Buying Power

When you start thinking about buying a home, most likely you begin with how much house can you afford to buy.  I know that’s how I started.  But the way to really look at how much you can afford is to think of your Buying Power in terms of your monthly payment.

There are many factors that go into calculating the actual price range of homes you can afford, but for simplicity we will make some assumptions.  You have a 20% down payment toward a 30-year fixed rate loan, good credit with FICO scores in the mid-high 700s, and you have a stable job where you can show pay stubs each month — basically, a solid buyer.

In our example, let’s say you have decided you don’t want to spend more than $3,000/month on your mortgage (of course there are other expenses like property taxes, insurance, HOA, etc).  If interest rates are 6.25% today, then this means you can have a loan amount of $487,000; add your 20% down payment and this gives a purchase price of $609,000.

I know there are quite a few buyers “on the fence” right now who would like to take a “wait and see” position because they think prices are going to drop further due to all the bad news in the media.  I completely understand, and waiting for prices to drop may make sense depending on your underlying reason for buying a home.

However, waiting also comes with a risk.  For the same example above, lets say you are determined to wait until home prices drop further before you jump in to buy a home.  If during the time you are waiting, interest rates go up 1/2 of a percent (from 6.25% to 6.75%) this will impact on your Buying Power.  Now, at 6.75% your same $3000/month mortgage budget can only get you a loan of $462k, and with your 20% down payment, your Buying Power came down to $578k — basically the 1/2 percent of interest increase has cut down your Buying Power by 5%.

In the end, your Buying Power is the most important component of buying your home.  It may not make sense to wait for home prices to come down 5% (from $609,000 to $578,000 in our example) because if interest rates go up 1/2 of a percent during the time you are waiting, the same home will still cost you $3,000/month mortgage. 

So while you are waiting the home prices to come down more, you also need to pay attention which direction the interest rate would go in the future.  Put together your Buying Power profile and when you feel it is as strong as you can get, you should focus on finding the right home that fits your profile no matter what is happening in the overall market.


Home vs. Inflation

It is often said that buying a house is your best ‘hedge’ against inflation.  I didn’t really understand what that meant until recently.

Inflation is the yearly increases we feel in the prices for everyday items we need or use in our daily lives.  As an example, the Costco roasted chicken was one of the best values in the store at $4.99 for a whole chicken, ready to eat.  I noticed a few months ago that they raised the price to $5.99 and just this past week I noticed it is now up to $6.49.  That is a 30% price increase in less than a year and I’m sure you can find similar stories about other products that you buy regularly.

If inflation is kept “in check” by the Feds, it will likely be around 2.5%-3% per year and generally speaking, we all get pay raises at or above the inflation level.  This helps us feel like we are not paying more for daily life as a percentage of our income.  Essentially there is nothing we can do to control the prices of gasoline, cereal, or pizza — but there may be something we can do to control a big percent of our monthly expenses.

When renting a home or apartment, the monthly rent will increase according to inflation and sometimes even higher.  Most of the time I see 5% per year on average and this is what we coach our investor clients to expect from their rental properties.

Lets say you rent a place for $2,000 per month.  With 5% increases each year, this same place will be renting for $2,550 after 5 years — this seems believable.  As for your income, lets say you make $10,000 per month now and only see 2.5% raises each year.  You will be making $11,314 per month after 5 years — again, this is probably believable.

Since housing is the majority of our monthly expenses, it makes sense that if we can control the increases in our housing expenses it will provide the biggest relief as inflation increases other prices each year.  This is where buying a home comes in. 

It’s hard to go to your landlord and say you won’t allow them to increase your rent (but I never tried so let me know if it works for you.)  But when you buy a home that is exactly what you are doing.  If you use a standard loan program like a 30-year fixed mortgage or a 7/1 ARM, you are essentially locking in your payment at today’s rate for at least 7 years.  So in our example, if your $2,000 per month rent was a mortgage payment instead, it would still be $2,000 per month after 5 years and the extra $550 per month would stay in your pocket.

This is why buying a home is considered a big step toward reducing your exposure to inflation since the biggest monthly expense (housing) is controlled as prices of other items continue to increase.  I do believe that it takes a somewhat “long-term” viewpoint because most people won’t think that a $100 per month increase in rent is a big deal, but after 5 years, it is a big deal.

That’s how it works.  Are you in control of inflation or is it controlling you?


Building Wealth – Part 1

I used to believe that working hard will bring me a comfortable life and the stock options I receive would bring me even more money if I work for a good company.  I have been working for nearly twenty years but I didn’t get rich, not even close. 

If you have been living and working under the assumption that income from your job is what will lead you to true wealth, like I used to believe, then you have been misled.  Living in the Bay Area, most people go through their hectic lives believing they will find the next Google, or Ebay, or Yahoo so it’s the stock options that will make them rich.  Yes, that does happen, and you may be fortunate to make the right moves and be in the right place at the right time.  In fact, that goal is what drives quite a lot of the Bay Area.  However, when I review the path taken by most multi-millionaires to get to the point where they are quite wealthy, it’s not their job that got them there – it’s their investments!

My parents have never taught me about the values of the money or how to manage it and I didn’t learn that while I was in school either.  Fresh out of college, I was so into my job and building a career that the only thing I did it right was saving some of the money that I made.  And then I started learning how to use my savings to invest in stocks.  Overall, I did make some money over the years but not enough to make myself rich.  As time went by, I gathered all my saving and the money I made from the stock market to buy my first home — which was another good move I made.  Not until I started reading books like “The Millionaire Mind”, “The 5 Lessons a Millionaire Taught Me”, and “The Richest Man In Babylon”, etc or the workshops and seminars that I attended over the past few years did I discover the real path to true wealth.

The definition of “True Wealth” — the point at which your passive income is at such a level that it can be used to support your life’s mission without the need to work at a job.  “Passive Income” is the income generated from investments, not from your job; and “Life’s Mission” is the motivation and passion that drives the reason why we work to make money today.

First and foremost, save, save, save.  This may sound simple — or maybe it even sounds impossible.  It is non-negotiable.  If we want to get to true wealth, we must start and continue to live off less.  The rule we MUST live by is 70-30.  Out of our gross income each month or week, we need to live off of 70 percent (used to pay housing, food, entertainment, etc) and save 30 percent.

There are different theories as to what to do with the 30%.  Depending on your beliefs, you may want to give 10% to charity or the church; 10% to aggressive investments; 10% to stable investments.  Another theory is to put 10% into savings for a rainy day; 20% to all types of investments.  It’s really up to you but my key point here is that we need to adjust our personal living standard to only use the 70%.  Make it a habit.  This is a rule – no matter how much money we make.  Even if you are making a lot of money, the rule stands – live off 70%, save and invest 30%. 

I would like to share a story of a multi-millionaire that I know.  He and his family had saved enough to move up to a huge multi-million dollar home.  Usually the first thing people do after getting a new home is go out and buy a bunch of new furniture!  Of course, his wife wanted nice, expensive furniture – but they had a deal, as long as they were sticking to their budget, they would not buy anything now so they could save money for the furniture she really wanted.  Here we have a guy worth millions of dollars, making millions of dollars, and even he has the constraints of a home budget.  He and his wife stayed within their budget plan.  For months they would have friends over to entertain and show them around the big new house, but everyone would comment – “why are so many rooms empty, are you guys can’t afford furniture?”  Then the day came – an entire freight container arrived with one-of-a-kind custom made furniture from Europe.  Their budget allowed them to save for the day when they could buy exactly what they wanted.

Next time I’ll post some ideas about the basics of Home Budget to help define living off the 70%.  Don’t worry, we’ll get the part where we are investing the 30% – after all, we are in the Real Estate business!


0% Interest Game

Have you played the 0% interest credit game?  I guess I knew it was possible but I didn’t know how popular this was until a client of ours told me about it. 

Like I do, you undoubtedly get bombed with numerous credit card offers each week.  Most of the time I throw them out, but if you take the time to read them carefully, you may be passing up an opportunity.  The “game” is played by holding a large amount of unpaid debt that you continue to transfer around to new cards, one after another, and basically avoid paying any interest!

So here’s the way I read it.  Each of these cards have an initial period where they offer 0% interest provided that you pay the minimum monthly payment.  Before the initial period expires, you need to have identified and opened a new card and transfer the balance onto it.  If you miss the timing then you will face substantial interest due.

There is another ‘catch’ in that most of the cards I found (Balance Transfer Credit Cards or Compare 200+ Credit Card Offers) have a balance transfer fee of about 3%.   The way I see it is that even if you can’t get a card with a 0% transfer fee, you still just paid 3% interest for a whole year.  That’s WAY better than even an equity line at prime + 0 (7.5% today)!  My client was telling me that she knows people doing this with $100’s of thousands of dollars in debt.

But there is a downside.  Carrying a lot of rotating debt on credit cards will hurt your overall credit rating if you go to get a home or car loan.  Also, there may come a time when you cannot qualify for a card when you need to make a transfer.

However, there is a big different between borrowing money to buy consumer goods versus borrowing money at a discount for the chance of making a higher return investment.  For example, if I were to give this a try, first off I would make sure I could pay off the credit card fully whenever needed.  Then, I would get a 0% interest card that allowed new charges AND allowed cash advances to be made interest free for an entire year.  I would use the cash advance blank checks that come with the statement to deposit money into my investment account and away I’d go – buying stocks, mutual funds, ETFs, whatever. 

Fine print:  Not FDIC Insured.  Not Guaranteed.  May Lose Value.  May Hurt Your Credit.

Have you ever done this 0% interest game?  Do you know anyone who has done this?  I’d like to hear from someone who has done, or is doing this to see how successful you’ve been.

As always, we appreciate your comments.