25% Gross Income. Don’t become a Jones!

When we set out on our home search we often think of a lot of things but rarely do we really analyze our budget totally. For many years Conventional Lending and Conventional Wisdom would tell you that your Housing payment Taxes and Insurance should not exceed 28%. Government Lending would set that standard over the years at 31%.

What do the Experts Say? In the book Total Money Makeover by Dave Ramsey he suggests that 25% is a great number to shoot for.

So what do these percentages mean? Debt to income is a measure of your debt versus your income. In this case the debt that we are talking about is your total housing responsibility. The income is your Gross Monthly Income not what you take home to live on.

Let’s Look at Example – Borrower A makes $8,000 per month Gross Income. Their Future Housing Payment will be $2,700 out the door. Their Debt to income in this case would be 2700/8000 = 34%. Based on conventional wisdom or even the number for government lending this would be higher than we would like to see. However, it is very common that this is acceptable through the automated underwriting engines. In fact I have seen ratios that are in the high 30′s and low 40′s make it through the system. In this example it would be advisable to have a payment that does not exceed $2500 on the government side and $2240 on the traditional conventional thought. According to Dave Ramsey $2,000 would be the max and I tend to agree with him.However, if I insisted on this I would be out of business!

Why are high ratios bad? Just take a look at the numbers as a whole. Going back to Borrower A. Borrower A represents a family of five. They like most families have expenses like daycare, food, insurance, cell phones, and you know the rest. So let’s mock an expense report.

Gross Monthly Income $8000 in a 30 % tax Bracket leaves the take home pay at $5600 per month.

$5,600 – $2,700 Housing – $800 Food – $500 in Auto Loans – $800 in Daycare conservatively = $800 remaining for all the everyday life expenses. It would be impossible to not use a credit card. How could you save for retirement, Christmas, incidentals etc.

Same Example: $5,600 – $2,000 Housing – $2,100 = $1500 which would be better.

So why do we not all buy with a 25% housing ratio? The Jones’. We get so caught up in the need to have a home like our friends. Facing the fact that we simply may not be able to afford a home is just to difficult. We, as a society, have not been taught about the numbers. I realize that some wise individual may read this and say you did not mention the tax benefits of home ownership. You are making a lot of assumptions on net income as they have three dependents, 2106 expenses, and a whole slough of write-offs. I understand that. I also know that I did not include many of the incidentals that we come across or even mention vacation. I simply want to illustrate a point that may get us to challenge ourselves to look deep into our finances. Owning a home is awesome. Living to service the home is not. When you are stressed each month about whether or not you will be able to pay by the first your whole life is affected.

Please consider your entire budget and consult a CPA before you even look at homes – The reason that I say this is simple. If I go to the local lots and test drive a 2010 Range Rover and then I realize that to have a life I would have to buy a base model pickup truck disappointment would overtake me.

My Job as your professional consultant for Mortgage is to lay out the facts – I want to make certain that I set you up for financial success not only a mortgage. I wish that I had been set down and taught these very basic principles before I entered the work world and housing market.

The principles out-lined here are not my own. They are a collaboration of wisdom that has been passed on to me over time and through trial and error.They are opinion. I have seen some great devastation and continue to see situations that are less than ideal and always will. Free will is awesome we are all given the opportunity to decide what is right and wrong for ourselves. I hope that you have enjoyed the material.

Loan Mod, Short-Sale or Bankruptcy Oh My!

Many times in today’s economy homeowners are internally wrestling with the question: Do I Modify, Short-Sell or file for Bankruptcy? Yes, you can also throw in do I simply let it go if you would like but for the sake of the post it is not included.

The answer to the question is not a simple one. Many times I find the reason that it is most difficult to decide is the lack of understanding the consequences. Each option comes with serious pros and cons that will have a long term affect on your life.

Important Questions to consider when looking into your options are:

Is my loan a recourse debt or is it non-recourse debt? - Click here for Wikipedia’s Definition of Non-Recourse Debt .

What tax consequences will I face if I execute a Loan Mod, Short-Sale or file Bankruptcy?

What are the Long term Credit Consequences?

How Much do I have to pay to get this done?

How do I find the right Loan Mod company, Realtor or Attorney there are so many? Does this person specialize?

These are only a few of the important questions that you should ask when considering your options. Let’s take a moment to explain in the most basic terms what each of the options mean:

Loan Modification – A Loan Modification is a modification to the terms and conditions of your current note. Common modifications include extending the payback period(amortization), decreasing the interest rate for a set period of time, extending the period of time your rate will be fixed, switching from an adjustable to a fixed rate option, principle reduction or any combination of the aforementioned and more. Loan modifications can be done directly through your lender(recommended) or you can hire a third party Loan Modification specialist (ask if they are approved by the Department of Real Estate). Here is a great place to start for a Loan Modification. Be careful if you get a principal reduction on your loan modification as you may have tax liability on the debt that was forgiven.

Short Sale – A short sale occurs when you sell your home for less than you owe on the property. Your lender has to agree to take a loss for the amount that you will be short.  Ex – you owe 500K and the property will only sell for 400K. You are shorting the lender a 100K plus Real Estate commissions. This is where it can get tricky. If you have a first and a second on the property it is imperative that you consult both a CPA and an Attorney or qualified Real Estate agent. Depending on the type of debt (recourse or non-recourse and purchase money or refinanced loan) there can be tax consequences that can hurt you bad come tax time. See what happens is the amount that you are forgiven by the lender 100K in our example will be treated as income. The lender will 1099 you for the amount that you shorted them and you may have to pay income taxes. There is also other potential tax ramifications. (Consult your CPA as I am not qualified to discuss your tax liability. The above are merely for illustration and example purposes.) If the debt is recourse debt the lender may also come after personal assets that you may have. If the debt was purchase money in the state of California a bill was passed that for a short period of time they will forgive the debt without the tax consequence. Debt must have been purchase money. Will take care of tax consequence but if it was Recourse debt this does not mean the bank will not try for personal assets. Again please see qualified accountant and/or Real Estate Attorney for legal advice. If you are considering a short-sale make sure that you seek out a qualified referral. There are many agents out there that understand the process and will do an extraordinary job for you.

Bankruptcy – In my opinion, this is the last option that I would seek out. My opinion is merely that but in Dave Ramsey’s Total Money Makeover he too advises strongly against this option. In the last few years new Bankruptcy laws have made it harder to file for bankruptcy Chapter 7. Credit recovery from a Bankruptcy is the most difficult of the three options. If you have one slip up post Bankruptcy it will be scrutinized and can ruin your chances of future loan approval. More than that the humiliation of all your items being taken away from you will remain in your mind for a long time. However, this could be the option that best suits you. Chapter 7 is a complete wiping out of the debt. You can apply for a Mortgage 24 months after the Bankruptcy is discharged as long as you have re-established credit. Chapter 13 is the reorganization of debt to a more affordable payment. You can apply for a home loan after 1 year of timely payments on the debt but the loan must be approved by the trustee. Can a home loan be included in a Bankruptcy? In short this is called a Cram-Down and has been argued for and against in light of the economic crisis. Wikipedia gives a good explanation of where we stand but this is continually changing as the need changes and as the voices are heard. For current information please consult a Bankruptcy Attorney.

So the question remains: What option is best for my situation? As you can see the answer is not very simple and will be very different for each family. Please do not take the advice of a friend who short-sold and says this is the right thing for you. Consult your local professionals. Proverbs 24:6 “So don’t go to war without wise guidance; victory depends on having many advisers.” – Basically what is being said is get the advice of many wise professionals. Sift through the information find the consistencies and inconsistencies and determine what route works best for your individual situation.

****Again, I will say that I am not legal counsel and what is posted is meant to be illustrative and thought provoking only. Always consult legal counsel regarding your specific situation. If you need the name to someone that may be able to help you I can always refer you to quality professionals in their respective industries********

Grandma and Grandpa Learned me Good!

Death is an inevitable part of life. Everyone will experience losing a loved one at some point of their life. Losing a loved one is a very difficult thing to process. It can stop you in your tracks and send your mind into warp speed. As your mind is warping you think about what I should have done, need to do, regret doing, and all the ways that you failed to connect to the loved one you have lost. Then you step back for a moment and begin to remember all the good things that you did with the loved one. You begin to see all the things that they had taught you that you did not know were lessons at the time.

As many of you already know I recently lost my Grandmother. Evelyn Freeman was one of the greatest people that I have had the opportunity to be influenced by. She was a mother, daughter, wife, grandmother, great-grandmother, friend, confidant, disciplinarian and most of all a teacher. It is because of my Grandparents that I am so sharp with my math skills. We would sit down at the table and play 10,000 which has various forms. We play with seven dice and have for the last 30 years. The game requires addition, quick number recognition and some luck if you want to beat my grandfather. After we took each other’s money playing 10,000 my dad and grandpa would begin to snore and grandma and I would sit up and play Skip-bo. This was another game that required math skills and the ability to plan ahead, have a strategy, notice potential obstacles, and be crafty and alert. I lost a lot but my grandmother would give in and let me win a few to keep me going. Many times she would stop and say did you see this Mathew? You could have done this if you would have been patient.

Here are a few things that Grandma and Grandpa taught me:

Commitment – 68 years my grandmother and grandfather were together. They were committed to their relationship that may not have always been just peachy. Through the good and the bad they stuck by each other and worked through it. Grandpa was a farmer and crops were not always plentiful. There were many times that their home value tanked and others when it sky-rocketed. Grandma and Grandpa knew a few things.

1. They always needed a place to stay and so they saw their place as “home” first and an investment second(it’s worth 77 times what they paid for it years ago).
2. Slow and steady wins the race. They were never in a hurry to make significant upgrades that they could not pay for with cash. Their “home” provided everything they needed. Although many of their friends were building palaces that eventually crumbled they stuck together.
3. Maintaining the goal of paying off the mortgage so they had to answer to no-one when they could have pulled out lot’s of money to do what they loved, Gambling.

Price is what you pay value is what you get – Grandma and Grandpa paid the price of hideous wallpaper that still resides on the walls in exchange for the ability to live without financial fears. As the crop failed they knew that they had enough seed stocked away to get them through the times. The wallpaper can wait. They did not rush to buy the next big thing. They also always stuck with a fixed rate mortgage. One term and done. If they refinanced they made sure they they stayed on track to pay off. Never backwards.

A slow start is a good start – This was a saying during every dice game when grandpa was losing. What he was really saying was: Every strong household needs a solid foundation. There is no need to rush anything in life. Live in the moment and understand what the future may bring. Know your history and be prepared for it even if it requires you to stay in second gear a little longer. “Don’t be lightning McQueen and allow your tires to blow!” When you build a foundation that is solid you will always catch up to the others. Just think about the three little pigs:)

Exercise good Judgement – Going back to skip-bo grandma was trying to tell me not to get ahead of myself. Study the board and my opponent, my market, prepare and seize the opportunity when it presents itself. Today’s market is that opportunity. Low prices and low rates. A perfect storm if you will. The government will pay you to buy your first home. Let your opponent show their cards and then make your first move. Always have a counter and never be too desperate.

1. Exit Strategy – So much of the market mess was created by the lack of an exit strategy. We knew how to get in and capitalize if the market stayed the course. We did not plan a strategy to get out. Long term hold, investment that pencils out from the gate, ability to stay the course as things go awry, and the ability to avoid panic. A carefully crafted exit strategy can be the difference. Grandpa and Grandma stayed the course and were always in a position to sell if they needed to simply because they did not leverage their home for toys.

Risk only what you are willing to lose - As I said earlier my grandparents loved to gamble. They always seemed to win although I know that this was not always the case.  What I began to realize as I grew older is that they only gambled with what they were willing to lose. This gave them the ability to to play freely. They did not have to worry about the downside of a bet. Lose and go home to play again another day. They did not gamble what they could not afford to lose. Many of us gambled with the very thing that we could not afford to lose. We took major risks, we rushed, bought more of a home than we ever deserved to own and now we are hoping that others can bail us out. Believe me when I say I am not criticizing. This was a hard learned lesson. For those that read this and say I have done everything right. My home is upside down and now I have to bailout all the others that made the mistakes my grandparents would have said:

1. No-one else matters. Are you selling your home? If no then remember that our home is worth 77 times what we paid for it. Have you lived in your “home” for 45 years. Be patient and you will be rewarded for your patience.
2. A slow start is a good start – so you started backwards – you are now only left with forward – cherish it!
3. Owning a home is like marriage. It is a commitment that you must stick with. Don’t divorce your home at the first sign of adversity. Remember what you loved about it in the first place and focus on that. In the waning moments of my grandmother’s life she looked over at my grandfather and said, “I always had an eye for that man.” She remembered that her commitment was to the very end.
4. Remain childlike. Continue to question until they day that you are gone. My grandpa said to me the other day, “Mathew I am always learning something new. I know a lot about farming but the things that they can do now days. I just finished learning about a new almond tree that does not require pruning or bees. Bees are $145 a hive driving the profit down. We will see how they yield in comparison but they are the new thing.” Perspective for a moment, this is my 93 year old grandfather who can spit out the number of days before corn will produce good silage. 105 days if you were wondering.
5. Use or lose it! Freeman’s live long and it is mainly because they continue to challenge themselves to the end. We are a stubborn bunch who are strapped with curiosity. That game 10,000 not only taught me the sharp arithmetic skills that I have come to love but it kept my Grandparents learning and teaching.

If you are one of the many that lost your home to foreclosure or had to short-sale just know that this does not define you. How you bounce back will. I strongly suggest Dave Ramsey’s Total Money Makeover it will change the way that you look at money management forever. Three years and some guidance from one of the most sought after finance educators in the country and you will have positioned yourself to buy again. If you are one of those that has done everything well and were a victim of the market answer this: Do you open your 401K statements and look at the balance weekly? If you answered know then stop thinking about the house.

In conclusion, when I was reflecting back on the life of my Grandmother I began to realize that I am in such a hurry sometimes. Why the rush? My grandmother lived 89 happy years and one of the last things that I heard her say was I always had an eye for that man. Take care of him. She knew what was ultimately important. She also asked to go in her home. Not a convalescent or a hospital room. No, she wanted to go in the very home that she spent her life in. Home-ownership to my grandmother was a commitment. One that was not rushed, doctored up, neglected, but one that was honored. She was humbled by the fact that she was allowed the opportunity to own acreage in the heart of the valley. Prime agricultural Real Estate. She was not willing to risk that and move to bigger and better. She gambled only what she was willing to do without.

In loving memory of Evelyn Freeman. You will forever be missed but never forgotten. May your lessons continue to be passed on for generations to come.

Definitons: DTI also known as debt to income

DTI also known as debt to income is becoming one of the most important factors when obtaining a loan. The debt to income is a ratio of your debt versus the gross monthly income. This ratio is largely evaluated when determining the risk of the loan. Here is how we calculate your debt to income.

Front end debt to income is the total housing expense divided by your gross monthly income. Total housing expense includes your principle and interest, mortgage insurance, taxes and homeowners insurance monthly. This is commonly referred to as PITI, principle, interest, taxes and insurance. The mortgage insurance is not always charged.

Ex. (excludes mortgage insurance) 100K loan amount @ 6% interest = $599.55 principle and interest + $104.17 taxes and $30 for homeowners insurance = $733.72. If you make $3,000 per month gross then your front end DTI will be $733.72/$3000 = 24% housing debt. This means that your housing debt monthly is 24% of your gross monthly.

The back end ratio which is very closely looked at will take into account the minimum monthly debts that you are expected to pay that report to your credit. Examples include credit card minimums, car payments, student loans, or any other note loan. So the back end ratio will be the housing expense + all the minimum amounts due divided by your gross monthly.

Ex. car payment = $300, credit cards = $300 and student loan = $200 then you have $800 debt load per month. If the house payment is $733.72 + $800 = $1533.72 divided by the gross monthly income of $3000 will give you the back end ratio of 51%.

51% back end ratio would be considered very high and you would have to have compensating factors.

When evaluating your own debt to income simply remember the new total housing payment + other debts that are required to be paid on the credit divided by your gross monthly income should give you an idea. The recommendations for an FHA loan are 31/43 which would include the additional payment of mortgage insurance. Dave Ramsey in his book The Total Money Makeover recommends that your housing payment or front end ratio should never exceed 25%.

Your Mortgage: Liability or Asset?

There are many schools of thought that will argue the above question until the end of time. There are those that believe that we should never pay off a mortgage because we need the tax benefits. There are others that believe that we need to pay off the Mortgage as fast as we possibly can. Owe No one would be their credo.

Whether you are the former or the latter you have your reasons and you are entitled to them. I think that for the public to form their own opinion on the subject, it would be wise to first define Asset and Liability.

*Asset – any item of economic value owned by an individual or corporation, especially that which could be converted to cash. Another definition is an item of valued owned.

This can be very tricky to many but think about a car real quick. Who has the pink slip if there is a loan on the car? The answer is not you! It is the banks asset and your liability. As for a mortgage, if you owe the bank then the Real Estate Market will determine if you can convert that to cash or not. Only when you own the home free and clear do you have the control of cash conversion. (ASSET)

*Liability – An obligation that legally binds an individual or company to settle a debt.  Also, one that acts as a disadvantage.

Basically the definition states Binding, Debt, and Disadvantage. All words that seem to have a negative connotation to them when we are talking about becoming wealthy.

Dave Ramsey, accomplished author that has written the bestseller The Total Money Makeover, A proven plan for financial fitness; talks about the mortgage in his book. He states that there are two myths 1) it is wise to keep a mortgage to get the tax deduction and 2) It is wise to borrow all I can from my mortgage because of great rates and then I can invest it.

While I believe that there is never a completely correct answer Dave Ramsey raises a few good points. If you pay mortgage interest in the year and you are in a 33% tax bracket then having a mortgage saves you 33 cents on the dollar. If you did not have a mortgage you could have saved the whole dollar and given Uncle Sam 33 cents at the end of the year. You do the math. 

Would you rather pay the IRS because you have no debt or save some of what you would pay the IRS because you have a mortgage. Your Choice.

Second I do not think that it is bad to borrow from your home if you reduce the term of the loan. For Example. If you take out 50K to do some remodel and you have had your mortgage for 6 years out of thirty then get a twenty year when you take out the money. Do not start back at 30 years as it will set you way back.

Another thing to consider is that to get a 30 year and pay extra to pay it off in fifteen is not as good and cost more than getting a fifteen year fixed mortgage period. (This is a whole other blog topic).

In conclusion, your mortgage by definition is a liability until you have the deed to the property. Until you own the home free and clear your mortgage is a liability with some benefits that other liabilities don’t have. If you are looking to accumulate wealth in your lifetime then I would think it to be wise to consider how to pay off your mortgage. The mortgage is a necessary liability to home ownership. Learning to structure the liability is the key. Do not buy a property that stretches your debt to income to the max. Your mortgage payment should be no more than 28-31% of your gross monthly income. Also, I think that it is important to see what your other obligations you have and evaluate if paying them off first would help.

I beleive that it is important to have a plan, know where you want to go and consult professionals to help you get there.  As most of this is simply an opinion shared by some and not others it is simply one point of view. It is merely illustration.

*The definitions were taken from investorwords.com and Merriam Webster on-line.