4 Different Rules of Thumb For How Much House You Can Afford

housemoneyUpdated. Buying a house is always an exciting yet terrifying time. Deciding on how much we can “afford” is often limited by how much someone will lend us. Mortgage lenders use income size, income stability, credit score, down payment size, and other factors before approving a loan. Let’s explore the idea of a “rule of thumb” to greatly simplify such a complicated matter. The most common way to express affordability is as a multiple of your household or individual annual income.

CNN Money says 2.5 times:

The rule of thumb is to aim for a home that costs about two-and-a-half times your gross annual salary. If you have significant credit card debt or other financial obligations like alimony or even an expensive hobby, then you may need to set your sights lower.

The now-defunct Washington Mutual Bank suggested up to 4-5 times:

As a broad generalization, most people can afford to purchase a house worth about three times their total (gross) annual income, assuming a 20% down payment and a moderate amount of other long-term debts, such as car or student loan payments. With no other debts, you can probably afford a house worth up to four or even five times your annual income.

Investopedia offers up 2 to 2.5 times:

Generally speaking, most prospective homeowners can afford to mortgage a property that costs between 2 and 2.5 times their gross income.

Running Your Own Numbers

Where do these numbers above come from? Most government-backed mortgages utilize the following ratios for their underwriting:

  • Front-end debt-to-income ratio = housing-related costs (PITI) divided by gross income. PITI stands for principal, interest, taxes, and insurance.
  • Back-end debt-to-income ratio = housing-related costs (PITI) plus all recurring monthly debt, all divided by gross income. Recurring monthly debt includes student loans, car loans, credit card debt, and alimony/child-support obligations.

Essentially, they want to be sure that housing costs don’t take over your entire budget and also that you can still handle your total monthly debt load. (Left out are things like food, transportation, other insurance, health care, etc.) Each of the major lending agencies has their own set of DTI limits, but let’s use the standard Federal Housing Administration (FHA) limits of 31% for front-end DTI and 43% for back-end DTI.

You can insert your own numbers here, but let’s use these statistics based on the average US household:

  • Household income. Government statistics have the median US household earning around $52,000 gross a year, or $4,300 a month.
  • Taxes and homeowner’s insurance. Depending on the survey, the national average is somewhere between $2,000 and $3,000 for annual property taxes and roughly $1,000 for annual homeowner’s insurance premiums. Together that’s roughly $300 a month.
  • Credit card debt. The Federal Reserve reports the average household credit card debt to be about $7,500. The underwriting guidelines use minimum payments, so if you assume a 3% minimum payment that’s $225 a month.
  • Car loans. Experian reports that the average monthly loan payments was $450 for new cars and $350 for used cars. Let’s use $400 for this exercise and assume one new car per household.
  • Student loans. For households with student debt, Brookings estimates that the average monthly payment is $240.
  • Current 30-year fixed mortgage rate. Bankrate and HSH report this to be about 4.25%.

20% Down Payment, 31% Front-End Ratio
Using a 31% front-end ratio, that means PITI (principal + interest + taxes + insurance) can be $1,333 a month. Taking out $300 for taxes and homeowner’s insurance, that leaves us $1,033 a month for principal and interest. With a 20% down payment and a 4.25% interest rate, that works out to roughly a $210,000 maximum loan size and $260,000 maximum total home price = 5 times gross income.

20% Down Payment, 43% Back-End Ratio
Using a 43% back-end ratio and the average consumer debt numbers from above, we start with $1,850 and take out $300 for taxes and HO insurance, $225 for credit card payments, $400 for car payments, $240 for student loans. That leaves us with $685 for the mortgage payment at 4.25%. The resulting $140,000 max loan size with 20% down payment gives a $175,000 total home price = 3.4 times gross income.

5% Down Payment, 31% Front-End Ratio
The minimum down payment amount for a FHA loan is actually only 3.5%, but you will be subject to additional Upfront Mortgage Insurance Premium (UFMIP) of 1.35% of the loan amount plus an ongoing PMI of 0.80-0.85% of the loan amount annually based on your loan-to-value ratio. Having to pay PMI means less money available to go towards the loan, so our numbers now only give us a $185,000 max loan size. With a 5% down payment, that means a total home price of $195,000 = 3.75 times gross income.

5% Down Payment, 43% Back-End Ratio
Doing the same calculation using the 43% back-end ratio which takes into account other debt payments, you end up with only roughly $110,000 max loan size and loan and total home price of $117,000 = 2.25 times gross income.

By doing this exercise, we see that someone with a car note, credit card debt, and student loans is certainly going to have a much different measure of affordability than someone without such pre-existing obligations. Perhaps there is no easy rule of thumb? If I had to, I would say that a household with “significant” debt could start at 2x income, while someone with very little debt could start with 3x income. But it shouldn’t be too difficult to use this example to get much more accurate numbers.

Most importantly, just because someone is willing to lend you a certain amount, doesn’t mean you have to take it! Here are some posts that may help you get the most value for your housing dollar:

Home Improvement Receipts: Scan Now, Save Indefinitely

housecostbasis2For many people, when they sell a home they don’t even consider taxes. But over time, especially if you live in a relatively expensive area, more and more people will bump up against the federal capital gains exclusions of $250,000 for individuals and $500,000 for couples. (You must have lived in the home for at least two out of the five years before the sale.)

This NY Times article projects that the following share of homeowners in certain high-cost cities will exceed the 250k/500k limits within the next 10 years, assuming just 3.5% annual growth and no further improvements. (Also consider the uncomfortable idea that you really can’t know if you’ll be single or married when it comes time to sell your home.)

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Most importantly, the article provides a good reminder to save all of your home-related receipts because they can raise your cost basis and thus reduce any potential capital gains. It’s so easy, and those little pieces of paper can literally be worth thousands of dollars down the road when the tax bill hits.

In general, you should save all of your home repair and remodeling receipts, although things considered maintenance won’t count (painting, fixing leaks, patching cracks, etc.). Here are a bunch of things taken from IRS Pub 523, Selling Your Home. Don’t take this as specific tax advice, but instead as a potential reminder in case you have done something on this list but don’t have the receipts properly stored away and archived.

Home Acquisition and Closing Costs.

  • Charges for installing utility services, legal fees for preparing the sales contract, title search fees, recording fees, survey fees, transfer or stamp taxes, and owner’s title insurance.

Home Improvements

  • Additions. Bedrooms, bathrooms, garages, decks, patios.
  • Exterior. New roof, siding, satellite dish, storm windows.
  • Interior. Built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting, fireplace.
  • Lawns and grounds. New driveways, landscaping, fences, retaining walls, sprinkler system, swimming pools.
  • Systems. Heating, air conditioning, furnace, duct work, air/water filtration, security system.
  • Plumbing. Septic, water heater, water softener, water filtration.
  • Insulation. Attic, walls, floors, pipes, ductwork.

Physical receipts can get lost or fade over time, but the IRS accepts electronic records so it is quite easy to make a PDF using either your home scanner or just your smartphone. I use the well-reviewed Scanner Pro app and am impressed by its quality, but there are many competitors out there that I haven’t tried. You can then save to a cloud service like Dropbox or Evernote, or simply e-mail them to a searchable gmail account as another form of backup.

Charlie Munger On Leverage and Paying Your Mortgage Off Before Retirement

housemoneyWhile reading back through various transcript notes from the 2015 Berkshire Hathaway Annual Meeting, I recalled the following quote from the Q&A session. A shareholder had asked why Berkshire had never borrowed money to buy stocks (i.e. leverage). Charlie Munger replied:

It’s obviously true. If we’d used the leverage that some others did, Berkshire would have been much bigger … but we would have been sweating at night. And it’s crazy to sweat at night.

This is an important point, as many other similar investors have used leverage to boost their returns (not always, but some with success). Buffett and Munger certainly could have justified such an action, especially given their excellent investment track record.

Munger did not make this jump, but I believe but an individual investor could also apply this quote to paying off their mortgage early. Even I enjoy discussing the details of mortgage payoff vs. retirement savings, and acknowledge that mortgage interest rates are low while stock returns are historically higher. Why use your money to pay off your mortgage when you could invest in stocks instead?

The problem is that if you are putting off paying off your mortgage just so you can invest in stocks, you are using leverage! That is, you are taking borrowed money and then putting it at risk. That may increase your overall returns, but it will also increase your exposure to bad outcomes. For most people – not everyone, but most – paying off your mortgage debt will help you sleep better at night. Based on his biography, Warren Buffett himself bought a house in cash when he got married. Even though he was confident he would have made more money by putting those funds toward his investment partnership, he chose not to have a mortgage.

In addition, many financial advisors are incentivized to maximize the amount of your money that they manage, as they can’t earn any fees off your home equity. Wes Moss, a fee-only advisor and Money Matters radio show host, ignores that and gives blunt advice in his book You Can Retire Sooner Than You Think:

Sooner or later, every homeowner asks the simple question, “Should I pay off my mortgage?” and immediately gets bombarded with a variety of complicated, hedged responses. Here is the simplest possible answer: Yes. If you are anywhere near retirement and can afford to pay off your mortgage, you should.

I view this as an example of how real-world, experience-based advice can differ from theoretical, academic-based advice. Humans are not perfectly rational. I have never regretted paying off my mortgage early, although I do agree with the qualification that mortgage payoff should roughly coincide with retirement date.

* Of course, Warren Buffett quickly added: “…over financial things.” Ba-dum-bum-ching!

Real Estate Crowdfunding Experiment #1: Property Details and Numbers Breakdown

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Woohoo, I just received my first interest payment on my real estate crowdfunding experiment #1. I put in $5,000 at 11% APR, which should work out about $46 a month but the first partial payment was an underwhelming $16.81. I e-mailed Patch of Land and they said I could share the details of my loan, so here they are. If you are a SEC accredited investor and a (free) registered member, you can view it on their site.

Financial details. Here is the summary and breakdown from the Patch of Land listing:

The developer is requesting a loan of $179,000 in order to purchase and renovate the underlying property. The property was purchased for a total of $155,000 in April of 2015. There is minor renovation needed for the underlying property, totaling $55,000. The borrower will receive 2 draw(s) totaling $175,420 over the course of the loan. The initial draw in the amount of $120,420 occurs when the loan closes. The second draw of $55,000 will be disbursed when renovation is completed. The borrower plans to sell in 1 year or under.

polwestsac

Loan is secured by the property, in the first position. Also have personal guarantee from borrower (not worth much). 6-month term (roughly April 15th to October 15th). 11% APR interest, paid monthly.

So the developer is contributing roughly $40,000 and the loan is roughly $180,000. So a total of $220,000 is being put into this house. Considering that the loan will charge roughly $10,000 in interest over 6 months, plus a potential 6% brokers commission upon sale, this house would have to sell for around $245,000 for the developer to break even. The developer thinks the house can sell for $275,000 but it all depends on how well they spend that $55,000 in renovation costs and how the local market holds in the next 6 months. A 3rd-party appraisal gave a estimated after-repair value of roughly $240,000, which is probably a conservative number but suggests a potentially tight profit opportunity for the developer.

In the end, I do believe it likely that the loan amount of $179,000 can be recovered from this property in a liquidation scenario (see below). It is important to note that the developer doesn’t actually get the final $55k until the renovations are completed and thus the home will be worth more.

Property details. Single-family home in West Sacramento, California. The address is 508 Laurel Lane. You can look up details from public records using sites like Zillow or Trulia. Built in 1954, 3 bedrooms, 1 bath, 1,675 sf living area, 7,000 sf lot. The pictures provided suggest a house that is definitely in need of a kitchen remodel and light repairs, but it wasn’t destroyed inside. The house is about the same size and appearance of other houses in the neighborhood.

I am not familiar with the Sacramento area. The zip code of 95691 appears to have slightly above-average selling prices compared to West Sacramento overall. According to Google Maps, the neighborhood is relatively close to freeway access and downtown Sacramento. I also looked at Google Street View and I liked that the neighboring houses all appeared to have well-maintained houses and manicured lawns. That suggests pride of ownership and/or a certain level of peer pressure to keep your house looking nice. Based on a quick Craiglist search of comparable rentals, this house should support roughly $1,400 to $1,500 in monthly rent, which is not bad compared to the ~$245,000 that I’d like this house to sell for once fixed up.

In the end, there are a number of risks in this deal, but otherwise it wouldn’t pay an 11% annualized interest rate. From my vague understanding of hard money loans, I was hoping for much lower LTVs in the 50% range instead of the 80% range. Perhaps the lessening of loan standards from new money flooding this new asset class is already happening. It would be educational to see how they handle a liquidation… but I should just sit back and quietly cash my interest checks.

Real Estate Crowdfunding Experiment #1 – Background and Introduction

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After I took out roughly $7,500 out of my P2P lending experiment, I started looking for another place to put my money at risk. :) I decided on trying out real-estate crowdfunding, which tries to make real estate investing (either through equity or debt financing) more accessible to individual investors. Right now, all of the major sites require you to be an accredited investor as defined by the SEC. Keep in mind that these investments can be quite risky and that this is an experiment with a small portion of my portfolio set aside specifically for such purposes.

I’m going to be upfront; I didn’t spend an enormous time vetting each and every website out there. I swapped a few quick e-mail questions with a few sites and signed up with some of them (you have to sign up for a free account in order to view the investment opportunities). Due to my analytical tendencies, I missed a bunch of them because the good ones were often fully funded within 24 hours. Other times, I had time to do more research and simply never got back around to it. I finally set some simple criteria and decided that I would jump on the next one that fit the bill. The criteria:

  • Try out one of these new crowdfunding real estate websites – Realty Mogul, Fundrise, Realty Shares, Patch of Land, and others.
  • Single or multi-family residential property.
  • I wanted to be a lender, and the loan must be secured by the property, in the first position.
  • Short-term financing deal with 1 year term or less.
  • Loan-to-value of under 80%, based on my own rough numbers.
  • At least 10% annualized return (10% APR interest).
  • Invest only $5,000 per property.

I found an investment that fit, electronically signed the required documents, and the deal appears to have completed funding. Here are the results:

  • Patch of Land
  • Single-family home in West Sacramento, California
  • Loan is secured by the property, in the first position. Also have personal guarantee from borrower.
  • 6-month term (roughly April 15th to October 15th), with the goal of a quick rehab and reselling of the property.
  • LTV is 78% per my rough numbers.
  • 11% APR interest, paid monthly.
  • $5,000 invested.

pollogoI’m not sure exactly what details of this investment I am allowed to share, so I’ll save that part for later. It will be good for you guys to pick apart, but it doesn’t really matter for other investors as the project is already 100% funded. I’m just waiting on my first interest payment in May, and hope to be done by October. At the end of the year I will get a 1099-INT.

Here’s part of the pitch for Patch of Land:

Patch of Land is a curated real estate debt crowdfunding platform that sources, originates, and underwrites loans to professional, experienced real estate developers. Patch of Land is one of the first real estate crowdfunding platforms. We have been building a strong track record of funded projects and investor returns since 2013. We are considered one of the top 5 real estate platforms by leading crowdfunding publications.

Loan proceeds are used to rehabilitate residential and commercial real estate properties across the country. Loans are secured by the underlying property and personal guarantees from the borrowers. Patch of Land then matches those loans with accredited and institutional investors for funding. Loans are issued for terms of 12 months at rates ranging from 10 to 18% APR, paid monthly to investors.

What I liked about Patch of Land is their stated commitment to individuals provide significant funding and also that many of their borrowers are experienced individual real estate investors. In that way, it’s almost a peer-to-peer feel, as opposed to institutional investors providing the cash to large real estate organizations.

Along those lines, Patch of Land recently completed a $23.6 million round of funding, and $3.6 million of that came from SeedInvest, a crowdfunded start-up investing firm. So technically, I could have also been a part-owner of this start-up as well. For now, I’ll stick with being a “real estate lender” and maybe I’ll add the “venture capitalist” title later. I would like to invest another $5,000 into partial ownership of a commercial property via another crowdfunding site.

Time Again to Reconsider Refinancing Your Mortgage?

If you have a mortgage with an interest rate over 5% or even 4%, hopefully you have explored refinancing it to a lower interest rate. Yes, it can be a bit of a pain, and that is why many people leave tens of thousands of dollars, if not over a hundred thousand dollars, on the table. A one-time hurdle now is better than worrying about skipping lattes forever! Here are some useful nuggets of information that will hopefully motivate you to pursue it further.

Mortgage rates are back near record lows and refinance applications are spiking. From the NY Times on 1/20/15:

The average rate on a 30-year fixed-rate mortgage was 3.8 percent at the end of last week. That is down from 4.5 percent as recently as last spring, the lowest since May 2013 and far below the 5 percent-plus rates that prevailed as recently as early 2011. […] Homeowners who secured their current mortgage in late 2013 or early 2014, or anytime before mid-2011, may want to at least plug their numbers into an online calculator to see if the potential savings are worthwhile.

refi1

Home price appreciation may mean you can refi and get rid of private mortgage insurance. Home values have been rising, so you may now be eligible to refinance when you weren’t in past years, which could reduce your interest rate and/or enable to you stop paying for mortgage insurance.

20% of people who could benefit from a refinance didn’t… From a NBER paper and this CBS Marketwatch article

For example, in the period they study, December 2010, 20 percent of households that would have benefited from refinancing and had the ability to refinance did not do so. The median amount of unrealized savings was approximately $160 per month, or $11,500 per household over the remaining life of the loan.

… and they could have saved big bucks.

… a household with a 30-year, fixed-rate mortgage of $200,000 at an interest rate of 6.5 percent that refinances when rates fall to 4.5 percent will save over $80,000 in interest payments over the life of the loan, even after accounting for typical refinancing costs. With long-term mortgage rates at roughly 3.35 percent, this same household would save roughly $130,000 over the life of the loan by refinancing.

Shop around! People spend more time comparison shopping for a $500 computer than a mortgage that could save you $10,000. From Bloomberg:

Mortgage interest compounds the cost, and over the life of a loan, small differences in an interest rate really add up. The best way to save, then, is to shop around for the best rate possible, but a new survey by the Consumer Financial Protection Bureau (CFPB) finds that half of homebuyers consider only one lender or mortgage broker. That’s particularly unimpressive considering that typical shoppers will spend at least four hours choosing a new computer.

There are new tools to help you comparison shop. Forget average interest rates. You want the interest rate for your situation. The Consumer Finance Protection Bureau (CFPB) has a new rate checker tool that takes into account your credit score, state of residence, house price, and down payment size to see what other interest rates people are getting. I like they show an actual distribution of rates and the number of lenders offering that rate:

refi2

In the end, you will have to gather lots of paperwork and probably deal with a couple hiccups to get your refinance done. I never said it would be fun, but it is profitable. You can try the big networks like and Quicken Loans, or you can ask around for a referral to a reputable mortgage broker. The CFPB recommends that you get quotes from three or more lenders. That way you can compare and even negotiate one off the other. “Rates often change from when you first talk to a lender and when you submit your mortgage application, so don’t make a final decision before comparing official Good Faith Estimates.”

Big List of Free Consumer Reports (2/2): See Your Confidential Housing, Insurance, & Employment Data

magUpdated for 2015! As these are available only every 12 months, it is a good idea to check them the same time each year.

Here is the second part of my big list of free consumer reports from over 50 different reporting agencies. The first part included your credit, banking, and subprime lending-related information. This part includes your housing, insurance, and employment history. Request your free copy of what these databases have stored about you and are telling prospective landlords, insurers, or employers.

Again, you may not need to check all of these, and many may not even have a file on you anyway. But for example if you are a renter then you’d want to make sure your rental history is clean and correct, because if I was a landlord I’d avoid anyone with previous blemishes on their record.

Rental History

Realpage Consumer Report. Provides tenant screening through their LeasingDesk product, including “the industry’s largest rental payment history database.”

CoreLogic SafeRent. SafeRent provides both tenant and employment screening data, including information regarding landlord tenant and criminal public court records. One free report every 12 months.

Experian RentBureau Rental History Report. “Every 24 hours, Experian RentBureau receives updated rental payment history data from property owners/managers, electronic rent payment services and collection companies and makes that information available immediately to the multifamily industry through our resident screening partners.”

First Advantage Resident History Report. Tenant and employment background checks. One free report every 12 months.

Contemporary Information Corp. CIC provides background checks on prospective tenants and/or employees and contractors for landlords and management companies. Keep records of any rental evictions.

Tenant Data. Provides tenant history reports, including any reported damages, unpaid balances, evictions, lease violations, noise complaints, or unauthorized pets.

Auto and Property Insurance

C.L.U.E. Personal Property Report. A division of LexisNexis, CLUE stands for Comprehensive Loss Underwriting Exchange, which collects information that is used to calculate your insurance premiums. This report provides a seven year history of losses associated with an individual and his/her personal property. Includes date of loss, loss type, and amount paid along with general information such as policy number, claim number and insurance company name. This also means you can find out about previous claims on the house you are currently renting or recently bought, even if they weren’t made by you.

C.L.U.E. Auto Report. This report provides a seven year history of automobile insurance losses associated with an individual. Includes date of loss, loss type, and amount paid along with general information such as policy number, claim number and insurance company name.

Verisk Analytics aka ISO aka A-PLUS Loss History Reports. ISO stands for Insurance Services Office, A-PLUS stands for Automated Property Loss Underwriting System. Auto and property loss claim history.

Insurance Information Exchange. Provide reports including your motor vehicle records and driver history, including any traffic violations or related criminal history. May require proof of adverse action to obtain free report.

Utilities

National Consumer Telecom and Utilities Exchange. NCTUE is a “membership of companies that provide services (telecommunication, pay TV, and utilities) […] to aid in risk mitigation.” Basically they track when people don’t pay their phone, cable, or utility bills. One free report every 12 months.

Medical History

MIB (previously known as Medical Information Bureau). Run by 470 insurance companies with a “primary mission of detecting and deterring fraud that may occur in the course of obtaining life, health, disability income, critical illness, and long-term care insurance.” They record information of “underwriting significance” like medical conditions or hazardous activities. If you have not applied for individually underwritten life, health, or disability income insurance during the preceding seven year period, then you probably don’t have a record.

Milliman IntelliScript. Tracks your prescription drug purchase history. “Milliman IntelliScript will have prescription information about you only if you authorized the release of your medical records to an insurance company and that company requested that we gather a report on you.”

OptumRX / MedPoint Health Report. Tracks your prescription drug purchase history. Now called OptumRX, formerly Ingenix.

Employment History

The following companies all offer background screening services for employers. Most will not have any information about you unless you authorized a potential employer to run a background check on you (probably during the application process). Some will not provide you information unless there was adverse action. Otherwise, you can get one free copy every 12 months.

The Work Number. (division of Equifax) They also keep historical income records.

Accurate Background, Inc.

American Databank, LLC.

EmployeeScreenIQ.

General Information Services.

HireRight.

Info Cubic.

IntelliCorp.

Pre-employ.

Professional Screening & Information, Inc.

SterlingBackcheck (formerly Sterling Infosystems)

Trak-1 Technology.

Verifications, Inc.

Reminder: Also see Part 1: Big List of Free Consumer Reports with Your Credit, Banking, and Payday Lending Data.

Sources: ConsumerFinance.gov, FTC.gov, AnnualMedicalReport.com, Wikipedia

Big List of Free Consumer Reports (1/2): See Your Confidential Credit, Banking, and Payday Lending Data

magUpdated for 2015! Since these are available every 12 months, it is a good idea to check these near or around the same time each year.

There are many companies out there that make money by collecting and selling data – your personal data. In the past, it was often difficult if not impossible to see what they were telling prospective lenders, landlords, even employers about you. Under the FCRA and/or FACT Acts, many consumer reporting agencies (CRAs) are now legally required to send you a free copy of your report every 12 months, as well as provide a way to dispute incorrect information. I have split them into two parts:

Some have an online request form, but many require snail mail with proof of identity. You probably won’t want to bother checking all of them (for example if you rarely write checks or use payday loans), but if you’ve experienced any sort of rejection or adverse reaction in these areas the cause might be found inside one of these databases. Keep in mind that you may not have a file with all of these places.

Credit-Related

Experian, Equifax, and TransUnion. The three major credit bureaus track your credit accounts, payment history, and other related information like bankrupts and liens. Free copy of each once every 12 months.

CoreLogic Credco. One of the largest credit-related CRAs and often used by mortgage lenders, your CoreLogic Credco Consumer File can contain: previous homeownership and mortgage info, rental payment history, any reported delinquencies, and other debt obligations like child support. Free copy once every 12 months.

LexisNexis. One of the largest personal information databases that includes public records, real estate transaction and ownership data, lien, judgment, and bankruptcy records, professional license information, and historical addresses on file. Free copy, must mail in form.

Innovis. A supplementary credit report and identity verification provider. Free copy once every 12 months.

IDA, Inc. Per their site, they are a “credit reporting agency that produces credit reports and scores from our repository of consumer information contributed by a wide array of companies including leading financial services organizations, wireless providers, utilities, retailers, auto lenders and many others.” Free copy, must mail in form.

  • IDAInc.com request page
  • 866-361-7984

Microbilt and subsidiary Payment Reporting Builds Credit (PRBC). Microbilt is a credit reporting agency, per their site a “leading provider of alternative credit data to businesses that want to offer credit and other financial services to the approximately 110 million underserved and underbanked consumers in the United States.” Free copy once every 12 months.

L2C, Inc. A credit reporting agency, appears focused on the underbanked or unbanked population. Limited further details.

Banking-Related

Chexsystems. A consumer information database used by an estimated 80-90% of all banks to help determine the risk of opening new accounts. Think of it as the banks’ version of a credit bureau. If a person commits check fraud or overdraws their account, it will be listed here. In addition, the simple act of opening or closing a bank account may be recorded in their database. Having a negative ChexSystems record can leave you blacklisted from opening bank accounts at most major banks. Free copy once every 12 months. Must order by phone, mail, or fax.

TeleCheck. Per their site, they provide “industry-leading check acceptance, check processing and risk analytics services to merchants and financial institutions.” One of the major companies that protect businesses and banks from bad checks. Must order by phone or mail.

Certegy Check Services. Per their site, a “check risk management company that provides verification, guarantee and risk analytics to thousands of businesses that choose to accept checks as a form of payment for goods or services.” Clients include check-cashing stores and casinos. Free copy once every 12 months. Must order by phone or mail.

Early Warning Services. A collaboration between a group of big banks including Bank of America, BB&T, Capital One, JPMorgan Chase and Wells Fargo. Provides fraud prevention and risk management in relation to bank accounts and payment transactions. Must order by phone.

Subprime-Related (Payday Lending)

The following companies focus on subprime customers with clients including payday lenders, title loan lenders, rent-to-own stores, and subprime auto loan providers.

Teletrack (affiliated with CoreLogic).

FactorTrust. Free copy once every 12 months.

Clarity Services, Inc. Must mail or fax form.

DataX Ltd. Must mail form.

Reminder: Also see Part 2: Big List of Free Consumer Reports with Your Confidential Housing, Insurance, & Employment Data.

This should serve as a mid-year notice, but I will refresh this post as a reminder around January 1st (that’s when I like to pull all my reports).

Sources: ConsumerFinance.gov, FTC.gov, Wikipedia

The Invention of the Fixed Rate Mortgage

homefrontBusinessweek magazine celebrated their 85th anniversary by listing what they deem the 85 inventions with the greatest impact over the last 85 years. #1 was jet engines, but #17 was the fixed-rate mortgage.

At the time, it was bold and controversial decision done in response to the Great Depression. The government wanted a way to refinance home mortgages currently in default to prevent foreclosure:

In 1933, to provide stability, the now-extinct Home Owners’ Loan Corp. introduced a new type of mortgage: It had a fixed rate and was fully amortized, meaning borrowers paid off the entire loan by the end of the term. Not everyone cheered. Critics railed that it was “crazy and un-American [to be] putting people in debt for 15 years,” says Louis Hyman, author of Debtor Nation: The History of America in Red Ink.

That last quote suggests that a 15-year mortgage was really long and people used to pay off their mortgages a lot faster. I’m not really sure if that was the case, or if there was just a big split between people who could pay cash for a house and those that couldn’t. Wikipedia states that the previous standard in the 1920s was either 3-5 year interest-only mortgages offered by commercial banks or 10-12 year loans which required buying shares in the lender itself (not good when the share value plummets in an economic crisis).

If you think about it, fixed-rate mortgage are pretty reasonable terms. A fixed payment every month evenly spread out over 30 years, and as long as you don’t miss any payments you’ll be fully paid off by the end of the loan period. It kind of makes you wonder if private companies would have created such an instrument in the “free market” absent government intervention. Of course, you have to wonder what would housing prices be like without their existence? (Just today I see that Fannie and Freddie announced the backing of 3% downpayment mortgages.)

Since they do exist, I still think people should use them to time their mortgage payoff with their retirement date. For many people, a 30-year fixed rate mortgage will do just that if they don’t refinance into a longer term. Start at age 30-something, finish at 60-something. For those that are serious about early retirement, then the 15-year mortgage may be a better fit.

Effect of Student Loan Debt on Homeownership Rate

Multiple sources are suggesting that increasing student loan debt levels will have a significant impact on future housing prices because people will delay their home purchases (or put them off entirely). Although that seems like a reasonable assumption, I haven’t actually seen any hard data on it.

In a recent Vanguard research paper titled No bubble to burst: U.S. student debt is not housing [pdf], they took data from the Federal Reserve’s 2010 Survey of Consumer Finances and U.S. Census Bureau and found that:

Although financing a bachelor’s degree with student debt decreases the likelihood of a typical 30-year-old college graduate purchasing a home by –1.7%, obtaining that degree also increases the likelihood of purchasing a home by 10.8%, relative to not attending college at all.

vanguard_home

In the end, the conclusion seems to still be consistent with other findings. Getting that college degree is still “worth it” financially, even with the accompanying debt, at least on average. Your income is higher, you’re less likely to be unemployed, and you are more likely to own a home.

vanguard_home2

I suppose the primary thing to avoid is to not be above average on the debt. If you have to take on $120,000+ of debt just to get a 4-year degree, you’re probably going to the wrong school anyway. If the school really wanted you, they’d offer you a better aid package with grants and/or tuition waivers.

Early Retirement Lesson #3: Home-Buying and Mortgage Advice

housemoneyHere’s another installment of what I would tell my kids about pursuing financial freedom (if they weren’t still in diapers). Previous topics have included the importance of savings rate and whether to focus on earning more or spending less. This time, I wanted to talk about buying a home and mortgages.

Should you buy or rent? Now, there are many buy vs. rent calculators. Here is the best one in my opinion. But as they say garbage in, garbage out, so be careful. Your answer will strongly depend on unpredictable things like future investment performance and/or home price appreciation. In general, the longer you plan on staying in a geographical location (say at least 5-7 years), the better it is to buy your own place. But if you are the nomadic type and want to travel the world, then renting can work out to be much better. In my experience, buying a house often ends up a lifestyle-based decision and not just about the numbers.

If you decide to buy, my opinion is that you should adjust your mortgage size and term to coincide with the date of retirement. I define retirement as when your expenses are exceeded by your non-work income like pensions, Social Security, annuity payments, stock dividends, rental income, or other investment income. Example scenarios:

  • If you love your job and plan on working for the next 30+ years, then go ahead and get a 30 year mortgage. Maybe you have a job that you could work part-time or isn’t very stressful. In this case you have lots of human capital and a long stream of future work income. Take on the 4% interest rate fixed for 30 years, and over time your salary will rise with inflation while your payment stays the same. Be sure to buy a house that you can afford while still investing for retirement. If anything, you could do a DIY biweekly payment plan and pay off that 30-year mortgage in under 24 years.
  • If you have the early retirement bug and want to retire in 15 years, then you should find a home that you can afford with a 15-year mortgage. The interest rate will be lower and as long as you can swing the payments in the beginning, you’ll quickly get used to it. The hard part is to find an affordable home with those higher monthly payments. The hardest part is to be satisfied with it as you’ll have the option and expectation from others to spend more. This is why I think the 15-year mortgage is a powerful tool for aspiring early retirees. It forces you to commit to a long-term lifestyle that fits your goals. Buy a house at age 25, and you’ll be done by 40.
  • Let’s say you receive a monetary windfall (inheritance, huge raise, IPO) and all of a sudden an early retirement is on the table. I wouldn’t necessarily pay off the mortgage completely if you aren’t ready to retire yet. You’ll want to balance the opportunity to invest in potentially higher-returning investments (stock mutual funds, dividend-paying stocks, other real estate) with pursuing the benefits of having a fully-owned house (less stress, less leverage, lower required monthly expenses). My solution would be to pay enough of the mortgage down such that with your usual monthly payments it advances your mortgage payoff date to match your retirement date. If you won the lottery and that date is tomorrow, then yes pay it all off!

One of my reasons for matching mortgage payoff with retirement date is psychological. When you are working, your paycheck is the same every month. This matches well with a fixed mortgage payment. But investment income is often variable. If the tenant in your investment property decides to squat and you have to spend months going through eviction proceedings, your rental income may drop to zero for a while. Many experts now recommend a dynamic withdrawal strategy from your investment portfolio, which would also result in a variable income. But mortgages are like an alligator. You must feed it; if you don’t then it eats you. Other expenses like travel and dining out, those can be adjusted. So I don’t like the idea of having a mortgage in retirement, especially if it is a large percentage of your overall expenses.

However, paying off the mortgage too early can also cause regret if the stock market is rising while you’re piling money into a 4% mortgage. If you are still in the accumulation phase, at times like now you’ll be reminded that you could be investing your paycheck in the market generating higher returns. But if you’re retired, that meant your nest egg was already big enough. If the market goes up, your next egg goes up and you are happier. If the market drops, hey, you already have a paid-off house. So that is why I don’t recommend paying off the mortgage too early, either.

Finally, early retirement with a paid-off house is great because lower expenses means smaller withdrawals from your portfolio, which also means a lower overall tax rate. In fact, with a mix of Traditional and Roth IRAs, we’ve seen that a couple could withdraw over $50,000 a year and still pay zero taxes on retirement. A lower income can also help you qualify for things like health insurance subsidies.

Short version to my kids: If you want to retire early and don’t move around much, buy a modest home where you can afford a 15-year mortgage payment and save at least 25% of your income. If your lifestyle entails lots of moving around, rent and save 50% of your income.

(Related: Pay Off Mortgage Early vs. Save More For Retirement? Digging Deep Into The Details)

Why Non-Traded REITs Are a Horrible Investment

housemoneyJust as important as finding a good investment is knowing what investments to avoid at all costs. If you simply manage to avoid putting any money into financial sinkholes, you’ll come out ahead. I’ve already mentioned the common mistake of cashing out your 401(k) when moving jobs.

Joshua Brown of The Reformed Broker has some great insights into the sales-driven world of products peddled to us retail investors. He talks about non-traded REITs (real estate investment trusts) as opposed to publicly-traded REITS that you can buy via a low-cost, diversified fund like the Vanguard REIT Index Fund (VNQ or VGSIX). Non-traded REITs have been increasingly popular in the current low interest environment as they are structured to look like they provide a solid income stream.

In this recent post, he shares a hilarious fictional conversation that would happen if the broker was abnormally honest about the fees involved. Read the whole thing, but here’s a snippet:

With your portfolio size and risk tolerance I would recommend a $100,000 investment. Given that amount let’s first go over the fees. If you invest $100,000 I will be paid a commission of $7,000. My firm is going to get $1,500 – $2,000 in revenue share. My wholesaler, the salesman that works for the investment’s sponsor company, will get $1,000. He is a great guy, buys me dinner all of the time and takes me golfing. The sponsor company is going to get around $3,000 to pay for some of the costs they incurred in setting up the investment. So all in on Day 1 there will be around $87,000 left over to actually invest. I bet you are getting excited.

You hand over $100,000, and after everyone has gotten their cut, there is only $87,000 actually left over to invest in anything. It doesn’t matter what property they buy, the odds are completely stacked against you already. Studies have shown that publicly-traded REITs have higher historical returns than non-traded REITs. On top of that, non-traded REITs have poor liquidity and you may be locked in for 5 years or more. Despite all this, over $20 billion of non-traded REITs were sold in 2013.

Here’s a Reuters article by James Saft that goes into more detail about the many disadvantages of non-traded REITs. Amongst the more amusing excerpts:

When a financial advisor tried to sell my sister a fee heavy non-traded REIT last year, pitching it as an alternative to fixed income, I told her she ought to fire him. […]

The Financial Industry Regulatory Authority, an industry funded oversight body, went so far as to issue an “investor alert” about non-traded REITs in May of last year, warning about inaccurate and mis-leading marketing of the vehicles as well as other risks. Just to give a flavor of the company in which non-traded REITs are traveling, the most recent FINRA investor alert was about marijuana stock scams.

Bottom line: Avoid non-traded REITs. If you want commercial real estate exposure, buy a low-cost fund like VNQ or VGSIX.