How Much Home Can You Really Afford?
So, youre getting ready to buy your first home, and you feel like youre at the mercy of the market. And your mortgage lender. In some ways, it might even feel like theyre working against each other - especially if youre in a really hot market in which you cant qualify for the amount youd need to buy what you want.
When it comes to providing pre-approvals for would-be homebuyers, lenders today are more careful than they were in the years leading up to the market crash, and that means your financial picture will be more rigorously scrutinized to determine your credit-worthiness and develop your max approval amount. Trust us, thats a good thing. The last thing you want is to be house poor. Having a great place to live that you cant enjoy or furnish or even leave because you have no money left wont be fun.
"Just because a lender says younbsp;cannbsp;afford a certain mortgage doesnt mean younbsp;should," said TIME: Money. "Consider your take-home pay - what actually goes into the bank after taxes, health insurance, and savings for retirement and college. Then add up all your monthly bills, not just debt but also things like utilities, phone, and groceries. You want to feel comfortable that you can cover all your household obligations while still meeting your other financial goalsnbsp;andnbsp;keeping six months of expenses in annbsp;emergency fund."
Thats why its so important to consider all of your monthly expenses >
Increased commuter costs
Are you moving out to the lsquo;burbs? That hour-long commute each way is going to add to your bottom line. Of course youll be using more gas. Will you also incur tolls? Then there is the wear and tear on your car, which could mean additional costs. You can estimate your commuter costs here.
Higher utility bills
A larger place could mean higher utility bills. Then again, more energy-efficient appliances, windows and doors, and HVAC could potentially result in lower bills, which could be a reason to look for a newer home over something older. Its not out of line to inquire about utility bill costs from the existing owner through your Realtor is probably best. This information could be critical in helping to make the best decision when buying a new home.
Your pre-approval amount is an all-in number, but that number only includes principal, interest, taxes, and insurance. If you are buying in a community that has a Homeowners Association, your fee will be a separate cost that needs to be considered. An HOA fee can range greatly depending on your location, the number of homes in the community, and the amenities and services included.
Youre likely going to have a mailbox full of credit card pre-approvals and offers from places like Home Depot and Lowes after you close escrow - and they can be tempting. Reeeaaallly tempting, especially if you need new appliances or countertops or flooring or all of the above. Ditto for furniture stores, because, like Lowes and Home Depot, those offers are often zero-interest deals. It may make sense to take advantage of one or more of them to make some necessary or wanted updates to your home - if you can swing the payments. They obviously add to your monthly obligations, even at no interest. And keep in mind that if you miss, or are late on, a payment, that zero interest is replaced with a much larger number, and that means youll face a much larger balance to pay.
If youre coming from an apartment or a rental where the outside maintenance is taken care of by someone else, get ready to either: buy a lawnmower and an edger and spend your Saturday mornings in the yard, or pay someone else to take care of it.
If youre buying a brand-new home, youll typically have a warranty provided by the builder or developer, often for one year. You have the option of extending that, or buying/extending an existing warranty on an older home, and all of those options will cost you.
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Backyard DIY Projects
You dont have to pay through the nose to have the best backyard on the block. If you have a few simple DIY skills and know how to use a tape measure and level, you can easily upgrade and update your backyard all on your own.
If youve ever dreamed of a lovely garden path, perennial garden or a privacy fence, but youve hesitated because of cost, now is the time to invest a little sweat equity to create the backyard of your dreams.
Plant a Perennial Garden
Tending perennials may seem daunting to inexperienced gardeners, but in reality, theyre some of the easiest flowers to grow. Best of all, plant them once and they return to bloom every year. Perennial gardens make lively backgrounds for your annual plantings. Use them along fences and border porches and decks to add color from early summer to late fall.
To ensure the stability and livelihood of your perennial plants:
- Keep the roots wet until you put them in the ground
- Plant them in improved soil
- Apply regular helpings of water and fertilizer
- Place a 3-inch layer of mulch around, but not touching, the plants.
Install a Privacy FencePhoto by tristanf via Flickr
If you crave a secluded backyard oasis, consider installing a 6-foot or 8-foot section of privacy fence. Your local home improvement store sells this type of fencing in sections. All you have to do is level the terrain and dig the post holes. Use a quick-setting cement to anchor your fence posts, making sure everything is level and square before moving on to the next section.
With a little tenacity, you can install a privacy fence in one weekend. Done properly, it adds privacy and enjoyment to your backyard and value to your home.
Replace Your Pool LinerPhoto by Creative Ignition via Flickr
It sounds like a difficult challenge, but replacing your pool liner is quite simple when you start with the right tools and quality supplies. Visit webpages such as poolproducts.com inground liner to find the materials you, as a DIYer, need to perform simple maintenance on your in-ground pool. Keep the following points in mind as you replace your pools liner:
- Replace your liner during warm weather
- Remove all water and debris from your pool
- Avoid over-stretching your replacement liner
- Utilize sandbags to secure the base seal
- Have a comprehensive understanding of the process before starting.
Hardscape Your BackyardPhoto by ARNOLD Masonry and Concrete via Flickr
The addition of pavers, retaining walls, fire pits and patios all add value and comfort to your backyard, but many homeowners dont realize they can easily complete these upgrades without the help of professional landscapers.
Lay decorative pavers on a bed of tamped sand to make an easy patio that stands up to the elements, or layer simple bricks with or without mortar to make attractive and functional retaining walls. A meandering garden path guided by decorative cobblestones can lead to a simple water feature or wooden bench in your garden. Delight your backyard guests and yourself this summer by creating a simple hardscape that complements the design of your home.
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Considering the Argument for Adding Individual Mortgages to Your Investment Portfolio
Investing in mortgages should not be looked at with trepidation. As with other cash flow investments such as corporate bonds, government notes, or money market funds, mortgage investments can be looked at in the same vein. Mortgage investments have an attractive risk-return ratio in comparison to other income-producing investments. If you choose your investment intelligently, individual short-term mortgages which I define as first deeds of trust on real estate with 65 loan-to-value LTV ratios, maturing in two years or less are considered more risky than money market accounts or US Treasury bills, but they offer yields at the level of high yield corporate bonds, or even higher with potentially lesser risk.
Chart 1 shows the general risk of short-term mortgages as compared to other income producing investments.
Risk in terms of loss of principal taking into consideration opportunity costs if interest rates rise. Generally, individual mortgages do not trade in the open market; thus, the principal is not subject to market fluctuations as compared to Govt T-Notes, Govt Notes, and Corporate Bonds. In addition, mortgages that have a 65 LTV enjoy some protection if the underlying property declines in value. Govt Notes and Bonds have no collateral backing but are Govt backed and Corporate bonds usually have no specific collateral and are based upon the full faith and credit of the issuer.
Chart 2 shows the general return of mortgage investments on a current rate of return as compared to other income producing investments.
Chart 3 is a grid that shows the comparative advantage of mortgage investments over alternative income producing investments when considering opportunity risk/reward ratios by combing Charts 1 amp; 2.
For purposes of this article, we have defined the following:
Govt T-Bills -- 1 yr obligations guaranteed by the US Government
Govt T-Notes -- 5-10 yr obligations guaranteed by the US Government
Govt T-Bonds -- 15-30 yr obligations guaranteed by the US Government
CDs -- 1 yr FDIC insured
Money Mkt Funds -- liquid mutual funds maintaining a 1 share price
Corporate Bonds -- 15-30 yr obligations guaranteed by a US corporation rated BBB or better
Mortgage Investments -- 1st deeds of trust on real estate with 65 loan to value maturing in two years.
Risks involved in mortgages vary from the other investments that financial advisors might be more familiar with and more due diligence is required. First of all, unlike CDs or US government obligations, mortgage investments are not FDIC-insured and have no government guarantee. Do not confuse these types of mortgage investments with past GNMAs, the pooled investments created by the quasi-governmental mortgage company Ginnie Mae and sold to the public. GNMAs are mortgage-type investments and have a quasi-government backing. By contrast, the mortgages used in the above examples are individual mortgages; thus, the principal is fixed and does not fluctuate unlike GNMAs, which return a portion of principal with each interest payment and trade in the open market and are thus subjected to market volatility. The mortgage investments backing is primarily going to be the underlying real estate on which the mortgage is recorded specific versus blind pool and almost all short-term mortgages will pay interest only, thus keeping the principal intact.
However, all income-producing investments carry some risk -- and its often misunderstood, even by sophisticated financial advisors. For example, money market funds generally are only backed by the mutual funds integrity to honor the 1 share price because all they are holding are short-term obligations, both government and corporate. However, in the early 1990s, when many corporate bonds went sour, investors suddenly learned that their 1 share price was not guaranteed; they could actually lose principal. The mutual fund families that sponsored the money market funds paid out of pocket to subsidize the share prices, thereby preserving the sacred cow.
Corporate bonds carry the risk of strength and integrity of the corporation that issued the bonds. Independent rating services such as Standard and Poors and Moodys have been shown to misjudge the security of many corporate bonds -- whether through conflicts-of-interest or simple mistakes. Even without misjudgments, the price of a corporate bond fluctuates based on the performance of the company, its industry, and the economy overall. In addition, as interest rates rise, the value of the bonds decrease.
The risks that a mortgage investor faces primarily involve the borrower and the underlying real estate. An investor may choose to work with a borrower with less than perfect credit if there is sufficient equity in the property that it is worth the risk. Alternatively, a property may be marginal, but the borrower has excellent credit. These are the main factors determining the interest rate that an investor can expect on his mortgage investment.
Another factor in determining the rate on a mortgage is the competition for these types of investments. In the past, they were considered one of the best kept secrets in investing. No longer. The competition for mortgage investments has heightened to where lenders are competing for loans. This, in turn, drives down the rates. Good for the borrowers; not so for the investors. On the positive side, what once was considered an illiquid investment has risen to a semi-liquid investment. Although there is not a trading market for mortgages as there is for stocks and bonds, new companies have come to the marketplace in search of purchasing existing loans; thus, a market has opened up providing liquidity to those holders of mortgages who want to sell their loans. Giving up yield for liquidity has been attractive to some investors. The yield may be upwards of 1 lower for this ability to sell, but many have decided it is worth it. An Internet search of purchasers of mortgage investments provides many companies willing to buy them.
With the Great Recession now more than five years in the rear view mirror, many financial institutions have loosened some of their lending restrictions. This has also caused interest rates to remain competitive for borrowers. However, because of strict regulations with Dodd Frank and the ATR [Ability To Repay] requirements imposed upon both conventional and private lenders, many borrowers are facing difficulties obtaining the financing necessary to purchase owner occupied real estate used for their primary residence. Otherwise, >
One of the major problems holders of long-term debt instruments be they government or corporate bonds encounter is not so much the risk of failure, but the opportunity cost during rising interest rates. As interest rates rise as we are slowly starting to see now, the investor is caught holding investments that are losing principal, albeit temporarily. Sure, these investors can hold on to lower-return investments until maturity, but the price they pay in the lack of opportunity to participate in higher yielding instruments usually outweighs the wait. Of course, in times of declining interest rates, one would be better served to be in the longest-term bond possible and to sell just as interest rates begin to rise. The question then becomes one of using a crystal ball in which way interest rates are headed.
One solution for the risk-averse investor is to look to short-term mortgage investments no more than 5-year maturities for >
Where do investors and their advisors find these short-term real estate mortgages? There are lenders called "private money real estate lenders" who provide private financing to borrowers who may not be able to obtain conventional loans for a variety of reasons. Advisors should primarily deal with lenders who have a good reputation and record the deed of trust. In some cases, investors may want to invest in a specific mortgage because they know exactly which property is securing their investment; however, the down side to this strategy is that there is now a lot of competition for these types of loan investments and one may be sitting on the sidelines waiting for an opportunity to invest. If the investors money sits too long [in a low interest, liquid account waiting to deploy funds for a new loan], the blended rate of return after the loan is found and invested in may be lower than if the investor invested in a Fund that holds mortgages. For example, if an investor allows his/her money to rest in a money market fund paying 1 and it takes six months to find an 8 note, after one year, the average rate of return for that year was only 4.5 as compared to a Fund that may pay 7. Something else to consider is that a Fund may allow for a reinvestment of monthly distributions thereby compounding the yield. With an individual mortgage, the lender has to take the monthly payments with no reinvestment allowed. In addition, a Fund allows for diversification because the Fund has many mortgages, similar to a mutual fund holding a variety of stocks. Because this type of investment is no longer a secret, many individual investors are competing for mortgages. When a broker presents a potential scenario to an investor, that broker usually also sends the same scenario to many other potential investors, as the broker wants to make sure that he can fund the loan in a timely fashion to the borrower. Many an investor has gotten upset when, after giving the broker the green light for the loan, the broker informs the investor that he was too late and some other investor snapped up the loan. This creates a frustrating situation for the investor and wastes his time. At some point, the investor may tell the broker to stop sending him deals, as he never knows if he will be allowed to invest in the specific loan [because another investor was faster in saying, "yes"].
Many investors choose to invest in a Fund to avoid those disappointments. In addition, many Funds provide a liquidity feature, so the investor can withdraw his money if he needs to. Advisors should look for Funds that charge no load to get in or out and make sure the manager of the Funds interests are aligned. One way is for the Fund to participate in the points being charged to the borrower. This lends itself to make sure the manager does not charge a large amount of points [which the manager could retain] and a small interest rate [which is paid to the Fund].
Although short-term mortgages and mortgage Funds are not the "end all" investment, they may play a prominent place in many investment portfolios looking to provide high yields for >
Edward Brown is in the Investor >415-883-2150
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