How To Buy A House In An Expensive Area

July 12, 2018

Owning a home is a financial goal for many Americans. For those who live in the most expensive real estate markets, like the New York City area, the D.C. area, the Boston area and pretty much the entire states of California and Hawaii, that goal may appear hopelessly out of reach. Median housing prices in these regions are astronomically high compared to the U.S. median home price ($264,800 as of May 2018). How do you save enough for a home down payment when you are already paying very high rent as a percentage of your income? It can be done, but it’s not likely to happen the traditional way.

Make sure it makes sense to buy

Buying a home is likely to be the largest financial commitment you make in your life. Make sure that it really makes sense to buy instead of continuing to rent. As I’ve said before:

“Real estate is like marriage. The wrong choice can really mess up your life. Renting, on the other hand, is like dating. It’s something you should keep doing until you are sure you want to settle down and are ready for a committed relationship. Many people are happy dating – and renting – for a long time before they decide to commit.”

If you are ready to commit to a geographic location (and school district, if you have kids), the next step is to evaluate if it makes sense in your geographic market. Is it cheaper to rent or buy? Use this tool from the New York Times to run the numbers.

Calculate your home budget from your rent

If you are renting, you may already be paying a mortgage, interest and property taxes – your landlord’s. Use your monthly rent as a starting point for how much you can realistically afford to pay every month in total housing costs. Last week, I spoke to an employee on our Financial Helpline who wanted to buy her first home in Southern California. She and her husband paid rent, not including utilities, of $2,800 per month. We ran some numbers (see the calculation here) and determined that if their housing costs were similar, they could support a mortgage of $460,000 to $510,000.

You can run your own assessment with this calculator. Make sure you include assumptions about down payment, mortgage term, mortgage interest rate, private mortgage insurance (mandatory with a low down payment mortgage), homeowner’s insurance and property taxes. Don’t forget:

  • If your current rent includes utilities, make sure you back out the average cost since you’ll be paying those directly as a homeowner. Keep in mind that if you’re increasing your home size (e.g., from a 2-bedroom apartment to a 3-bedroom single family home) your energy costs will probably increase.
  • If you’re looking to buy a condo or home, your current rent must support a mortgage, interest, insurance, taxes – and possibly HOA fees.
  • Home maintenance will be extra. Be prepared to budget an additional 1 to 4 percent of your purchase price annually for the care and upkeep of your home.

Don’t fixate on one neighborhood

You may love where you are living now, but there is more than one neighborhood for everyone. You may find that looking outside of your current area opens the possibility of lower home prices, better schools or a more spacious home. I suggest you house hunt in a minimum of three different neighborhoods before you settle on your top target location.

Look at your trade-offs

For example, if you live closer to your workplace so you can walk to work and to the grocery store, you might be able to give up one car. Conversely, it may be worth paying more to keep your child in their school. Consider the commute time and the effect on family life. As the saying goes, you can have anything you want but not everything you want.

Explore first time homebuyer programs

Lenders typically require that home buyers pay at least 20 percent of the home’s purchase price and will offer a mortgage of up to 80 percent of the appraised value of the home. In an insanely expensive real estate market like Southern CA or the NYC region, where median home prices are very high, a 20 percent down payment could amount to several years’ salary.

Accumulating that large of a down payment may not be realistic while you are paying high rent each month, but that does not mean you can’t buy a home. You could be eligible for a low down payment mortgage backed by the FHA, VA, USDA, or Freddie Mac, with some as low as 3 percent of the purchase price. Explore all the first-time home buying programs summarized in this article.

City, county, and state governments may also offer down payment assistance programs, so check and see if you qualify. For example, I encouraged the helpline caller I mentioned to check out the CA Housing Finance Agency for down payment assistance as it appeared that she might qualify based on her household size and income. A similar family in NYC could check out their Home First Down Payment Assistance Program.

Downsize your lifestyle while saving for a down payment

During the 1-3 years prior to your home purchase, consider downsizing your lifestyle to save as much as possible for your home down payment, closing costs, and moving expenses. If you can shave off just $10 per day by eating at home more and put that money away in a savings account or money market fund, you will have $10,800 after three years. (See calculation here.)

Let’s say you downsize from your 2 bedroom to a studio apartment and save $600 per month. After 3 years, you’d have $21,600. (See calculation here.)

Do both? That’s $32,400 after 3 years. (See calculation here.)

Perhaps you have kids and it’s not realistic to move into a smaller space? Consider downsizing other areas of your financial life, such as going from two cars to one. I gave up my car in my thirties when I lived in an urban area and our Forbes blog editor Erik Carter went carless as well. We both saved thousands in transportation costs. If you’ve got kids, it may be impractical to get around everywhere without a car, but do you really need two?

Even if you can’t downsize your housing or your transportation, you may be able to downsize other areas of your lifestyle, such as cooking more at home, managing the high costs of your children’s sports, and foregoing some small luxuries while you prioritize home savings. Need more ideas? Check out my post on 11 Easy Ways to Save Money Without Changing Your Lifestyle.

Maximize your credit score

The higher your credit score up to a certain point (about 760), the better the mortgage interest rate you will receive. Those homebuyers with better credit will be more likely to be eligible for a lower down payment program than those with poor scores (although programs are available for both). A lower mortgage interest rate also means you’ll be able to buy more home for what you can afford every month. While it can take 5-7 years to dramatically improve your credit score if it’s very low right now, you may be able to improve your credit score incrementally and quickly by using these tips.

Consider multi-family housing

Are you interested in also being a landlord? Both conventional (20% down) and flexible down payment FHA or Freddie Mac backed loans are available for owner-occupant duplexes and small (up to 4 units) buildings so you and your family could live in one unit, and you could rent out the remaining units. If you have long term leases in place before purchase on the other units, you may be able to use the projected rental income to help qualify you for the loan. If you think you have landlord potential (take this quiz to find out), a multi-family home may help you get in your own home and build a portfolio of investment properties.

 

This post was originally published on Forbes.

Are You Really Ready To Buy A Home?

July 09, 2018

With mortgage rates and home prices on the rise, many people are scrambling to buy a home before homes become even less affordable than they already are. If you don’t own a home, should you jump on the home buying bandwagon? Here are some questions to ask yourself first:

How long will you keep the home?

Don’t count on home prices to keep rising forever. At some point, rising mortgage rates and a weaker economy could mean lower home prices just when you want to sell. Just like with stocks, real estate should be thought of as a longer term investment for at least 3 – 5 years. Unlike stocks, falling prices could leave you owing more in mortgage debt than you own in real estate.

Even if home prices don’t fall, real estate transaction costs can more than wipe out any short term profits you make. In some cases, renting can make more financial sense. Check out this calculator to see how long you’d need to own a particular home to come out ahead of renting.

How much can you afford?

Take a look at your actual expenses to estimate what you can afford to pay. Don’t forget to include home insurance, property taxes, and possible HOA fees in addition to the mortgage payment. It’s important to do this before you start looking at homes and talk yourself into believing you can afford something that you can’t. (don’t forget increased utilities if you’re looking to upgrade to a larger space either)

How much do you have in savings?

Ideally, you want enough to put 20% down and avoid having to pay private mortgage insurance. You’ll also need 1-3% to cover closing costs plus however much you intend to spend on moving, renovations, and furnishings. Keep in mind that this is on top of the 3-6 months of necessary expenses you’ll need in your emergency fund, especially now that you’ll be on the hook for maintenance and repairs.

How is your credit score?

The lowest credit score to qualify for a mortgage is typically 620 for a conventional loan and 580 for an FHA loan. A credit score of 740 is generally needed to get the best rates though. If your credit score needs some improvement, you may want to start by checking your credit reports for errors (you can get them for free every 12 months at annualcreditreport.com) and dispute any negative ones that you find. Paying down debt and making on time payments helps too. You can get a free credit score and evaluation at creditkarma.com.

Do you have any high interest debt?

In addition to improving your credit score, paying down debt can also improve your debt-to-income ratio. This doesn’t mean you need to be completely debt free, but lower is better. Focus on high-interest debt like credit cards and personal loans.

If you plan to keep the home long enough to make it worthwhile, know how much you can afford, have adequate savings, a good credit score, and no high interest debt, you’re ready to buy a home. Just be sure to stick to your housing budget. If not, you may want to get your proverbial house in order before you buy one.

 

 

What It Was Like To Buy A Home Through The NACA Program

July 06, 2018

If you have read any of my former posts, you probably know that at one point my husband and I were what you would call in the South, a financial “hot mess.” In order to get out of it, we decided to sell everything but the kids (trust me, at times I was really tempted) and rent until we became debt free (about $150K in debt).

Getting started on buying a home

After our debt payoff we knew we wanted to buy a home. Once we built our emergency savings and saved enough for a 20% down payment, we explored our options. We researched home-buying programs in our state (Georgia) and learned that the definition of a “first home-buyer” varied. It could mean you have not owned a home in the past 2-3 years or it could mean that you do not own a home at the time you enter the program. We also learned that some home-buying programs do not have an income cap.

Exploring NACA

As I explored programs, a few friends of mine mentioned the Neighborhood Assistance Corporation of America (“NACA”) program. NACA is a nonprofit, HUD-approved community advocacy and homeownership organization. NACA partners with banks such as Bank of America and Citigroup to provide affordable homeownership with a focus on low to moderate income people and communities, particularly those who are credit challenged.

NACA criteria

In general, the potential home-buyer (oftentimes called a “member”) is required to meet the following criteria:

  • You must not own another property when closing on the NACA mortgage
  • The home must be occupied by you, the buyer, for the life of the NACA loan
  • You must volunteer to help with the program (there’s lots of flexibility in what is considered volunteering)

NACA perks

Some of the perks of NACA are:

  • No down payment
  • No closing costs
  • No points or fees
  • At or below market interest rate (everyone receives the same terms)
  • Ability to buy down points to virtually zero (the points a member can buy down typically depends on the buyer’s income and chosen mortgage – 15 year or 30 year)
  • No income maximum or minimums
  • No perfect credit required
  • No credit score consideration (approved based on individual circumstances)
  • No Private Mortgage Insurance (PMI)

Our friends were honest about the fact that the process is slow and the paperwork is huge. Since my husband and I were flexible on the date we wanted to own a home, we said what the heck, and started the NACA process.

Our personal NACA experience

You can talk to 10 people who went through the NACA process and you will hear 10 different perspectives. This was our personal experience, which I understand may vary from other people who used NACA for a home purchase.

Getting started: the first home buyer workshop & working with your MC

First, you must attend a workshop to get into the NACA Program. After the feedback from friends who went through NACA before, we went ahead and attended the workshop a year before our desired home purchase date. Luckily we got there early, as there were over 300 people in attendance.

The presenter did a great job going over the good, bad and ugly of the process. He mentioned the process can take a year or more depending on the financial stability of the member. You get a workbook explaining the process. Afterwards, I had to fill out paperwork and I was told that we would be contacted for our first meeting.

In my case, I had to reach out to NACA to schedule our first meeting with a housing counselor (sometimes called a Mortgage Consultant or MC). The first available meeting was a month later.

Meeting with the Mortgage Consultant (“MC”)

The main job of the MC is to ensure you are ready for homeownership. We had a huge list of required financial documents. We also needed to get a tax transcript of our last two tax returns. We had to have ours sent by mail, which took about 2 weeks, so in retrospect, we would have ordered our transcript before that first appointment. We also needed employment verification information.

Our MC combed through all of our financial information to verify our monthly savings, income, expenses and on-time payments. We had to explain any unusual deposits, including tax refunds. The MC entered our financial information and gave us an action plan of additional information needed to move forward. Our MC also discussed the mortgage options and we were told our maximum home purchase price. The total meeting time was about 2 hrs.

Working with your MC

I had read so many comments about how difficult it is to communicate with an MC, so I asked when was he typically at work (including upcoming vacations), the best way to communicate with him (email, through the NACA portal, by phone, etc) and the most efficient way to send him requested documents. From what I understand, most NACA offices are understaffed and the MCs are typically overworked. That basically means your MC may not have time to consistently work on your file.

Being persistent

Consider scheduling appointments, even if by phone, to block out time for your counselor to focus on your file. Review all paperwork to make sure all information is accurate. Follow-up at least weekly with your counselor on the status of your file (this is why it is so important to understand how to best reach them and their schedule).

If you cannot reach them, contact the NACA office. The staff may be able to access your file and give you an update. Unfortunately, my first MC quit, and our file was lost. We had to start the entire process over again with a new MC. We asked her the same questions to understand how to best work with her and she was very efficient. We were NACA Qualified, preapproved for a mortgage, about a month after she took over our file.

Once you’re NACA qualified

Once we were “NACA qualified,” we had to attend another workshop on purchasing a home. We received a qualification letter before the meeting that we were told was good for 90 days, so we attended the first workshop available so that we could get started on buying. If there is one time in your life to be 100% alert, it is at the purchasing workshop.

The workshop presenter went over the entire NACA homebuying process and he was very blunt about how difficult and time consuming the process can be. He warned that if anyone was under a tight deadline, that NACA may not work. Do not leave with any unanswered questions – I asked questions for about an hour afterwards.

Choosing your Realtor

At this point, it was time to choose a Realtor. NACA pushed hard for us to work with an in-house NACA Realtor, but we decided to work with an outside Realtor who had NACA experience. I cannot overstate how critical it is to choose a Realtor who is knowledgeable about the NACA process. Our realtor, Nicole, ended up being a lifesaver in guiding us through the process.

Once you’ve found your home

Once we found the home we wanted to purchase, we started the process of getting the house under contract. NACA is very specific in the language that must be used in the Purchase and Sales contract for your future home, which is one way that Nicole helped tremendously.

Dealing with the NACA inspection

The home inspection must be done by a NACA approved home and pest inspector, and once complete, the inspector sends the report to NACA for review. At that point, we received a list of required repairs that had to be addressed in order to purchase the home through the NACA.

This process can be difficult. The reason why NACA is so stringent is that they want to ensure that the buyer is not going to move into a home with so many issues that it puts the buyer into financial peril.

The stringent NACA home purchase criteria is part of the reason that some Realtors will talk a seller out accepting an offer from a potential buyer using NACA, which almost happened to us. Nicole understood the concerns and was able to address this privately with the seller’s Realtor. This settled her nerves and she and the seller agreed to work with us.

We worked with our Realtor to decide which repairs we would address and which repairs we wanted to ask the seller to address. A buyer has the choice to pay for repairs out of pocket or potentially wrap the cost into their mortgage. Again, I cannot overstress the importance of working with an experience Realtor. Nicole saved the deal.

Verifying that you’re still qualified

After we were approved to moved forward after the inspection, we had to be approved for NACA credit access, which verified that we were still NACA qualified. (did I mention the loads of paperwork?) Once we were approved, we completed the NACA loan application. This process went extremely quickly for us in large part of the upfront work we did:

Making the loan application easy:

  • We organized all the required information in Google Docs ahead of time
  • We made sure that we remained NACA qualified throughout the process
  • We made a point to understand the way our housing counselor wanted to receive information
  • We kept our files up-to-date with the latest account and pay information
  • We quickly provided any requested documents
  • We obtained an efax number to send documents that had to be faxed
  • And again, we had an experienced Realtor.

Getting to the closing table

At long last, our file was transferred to a closing coordinator. I immediately contacted her and asked her the same communication preferences I asked the MC. She was very efficient. At this point the seller had finished the repairs he had agreed to and the home inspector re-inspected the house.

We also had to find a contractor for the repairs we were required to fix. To speed up the process, I choose a few contractors from the NACA approved list and luckily, they were able to provide bids on the needed work quickly. In fact, because these contractors understood the NACA process and were quick with their responses, we received our “Clear to Close” ahead of schedule!

After closing

At closing, we learned about the NACA Post Closing Program, which offers free comprehensive counseling, including financial and credit guidance, short-term financial assistance to help pay the mortgage and even assistance with a loan modification if needed. This was nice to know – they really do want to help build great neighborhoods!

Worth it in the end

The process was long and tough, but for me it was worth it in the end. We ended up with a 15 year mortgage with an .65% interest rate that easily fit into our budget. (no, that decimal is not out of place – our interest rate is really less than 1%)

Deciding if NACA is right for you

If you are interested in doing a loan with NACA, you have to have a lot of flexibility on the date you want to be a homeowner, a lot of organizational skills to balance the process, and patience not to scream as you are being asked to send in a document yet another time. Chocolate was the best coping mechanism for me. If you can make it through the process, it’s a great deal.

 

Is A 15 Or 30-Year Mortgage Better?

June 13, 2018

One of the most common questions we receive as financial coaches is, “Should I do a 15-year or 30-year mortgage?” Maybe you’ve heard that a 15-year is better, but like many financial questions, it really depends on your personal circumstances. Let’s take a quick look at the history of mortgages and explore the criteria for deciding.

Why are mortgages 30 years anyway?

Prior to the Great Depression, mortgage terms were actually shorter, but in order to stimulate home-buying as the economy turned around, the government agreed to back longer-term loans. The thinking on the 30-year loan was that a person would be able to pay off the loan over the course of their working years. This was obviously back when many people purchased one home and lived there for the rest of their lives.

While many credit the 30-year mortgage for fueling the American dream of owning your own home, we have recently started to see a call for the end of the 30-year mortgage due to concerns about the amount of interest that borrowers pay, along with recent abuses of the system. (remember the 2008 financial crisis? Blame it partially on mortgages lent to unqualified borrowers)

That fact of the matter is, in most developed countries, the 15-year mortgage is the standard.

Breaking down the numbers

The concern about the amount of interest paid on a 30-year mortgage is easy to see once you enter it into a calculator. On a $244,000, 30-yr mortgage at 4.5%, the buyer would end up paying $201,000 in interest over the life of the loan PLUS the original $244k borrowed. Compare financing that same amount using a 15-year mortgage at 4% (the shorter timeframe usually also comes with a lower rate). The total amount of interest paid drops to just under $81,000. That is 60% less interest!

That same calculator also illustrates that much of the interest is paid in the earlier years of the mortgage. This is especially important when you consider that most people will not live in the same home for 30 years. If you make 2 – 3 home purchases over your lifetime as many of us now do, while continuing to choose the 30-year option, you are restarting the interest train without making much of a dent in the principal.

Why doesn’t everyone just choose 15 years?

It certainly looks appealing to see that interest amount cut down by 60%, but one mortgage calculation does not settle the debate. When someone chooses a 30-year mortgage, they are exchanging payment flexibility with the cost of the interest. Depending on your circumstances, the 30-year mortgage payment may be better for your budget. Here’s how to decide.

What can you afford?

First, consider the amount of the mortgage in my example above of $244,000. That is the average amount of national mortgage originations. $244,000 could easily help you get into a 3,000 square ft home in my part of Tennessee, but in many areas of the country that same amount wouldn’t even get you into 900 ft condo. Therefore, a 15-year mortgage fitting into your budget will vary depending on where you live. To satisfy your housing needs in certain areas the 30-year may be the better option.

Do you need payment flexibility?

What about future income? Are you planning to go from a 2-income home to 1-income in the future? The lower 30-year mortgage payment offers flexibility for those future changes. One way to hedge would be to pay your 30-year mortgage at the pace of a 15-year, then drop down to the 30-year payment when your life dictates. This will definitely save you in overall interest costs.

How to get 15-year results with 30-year flexibility

One way to give yourself the flexibility of a lower payment over 30 years but with the intention of paying less interest would be to pay the same amount of a 15-year mortgage while signing up for a 30-year mortgage. This is also a helpful way to go about it if you’re already in a 30-year mortgage and don’t wish to go through refinancing.

Typically, 30-year mortgages have a higher interest rate, so it would cost a little more than the normal 15-year mortgage  to do this, but again you keep the flexibility of the 30-year mortgage. If you paid the 15-year payment to the loan in the 30-year example, you would pay off the loan in 15 years and 10 months. The total interest over the life of the loan would be $97,000. In other words, you’d pay an extra $16k over an extra 10 months for that flexibility.

To achieve these results you have to maintain a disciplined approach. One way to make sure the payments occur regularly is setting up an automatic debit from your checking to your mortgage. Also be sure to confirm those extra payments are being applied to principal and not just treated as early payments.

Look at the big picture

It’s important not to make this decision in a silo though. Technically speaking, a 15-year mortgage will always make more financial sense when you’re strictly looking at total interest paid over the life of the loan. However, if committing to the higher monthly payment would compromise your ability to save for the future or potentially cause you to take on credit card debt, then the benefits of saving on interest could be negated by lost opportunity in saving or higher interest paid on credit cards.

Like most things with your personal finances, it’s a trade-off. What is most important to you?

Important Home Maintenance Tasks I Do Every Spring

June 01, 2018

Being a homeowner comes with a lot of pride and satisfaction, not to mention the financial benefits of building equity over time. But it’s not all fun and games — owning a home also involves a lot of work to protect your biggest investment.

Spring is a great time to spruce up the yard, wash away the grimy left overs of a long winter from the garage and windows, and do some basic maintenance to address any other issues that may have popped up over the winter. Here are some of things on my spring to-do list to keep my house intact and running efficiently:

Inspect the roof

I have asphalt shingles on my roof, and they are certainly subject to damage from wind, hail, and water. The roof is the first line of defense against water, so making sure it is in good repair is very important.

How I do it: I like to hop up there in the spring and make sure there are no damaged or missing shingles (I also do this after hail storms we are prone to get in Colorado). If there are, I will call a licensed roofer to handle the repairs to make sure no water is getting into our home.

Clean the gutters

The gutters and downspouts are designed to divert water away from our house to prevent water from collecting around the foundation. Clogged gutters and downspouts can also cause wood trim to rot, which give critters access to the attic.

How I do it: I clean ours in the spring and in the fall to make sure they are running freely. It is easy to do with a blower, hose, or your hands (but wear gloves – you never know what may be in there).

Check the sprinkler system

I am big on having a nice lawn so my sprinklers and drip irrigation are important to keeping everything looking its best.

How I do it: I always run the system through all the zones and walk around the yard, making sure no sprinkler heads are broken. I also adjust the heads that are spraying the wrong way (there is always one or two that want to water the sidewalk and street) to avoid wasting water. (Sidenote: I also try to water early in the morning or later in the evening when it is cooler so water is not wasted in the hottest parts of the day).

Heads that are hitting the house or fence can also cause damage. I have been working with sprinklers for a long time, so I typically do this myself. But if you are not sure how, or you have bigger issues like burst pipes around the backflow, best to call in a pro.

Check seals around windows and doors

Sometimes harsh winter weather can harden or crack caulk around windows and weather seals around doors. This can drive up cooling costs in the summer and let water in.

How I do it: I like to inspect all the seals in the spring then make any needed repairs. This is one I can almost always do myself after a quick run to the hardware store.

Inspect the driveway and sidewalk

Dramatic temperature swings that cause freezing and thawing is brutal on concrete. Large cracks are a safety hazard and possible liability concern for homeowners.

How I do it: After the snow and ice has melted (and there’s little chance of it returning, although this is always a toss-up in Colorado), I take a quick tour of the paved surfaces to see if there are any new issues. This one is out of my skill set, so I suggest a professional to make any needed repairs.

Other things to consider

I also like to wash the windows inside and out (ok, to be honest, my wife does this one). It makes the house look nice and allows more light to come in.

I would also suggest checking for any peeling paint as that can lead to water damage. Other tasks include:

  • Having your A/C unit serviced and filters replaced
  • Cleaning out dryer vents
  • Checking the washing machine fill hose
  • Cleaning and fixing damaged screens
  • Replacing smoke detector batteries

Hopefully this gives you some ideas to help avoid costly damage to your property by doing some maintenance around the house this spring. If nothing else, now you have plans for next (and maybe the next after that) weekend!

How To Invest In Real Estate

May 25, 2018

Once you’ve decided that you’re ready to invest in rental real estate and taken the quiz to see if your personal finances and real estate knowledge are solid, you need to decide what kind of investor you’ll be.

Know your investor personality

When it comes to managing your real estate investments, would you prefer to be heavily involved in the day to day or a passive investor that puts their trust in someone else to manage things?

If you want to be a “hands-off” real estate investor, then you’ll have little to no involvement in the selection and management of investment properties themselves, and instead will be putting your money and trust in a team of real estate professionals to make those decisions for you.

Alternatively, if you have the time, knowledge and interest in the real estate world, you may choose to be a “hands-on” investor. That means you’ll be actively researching, selecting, and managing individual investment properties, although you may choose to hire a property manager to handle the day-to-day work associated with any of your investment properties.

Evaluating Your Real Estate Investing Options

ACTIVE REAL ESTATE INVESTING OPTIONS FOR HANDS-ON INVESTORS

Single family home

A single-family home is a standalone house meant for one family.

Pros

  • Families can be long term tenants
  • Most potential for appreciation
  • Easiest to sell

Cons

  • Maintenance is more expensive
  • Lots of capital is required to develop a diversified portfolio

Condominium/Townhouse/Co-op unit

Single unit condos and townhouses have similar investment characteristics as single-family homes. Co-op units are similar, but may have additional community regulations for owners and tenants.

Pros

  • Generally less expensive
  • More urban opportunities
  • Condo association pays maintenance

Cons

  • Condo or co-op association fees and assessments
  • Co-op board must approve tenants (but not condo boards)

Fix and flip

A fix and flip involves buying a house that needs updating, making renovations, and then selling quickly (hopefully for a profit).

Pros

  • Potential for a quick profit
  • Flipping looks so fun on HGTV
  • Get paid for sweat equity

Cons

  • Unanticipated renovation costs
  • It could take longer to renovate or sell
  • Carrying costs if the home doesn’t sell

Multi-family (2-4 units)

Multi-Family Housing contains independent dwellings from more than one family. This could be a duplex (2 units), a threeplex (3 units), a fourplex (4 units) or an apartment building (5 more units).

Pros

  • Multiple monthly rents
  • You can be an owner-occupant and investor
  • Owner-occupied 2-4-unit buildings can be financed with lower down payment loans

Cons

  • Increased landlord responsibilities
  • Maintenance more expensive
  • Apartment buildings (5+ units) are financed by an apartment loan

Manufactured/Mobile/Tiny homes

A manufactured home is ready once it leaves the factory. A mobile home is a standard sized trailer which is placed in one location.

Pros

  • Inexpensive
  • Lower maintenance
  • Easier to purchase multiple units

Cons

  • Lower rent
  • Hard to finance
  • Higher tenant risk

Commercial buildings

Commercial buildings house businesses such as offices, retail stores, restaurants, etc.

Pros

  • Comes in many sizes and purposes (office complex, shopping center, medical building, industrial, warehouse, etc.)
  • Multiple monthly rents and flexible lease terms (e.g., tenants pay maintenance)
  • Objective standards for valuation
  • Tenants have strong incentives to maintain the property

Cons

  • Increased landlord responsibilities
  • Requires professional help to maintain property
  • Specialized commercial loans which may require a personal guarantee (recourse)
  • Large down payment

PASSIVE REAL ESTATE INVESTING OPTIONS FOR HANDS-OFF INVESTORS

Real Estate Investment Trusts (Publicly traded REITs)

Pros

  • Funds must pay out at least 90 percent of income in dividends
  • Publicly traded – easy to buy and sell during market hours
  • Own real estate without the headaches of managing it

Cons

  • Need to invest in many REITs to have a diversified REIT
  • Stock market risk
  • Requires faith in management to pick the right properties
  • Rising interest rates affect profitability

Mutual funds and exchange traded funds (ETFs)

Pros

  • Actively managed or passive index funds available
  • Diversification across real estate sectors
  • Publicly traded – easy to buy and sell during market hours
  • Own real estate without the headaches of managing it

Cons

  • Mutual fund trading can pass unexpected capital gains to shareholders
  • Stock market risk
  • Requires faith in portfolio manager if buying actively managed
  • Management fees

Crowdfunding sites

Crowdfunding sites match real estate investors looking for funding for their real estate project with investors looking to invest.

Pros

  • Invest in real estate loans
  • Crowdfunding site does the underwriting
  • Easier to build a loan portfolio

Cons

  • Poor investor protections/higher potential for fraud
  • Hidden fees
  • Loan risk and bankruptcy risk

Private placements – REITS and Real estate limited partnerships

Higher net worth (“accredited”) real estate investors have access to private real estate funds through private placement.

Pros

  • Potentially higher dividends or net income
  • Diversified portfolio of properties or loans
  • Funds which specialize (e.g., hospital properties, manufacturing, apartments, etc.)

Cons

  • Only available to higher net worth investors
  • High fees
  • Illiquid

Know your exit strategy before you invest

When investing in real estate, you must begin with the end in mind — before you even make an offer or purchase a fund, you need a plan for if and when you will dispose of your investment.

Decide ahead of time under what circumstances you will sell — after a certain number of years? Once the property has appreciated a certain amount? When you need the capital for something else? It’s important to establish this up front so that you aren’t at risk for emotional selling.

No matter what type of investor you are, or what type of property you would like to buy, if a short-term loss of value is something that would cause you to “cut your losses” and liquidate, you may not yet be ready to invest in real estate.

 

 

 

Are You Ready To Invest In Real Estate?

May 22, 2018

Owning homes, apartments or commercial buildings can be an excellent source of current and future income. Rental properties can help diversify your portfolio, generate cash flow, and build your overall net worth. However, successful direct investment in real estate, such as buying residential or commercial properties, or making a private investment in a fund which does, requires that you know the financial risks as well as opportunities and are in a good position to take them.

To know if you’re truly ready to invest in real estate, here are some questions you should ask yourself:

Why are you investing?

Make sure you know why you are looking to invest in real estate. Typical reasons include:

  • Wanting to own your own real estate business
  • Rental income
  • Investment gains through “flipping” (buying a property, improving it, then selling it quickly)
  • Buying a vacation home both for your use and for rental
  • Portfolio diversification

What type of real estate investment are you targeting?

The type of real estate investment you choose depends on your ultimate goals, your tax situation, your capacity for financial risk and your net worth. There are many ways to invest directly in real estate, such as single-family homes, 2-4 unit buildings, apartment buildings and commercial buildings. There are also privately managed real estate investment funds, such as real estate investment trusts and limited partnerships, where you can invest in a diversified portfolio of properties. To dive deeper into types of real estate investments, see this article on what to look for in an investment property.

Do you have the cash?

You’ll need a fair amount of cash, a good credit score and a stable financial position to invest directly in real estate. Make sure you have:

  • Zero credit card or other high interest debt
  • Cash for the down payment (typically 30 percent for an investment property)
  • Additional cash savings to cover any property improvements
  • Cash savings to cover a minimum of one year of the property expenses (taxes, utilities, property manager, maintenance, etc)

Realistically, to invest in and maintain a $200,000 property, you’ll need at least $60,000 – $80,000 in cash savings. To evaluate if you are financially ready to invest directly in rental real estate take this quiz.

How will you finance the purchase?

Investment property mortgages are generally not insured, so buyers are expected to put down 20-30 percent of the property’s value as a down payment. The FHA and Freddie Mac do have lower down payment mortgage programs for owner-occupants of multi-family properties, so check those out if you’re planning to live in the building.

You’ll need a high credit score (740 or above) to get the best mortgage interest rates. Before you speak to a lender, check your credit scores for free at annualcreditreport.com or an app like Credit Karma and if needed, take steps to try and improve your credit score quickly.

Are you able to accept the risks?

While real estate investments can help you build your net worth and generate income, there are substantial risks. Make sure you’re protected. Risks include:

  • Market risk – the real estate market is unpredictable and has a slow cycle
  • Vacancy risk – the property doesn’t rent or rents for less than you projected
  • Liquidity risk – you can’t sell the property or your share of the investment fund easily
  • Location risk – you pick the wrong location or something happens which changes location value
  • Diversification risk – you don’t have enough capital to build a diversified real estate portfolio
  • Tenant risk – your tenant doesn’t pay the rent or trashes the place
  • Legal risk – you face litigation from a tenant, neighbor or local government

What’s your exit strategy?

You can’t walk into an investment like this with the mindset of, “I just want to make as much money as possible.” That’s a recipe for disaster. Before you invest, make sure you begin with the end in mind with a clear picture of what your exit strategy will be.

Under what circumstances would you sell your investment? How much time will you give it? What does success look like, e.g., rental income, appreciation, etc.? When would you want to cut your losses if they occur? This is a very important and often overlooked step in the process, but it can make a big difference in the ultimate success of your venture.

Not sure if you’re ready yet?

If you’ve evaluated your situation and real estate knowledge and decided you’re not quite ready to be a hands on investor in real estate, that does not mean you must refrain from all real estate investments. If it fits your financial situation, you can invest in real estate mutual funds or exchange-traded funds (ETFs) in your retirement or brokerage accounts. That way you’ll still be exposed to the diversification that real estate provides, without exposing yourself to the financial risks you’re not ready to take.

Should You Pay Off Your Mortgage Or Keep The Tax Deduction?

May 09, 2018

One of the more common questions we receive as people prepare for retirement or just get close to paying off their homes is whether they should pay it all off early or keep paying on it to keep the tax deduction. Here are several reasons why this is a classic case of letting the tax tail wag the dog:

1) The interest decreases as a percentage of your mortgage payment. When you first take out a mortgage, most of your payments are interest so it’s mostly deductible. However, the interest portion steadily declines so that by the time your mortgage is almost paid off, your payments are mostly non-deductible principal. And with the new higher standard deduction amounts, a lot more homeowners may find themselves no longer itemizing their deductions even if they have many years to go on their mortgage (see reason #2).

2) The mortgage interest deduction may not benefit you as much as you think. In fact, it may not benefit you at all. As an itemized deduction, it only helps you to the degree that your itemized deductions exceed your standard deduction ($12,000 per person in 2018) since you only get whichever one is higher. If your standard deduction is higher, you don’t deduct your mortgage interest at all.

Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100. You can use this calculator to see exactly how much your mortgage interest is really saving you in taxes.

3) The cost of the interest is always more than the tax savings. Let’s assume that you have $10,000 in mortgage interest (not just payments) and all of that exceeds your standard deduction. Even if you’re in the top 37% tax bracket, you’d still be saving only $3,700 in federal income taxes. Does it really make sense to pay $10,000 to save $3,700?

When it doesn’t make sense to pay your mortgage off early

That all being said, there are some good reasons NOT to pay down your mortgage early. They just (mostly) have nothing to do with taxes. All of the following should be considered higher priorities:

1) You don’t have adequate emergency savings. An emergency fund can help you make those mortgage payments even when you’re in between jobs. Don’t rely on a home equity line of credit for that. Your line of credit might get canceled, especially when the economy is weak or you’re unemployed, which is exactly when you most need it.

2) You’re not contributing enough to get the full match in your employer’s retirement plan. It’s hard to beat a guaranteed 50% or even 100% return on your money.

3) You have higher interest debt. It makes a lot more sense to pay down a 10% credit card than a 4% mortgage. If the rates are close, don’t forget to factor in the tax deduction to reflect the true cost of the mortgage. (Student loan debt is also deductible up to $2,500 per year assuming you don’t exceed the income limits.)

4) You’re eligible for HSA contributions and haven’t maxed it out. Contributing to an HSA is the most tax-advantageous thing you can do since the money goes in pre-tax and then can be used tax-free for health care expenses. If you’re in the 24% tax bracket, you can save 24% on your HSA contributions and earnings that you use for health care expenses. The only catch is that you must have an HSA-eligible health insurance plan to contribute.

5) You can earn more by investing your extra money instead. To be on the safe side, I like to assume you’ll average about a 3% return if you’re very conservative (20-40% in stocks), 4% if you’re moderately conservative (40-60% in stocks), 5% if you’re moderately aggressive (60-80% in stocks), and 6% if you’re very aggressive (80-100% in stocks). If your mortgage interest rate is less than that, you’re probably better off investing your extra savings. If you’re investing in a tax-sheltered account like a 401(K) or IRA, the tax benefits cancel out the mortgage interest deduction.

Depending on your situation, paying off your mortgage early may not be a good idea. But it’s seldom because of the tax deduction.

What To Do If You’re Struggling With Your Mortgage Payments

May 08, 2018

Losing your home to foreclosure and potentially being homeless is one of the biggest financial hardships you can face. However, there may be situations in which walking away from your home actually makes sense. Here are some questions to ask yourself: 

Do you have equity in your home or are you underwater?

Home equity is the difference between the value of your home and what you owe. You get to keep any equity leftover after a foreclosure sale, but that equity is likely to be reduced by late payment and foreclosure fees assessed by the mortgage company. Mortgage companies will typically also accept offers for less than the home’s value in order to sell it quickly and because they won’t benefit from selling it for any more than the mortgage value. On the other hand, if your home value is significantly less than what you owe, a “strategic default” can be your best financial choice even if you can afford the payments.  

How much can you afford to pay?

Start by look at your bank and credit card statements over the last few months and record your expenses on a worksheet like this. Then see if you can find ways to reduce any of those expenses to make the mortgage payments. If you want to keep your home, you may want to prioritize the mortgage payments even over unsecured debt payments like credit cards and personal loans. After all, defaulting on either type of debt will hurt your credit but the latter can be wiped out in a bankruptcy without losing your home. A bankruptcy can hurt your credit score more, but a foreclosure can make it harder to get a mortgage in the future. Plus, we all need a roof over our head.

Are there alternatives to foreclosure?

Once you know how much you can afford to pay towards your mortgage and it’s not enough to get current, contact your mortgage company and see if you can work out a plan with them to avoid foreclosure. This may mean modifying the terms of the loan to make it affordable for you or giving the home up through a short sale or a mortgage release/deed-in-lieu of foreclosure. These options will hurt your credit score but not as much as a foreclosure. 

If you’re having trouble making your mortgage payments, don’t despair. There are options that can keep you in your home or you may even be better off walking away from it. If you’re not sure what to do, see if your employer offers a financial wellness program with free access to an unbiased financial planner who can help you decide which option is best for you. 

Should You Use Your Retirement Savings To Buy A Home?

May 01, 2018

First-time home-buyers are often surprised by the requirements of obtaining a mortgage, especially when it comes to the down payment. One way you can improve your chances of getting a home loan is by putting at least 20% down at the time of purchase. For existing homeowners like me, coming up with a 20% down payment usually starts with selling the home I’m in right now and using the equity to make a down payment on my next home.

But what about someone that may be buying a home for the first time? Coming up with a $50k down payment on a $250k home may take several years of aggressive saving, but your retirement account may not be a bad place to go for the additional funds needed to get you on the path to home ownership. In fact, the IRS offers certain breaks for taxpayers that choose to use retirement assets to purchase a first home. Here’s how it works.

Who qualifies as a first-time homebuyer?

Interestingly enough, you don’t actually have to be buying a home for the first time in your life to be considered a “first-time” homebuyer.  IRS publication 590 defines a first-time homebuyer as any homebuyer that has had no present interest in a main home during the 2-year period ending on the date of acquisition of the new home.

In other words, as long as you haven’t lived in a home you owned for the last two years, you are considered a first-time homebuyer even if you owned a home previously. If you are married, your spouse must also meet this no-ownership requirement.

Using your IRA

Most people know that when you take money out of a traditional IRA prior to age 59½, there is usually a 10% penalty tax for early withdrawal. However, the IRS offers an exception for first-time homebuyers that allows first-time homebuyers to withdraw up to $10,000 over a lifetime without penalty for first-time home purchases. Keep in mind that while the distributions are not subject to penalty, they are still subject to income taxes. $10,000 probably won’t be enough to cover your full down payment, but it can help.

Does it make a difference if I use a Roth IRA?

It does. If you’ve owned a Roth IRA for at least five years, any distributions used for a first-time home purchase (subject to the $10,000 lifetime limit) are treated as qualified distributions. That means the amount distributed will not only be exempt from penalties, but also income taxes. If you have not owned a Roth IRA for at least five years, your distribution may still avoid penalties but some or all of it may be subject to income taxes.

How to use more than $10,000 from your Roth IRA

One thing you should understand is that Roth IRA distributions are subject to ordering rules, which basically means any money you put in comes out first and is therefore not subject to taxes or penalties (since you already paid taxes on the money before it went in). Therefore, the exception described above is really only applicable after you have withdrawn all of your contributions, so many people find themselves withdrawing all of their initial contributions PLUS $10,000 of growth, with no tax consequences.

Using your 401(k) or 403(b)

The same exception doesn’t apply to your retirement account through work — the only way to withdraw money from you employer-sponsored retirement plan (e.g. 401(k)) for a home purchase while you are working is through a hardship withdrawal. Buying a home is one of the reasons allowing for a hardship withdrawal, but you will pay that early withdrawal penalty if you’re under age 59 1/2 and any pre-tax withdrawals or growth in your Roth 401(k) will be taxed as well.

Using a plan loan instead

Some people use the 401(k) loan provision to access those funds to buy a home without the tax consequences, but it’s important to factor in that you’ll have to pay the funds back in order to avoid taxes and penalties. Many companies give you longer than the standard 5 year pay-back period to repay a residential 401(k) loan, but you may have to prove that you actually closed on a home in order to maintain the longer pay-back period. Also, if you leave work before paying off the loan, many plans require you to pay off the balance within a few months of separation or risk defaulting on the outstanding balance.

So is it a good idea to use retirement assets to purchase a home?

That depends. If you plan on using the equity in your home as supplemental income in retirement, some investors may consider this a good way of diversifying your retirement portfolio. However, if you have trouble making payments on the loan, not only could you end up losing your place to live, but you may also jeopardize part of your retirement nest egg. Read this Forbes article for more things to consider and like with all financial decisions, you should weigh your options carefully before deciding which approach to take.

 

What I Learned When Our Home Sold In Less Than 24 Hours

April 30, 2018

Editor’s note: This post is part of our Personal Stories series, where our financial coaches share their own financial journey. We hope you enjoy getting to know us a little better and ultimately learn from our mistakes!

OK, so here’s the situation…

Two years ago, my wife and I decided it was time to move to a bigger house. Our house had always been our “10-year home” and we had reached that decade mark and the time had come to try and sell our home. Our goals were to:

  • Move into the school district we wanted our kids to go through middle and high school in
  • Add 1,000 – 1,500 of finished square footage for our growing brood
  • Update to a newer home with more modern finishes and floorplan.

The housing market in our area had been heating up over the several years leading up to the spring of 2016, so the timing seemed right to cash in on our home.

“I got this”

We met with our real estate agent and started planning the strategy for listing our home about 3 months prior to putting it on the market. We put in a lot of sweat equity to try to impress prospective buyers, including:

  • Repainting the entire inside of the home
  • Replacing all the carpet
  • Refinishing the hardwood floors
  • Decluttering – especially the unfinished basement that had turned into a grave yard of old baby clothes (our kids were 6 and 9 at the time), old sporting equipment (never know when you might need that broken treadmill from the 90’s right?), and everything else we had collected (and never used) from the last 10 years of life
  • Having professional listing photos taken

At the end of the day

After working with our agent and agreeing on an asking price, we put our house on the market. After about 45 minutes of calm, requests for showings started to pour in. We had 12 requests the first day the house hit the MLS! Within 24 hours, we had 3 above asking offers in hand – we were floored! Despite our initial idea of not accepting any offers until after the first weekend passed, we agreed on the right offer and that was that. A little over a month later, we were at the closing table and the deal was done.

If I could turn back time

We knew we were in a seller’s market, but it turns out we were in a price point that was absolutely on fire based on lack of inventory. Our agent knew this and did his job in telling us, but we were still shocked at how quickly the home sold. In hindsight, I don’t think we would have spent the time and money on cosmetic upgrades as I am not convinced they did anything to help sell the house.

I also think we could have asked for a higher price, but we were concerned about the appraisal coming in to validate the deal (and our home before this home sat on the market for a long time, which was not fun).

We also needed to start our home search quicker. Things happened so fast, that we felt a bit behind the 8 ball in terms of where we going to move. We decided to build our new home (that is a whole other post) and ended up in an apartment for 6 months while that was being completed. We could have saved some hassle and cost by planning the build better around the sale of our home.

What we got right

The de-clutter was the best idea ever! It made our move so much easier and helped us get a grip and say never again to accumulating so much stuff we never use. Not to mention, we made a little extra cash in a yard sale and had a lot of donations we could write off.

If I could tell you just one thing

Do your homework. Understand your local housing market well in advance of listing your home. In our case, we spent unnecessary time and money staging a house that would have likely sold for the same price and in the same time without the things we did. But in other market conditions, staging can be the key to make your home stand out. Your real estate agent is a key resource in helping you understand the local market and is a crucial part of the process.

What I Wish I’d Known Before My Divorce

April 03, 2018

As a guy who has gone through a divorce, I always feel a special need to help those who are about to go through that process or who have gone through it and are in the process of rebuilding. I joke that prior to my divorce, I was on track to retire by 55 and live very comfortably, and after the divorce, I’m on track to retire at 85.  But…I’ve never been happier!

What’s it worth?

Is a smile on your face and a lighter mental burden worth an extra 20-30 years of working? For me, the answer is a clear YES, but so many others wrestle with that question for years before either remaining in the marriage or going through a divorce.

I’ve talked with a number of people recently who are not sure which direction their marriage is going. They wanted some ideas on how to be prepared financially so that they are not devastated or blindsided by things that could happen if the marriage ended in divorce. I always hope that they can work on fixing whatever is wrong in the marriage, but if they go down that path, here are a few things that I wish I had determined in advance:

1. Property values

In my divorce, there was an enormous amount of time spent on arguing about the value of my boat. I lived on it for the first 3-4 years after we ended the marriage and I thought it was worth far less than my ex thought it was worth. Boats are a non-essential item and after the housing collapse, stock market collapse and abysmal economic recovery, boat values dropped substantially. I knew people who bought boats in the mid-six figures and couldn’t give them away during the recession. (Between maintenance, slip fees, gas and insurance, boats are not low-cost items.)

Each spouse should complete (separately, without comparing notes) a financial statement from a court or this net worth & budget worksheet. This will be an important part of any financial settlement and could help identify areas where spouses view things differently. If one spouse has an asset that is valued at $10 and the other has it valued at $100,000, there is an obvious discrepancy here.

Getting it resolved out of court

A resolution to that situation prior to a court ordering an independent valuation can be a major cost saving and can also prevent months and months of delays.  (Delays are costly….trust me on that one!) Similarly, if one spouse has an asset (such as an interest in a family-owned beach house) on their sheet and the other spouse does not, filling out this form can help reconcile the differences prior to mediation or litigation.

2. What is going to happen with the primary residence?

Again, this was an area of contention in my divorce. The smart thing to do financially would have been to sell the house and for each of us to buy smaller places in the same school district. My ex, however, grew up in the neighborhood where the house is located and she was committed to staying there.

My initial thought was that she wouldn’t be able to make that work financially (What do I know? I’m just a financial planner) even with alimony and child support thrown in. She was given 3 years to refinance to get my name off of the mortgage.

When it goes wrong

However, in those 3 years she apparently had some other financial things happen that caused her credit score to drop and she couldn’t get approved for a refinance on her own. So I was stuck on the mortgage, and when she missed mortgage payments, my credit score took a big hit.

That created a problem for me recently when I was applying for a mortgage on my current house. In retrospect, I should have fought harder to make the refinance happen instantly or else sell the house. I was more concerned with not disrupting my kids’ lives than with my credit score and it has caused some longer term irritation.

The house is usually the #1 financial obligation in most marriages, and having a well thought out game plan for what to do with it will save you from headaches down the road. Know what your current costs are and what your future costs will be if you move out of the existing house and either buy another home or rent a place. Americans spend a large percentage of their income on housing, so using a divorce as a way to downsize your housing costs can prove to be a spectacular long-term decision.

3. To litigate or mediate

My ex and I did a full-blown litigation since only one of us wanted to mediate or collaborate. We are all entitled to our opinions and our own decisions, but at times those decisions can be rather costly! If at all possible, working with a mediator or collaborative divorce attorney can be far easier and less expensive than a full-blown litigation. Having a conversation with your spouse (or soon-to-be-ex spouse) about this in a calm setting where you can make clear headed decisions can be a tremendous cost saver.

If you are looking for a mediator, here are some things to consider. And for those who haven’t heard of collaborative divorce, here’s a quick primer on it. Either mediation or collaborative divorce can lead to a far friendlier, more positive and less expensive outcome than traditional divorces that go to litigation.

4. Future expenses

This one sounds simple and maybe basic, but far too many people don’t know what the “day after the divorce” looks like. In working with someone who is just starting the mediation process, we determined that she would not be able to afford her home. She is now considering selling the house and using the equity to buy a small condo that could be paid off in 10 years after the divorce.

She’ll actually be closer to her retirement goals as a single woman than when she was part of a two-income marriage! Using the net worth and budget worksheet to project what life looks like post-divorce will help guide some decisions about where to live, what expenses might need to be minimized, and if there are things that need to just flat out be eliminated. It’s tough to picture this, but it’s worth the effort.

Divorce is costly as it is. Not preparing in advance can only make it more so. If you are in the process of contemplating a divorce or are in the early stages, taking these steps could help you walk through the process with as little damage to your long-term goals as possible.

4 Important Things To Consider When Buying A Condo

March 28, 2018

When it comes to buying a home, one of the first decisions you’ll need to make is the type of home you want to buy — a single family, town home, condo, etc. When my wife and I moved from California to the Midwest several years ago, we found ourselves shopping for a condo for the first time ever. The education we received through the process of buying, owning and now as landlords due to our move back to Cali was priceless. Here are the 4 things we learned to look out for when shopping for a condo:

1. Assessments (or HOA fees)

Be careful of these! This can take a supposedly affordable monthly housing payment and send it through the roof. For example, assume you have a mortgage payment of $1,500/mo and an additional $500/mo for taxes and insurance; that gives you $2,000/mo, BUT your building has assessments/HOA fees of $525/mo, so your real monthly cost is $2,525! You need to be aware of how that impacts affordability.

Know what it covers

You also need to know what you get for all that money, as each HOA is different. Often it will be landscaping, trash removal, water, common insurance and security. But take a close look because some assessments may also include pricey utilities such as gas and air conditioning (I actually saw one that included cable!).

You’ll also want to get an idea of what the HOA keeps in “reserves,” aka how much extra they have in their account to cover irregular expenses that come up. Which brings me to my next point.

2. Special assessments

This can be a tricky one as this type of assessment should only be implemented if absolutely necessary, but if you’re looking at a place that keeps low reserves, it could come up more often. Some examples might be for fixing a leaking roof or doing some retro-fitting in an earthquake zone. The bottom line here is that you will want to ask what special assessments have been levied in the past and what the likelihood of another is so that you can factor that into the total cost of what you’re buying.

3. Association budget

The answer to the aforementioned question often is answered by what the cash reserves looks like for the complex. Generally more established buildings have very healthy cash reserves so that most wear and tear type improvements — like a new roof due to age – will not require a special assessment. Always ask not only about the cash reserves but also how long the existing Board members have been in place.

4. Property taxes

This is on everyone’s favorite list and is pretty self explanatory, but be careful. Depending on where you live, and often in the same building (the higher you go, the better the view) you can find a wide range of tax amounts. Don’t just look at the average, get the numbers for the specific unit you’re looking at. Also note if it’s been many years since the property has sold — taxes are calculated based on property value, so if the unit is selling for much higher than it’s valued on by the county assessor, you could see an increase once your purchase price is recorded.

The bottom line

If you find yourself trying to decide between more than one unit, make sure you’re including all of the factors that come along with condo living. On one hand, it was nice to know that any issues with the roof or exterior would be shared with neighbors, but on the other, it can get very expensive very quickly if you don’t know what you’re signing up for when you buy.

Should You Pay Your Mortgage Off Early Or Keep The Tax Deduction?

March 27, 2018

I recently received a question after one of my workshops from a woman who was wondering if she made a mistake paying her mortgage off early because she no longer has the mortgage interest deduction. I can’t tell you how many times I’ve gotten different versions of that same question (including after a later workshop session that same day). Here are several reasons why this is a classic case of letting the tax tail wag the dog:

1. The interest decreases as a percentage of your mortgage payment. When you first take out a mortgage, most of your payments are interest, so most of what you pay is deductible. However, the interest portion steadily declines so that by the time your mortgage is almost paid off, your payments are mostly non-deductible principal anyway.

2. The mortgage interest deduction may not benefit you as much as you think. In fact, it may not benefit you at all. As an itemized deduction, it only helps you to the degree that your itemized deductions exceed your standard deduction since you only get whichever one is higher. Considering that the standard deduction is now $12,000 per person (or $24,000 for a married couple), AND the income and property tax deduction is limited to $10k per year, many people will fail to qualify for itemized deductions going forward, even if you have many years to go on your mortgage.

Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100.

3. The cost of the interest is always more than the tax savings. Let’s assume that you have $15,000 in mortgage interest (not just payments) and all of that exceeds your standard deduction. Even if you’re in the top 37% tax bracket, you’d still be saving only $5,550 in federal income taxes. Does it really make sense to pay $15,000 to save $5,550?

That all being said, there are some good reasons NOT to pay down your mortgage early. They just (mostly) have nothing to do with taxes. All of the following should be considered higher priorities:

Reasons NOT to pay down your mortgage early

1. You don’t have adequate emergency savings. An emergency fund can help you make those mortgage payments even when you’re in between jobs. Don’t rely on a home equity line of credit for that. Your line of credit might get canceled, especially when the economy is weak or you’re unemployed, which is exactly when you most need it.

2. You’re not contributing enough to get the full match in your employer’s retirement plan. It’s hard to beat a guaranteed 50% or even 100% return on your money.

3. You have higher interest debt. It makes a lot more sense to pay down a 10% credit card than a 4% mortgage. If the rates are close, don’t forget to factor in the tax deduction to reflect the true cost of the mortgage. (Student loan interest is also deductible up to $2,500 per year.)

4. You’re eligible for HSA contributions and haven’t maxed it out. Contributing to an HSA is the most tax-advantageous thing you can do since the money goes in pre-tax and then can be used tax-free for health care expenses. If you’re in the 24% tax bracket, you can save 24% on your HSA contributions and earnings that you use for health care expenses. The only catch is that you must have an HSA-eligible health insurance plan to contribute (although you can still spend the funds if you switch to a lower deductible plan in the future).

5. You can earn more by investing your extra money instead. To be on the safe side, I like to assume you’ll average about a 3% return if you’re very conservative (20-40% in stocks), 4% if you’re moderately conservative (40-60% in stocks), 5% if you’re moderately aggressive (60-80% in stocks), and 6% if you’re very aggressive (80-100% in stocks). If your mortgage interest rate is less than that, you’re probably better off investing your extra savings. If you’re investing in a tax-sheltered account like a 401(K) or IRA, the tax benefits cancel out the mortgage interest deduction.

Depending on your situation, paying off your mortgage early may not be a good idea. (At retirement is a different story.) But it’s seldom because of the tax deduction.

The 3 ‘D’s’ Of Selling Your Home

March 22, 2018

Before my stepson and his wife took the plunge and put in a contract for their first home, I helped them search out their new place. As we looked at place after place, I was often shocked at how sellers put no thought at all into the staging or curb appeal of their homes. If you’re planning on listing your home for sale, remember that you never get a second chance to make a first impression.

For buyers, it’s all about the three “L”s: location, location, location. But for sellers, you should pay attention to these three “D’s”:

De-clutter

Clear the clutter! It amazed me to see overstuffed closets, basements full of boxes, stacks of magazines on tables, and old DVD machines that probably haven’t been used in years with cables and cords everywhere, all of which distracted from the true living space of some of the houses that got crossed off the list. According to Noelle Barbone of Weichert Realtors, “clutter eats equity,” so less really is more.

If you can’t bear to part with all of the clutter, rent a storage unit to get it off-site.

De-personalize

No one wants to see a hallway full of your family pictures as they try to envision their own family’s future in the home. Your kid’s finger paintings may be works of art to YOU, but don’t need to be displayed on the refrigerator door when you have potential buyers coming for a visit.

Your 20-year collection of cat-shaped salt shakers should already be packed and stored away since buyers sometimes have a difficult time seeing beyond your decorating touches.

Deodorize

Even dog lovers don’t like to smell other people’s pets, so it’s a real turn-off to be greeted by the scent of a dog, even if Fido has been removed from the premises. Freshen the air by opening the windows for a few days. Most importantly, don’t try to hide smells with potpourri or candles burning since that is a dead giveaway to a smelly problem.

Messy cat litter boxes were the most common turn-offs as we went on house tours. If you have a cat, at least change the litter the day you plan to show your home or better yet, find a cat sitter for the day and take the litter box out of the house entirely.

The house my stepson and his wife finally chose met all three “D’s” since it was vacant and appeared to have had a thorough cleaning from top to bottom prior to the open house. No one’s clutter to navigate around, no family history on the walls, and a clean “new paint smell” welcomed us in the door.

It needs lots of updating in the kitchen and bath, but they were able to easily envision their own family memories being made in their first home.

Avoid These 8 Home-Buying Mistakes

March 13, 2018

The prospect of buying a new home can be exciting. Once you zero in on that property and prepare to make an offer, all types of dreams begin to rush in like your new commute to work, your first time having family or friends over, grilling out, enjoying the scenery of your space. As exciting as all of this sounds, before you make your offer, you must take a moment consider the long game. You must de-romanticize the process and the think about selling before you buy.

Here are some mistakes you should avoid so the home of your dreams doesn’t become a nightmare.

Mistake #1: Buying too much house

Why it’s a mistake: You met with your lender and they gave you the amount that you can qualify for in terms of a mortgage. That number may look good but a lot of times it is the top amount that they are willing to lend you, but not necessarily what you can afford. Just because you can qualify for that much does not make it the ideal amount to finance.

How to avoid: Do not rely on the lender to set your target. The right house is the intersection of your family’s needs/wants and cost. Take a moment to list the must haves for your home purchase. Then examine your budget and determine how much you can dedicate toward housing while maintaining savings and your standard of living. Then use a calculator to determine how much of a loan you will need to achieve your goal.

From there determine what properties satisfy your must haves at the right price. You will eventually need to work with a mortgage company, but you should have good idea of what you plan to pay for a home going in and not just what you qualify for.

Mistake #2: Buying too little house

Why it’s a mistake: You risk outgrowing it too quickly and losing money by have to sell again too soon. Realtor costs, attorney’s fees, and mortgage closing costs can make the cost of buying home expensive. Multiple transactions in a short period of time can make it very costly without yielding growth in your equity.

How to avoid: When you decide on what house makes the most sense, be sure it is at least a five-year decision. Are you looking to grow your family (get married, have kids, adopt a dog) in the near to midterm? If so it makes sense to buy with that in mind. When we moved into our home we were expecting our first child. Now we are family of five and thankfully we have not had to move because of the additions. If we had to move 5 years in we would have likely lost money on the sale due to the mortgage crisis.

Mistake #3: Buying because it’s a “good deal” and not because you love it

Why it’s a mistake: You’re going to come home to this property every day so you better love it. It’s true that owning a home is a good way to help increase your wealth, but that shouldn’t be the primary consideration in choosing. Buy a home that you won’t mind living in even if it falls in value for a little bit, rather than speculating and trying to make a buck, and risking that you’re stuck in a money pit you hate. 

How to avoid it: Ask yourself if you could keep living there beyond your initial plan. If the answer is no, keep shopping or consider the house as investment property and NOT your primary residence. 

Mistake #4: Getting in a bidding war and overpaying

Why it’s a mistake: It’s easy to let our competitive side get the best of us, especially when we find something we really love. But unless you’re bidding on a home that is under-priced in order to sell quickly, making an offer for higher than the asking price could cause problems both with the appraisal (you may not actually get approved for the mortgage you need if the appraisal comes in a lot lower than your offer price) and should you have to sell sooner than you plan. 

How to avoid it: Unless you live in a hot market right now (like Denver), it’s best to stop at the asking price when it comes to a bidding war.  

Mistake #5: Buying a home that’s 15 – 20 years old with all original appliances, roof, HVAC etc.

Why it’s a mistake: You found the right size house in the right neighborhood and it seems to be at a steal of price. You notice the house can use a little TLC and the appliances are a little outdated but you can always update that later right? Not so fast. You want to make sure you take the value of that TLC into account when making your offer.

How to avoid it: If you are purchasing a house it is imperative to determine when major repairs and replacements are due. Once you know where you stand with the age of these items consider your cost to update or continuously repair such items. Be sure that you take this cost into account when you compare it with similar properties in the area that have been recently renovated and make sure you are getting the house at a discount. Also request the seller include or give a cost concession to purchase a home warranty.

Mistake #6: Thinking you can easily flip

Why it’s a mistake: Watching too much HGTV can lead to thinking that flipping a house takes only 23 minutes of hard work. The truth is house flipping is a lot harder than it looks on TV. It takes not only real estate knowledge but financial savvy, budgeting discipline, and some good luck.

How to avoid it: Go into the flipping process with a healthy appreciation for what it will take to earn a profit. You can do this by researching real estate in your area and networking with local professionals that specialize in investment real estate. Offer to help a friend or acquaintance that is actively flipping or renovating their own home. The free labor will be valuable to them but the lessons learned will be even more valuable to you. If your primary focus is not getting your hands dirty but reaping the profits there are national and local investor networks that pool their money but pay professionals to do the work.

Mistake #7: Not attending the inspection or ignoring warnings that the inspector uncovers

Why it’s a mistake: As much as you are excited about the prospect of buying a home, it is the job of the home inspector to see all the warts that you may miss. The home inspector gives you the opportunity to address any issues, usually at the seller’s expense, before the home becomes yours.

How to avoid it: Talk to your home inspector and review their process to make sure they are as thorough as possible. The best way to do this is speak to multiple inspectors. Make sure to attend the home inspection and ask questions. When I bought my first home the home inspector could show me imperfections in the home and gave me tips on how to care for the home. For my last home purchase, I not only had an inspector but a very finicky friend that happened to be a builder to pick apart the home. We walked away with a comprehensive list to of things to present the seller.

Mistake #8: Taking the home buying “package” rather than finding the best team for you

Why it’s a mistake: It may feel easier and less confusing to take on the home buying team offered by your Realtor or your lender but “one size fits all” does not apply to one of the most important financial transactions in your life. As mentioned earlier there is a long list of interested parties to the home closing process.

How to avoid: Be leery of taking anyone’s predetermined home buying team without understanding everyone’s role and comparing to them to determine if you are getting the best deal. Shop around for everything. Are your Realtor’s commissions competitive for the market? Shop for mortgage rates and compare your options. Pay attention to how to how and why the home inspector, closing attorney and even title insurance is chosen.

Buying a home is a milestone to be proud of — taking steps to avoid these mistakes can help you enjoy the fruits of your labor for potentially decades to come.

Should You Be Paying Off Your Home Equity Loan Sooner?

February 27, 2018

When it comes to the new tax law, by now you have most likely already heard that the income tax brackets were lowered, standard deductions increased, and there is a cap on state and local tax deductions. But there is another major change that could have an effect on your personal finances. The tax reform law alters the ability to deduct interest on home equity loans or home equity lines of credit.  

Changes to the mortgage interest deduction

The newly-enacted law places restrictions on home mortgages. The first restriction affects people who purchase a home between now and 2026 — basically you can only deduct interest paid on up to $750,000 in mortgage debt. The second part is that mortgages eligible for the itemized deduction must be used to purchase or improve it, including a home equity loan or HELOC (home equity line of credit). (Note that if you took out your mortgage on December 14, 2017 or earlier, you will still be able to deduct interest on up to $1 million in debt, but the home equity loan restriction affects all outstanding loans)

Can I still deduct my home equity loan interest? 

Because of the way the law is worded, it was initially assumed by many that if you have a home equity loan or line of credit with a balance, that the interest you pay would no longer be deductible as mortgage interest. However, this may not be true in all cases — according to recent IRS guidance, in many cases you can continue to deduct interest paid on home equity loans, as long as they were used to buy, build or substantially improve the home that secures the loan. 

Deductible versus non-deductible

For example, if you use a home equity loan to build an addition to your home or complete major renovations, the interest is likely deductible. But if you use a home equity loan to consolidate credit card debt or pay for your pet’s trip to the vet, you will not be able to claim the mortgage interest deduction. A loan is deductible if it is secured by your main home or second home (known as a qualified residence) and does not exceed the cost of the home and meets other requirements. 

When to re-prioritize debt paydowns

If you are no longer eligible for the home equity interest deduction, you may need to re-prioritize paying it down, but it’s important to look at the big picture. Since home equity loans and HELOCs often offer lower interest rates, you first need to consider your overall financial wellness before redirecting dollars to paying down home equity debt.

Focus on this first

In general, you should have a fully funded emergency fund, save enough to capture any matching contributions in an employer’s retirement plan, and eliminate higher interest debt such as credit cards or personal loans before paying down your home equity loan or line of credit (see Financial Priority Checklist).  

Making your money work hardest for you

If you already have your financial foundation in place your decision really comes down to where your money will work hardest for you. Financially speaking, your decision should be based on your after-tax cost of borrowing versus your after-tax return on your investments. If you are no longer able to deduct the interest on your home equity debt then your actual interest rate will become the main point of comparison.

However, if you have a variable interest rate you must also consider the significant likelihood of your interest rate creeping higher in the near future with the possibility of rising rates. There is also something to be said about the emotional aspect of eliminating debt. Paying off your home equity loan or HELOC ahead of schedule makes sense if it frees up cash flow to help you focus on future life goals such as paying for college or transitioning to retirement. 

As you can see, a lot has changed as a result of the recent tax law reform. One thing remains the same – you must constantly review your own financial plans to see how these changes will affect you. 

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How First Time Home Buyer Mortgage Programs Work

October 11, 2017

If you are shopping for a mortgage, you have probably seen all sorts of offers and advertisements aimed at first-time home buyers and wondered if these are really as good as they sound. In some cases, “first-time” programs are little more than attention getting marketing messages from lenders rather than actual assistance programs for people who may otherwise face challenges with qualifying for a home mortgage or finding a home loan at an affordable interest rate. With this in mind, it is important to understand the difference between mortgage lender marketing programs, actual loan programs, and financial assistance programs.

You can be a first-time homebuyer more than once

First of all, even if you have previously owned a home, you (or your spouse) may still qualify as a first-time home buyer. According to the U.S. Department of Housing and Urban Development, first-time homebuyer status is not limited to people who have never owned a home before (although that criteria obviously applies). For lending purposes, a first-time homebuyer includes anyone who fits one or more of these conditions:

  • An individual or a spouse who has not owned a primary residence for at least three years. This means married couples may qualify as first-time buyers even if only one of them meets this test.
  • A single parent who previously owned a home with a spouse while they were married.
  • Someone who has only owned a primary residence that was not attached to a permanent foundation (e.g., a mobile home) in accordance with applicable regulations.
  • Displaced homemakers whose only previous ownership was with a spouse.
  • Someone who only owned property that was not in compliance with local building code ordinances and which cannot be improved to meet building code standards for less than the cost of constructing a new residence.

Two types of programs

First-time homebuyer programs can be broadly categorized as either loan programs or financial support programs. Both types of programs can be helpful to first-time homebuyers.

Loan programs, such as those backed by the Federal Housing Administration (FHA), are available to all borrowers through various commercial lenders, but they have features that may be particularly attractive to first-time buyers with lower credit scores or little in the way of cash savings. Private lenders may also offer attractive loan rates and terms for first-time home buyers with good credit and the ability to make larger down payments on a home purchase.

Financial support programs for home buyers typically come from state and local government entities, although the federal government sometimes steps in to provide additional assistance during difficult economic times.

Loan programs

Mortgage loans are made by commercial lenders, such as banks, credit unions, or mortgage companies. These loans may be guaranteed by various organizations, both to protect lenders against borrower defaults and also to make loans more affordable for borrowers. Here’s how these various organizations work:

  • FHA. The Federal Housing Administration does not make loans, although they do insure loans made by commercial lenders to protect lenders if borrowers default on loan payments. FHA loans are available to all qualified buyers, and they can be particularly attractive to first-time home-buyers because the qualifications are easier. For example, a potential home buyer with a credit score of at least 580 may qualify for an FHA loan with as little as 3.5% of the purchase price for a down payment. Lower credit scores between 500 – 579 may also qualify with a larger down payment of 10%, though the interest rate on the mortgage loan will be higher.
  • VA. The Veteran’s Administration (VA) also guarantees portions of home loans provided by private banks or mortgage companies to active duty service members, veterans, and eligible surviving spouses. A home purchase loan guaranteed by the VA can help military vets and spouses purchase homes at competitive interest rates without the need to also make a down payment or purchase private mortgage insurance. Applicants must have satisfactory credit scores, along with sufficient income to meet expected monthly loan payments.
  • USDA Single Family Housing Guaranteed Loan Program. Similar to loan programs provided by FHA and VA, the United States Department of Agriculture (USDA) also provides loan guarantees to mortgage lenders so they can help borrowers with low and moderate incomes purchase homes in rural areas. The USDA program guarantees 90% of mortgage loan amounts for approved lenders to help offset the risk of offering 100% loans to eligible rural home buyers.
  • Freddie Mac Home Possible® Mortgages. The Federal Home Loan Mortgage Corporation (also known as “Freddie Mac”) makes it possible for lenders to offer home loans to buyers with down payments as small as 3% through the Home Possible®. Although this program is not limited only to first-time homebuyers, first-timers must first participate in a borrower education program.

Financial assistance

Financial assistance programs exist across all levels of government: city, state, and federal. These programs may provide assistance with funds for down payments, closing costs, or other expenses tied to the home purchase process. Here’s how they work:

  • Fannie Mae’s HomePath Ready Buyer Program. In 2015 the Federal National Mortgage Association (FNMA or “Fannie Mae”) launched the HomePath Ready Buyer program, which provides first-time home buyers up to 3% of the home’s purchase price in the form of a rebate to assist with closing costs. Participants must complete an online home buyer education course in order to receive the 3% rebate.
  • State-by-state home buyer programs. Many individual states sponsor a variety of home buyer programs designed to help first-time homebuyers and others qualify for home mortgages. Visit your state’s housing website to find details for your area.For example, first-time homebuyers with low or moderate incomes are eligible for the Texas Mortgage Credit Certificate Program as a way to convert mortgage interest into a federal income tax credit. New York state homebuyers can take advantage of the Conventional Plus program for down-payment assistance up to 3% of the home’s purchase price.
  • City & county homebuyer programs. Individual cities and municipalities may also offer assistance with home financing. For example, Miami/Dade County in Florida makes home financing assistance available to first-time homebuyers through a loan program facilitated between Miami-Dade County Public Housing and Community Development and local mortgage lenders. Similarly, the Mayor’s Office of Housing and Community Development in San Francisco provides loan assistance programs for first-time homebuyers. Consult with your city or county government offices for availability of similar programs.

As you review and evaluate the financial assistance or loan programs that may be a good fit for you, it is also a good idea to take inventory of your personal financial situation, such as checking your credit report (www.annualcreditreport.com), paying off credit cards and personal loans, and stashing more cash into your emergency fund. These tips and more are also available in 5 Steps to Buying a Home.

This post was originally published on Forbes Feb. 19th.

 

 

 

How To Know If You Are Ready To Buy Investment Property

October 09, 2017

“How do I decide if I’m ready to get into real estate investing?”

I get this question all the time over the Financial Helpline and in one-on-ones with the employees we work with. I also hear it regularly from friends who want to know my perspective on this as a financial planner.

What is interesting about this question is that the answer, surprisingly, has very little to do with the real estate market. And that’s why so many people make bad decisions in this area. They base their decisions on what they think the real estate market is going to do, when instead, they should be looking at their own financial situation to make a decision on this.

The answer has very little to do with the real estate market.

You are a good candidate for investment property if you meet all or most of the following:

1. You have a very stable job and significant cash cushion. Ideally that would be 1 year plus of your living expenses in a liquid account that you can tap into immediately with no or very minimal penalty (aka it’s not in a retirement account).

2. You have excellent credit (generally 750 or above). This important for two reasons:

  • To get a better loan rate and
  • If you end up having more vacancies or home improvement expenses than you expect, you will have better access to credit to cover these expenses if need be.

3. You are ready, willing and able to be a landlord. Ideally you would enjoy that responsibility and/or you can cover the costs of paying someone to maintain the property like a building super who can address issues that tenants face and ensure the property is properly maintained. This becomes very important when you are ready to sell, not to mention it is your legal obligation as a landlord to maintain the property for tenants.

4. You are looking for a good tax shelter to offset income taxes and capital gains.While all of us want to reduce taxes, investment property can be particularly attractive for those who are in a high-income tax bracket. Some ways you can take advantage of this are through write-offs on such things as mortgage interest, property tax, gardening, property management, etc. You may also be able to write off as much as $25,000 in real estate losses against your total income depending on your adjusted gross income (AGI).

5. You can separate your emotions from the process and buy for purely financial reasons rather than personal preferences. Remember, you won’t be living in this property so whether or not it’s your favorite style of architecture is irrelevant. But whether or not you have a positive cash flow (meaning your rental income exceeds mortgage and other property expenses) is very important. So, you need to be ready to cast aside a love of real estate as an art form and cultivate a love of it as an investment vehicle in order to be financially successful.

Bonus criteria, but not essential

You have a spouse with a stable job. This further reduces risk of a major cash flow problem if you lose your job

You know a lot about real estate and/or have people around you who are experts in real estate and can advise you. Key knowledge areas include:

  • home improvements/renovations that are most likely to enhance retail value;
  • understanding of rental and vacancy rates in the area you are looking to buy;
  • trends in real estate prices and key facts about the neighborhood and how the local economy may impact future housing prices.

Real estate agents can help here, but it’s nice to have people with expertise that you know and trust on your side as well. This is why large real estate investors have teams of people who work for them.

You should not buy investment property if you meet ANY of the following criteria:

1. You are stretching to buy the property, or you have any reason to believe that your job is not secure. If your debt to income ratio begins to exceed 35% after the purchase, then you are stretching. If you do not have a liquid cash cushion (1 year plus of your living expenses is recommended) and would have to tap into your investments to cover a financial emergency (e.g. longer than expected vacancies, roof begins leaking), you are stretching and until you develop this cash cushion, you should not purchase the property.

2. You enjoy a life free of hassle and try to limit your responsibilities. In other words, you don’t want to be tied down. In this case, it doesn’t matter how attractive the deal is, you are not ready to be a landlord and buy an investment property.

3. You have fair or poor credit (below 700). In this case, you may not even qualify for a loan. Or if you do, the interest rate could significantly drive up the cost of the mortgage and make the property a money pit where you are consistently paying more in mortgage than you are getting in rent.

4. You are already heavily invested in real estate relative to other assets. “Heavily invested” meaning 20% or more of your wealth, not including your primary residence, is tied up in real estate. This is particularly important if most or all of your real estate holdings are in one area — if housing prices plummet in that area, you could run into serious financial problems.

One more watch-out

Think twice if you are going to purchase the property with friends or relatives. This is not to say it can’t be done successfully — ironically, I’ve done it myself and it has worked out fine — but the odds are against you here. We were able to make our situation work because we selected partners who were financially responsible and also set up a legal structure to account for contingencies. If you’re skeptical about your potential partners’ financial position, you may want to shy away from the deal or go it alone.

Just the first step

Okay, so after all this, you should have a better handle on whether or not you are a candidate for investment property. But that’s only the first step. It doesn’t mean that the properties you are considering are a good investment. It only means that you are in a good financial position to be able to invest successfully in real estate.

The next step (for those who are good candidates for buying an investment property) is to find the right property. If I had a dollar for every time someone asked me if they should purchase a specific investment property…. well, I’d be able to buy another one myself!

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How To Save For A Down Payment On A First Home — Without Giving Up Avocado Toast

September 11, 2017

Are you renting now and want to buy your own home but aren’t sure how you’ll ever save enough money for the down payment? When Australian property manager Tim Gurner dissed twenty- and thirty-somethings everywhere by saying they’ll never buy a home because they are too preoccupied with spending money on avocado toast, he unknowingly created a new cultural reference.

Although I’m well past the early career stage, I found his comments to be condescending and missing the point, especially given the rapidly expanding level of student loan debt and the prohibitive cost of housing in many urban areas.

I also think he’s wrong. You can have your avocado toast and eat it too. Here’s why:

When you’re ready to buy a home, you’ll make it a priority.

Are you ready to buy a home now? There are three facets to being ready:

1. Are you prepared to commit to a geographic location? Many people in their late twenties and early thirties just are not ready to stay in one place yet. My 28-year-old stepdaughter is in the early career stage. She just finished her master’s degree and is starting a new job in a new city. How could she possibly know if she wants to stay there yet?

2. Do you have a spouse, partner and/or kids? Home purchases are strongly related to household formation. A “household” is a group of people living together, and the more new households form, the better it is for the economy overall. Early career adults become financially independent and boost the economy by buying cars, work clothes, travel, and eventually homes of their own.

If you’re single and not a parent, you may not feel as strong of a need to invest in a home purchase. I stayed single until age 39 and it wasn’t until my mid-thirties that I started to rearrange my personal finances to prepare for a home purchase. In fact, according to a Pew Research Center analysis, nearly a third of young adults are living in their parents’ home—a rate higher than in my generation. Economic research from the Federal Reserve Bank of San Francisco suggests that young adult residential choices (e.g., living with parents) may “delay the timing of the decision to set up households.” In other words, when you’re ready to settle down with a partner or raise kids, you’ll prioritize a home purchase.

3. Can you afford it? As I wrote in a recent blog post, it’s a good idea to keep total housing costs (e.g., mortgage, taxes, insurance, utilities, maintenance) to 25 to 35% of your after-tax income. For example, if your family take-home pay is $4,500 per month, you should try to keep your monthly housing costs somewhere in the range of $1,125 to $1,575. With a 20% down payment, a 30-year mortgage at 4%, and $200 a month for utilities and maintenance, that’s a mortgage range of approximately $128,000 to $200,000.

I realize the 35% ratio could be a challenge in an insanely expensive city like Los Angeles or New York, where housing costs can eat up to half or more of a family’s income, but it’s a helpful guideline. After all, if you are renting, you may be paying a mortgage already—your landlord’s mortgage.

Are your rent and utilities together 35% or less of your take-home pay? If so, you can probably afford the monthly costs of home ownership, although you may have to adjust your expectations about where you buy. You may not be able to afford your first-choice neighborhood, and that’s okay.

You don’t have to stay there forever. According to data from the National Association of Home Builders, the average buyer stays in their home for 13 years. You don’t want to be in a stressful situation where you spend so much money on housing that you can’t fund other important goals, such as retirement, college, or an emergency fund, or have enough wiggle room in your budget to enjoy life now.

Buying real estate is like getting married.

Gurner is correct that splurging on overpriced food items isn’t going to help you save the most effectively for a down payment on a home. The important point he is missing is that when you’re in the stage of life where you are prioritizing brunch with friends or travel over real estate purchases, you’re just not emotionally or geographically ready to buy a home. Real estate is like marriage. The wrong choice can really mess up your life.

Renting, on the other hand, is like dating. It’s something you should keep doing until you are sure you want to settle down and are ready for a committed relationship. Many people are happy dating – and renting – for a long time before they decide to commit.

Believe me. When the right one comes along, you’ll know it. Then everything will change.

You will use your ingenuity to save for the down payment.

I’m not suggesting you should spend all your money now on craft beer and yoga retreats in Bali. Even when you’re renting, it’s important to pay down credit card and student loan debt, build up cash reserves for emergencies, and sock away at least 10 percent of your income for retirement savings.  What I mean is that when you decide to buy a home (and not just daydream about it), that decision will align your actions towards your goal.

It certainly takes time to save for a home down payment, which is likely to be the largest sum of money you’ll ever have to save in a short period of time. The typical buyer puts down 20 percent of the purchase price in cash as a down payment. Per this Forbes article, a 20% down payment on the median home in Cleveland is a reasonable $25,000. In my part of the country, NY/NJ, it’s about $75,000. (California prices are in the stratosphere, so that can be the topic of another blog post.)

Remember, however, that “median” means “midpoint.” That means that 50% of the housing stock would require down payments less than that. In any case, be realistic – and be patient. For most people, it will take you five to seven years to save that kind of money, depending on how much you are willing to prioritize.

Let’s take the Cleveland home purchase example above. To save $25,000 in five years, at a 1 percent interest rate you’d need to save $407 per month. That’s about $13.50 per day; less than you may spend on lunch out or having drinks with a friend after work. It’s doable.

Where I live, in suburban NJ outside of NYC, it’s a bit more of a challenge since it may take you longer to save $75,000. However, you could save that in seven years by putting away $862 per month. That’s about $29 per day, which would involve some bigger choices, such as moving to a smaller apartment, giving up a car, trimming way back on eating out or getting a part-time job to earn some extra money. Once you’ve made the decision to buy, however, you’ll find those kinds of choices easier to make.

Perhaps you can swing the monthly payments plus property taxes, homeowner’s insurance and maintenance, but you don’t have the full 20 percent down payment saved. There are many good mortgage programs for first-time home buyers. (See a summary in my fellow planner Mark Dennis’ article here.)

The key is to know yourself.

When you are ready to buy a home, you’ll make it a priority. If you haven’t saved much up until that point, you’ll need to spend some years building up your savings account. That process will be good for you, and it will help you change your financial behaviors so that when you do buy a home, you’ll be a better steward of your financial investment.

This was originally published on Forbes, June 11