Straight To The Point

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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 …


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 as my answer: $698,860

2. What is your current mortgage?


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.  😉

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Yeah I had trouble in the beginning figuring out how to balance the 25% and 20% rules as well at first, but I think i’ve got a better hold on them now. In my case, I was starting out with such a negative networth that it seemed no matter what I did, I was in violation. I would basically have to live in a tent in someone’s yard and just send money to my student loans in order to get into a position to where I could buy a house and not violate, lol.

I think part of the trouble with the rules though, is the cost of home ownership in some cities. Having lived near Boston before, I can attest to the fact that it is a VERY expensive place to live. The same goes for Ryan in California. At some of these locations, if your not buying in the 500-800k range, your just not getting a house, unless your buying a trailer out on a dusty lot, 70 miles from the city it seems. I’m just lucky that in Louisville,KY, home prices are half or less than what they are in some of the bigger U.S. cities.

I also think that the rules ‘may’ be stretched a bit in a market like this, when you can get into a home that can potentially take a fast upswing in just a couple of years, as long as the mortgage to that home doesn’t currently drain your monthly cash flow and cost you more than it produces you at the end and provided that you put this new equity to use or sell the property and net the cash.

Scott – Expensive is no joke! My experience in Boston thus far is that homes in general are at least 100K more expensive than they are in Virginia Beach right now. That difference grows even bigger when you start factoring in the size.

The one redeeming quality is that most of the homes up there are on larger lots than here (1.0-1.5 Acres in MA vs. 0.25-0.75 Acres here in VA Beach).

That 100K extra is buying houses that are similar quality to my Virginia home but on average 2/3 smaller. So in reality its much more than my sticker tag math.

That size issue is what really makes the deal I’ve been able to “luck” myself into even sweeter.

Rather than paying 100K more and get 2/3 less space for a retail property….I’m paying 100K more and getting 2/3 MORE livable square footage than I currently have here in Virginia. That benefit (and a better location) are the result of buying a bank owned property.

While I’m not going to be in a trailer on a dusty lot 70 miles away, I did have to go 30 miles outside the city to find this home.

I need to make one correction to my numbers above. When I did my math vs. the 25% income rule I failed to include the changes in pay I’ll receive for moving to this new location.

In the Military, a non-taxable housing allowance is paid based upon your work location’s zip code. In my case, that allowance is going up a fair amount. I’ll also be receiving a sizable annual bonus payment for the duration of the new job.

When you throw those into the mix, my mortgage payment drops from 37% down to ~29%.

So it’s not as bad as I first thought. Sorry for the mistake.

Oops…I meant the Boston homes are 33% smaller (i.e 66% of the Virginia homes)…I’m still getting 66% more space in my deal however.

I’ve got to reread more and type slower. Sorry. 🙂

Jeff, sounds to me like the the 20% rule in some ways may not apply to this particular situation since your viewing your current primary living residence as not only a place to live (we all need one, that is a liability, hence the 20% restriction) but a speculative investment.
So whatever you have “invested” in the house is actually money working for you, earning you a nice expected profit. AND you using leverage supplied for you by the bank at probably a great interest rate.
Hence, instead of being in violation, your actually taking leaps into wealth building.

Jeff – when you factored the housing allowance back in, did you also factor in the taxes you are not having to pay on that? It might bring you down to 27% even 🙂 When do you report to Boston?

Yeah I didn’t even think about the military housing allowance to help you out Jeff, I forgot about that.

When I was in the Army, I was single, so I just lived in the barracks and didn’t have to house a family, so I never dealt with that.

Diane – don’t make the math any harder for me. 🙂 But I believe if I just worry about after tax income, I can just add the allowance straight to the bottom line w/o worrying about the missing tax burden.

Scott – This is the first sizable increase I’ve had in BAH because of a move. It’s usually w/in a few hundred dollars from place to place (at least where I’ve been stationed). Boston, however, is almost an even $1000 increase per month and I’m putting all of it to work.

Josh – I like your slant. It makes me feel better and better. Thanks!

As for the leverage…I’m using the bank for 95% of the purchase at 5.5%.

I started out trying to do a zero down loan on this property (it would have been my third zero down experience), but the purchase price drove it into jumbo territory so I needed to put up the 5% down payment to keep the loan in the lower conforming loan rate structures.

@ All – Great discussion! I hope that our other readers are inspired to jump in with their opinions as well, as everybody has something to offer on the subject of housing … after all, we all have to live somewhere 🙂

As to buying in expensive areas:

1. Don’t … if you want to get wealthy

2. Don’t upgrade, if you are already in a house, while you still break either/both ‘rules’

3. Do … if you MUST buy in that area AND this is your first home

… I don’t mind first home buyers breaking these rules to ‘get into the market’; since they are statistically unlikely to become wealthy – or even save anything substantial – anyway, this at least provides some sort of ‘forced savings’ … old fashioned, I know, but better than spending the mortgage on rent, beer, and skittles.

@ Jeff – I think that you need to look at this house as a ‘flip’ (i.e. investment) rather than as a house to live in; which means a few things:

a) Since you are considering this a speculative investment (i.e. a Making Money 201 activity … taking a bit of an educated ‘gamble’ to improve your Net Worth), the 20% Equity Rule doesn’t apply; this rule is aimed at ensuring that you have 75% of your Net Worth invested and working for you, so the money you have sunk into this house is clearly part of the this 75% and your primary aim with it is (OR, HAD BETTER BE) to make it work for you as hard/fast/safely as possible.

b) So, you need to ask yourself – hopefully, BEFORE you bought it 😉 – is it a good ‘flipper’? Do yo have a backup plan if it doesn’t ‘flip’ as well as you hope e.g. stay in the house yourself, or rent it out? Will it rent well/profitably?

c) But, you are not off the hook on these rules entirely: you are now effectively renting – from yourself. This is a tough one, because you can consider the mortgage as ‘risk leverage’ against the future capital appreciation (you hope!) and/or you can consider it ‘rent’. Again, you don’t want to spend more than 25% of your net income on housing costs, be it mortgage … or, rent. I think you are close enough on this one, anyway …

d) BUT, when calculating your adherence to the 25% Income Rule in the future, only allow the portion of your ‘housing allowance’ that you can be, say, 80% certain will continue for the next few years. Consider the balance as ‘found money’ and put at least 50% of it towards some sort of longer term investment/saving plan instead of into your housing (or other ‘spending’ category); this way, you make hay while the sun shines and protect yourself in case the next move doesn’t provide the bonus (or a substantially lesser one).

A final comment on these types of ‘hybrid’ investment opportunities: recognize them for what they really are: EITHER a house OR an investment. Be candid and honest with yourself and choose ONE:

– If primarily an investment, go back to the questions in b) and don’t buy if you can’t answer ‘yes’ to both, confidently

– If primarily a house, obey the 25% Income Rule and the 20% Investment Rule

If you can’t do either, then SERIOUSLY consider renting if you are planning to live in the house for, say, less than 5 years, if more than 5 years, refer to my earlier post on applying the 20% Rule:

@Adrian – In special cases can the house be both an investment and a home? For example, for a single person, I can rent out a room in my house which makes it another kind of hybrid. So if the rules are violated but then if one can make it a partial investment property, do we apply the rules proportionally?

Great question Mark.

@ Mark – It is a great question!

Naturally, there will be some true exceptions to any rule (otherwise everybody would have the same ‘rule book’ and we’d all be rich simply ‘by the numbers’): e.g. a duplex on one title, and you live in one and rent the other. But, what’s your exit plan … how do you release the investment portion of the equity?

If you have a good answer to that question, perhaps you can proportion the income and equity rules. Just don’t fool yourself …

@ Adrian – I think I have an exit plan.

1. Sell it. Ideally there’s a sizable profit here in three years or so, but that depends upon the RE market. However, I think I could fire sale the property if I needed to move it quickly and still make a profit. So the selling door is open.

2. Rent it. I would do this only if there was a good reason why I should hold on to the property longer. Things such as current RE market environment, potential for future appreciation and rental financials would be key indicators for me. As I mentioned in the post, I believe at $3600/month mortgage it would cash flow negatively for a while. If I can refi down to below 5%, I’ll in a better position to do damage control in a rental scenario. Obviously I’ll need to factor in closing costs etc. to determine whether the numbers make sense for me. I’m willing to suck up a negative cash flow of $300-600 per month (which I’ll call an investment) if it means I can continue to control the property long enough to realize future appreciation. I consider this similar to my dollar cost averaging approach to my 401K/IRA etc…albeit with maybe a bit more risk.

@ Mark – You’ve touched upon one of my strategies, reasons or maybe excuses to justify the mortgage payment I’m incurring on this one.

I’ve rationalized it as follows:

New Mortgage Payment =

Old (Virginia) Mortgage +
Additional Military Housing Allowance +
My Monthly 401K investments.

I am violating Adrian’s 50/50 “found money recommendation” with the additional housing allowance. But otherwise, I view this situation as one where I’m paying the same mortgage as I’m used to (Old + Found $ + existing investment).

As part of this plan I’m shifting my monthly 401K contributions into my home for the short term. Month to month, I expect it to “feel” the same financially.

@ Jeff – Again, you’re not violating any rules IF you are committed to flipping this house in 2 to 3 years (and are pretty confident that you can turn that tidy profit) … you are simply speculating, which is an accepted Making Money 201 activity PROVIDED that you are going in with “your eyes” open.

[…] Jeff is a Navy Pilot, so it should come as no surprise that he: (a) moves a lot, and (b) gets some housing assistance. Jeff is seeking to capitalize on his unique situation by flipping his current home … why don’t you add your comments to those that are already on his post? […]

i don’t think he should be speculating when looking at his future. I think the 20% and 25 % rules you have established seem to afford some protections against unforeseen future events or situations.
What if he can’t get the price he thinks he can on the current home? what if the housing market takes much longer to correct than he predicts? can he handle both these properties for as long as it takes?he doesn’t convince me that he has fully thought this through.
personally, if your gonna gamble, i think you should take a couple hundred , head to vegas and gamble. but with your home or future gamble is not cool.

@ Steve – Great questions; of all, since Jeff is looking at all of his properties as ‘speculative investments’ right now (well, at least the house he is living in), to me, the key question that you asked is this one:

“can he handle both these properties for as long as it takes?”


Steve/Adrian – Great questions.

Bottom line up front (or what some refer to as BLUF): Yes, I can handle both houses for as long as it takes.

I know it can be difficult to get a true picture of our decision making when we only convey the results in a few hundred words. I apologize if I left this a bit vague.

I’m a planner and analyzer by nature and would not have entered into this arrangement without a solid back up plan. In this case I actually have two back up plans.

Primary plan – Rent one house with positive cash flow while living in the other. This plan is in play and working well right now.

Back up plan – Carry both houses on my own back. I started this process with the assumption that I had to carry both homes indefinitely. By my math, that is not only possible, but quite doable.

Back up to the back up – Have a fire sale on properties. Fortunately I bought smartly (my opinion 🙂 ) on both homes. I am in the position of being able to discount both homes significantly relative to current comparable home sales and still make a profit.

As for gambling with my future…I think that’s inherent in just about any investment we’ll ever make. Given that opinion we are all gambling here at 7m7y.

Thanks for the discussion.

@ Jeff – Great strategy (hopefully, the backup/backup plan won’t be required as it sounds like you have – or soon will have – plenty of equity in these properties to tap into, if need be) …. Now:

Place your bets, please 😛