UKmortgageadvice

How Much Should You Borrow?

There’s little doubt that we’re borrowing more and there’s also little doubt that credit is one of the great conveniences of modern life. That said, like Goldilocks you want to borrow the amount that’s just right — and no more.

So what’s the right level of debt?

The loan qualification standards used by mortgage lenders are an important guideline. You can typically get that old standby — the fixed-rate, 30 year mortgage — if no more than 28 percent of your gross monthly income goes for mortgage principal and interest, property taxes and property insurance (PITI). In addition, as much as 36 percent of your gross monthly income can go to regular monthly costs — PITI plus car payments, credit card debt, school costs, etc. In addition, because they have more liberal qualification standards, you can often borrow more with other loan programs such as FHA, VA and adjustable-rate financing.

But no matter what type of mortgage financing you consider, the real question should be not how much can you borrow, but rather how much can you borrow comfortably. In other words, financial sanity counts.

Unfortunately the term “financial sanity” is an expression without a definition. The economics that work for the Webbers plainly may not work for the Johnsons. We each have different incomes as well as different interests, expenses and preferences. Given this background one might ask: What makes financial sense for me?

The answer looks like this: If you’re living from paycheck to paycheck, if monthly costs are a burden, if savings are small or non-existent, if you do not have health insurance then it’s time to re-think debt burdens.

The richest person I ever met, someone who started with nothing and created jobs for more than 50,000 people, once offered this advice: “The key to financial success is saving, and nothing is harder than saving that first 10,000. After that, it’s easy.”

In other words, it’s entirely possible to have a substantial salary and to fail the financial sanity test. The waiting rooms in every bankruptcy court are filled with people who once had big incomes and bigger debts. One day the numbers didn’t work and away went the trophy houses and the big cars.

So how do you begin the savings process?

The first step, literally, is to open a savings account. The very nice people who provide checking accounts and credit cards will also be happy to hold your savings.

The second step is to go after every nickel and dime you can find.

The economics of savings resemble gravity: Little pieces brought together in one place produce big results. Here’s an example: Imagine that you usually spend 2.50 per day on little things — coffee, candy or whatever. Instead, you set the money aside in an account that pays 6 percent interest. The result? After 30 years there’s almost 77,000 in your account.

There are any number of strategies to save money, but let me suggest a practical approach. Look at your debts. Pick the one with the lowest balance, say a small credit card that requires monthly payments of 25. Save and pay it off. Then identify the next remaining debt with the smallest balance. You now have 25 a month extra that can be applied to the second obligation. Save and pay off the second debt. Maybe with the second obligation you can save 50 a month. After the second debt is repaid, you have an additional 75 a month to attack the third debt.

During this process there are other steps to take. Bring lunch to work. Have one car (hard in some areas, but not impossible). Collect change at the end of the day and deposit rolls of coins every month or so. Eat out — but not often. Stay away from credit cards. Avoid late fees and maintain good credit by paying bills in full and on time.

As this process continues you’ll notice several interesting results.

First, borrowing for real estate becomes easy as debts decline and qualification scores rise.

Second, better credit results in reduced interest rates that can save you big money. Save a half percent as a result of good credit on a 300,000 mortgage and you’ll cut costs in the first year of the loan by nearly 1,500.

Third, there’s no tax on “savings.”

If you have 1,000 in credit card debt and auto costs each month, that money is available only after taxes are paid. To get that 1,000 in cash you may have to earn 1,300 or 1,400, depending on your tax bracket and location. If you pay off your bills and don’t have to pay that 1,000 a month, Uncle Sam does not raise your taxes and you gain the equivalent of a huge raise.

When you speak with lenders about your ability to borrow, consider that with good credit you likely can borrow as much as you need if not more. But also consider that as a matter of financial sanity you have a personal obligation to save. If you can buy a home, pay general expenses and still save 5 or 10 percent of your gross monthly income, the odds are overwhelming that borrowing will not be an undue burden now or in the future.

A Mortgage Secret for First-Time Buyers: It Can Pay To

A Mortgage Secret for First-Time Buyers: It Can Pay To Buy More

It’s not easy to buy a first home, so here’s a suggestion that may be surprising: Instead of buying one residence, buy several. What I’m suggesting has nothing to do with late night infomercials or books that promise fast and easy wealth from real estate. Instead, many first-time buyers can benefit from an interesting quirk in the mortgage system.

When you hear people talk about “real estate financing” they generally divide mortgages into two categories; loans for owner-occupants and more expensive and tougher loans for investors.

“Investment financing” is for buyers who do not physically reside at a property. “Owner-occupant” loans are for homes, the places where we stay at night, the phone rings and the car is parked.

But there’s a wrinkle:

Owner-occupant financing with little down and low rates is typically available for the purchase of more than a single-family house. Normally you can get owner-occupant financing for properties with one-to-four units as long as you use one as your prime residence.

In other words, your status as an owner-occupant allows you to buy more than just a house or condo. You can actually buy property that produces rent and increases your tax deductions.

When you buy properties with two-to-four units the world of real estate financing changes. Lenders will apply most of the rent to your income for qualification purposes. This means you can borrow more — and also that you can offset loan costs with the rents such properties produce.

Suppose you buy a property with four units. You’ll live in one and rent the others. Each of the three rental units has a fair market rental of 1,000.

In this situation you’re likely to get two benefits. First, the lender will count some portion of the rent — say three-quarters — as income for you when determining your qualification standards. In other words, 2,250 a month will be added to your income. (1,000 x 3 units = 3,000. 3,000 x 75% = 2,250)

Why 2,250 and not the whole 3,000? Because the lender assumes you’ll have vacancies, repairs, insurance, taxes and other costs for the rental units.

The lender also assumes something else: For tax purposes, three-quarters of the property in this example will be “investment” real estate. When reporting your income taxes you’ll list your rents and costs for these units. One of these “costs” will be depreciation, an accounting device that will lower your taxes but take nothing in cash from your pocket.

When lenders see depreciation they “add back” that cost when looking at your monthly income. The result is that your effective monthly income for loan qualification purposes will increase even more than 2,250 in this example.

Buying two-, three- and four-unit properties can make great sense, especially for first-time buyers. You’ll have “help” meeting monthly mortgage payments, especially in the first few years of ownership — the time that’s often the most difficult. Later on, if you elect to move you can sell the property or you might choose to keep it and just rent out the unit had been your residence.

As with all investments, neither annual income nor rising property values can be guaranteed. Some owners may feel uncomfortable having tenants so close and there’s always the potential for insufficient rents, excess vacancies and big repairs.

Also, beware of going too far. While up to four units is okay, five units automatically classifies the property as “investment” real estate under the guidelines for most loan programs, a title which means you cannot use owner-occupant financing even if you live on the property.

The good news, though, it that as an owneroccupant and also as a landlord you’ll learn a lot about the practicalities of real estate investing.

Real estate ownership requires ongoing maintenance and oversight. As an owner-occupant with a few units, you’ll learn “on the job” about making repairs, dealing with tenants, hiring contractors and maintaining property. These are valuable lessons which can provide income and wealth over a lifetime. In fact, many people who’ve become successful in real estate often started with just one small property, owner-occupant financing with little down — and two to four units.

For details, speak with appropriate professionals. Lenders can tell you about available financing; real estate brokers can provide information regarding local rental patterns plus you’ll want a pro to explain the tax benefits of multi-unit ownership.