgage to vacation and party spending. Compare it to renting.
You there, Ephialtes. May you live forever.
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Re: Best way to budget for mortgage payment?

Post by ochotona » Sat Apr 06, 2019 6:41 pm

If using an HBPP and planning to live 50 more years, best to use a 3.5% withdrawal rate.
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Re: Best way to budget for mortgage payment?

Post by sophie » Sun Apr 07, 2019 7:07 am

ochotona wrote:
Sat Apr 06, 2019 6:41 pm
If using an HBPP and planning to live 50 more years, best to use a 3.5% withdrawal rate.
Actually I beg to differ with this.

If you check withdrawal rates on Tyler's website, you'll find that the PP can actually support an SWR higher than 4%. The key is the portfolio stability. Failures in traditional stock/bond portfolios happen when there's a big drawdown soon after retiring. As long as the PP has a real return of at least 4%, it is almost bulletproof. In practice it's even better because of the cash component, which automatically helps you avoid selling assets when they're down.

My main concern with the "4% rule" and the retirement calculators/simulators is that in most of the retirement start years, over a 30 or 40 year retirement, portfolios are predicted to grow to absurd levels (e.g. 10s of millions). How often does this actually happen in practice? I'd guess rarely, and I think it's important to find out why that is. Could it be investing fees that have historically been much greater than they are today? Or is it higher spending during retirement than anticipated? Or poor investment management, e.g. panic selling during a downturn, or frequent portfolio switches? It would be interesting to know what happens to early retiree portfolios through the next major market slide. The ERE movement has essentially been untested under such conditions, which is probably why most of them advocate 100% stocks. If you remember, the authors of "Your Money Or Your Life" originally advocated putting everything into 30 year Treasuries and holding to maturity..
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Re: Best way to budget for mortgage payment?

Post by ochotona » Sun Apr 07, 2019 8:39 am

Sophie the OP has a 50 year planning horizon. "Safe withdrawal rates" have an implicit 30 year horizon. That's why he needs to pick a rate closer to the perpetual curve. I also got the same result from Monte Carlo is addition to Tyler's charts.
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Re: Best way to budget for mortgage payment?

Post by jason » Sun Apr 07, 2019 11:11 pm

sophie wrote:
Sat Apr 06, 2019 7:58 am
I don't think you should assume that you'll profit from selling your house. Generally, housing prices keep up with inflation but don't do more than that, absent a housing bubble.

What most of us do is regard the house as a consumption item. Your home equity figures as part of your net worth, but it does you no good unless you plan to tap it using a home equity line of credit or reverse mortgage. You might reasonably do these things late in your life, but I'd regard as an emergency measure only. Personally, I'm reserving home equity as a form of long term care insurance.

If you plan to sell your house and downsize in the near future, you can figure that into your retirement calculator as a one-time income event (home equity minus costs of the selling and moving process and purchase price of the condo) followed by reduced annual housing costs. That's why I like cfiresim, it makes it easy to do that.
I have also read that houses keep up with inflation. Homes appreciate around 3.5% per year, on average, which is similar to inflation. But because I have a mortgage with a 20% down payment, doesn't that mean I have 5X leverage? How do I calculate my potential CAGR on my own house based on historical averages?
I still don't get why a mortgage payment would be treated like a regular expense line item in a retirement budget. The main difference between making a mortgage payment and paying for a vacation is that if you spend $10K on a vacation, that money is gone forever. You will never get a single penny of it back, ever. But if you spend money by making mortgage payments, you will likely get a lot of that money back eventually, if you sell the house down the road. So, isn't making mortgage payments more like putting money into a piggy bank or into a forced savings account than a regular expense? If so, how do I incorporate the value/equity in my house into my withdrawal rate calculations?
My plan is that if the PP does very well, then I can likely just live in my house long term. If the PP does very poorly and my assets are shrinking too fast, then I can sell the house, likely at a profit, and then downsize.
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Re: Best way to budget for mortgage payment?

Post by D1984 » Sun Apr 07, 2019 11:37 pm

jason wrote:
Sun Apr 07, 2019 11:11 pm
sophie wrote:
Sat Apr 06, 2019 7:58 am
I don't think you should assume that you'll profit from selling your house. Generally, housing prices keep up with inflation but don't do more than that, absent a housing bubble.

What most of us do is regard the house as a consumption item. Your home equity figures as part of your net worth, but it does you no good unless you plan to tap it using a home equity line of credit or reverse mortgage. You might reasonably do these things late in your life, but I'd regard as an emergency measure only. Personally, I'm reserving home equity as a form of long term care insurance.

If you plan to sell your house and downsize in the near future, you can figure that into your retirement calculator as a one-time income event (home equity minus costs of the selling and moving process and purchase price of the condo) followed by reduced annual housing costs. That's why I like cfiresim, it makes it easy to do that.
I have also read that houses keep up with inflation. Homes appreciate around 3.5% per year, on average, which is similar to inflation. But because I have a mortgage with a 20% down payment, doesn't that mean I have 5X leverage? How do I calculate my potential CAGR on my own house based on historical averages?
I still don't get why a mortgage payment would be treated like a regular expense line item in a retirement budget. The main difference between making a mortgage payment and paying for a vacation is that if you spend $10K on a vacation, that money is gone forever. You will never get a single penny of it back, ever. But if you spend money by making mortgage payments, you will likely get a lot of that money back eventually, if you sell the house down the road. So, isn't a mortgage more like a piggy bank or a forced savings account than an expense?
The whole "homes appreciate at around 0.5% or 1% a year over inflation on average" is generally true, but has several important caveats.

One, that is ON AVERAGE. If you buy, say, several thousand homes, in several different regions of the country, spaced out over a decade or so to buy all of them, then yes, once you get all of them bought your average annual return afterwards is likely to be in that range. Now, averages can be kind of deceiving...stocks, for example, may "average" 9% or 10% per year over the long haul but that average is made up of excellent years like 2017, good years like 2013, crappy years like 2002, meh years like 2005, and god-awful-please-make-the-pain-stop-when-will-it-end years like 2008. Housing is not quite as extreme in its variance of annual returns but the concept is the same; the years from 2000 to 2006 were golden; the years from 2007 to 2011 or so were horrible, and the years from then to the present have been OK to very good. A major chunk (after location) of what determines your return on a piece of real estate is when you buy and when you sell. This is not even getting into the most important factor in real estate.....location, location, location! Buying a home in San Francisco or NYC 20 years ago would have been a brilliant move; buying a similar home in inner-city Flint, Michigan or rural West Virginia coal country would have been a disaster. Since most people don't own dozens of properties but only one or two, their returns will tend to differ quite considerably from a nationwide average and will be heavily determined by when and where they bought and when and where they sold.

Two, as for why the mortgage payment is treated as an expense item rather than as forced savings: It's simple; you have to keep paying it or they take your house. You have a choice whether to fund a savings account or brokerage account each month if hard times arrive and push comes down to shove; no such choice exists for a mortgage (at least for a non neg-am mortgage, anyway). Even if you do wish to count a mortgage as forced savings, you should really only count the principal amortization portion and not the whole payment as being part of said savings...and be sure to subtract maintenance costs/maintenance reserves from the amortization buildup; if you built up, say, $8,000 of equity in amortization one year but had to set aside $3,000 for maintenance and capital expenses (because hey, roofs leak, water heaters break, major appliances need replacing, etc) then you should really only count $5,000 as your "forced savings" that can be subtracted from the total mortgage payments made that year, rather than counting the full $8,000...and this is not even counting taxes, insurance, PMI, etc since those are part of the payment as well but obviously should not be considered as any kind of forced savings since you pay them straight to someone else.

Three, even if you do count the amortization as forced savings, how do you plan on accessing it? What good is a forced "savings account" if you can't tap it? Why should that even count as savings? I guess you could get a HELOC but beware that banks can cancel those at a moment's notice...oftentimes right when the real estate market crashes along with the economy (like circa 2007-08) and someone might need it most (i.e. if they lost their job or if they wanted to buy stocks or junk bonds on the cheap after a crash); the only other option to monetize the "forced savings" from amortization and capital appreciation would be to sell and move but if that's the case you have to find another house and the whole thing starts over again. If you ever find yourself in dire need of funds you can liquidate part of your stock portfolio, part or your gold holdings, a portion of your bonds, or half or a quarter of a savings account....but you can't sell only "part" of your house....it's either all or nothing.
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Re: Best way to budget for mortgage payment?

Post by Kriegsspiel » Mon Apr 08, 2019 7:17 am

jason wrote:
Sun Apr 07, 2019 11:11 pm
I still don't get why a mortgage payment would be treated like a regular expense line item in a retirement budget. The main difference between making a mortgage payment and paying for a vacation is that if you spend $10K on a vacation, that money is gone forever. You will never get a single penny of it back, ever. But if you spend money by making mortgage payments, you will likely get a lot of that money back eventually, if you sell the house down the road. So, isn't making mortgage payments more like putting money into a piggy bank or into a forced savings account than a regular expense?
Yes. Some of it is like a piggy bank (principal), some of it is like rent (interest, taxes, insurance, maintenance, HOA).
If so, how do I incorporate the value/equity in my house into my withdrawal rate calculations?
You don't. Go back to the piggy bank analogy. Putting money in a piggy bank isn't the same as investing in productive assets like stocks, bonds, rental properties, etc. It's wealth that belongs to you, but you can't withdraw a % of it each year; you have to break it open to get at it. Now, you could also break it open and glue it back together and start refilling it again (cash-out refi/HELOC), but you could have just put that money into other assets that don't have the large transaction costs real estate does, and that don't require you to make payments on them or else you become homeless.

Like MangoMan said, you still have ongoing costs that are "gone," just like any other expense that isn't savings. In the good scenario, these expenses (combined with the lost opportunity cost of your home equity) are less than what it would cost you to just rent a place.
My plan is that if the PP does very well, then I can likely just live in my house long term. If the PP does very poorly and my assets are shrinking too fast, then I can sell the house, likely at a profit, and then downsize.
I would plan to be able to live in your house or downsize independent of what your portfolio does. IE, once your house is paid off, are you going to be able to cover your expenses with a safe (perpetual?) withdrawal rate from your investments?
You there, Ephialtes. May you live forever.
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Re: Best way to budget for mortgage payment?

Post by jason » Wed Apr 10, 2019 11:48 am

Kriegsspiel wrote:
Mon Apr 08, 2019 7:17 am
jason wrote:
Sun Apr 07, 2019 11:11 pm
I still don't get why a mortgage payment would be treated like a regular expense line item in a retirement budget. The main difference between making a mortgage payment and paying for a vacation is that if you spend $10K on a vacation, that money is gone forever. You will never get a single penny of it back, ever. But if you spend money by making mortgage payments, you will likely get a lot of that money back eventually, if you sell the house down the road. So, isn't making mortgage payments more like putting money into a piggy bank or into a forced savings account than a regular expense?
Yes. Some of it is like a piggy bank (principal), some of it is like rent (interest, taxes, insurance, maintenance, HOA).
If so, how do I incorporate the value/equity in my house into my withdrawal rate calculations?
You don't. Go back to the piggy bank analogy. Putting money in a piggy bank isn't the same as investing in productive assets like stocks, bonds, rental properties, etc. It's wealth that belongs to you, but you can't withdraw a % of it each year; you have to break it open to get at it. Now, you could also break it open and glue it back together and start refilling it again (cash-out refi/HELOC), but you could have just put that money into other assets that don't have the large transaction costs real estate does, and that don't require you to make payments on them or else you become homeless.

Like MangoMan said, you still have ongoing costs that are "gone," just like any other expense that isn't savings. In the good scenario, these expenses (combined with the lost opportunity cost of your home equity) are less than what it would cost you to just rent a place.
My plan is that if the PP does very well, then I can likely just live in my house long term. If the PP does very poorly and my assets are shrinking too fast, then I can sell the house, likely at a profit, and then downsize.
I would plan to be able to live in your house or downsize independent of what your portfolio does. IE, once your house is paid off, are you going to be able to cover your expenses with a safe (perpetual?) withdrawal rate from your investments?
It there a way to run a Monte Carlo simulation to determine the CAGR of owning a house based on historical averages for real estate increases and inflation? For example, if I'm paying $3,000 per month in mortgage, taxes, and insurance each month, I'd like to figure out approximately how much of that I would get back (in real dollars) if I sold my house down the road, assuming average performance. And a Monte Carlo simulation normally would show a range of best case and worst case scenarios. I understand that I really can't count on average performance actually happening, and that real estate could crash, but I'm just wondering about the range of expectations based on historical performance.
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Re: Best way to budget for mortgage payment?

Post by Xan » Wed Apr 10, 2019 11:56 am

A single house isn't an ideal candidate for Monte Carlo. It would be like trying to do Monte Carlo with a single stock. I'm sure you could come up with something... But no Monte Carlo is going to have much of a clue what the floor or ceiling are for your residence.

Jason, I PM'd you a while ago; could you update your email address in the forum so that I quit getting bounces when it tries to email you?
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Re: Best way to budget for mortgage payment?

Post by ochotona » Wed Apr 10, 2019 12:52 pm

Xan wrote:
Wed Apr 10, 2019 11:56 am
A single house isn't an ideal candidate for Monte Carlo. It would be like trying to do Monte Carlo with a single stock. I'm sure you could come up with something... But no Monte Carlo is going to have much of a clue what the floor or ceiling are for your residence.
Totally agree. How will the simulator know about your inclination to paint it, redecorate it, fix the AC, fix the foundation, or chase out the Crips and Bloods?

Maybe study iShares Residential Real Estate ETF | REZ, but that would be apartments I think.
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