Straight To The Point…

No pictures of jets, Jeff? Straight down to business? So, THAT’S how it’s gonna be is it … ?

In the post, Jeff is flaunting his violations of both Rules, what are we gonna do about it??!

Seriously, Jeff has a plan and a strategy and I would be interested in hearing comments from any of our readers, including the 7MITs, of course … but, also the ‘silent majority’.

C’mon, we all have homes, so we all have something to learn/offer here …

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As most you already know I’m closing in rapidly on “closing” on a new home.  Rather than answer Adrian’s questions by using my current home in Virginia as the frame of reference (it’s soon to be a rental business), I’m going to do a little guestimating and use my future home in Boston as the basis for my answers.

1. What is your home’s current value?

The appraiser hasn’t visited the home yet, so I’m going to use the low estimate from Zillow.com as my answer: $698,860

2. What is your current mortgage?

$502,650

3. What is your current monthly mortgage payment – both as $ and as a % of your ‘usual’ after-tax income?

$3600 / 37%

4. How does your current setup fit within the 20% Rule and the 25% Income Rule?

Vs. the 25% Income Rule: At 37% I’m clearly in violation of this recommendation.

Vs. the 20% Rule: With the new home in the mix, my Networth is now approximately $509,210.  The equity I have in the home is roughly 698K-502K = $196K.

196K/509K = 38% so I am violating the 20% equity/net worth rule as well.

5. What – if anything – do you plan to do about it, if you currently break either/both of these rules?

The main reason I’m in violation of the rules is that I’m making a speculative play for appreciation on this property based upon two factors.  The first being my belief that we are at or near a low point in the real estate market and the second being that I was able to purchase the property at an additional discount because it’s a foreclosure.

At this point I don’t plan to do anything to adjust my situation with regards to the 20% rule.  I’m stretching myself to get into this house and I’m not ready (nor able) to stretch some more by doing a cash-out refi to get under the 20% rule (a cash-out refi will raise the monthly mortgage payment).

I’m trying hard to fix things in relation to the 25% Income Rule.  That’s what my Making Money 201 strategies are all about.  Click baby click!

6. What are your plans for your first home (if you currently rent) or your next upgrade (if you currently own)?

Do I have to think about buying another home already?  I’m so burned out on Mortgage lenders and Realtors, I can’t stand it.

If I must…the next home that I plan to occupy will likely not be much of an upgrade relative to the one I’m purchasing.  Size-wise, this new home in Boston is more than four people need, so if I buy a follow-on home to occupy, it will be because my family moves again.

A move away from Boston will likely result in a sale of this new property.  I believe the mortgage payment is/will remain in excess of local rents for a few years.  I’m not interested in running a negative cash flow rental property unless there is a really good reason that I should maintain ownership of the property.  If that be the case, then I am mentally prepared to operate the property at a loss and consider the negative cash flow as an investment.

I’m projecting the sale of the Boston property could yield 150-400K in profits depending upon what the real estate market decides to do over the next three years.  My fingers are crossed, but I’m in positive territory either way.  I’ve often heard that in real estate, you make your profit when you buy.

With a sale, I would take the resultant profits and put some of it into a new home and some of it into down payments for several rental properties.  I’m planning to split the profits 50/50 between a new home and several investment properties.

7. What questions/issues/opportunities, if any, that you would like to explore further do the above questions bring up?

I find the 20% Rule and the 25% Income Rule interesting book ends to one’s approach to affording a home and how much equity to have in it as you manage money.  On one hand you shouldn’t have too much of your net worth tied up in the equity of your home (20% Rule) and on the other you shouldn’t be using too much of your after tax income to pay your mortgage (25% Income Rule).

I’m going to caveat my next comment with the fact that I’m speaking off the top of my head and have not run the numbers in detail.

To me these these two rules work against each other.  Strictly abiding by the 25% Income Rule limits your ability to adjust your situation relative to the 20% Rule, and religiously following the 20% Rule in some situations could force you to grossly violate the 25% Income Rule.

If faced with this dilemma, should you knowing violate one rule to satisfy the other?   If so, which one should you sacrifice first?  I think violating the 25% Income Rule could be the greater danger.  Where is the balance point?

Of course, this is coming from a guy who is knowingly violating both rules.