Developing a Financial Strategy

This AskChristee article outlines how calculators provide information for smart homebuying decisions

The Normal Process

Most people will start the home buying journey by searching for homes on the internet. Thanks to technology, this is a very easy process. At some point, they will start working with a real estate agent and will be referred to a loan officer for a pre-qualification letter.

The Smarter Process

The intelligent first step, in the home buying process, should be to have a financial plan. For most people, buying a home will be their largest investment, and as such, some thought should be given to the many variables and options available. Why is this critical step typically overlooked for vast majority of home buyers?

Who should provide ‘financial counseling’ to a home buyer?

Real Estate Agent. Most real estate agents see their role as facilitators in the home buying process. Most real estate agents do not get involved with the financial aspects of buying a home. A nationwide survey verified that the vast majority of agents (99%) have very little knowledge regarding real estate finance. It is not their job, so the buyer is referred to a loan officer for ‘mortgage advice’.

Loan Officer. The same survey showed that less than 5% of loan officers suggested more than one mortgage option to potential home buyers. In the same survey, there was no consistency in the payment or home prices recommended by loan officers. Loan officers are not trained to be financial counselors to home buyers.

There are many variables to evaluate when developing a game plan to purchase a home. Below is a partial list.

1. What is an affordable monthly payment- ‘target payment’?
2. What price home will result in the ‘target payment’?
3. What mortgage type is best suited for the buyer?
4. What are the closing costs?
5. How much seller credit is available?
6. How much total cash is required to purchase a home?
7. What is the best utilization of available cash?
8. How will a specific area impact monthly payments and purchase price?
9. What is the potential tax deduction?
10. What are the potential federal income tax savings?

1. What is an Affordable Mortgage Payment?

Components of a Mortgage Payment:

(a) Monthly Principal and Interest – referred to as PI

(b) Monthly Property Taxes – 1/12 of annual property taxes.

(c) Monthly Property Insurance – 1/12 of annual homeowners’ insurance

(d) Monthly Mortgage Insurance – mortgage insurance is required on conventional loans with less than a 20% down payment and all FHA or USDA loans.

There are two perspectives to an affordable monthly payment – (1) The maximum payment which you qualify (2) the payment which you feel comfortable with based upon your lifestyle.

Maximum Mortgage Payment. Your maximum mortgage payment will be based upon your credit score, annual income, and monthly debts. This amount will vary based upon the mortgage program best suited to you – either Conventional, FHA, VA, or USDA.

Qualifying Ratios. A Lender will use a combination of qualifying ratios and AUS (automatic underwriting system) to arrive at a maximum monthly payment.

AskChristee ‘Buyer PreQual’ program will suggest a target payment based upon qualifying ratios and your credit score. You may change the target payment.

Lifestyle Payment. How will the maximum mortgage payment impact your lifestyle? How much discretionary cash will you have each month? What price home can you purchase with a lower monthly payment?

See the impact of a mortgage payment on your monthly budget. Click here to run AskChristee Monthly Budget.

2.  Price Home

Each county or city has different property tax rates. Part of your total payment monthly payment is property taxes. Thus, the price home with your target payment will vary from area to area. Additionally, the price home will change based upon the mortgage type.

AskChristee will show the exact price home, mortgage amount, and total payment based upon target payment.

3. Mortgage Type

There are 4 major mortgage types to consider – Conventional, FHA, VA, or USDA. Each mortgage type has very unique features such as minimum down payment, underwriting guidelines, mortgage insurance requirements, maximum loan amounts, minimum credit scores, upfront mortgage funding fees, and maximum seller credits.

For more information about mortgage types see the article ‘Selecting a Mortgage Type’.

AskChristee will display results for all mortgage programs to help choose the mortgage type best suited to you, considering your circumstances.

4. Closing Cost

Closing cost are based upon location such as a city or county within a state. Closing cost consist of 2 major categories – (a) Cost based upon the purchase price or mortgage amount and (b) Escrow or impound amounts, which are the required deposits for future payment of property taxes and insurance. Depending upon where you wish to purchase, closing cost can exceed minimum down payment requirements. Closing costs have a dramatic impact of total required cash to purchase.

For more detail information on closing cost see the ‘Closing Cost Guide’ article.

AskChristee will calculate and display closing cost based upon location and mortgage type.

5. Seller Credits

Each mortgage type allows for the seller to pay a portion of the buyers’ closing cost. The allowable seller credit is different for each mortgage type and loan-to-value ratio. Lenders may also pay a portion of the buyers’ closing cost – this is offset by a higher interest rate to the borrower.

Efficient use of ‘closing cost’ credit can reduce the amount of required cash to close. This could result in qualifying to purchase a more expensive home.

AskChristee will calculate closing cost credits based mortgage type and impose caps when necessary.

6. Total Cash Required

Total cash required to purchase a home is [down payment + closing cost – closing cost credit].  Total cash required will vary depending upon location and mortgage type. There are two important concepts to understand when discussing ‘total cash’.

Minimum Cash Required. Minimum cash is defined as the cash required to purchase a home, which results in the target payment. Expressed differently – maximum sales price with minimum cash.

Available cash that is less than minimum cash required will result in a lower purchase price.

Additional cash, beyond minimum required, will result in a higher purchase price.

AskChristee will automatically display minimum cash results. You may enter available cash and see results for spending the cash available.

7. Utilization of Cash

How much cash beyond minimum amount required should you invest in the purchase of a new home? Of course, this will depend upon your immediate and long-term goals. Let’s explore several different situations regarding cash while keeping in mind the old adage – ‘Cash is King’.

(a) Monthly Debts. Interest on consumer debt (credit cards, auto loans) is not tax deductible. Additionally, interest rates for consumer debt are higher than mortgage interest rates.

Debt consolidation refinance. It is not uncommon for homeowners to refinance their home to paid down on revolving monthly debts such as credit cards, car payments, etc. The interest on the new refinance loan amount may or may not be completely tax deductible. Please consult with your tax advisor.

Purchase Debt Consolidation. For many people, they can (and should) accomplish the same debt reduction strategy when purchasing a home. You simply put less money toward the purchase of the new house and use the remaining cash to payoff consumer debt.  Your new mortgage payment will increase slightly, however, your total monthly payments (mortgage payment + consumer debt payment) will be lower. Additionally, the interest on your purchase mortgage amount will be 100% deductible unless your new mortgage amount exceeds $750,000 – this is maximum of mortgage on primary and 2nd homes which is currently deductible.

(b) Cash on Hand. Even if you are not burdened with consumer debt, you may want to consider financing additional money on the purchase and retaining some cash.

(c)  Mortgage Free Plan. If your goal is to be mortgage debt free, then you should consider different strategies in achieving your goal. Should you allocate a large portion of available cash toward the down payment? Alternatively, you could retain some cash for unforeseen emergencies and each month make an extra principal payment. You may wish to run AskChristee Amortization to help you in this decision.

8. Selection of Area

There are many factors which influence the area which you wish to purchase a home. In other articles, we focus on many of those factors. In this article, we are viewing area only from a financial perspective.

Property Tax Rates. Property tax rate can differ dramatically from county to county or from county to city. The higher tax rates will alter the amount of your payment for principal and interest (PI) thus affecting the purchase price.

Closing Cost. Different counties or cities within a State may have different transfer taxes thus requiring more cash to purchase.

Insurance Rates. Property insurance rates will differ between locations. We suggest you discuss regional insurance rate with a licensed insurance agent.

9. Tax Deduction

One of the biggest advantages of owning a home is the ability to deduct your mortgage interest and property taxes from your income thus reducing your federal income liability. Interest on consumer debt (virtually all personal debt except mortgages) is not tax deductible.

AskChristee will estimate mortgage deductions for all purchase options.

10. Income Tax Savings

Your tax bracket and the amount of mortgage deduction determines the amount of potential Federal Tax savings. This is a tremendous advantage to homeownership. When you juxtapose your tax savings against your mortgage payment you see your ‘net mortgage payment’.

AskChristee will display Federal tax bracket, potential tax savings, and net mortgage payment for all available purchase options.

AskChristee and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and it is not intended to offer tax, legal, or accounting advice and should not be relied upon as such. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.