Category Archives for Invest & Retire

Should I Get Pre-Qualified or Pre-Approved for a Home Mortgage Loan?

In a posting from last week (see link below), I mentioned that my application for a mortgage loan pre-approval was recently rejected. I also mentioned that it was fairly surprising when the rejection decision came back to me.

My Money Blog – Can Graduate Students Get Approved for a Home Mortgage Loan?

However, what I did not mention was that the reason that I was so surprised was due to the fact that the same lender had pre-qualified me for a loan several weeks prior.

From this experience, I learned that there obviously must be a big difference between getting pre-approved for a loan and getting pre-qualified. But – just what is that difference exactly? The answer to this question and the decision of which to pursue will be the subject of today’s post.

“Mortgages for Dummies” by Eric Tyson does a wonderful job exposing the differences between these two related, but significantly different, processes. If you are interested in learning more about the details of mortgages, I would highly recommend clicking the link below and picking up a cheap, used copy of this useful book on Amazon.com.

Mortgages For Dummies, 3rd Edition – Amazon.com


What does it mean to get pre-qualified for a home mortgage loan?
In Tyson’s book, he describes mortgage pre-qualification as, “potentially a waste of your time and money and may even be grossly misleading.” Well, he definitely seemed to hit the nail right on the head with this description, at least as far as I experienced this process.

Loan pre-qualification is essentially a “casual” agreement with the loan officer about approximately how much money they might be able to lend you, after quickly reviewing your financial situation. It is very fast and cheap. It usually only takes 15 minutes or less.

In the pre-qualification process, since the lender does not verify the facts about your financial situation, he/she/it is not bound by any contracts to loan you any of the money for which you get pre-qualified.

This sounds like a waste of time to me…

And, what’s more – the mortgage broker told me that in this day and age, pre-qualification is just as good as pre-approval. Talk about a trustworthy, knowledgeable professional!


What does it mean to get pre-approved for a home mortgage loan?
On the other hand, mortgage pre-approval is a much more serious process. In my mind, it is ALWAYS going to be the way to go in the future. The process involves the following steps be taken by the mortgage lender:

• Review your credit history/credit report/credit score
• Analyze your past, present, and future income and expenses
• Amount of cash, investments, and debt you have
• Analyze your prospects for future employment.
• This is where the mortgage lender got stuck with my pre-approval application. They were wanting a note from the university I will be attending this fall to guarantee my continued employment for at least 3 years. I think this is a little ridiculous, but it is what they were wanting.

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

Index ETFs vs. Index Mutual Funds – Which Are Better?

In the majority of the posts to date, I have limited the analysis of the different investment instruments that can be used to satisfy the different asset allocation components to index mutual funds. Please see link below for more details.

My Money Blog – Mutual Fund Posts

However, in one post back in January of this year, I introduced the idea of using ETFs (Exchange Traded Funds) to invest if you are just starting out and only have a relatively low amount of money ($100-$3000).

My Money Blog – Use ETFs to Begin Investing with $100

Not included in this article was an explanation of what an ETF exactly is and how they stack up against regular index mutual funds. These topics will be the subjects of today’s post.

Note: Even though there are both ETFs and mutual funds that are actively managed, we are going to only focus on the index version of each of these, since we have learned previously that actively managed funds do not outperform the market.

What exactly is an ETF?
According to Investopedia.com (see link below for more information), an ETF, or Exchange Traded Fund, is an investment instrument that is very similar to a mutual fund, but is traded like an individual stock.

When you purchase a share of an ETF, your money is pooled with other investors’ funds, which are then used to buy shares of numerous individuals stocks, in order to be representative of an index (such as the S&P500) of which the ETF seeks to track. In this way, an ETF is very similar to a mutual fund.

Investopedia.com – ETF Definition

However, the pricing of an ETF is set throughout the day by the market demand/supply (not based on Net Asset Value at the end of the day like a mutual fund price is calculated)

Comparison of Historical Performance
Before delving in to the detailed comparison of the characteristics of mutual funds and ETFs, let’s take a look at how an ETF and mutual fund that track the same index faired during the last year.

For this comparision, we will look at the two Vanguard.com instruments shown below:

• Vanguard Total Stock Market ETF – Symbol VTI
• Expense ratio = 0.07%, minimum to purchase = 1 share = $59
• 1 year return = +41.3%
• 3 year return = – 4.14%
• 5 year return =  + 3.64%
• After tax returns still ~0.1% higher than index fund from Vanguard below.
• Vanguard Total Stock Market Mutual Fund – Symbol VTSMX
• Expense ratio = 0.18%, minimum to purchase = $3000
• 1 year return = + 41.2%
• 3 year return = – 4.23%
• 5 year return = + 3.52% 

As can be seen from this comparison, the only difference in return between the two instruments appears to be the 0.1% advantage that the ETF carries over the index mutual fund due to having a 0.1% lower expense ratio. Otherwise, the returns appear to be otherwise equal.

Comparison of Characterisitics of ETFs and Mutual Funds (Indexed)
The table below shows a comparison of the different attributes of index ETFs and mutual funds

Note: this table comes to us from page 256 of Jeremy Siegel’s “Stocks for the Long Run” (my investing bible). I would definitely suggest that you click on the link below and pick up a cheap used copy of this very useful book from Amazon.com.

Management
Shares of both ETFs and mutual funds can be bought that are managed in an index fashion. However, ETFs can be bought and sold throughout the trading day, similar to an individual stock.

Fees/Espense Ratios
Generally, ETFs have slightly lower fees than the corresponding index mutual fund. This can be seen in the example above. However, both index mutual funds and ETFs offerred from Vanguard have fees that are much lower than the industry average.

Trading Costs/Commissions
Typically, trading ETFs has involved paying regular brokerage commissions for trading (trading mutual funds of the brand in which you hold your account is free of commissions). However, according to a recent article and the Vanguard fee schedule link below, Vanguard has begun offering commision free ETF trading in-house. Definitely use this to your advantage!

Vanguard.com – ETF Commission Fees

Dividend Reinvestment
In Siegel’s book, he mentioned that ETFs do not offer dividend reinvestment. However, when I just opened a brokerage/ETF account with Vanguard.com this morning, there was an option that stated that they were now offering dividend reinvestment. Excellent! This is generally preffered for long term investing!

Tax Efficiency
Overall, both index mutual funds and ETFs are very tax efficient. However, ETFs are slightly better in the realm of taxes due to the fact that they generate fewer capital gains than mutual funds (mutual funds generate capital gains when the fund must sell holdings when individual fund investors sell/redeem their shares).

Note: this slightly advantage seen in tax efficiency for ETFs only applies to funds held in taxable accounts.

Price/Pricing Fluctuations
Before investigating this topic for this post, I tended to shy away from index ETFs because I expected that the ETF would not track its respective index as effectively as an index mutual fund. This was due to my belief that since an ETF can be traded all day long, it would therefore be subject to emotional overreactions (selling and buyin) of investors.

However, in reading more of Siegel’s book on the subject of ETFs, I discovered that ETFs actually track their respective indices very closely because insitutional/large investors can turn in shares of an index for the corresponding ETFs or exchange ETFs for their respective shares. In other words, arbitragers (investors taking advantage of price differentials) cause any price differential to disappear quickly. Thank goodness that those folks on Wall Street take care of that so I don’t have to worry about it!

Purchase Minimums
As I mentioned in the link about beginning to invest with ETFs, ETFs are much better for beginning investors because you only have to buy 1 share in order to get full diversification to the index that the ETF represents.

On the other hand, index mutual funds usually require a minimum investment of $3,000-$10,000 to buy a particular fund. One good thing though is that you do not have to maintain a balance minimum of $3000 in order to keep the fund.

Bottom Line
The key takeaway for me is that because Vanguard has started offering 1) dividend reinvestment and 2) commission free ETF trading, I am going to now use both Vanguard ETFs and mutual funds (index, of course). ETFs will fit well in my taxable Vanguard account in situations when I cannot afford the $3000 minimum to purchase a new mutual fund, but still want exposure to a certain asset class in order to balance out my asset allocation %’s.

So, bottom line is that you should probably use both ETFs and mutual funds, keeping the caveats shown below in mind.

You should only use mutual funds (stay away from ETFs) if you know you are subject to easy emotional reactions when the market either goes up or down. Since mutual funds do not fluctuate in price throughout the entire day, you will be less likely to over-react and sell/buy at inappropriate times.

You should only use ETFs (stay away from mutual funds) if you like to use leverage/margins, hedge your investments by selling ETFs short, and enjoy moving quickly in and out of your investments (I do not recommend this approach).

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

Can Graduate Students Obtain a Mortgage?

As many of you all know, I am currently saving up money for a down payment and attempting to obtain a home mortgage loan in preparation for closing on the purchase of a condo/townhouse/house this fall when I begin graduate school.

Why do I want to buy a house/condo/townhouse instead of renting?
Since I will be in graduate school for 4-5 years, I would like to be building up some kind of equity during this time period, instead of just wasting money with rent payments. Additionally, I want to try to follow the rule of thumb that it is better to buy your housing if you plan to be in the property for 3-5 years or longer.

Note: in a future post, I am planning to create a rent vs. buy calculator spreadsheet for everyone to use.

From a previous post (see link below), I was able to calculate that the loan amount I can afford is ~$95,000.

My Money Blog – How Much of a Mortgage Loan Can I Afford?

While I am certain that with my income right now, I can get approved for a home loan, I was not really sure if I would be able to gain approval for a home loan this fall, given that my income will be drastically less ($23,000 per year) during graduate school.
However, approximately 1 month ago, I went ahead and applied for pre-approval of a home mortgage loan, using a mortgage broker that was recommended by both the real estate agent and a friend who is also in graduate school.

I filled out all of the forms, provided tax statements, proof of income, proof of 2 years of employment, total net worth calculations, and account statements from where my various investment instruments are located.

Everything seemed to be going well, and the mortgage broker calculated that he should attempt to pre-approve me for a $125,000 FHA home loan (3.5% down payment minimum). However, when my application was submitted, the mortgage underwriter could not approve it due to the following reasons:

• The letter of employment from the university in which I will be attending graduate school this fall did not show a guarantee of employment for 3 years. Personally, I think this is a little ridiculous because even normal jobs are never guaranteed (if you don’t perform well).
• The letter did not mention if I would be liable for any tuition payments in my schooling.

Interestingly enough, it was never mentioned that my application was denied due to the normal reasons you hear about, such as insufficient credit or lack of income or liquidity.

He said that I would need a non-occupant to cosign the mortgage loan with me in order to get approved.

Conclusion
While it may be possible for a graduate student to obtain a home mortgage loan as the sole borrower, I definitely was not able to, given the income I will be receiving. It really seemed to throw off the mortgage lenders that I was going to be a paid student, as I am guessing they don’t receive too many of those applications.

In order to qualify for a home mortgage, you will most likely have to have a co-signer/co-borrower, even with great credit and a sizable net worth.

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

My Current Asset Allocation and Net Worth Growth – May 2010

From April 7th (when the last portfolio update was published – see link below for more information) to May 4th, the S&P 500 index went down 1.33%.

My Money Blog – April 2010 Portfolio and Net Worth

During that time period, my net worth increased 5.24%. I have now achieved the following financial goals in 2010:

• Achieved my short term target net worth for this year 
• Contributed the maximum contribution level of $5000 allowed for my Roth IRA for the year 2010 (and 2009 as well)
• Eliminated all significant holdings in individual stocks from my portfolios
• Have accumulated 82% of the cash towards my down payment target for a condo purchase this fall

Currently, 31% of my net worth is invested in fixed income instruments (cash or bond funds), and 69% is invested in equity. This is undoubtedly off of my targets of 25% and 75%, respectively, for these categories. The cash portion of my net worth has increased significantly since I am building up funds for a down payment for the condo I want to purchase this fall.

While the overall percentages for these categories are not ideal, a detailed look (table below) at the allocation breakdown reveals the real story and provides for better analysis of the current state.

Remember: a red flag goes off if your current % allocation in a category is greater than +/- 5% off of the target allocation.

% Cash (money market target 5%)      15%
% non-inflat Bond Funds (target 15%) 15%
% TIPS Bonds (target 5%)                  0%
% International Equity (Target 11%)    12%
% International Emerging Markets (Target 11%) 7%
% Domestic Large Cap (Target 8%)    20%
% Domestic Small Cap (Target 9%)     10%
% Domestic Small Cap Value (Target 13%) 8%
% Domestic Large Cap Value (Target 13%) 6%
% REIT (target 10%)                            6%

The components of my portfolio highlighted in red above are outside of the 5% safety band, and therefore, need to be analyzed for reallocation. Unfortunately, due to my current situation of saving up money for a mortgage down payment, it may just not be possible to satisfy all requirements at this time.

• Cash – As I have mentioned several times, I expected that this would be high due to accumulating funds for a down payment. No action can be taken.
• TIPS Bonds – Since I have no extra cash right now (due to cash accumulation above), I cannot purchase this fund due to the fact that you have to have $3000 to purchase it with Vanguard.
• Domestic Large Cap – Unfortunately, this is being held in my 401k account, and therefore, has a greatly reduced selection of index funds from which to choose. Because of this, no further action can be taken.
• Domestic Large Cap Value – Since this is held in a taxable account, I cannot sell my holdings to contribute funds to it. I will have to wait until new funds can be added to increase the allocation %.

Note: as mentioned before, I currently have a VERY large percentage of my portfolio in Domestic Large Cap stocks. This is due to the fact that I was contributing 100% of my 401k contributions purchase S&P500 index fund shares for 1.5 years.

Towards the end of March, I began moving money from the S&P500 fund to a domestic small cap fund in my 401k. This progress can be seen by the fact that the domestic small cap funds now make up 10% of my net worth, up from 6% at the beginning of March. Since the proportion has now passed my domestic small cap allocation target of 9%, I will stop this transfer activity.

My next moves for the May/June time frame will be to do the following:

• Since I am looking at buying a condo/townhouse in the summer/fall time frame, I will be trying to build up cash reserves in my high yield savings account for the down payment. I have already accumulated approximately 82% of the cash I am targeting for my down payment.
• Get pre-approved for a home mortgage loan
• Wish List (since most of my extra cash this month is being used to save for down payment, I will not have as much extra to play around with as normal – so these may or may not happen)
• Purchase an inflation adjusted bond mutual fund (TIPS)
• Begin contributing to the large-cap value funds in my taxable Vanguard mutual fund account.
• At some point, purchase the Vanguard Total Stock Mkt Idx (MUTF:VTSMX) to replace S&P 500 index fund. This gives better, broader diversification to the US stock market.

How Does Home Ownership Fit in to Your Overall Asset Allocation?

In previous posts, I have covered the following topics related to mortgage payments and asset allocation:

• My Money Blog – How Mortgage Payments Fit in to Account Payments Hierarchy
• My Money Blog – Target Asset Allocation

However, in these posts, I did not include exactly how the mortgage payments (and resulting home equity that is built) should fit in to your overall asset allocation target/strategy. This will be the subject of today’s posting.

To try to shed some light on this topic, let’s first see what the financial advisors do to handle this question. We will then see how we need to adapt their strategy since we have no restrictions with what we do.

How do financial professionals handle the asset allocation strategy with home equity?
Through an examination of the opinions of the financial press (see three links below), I discovered that there are basically three “camps” when it comes to opinions on how home equity should be treated when it comes to figuring out your overall asset allocation.

1) Not including home equity in the target asset allocation percentages at all.

This approach is generally taken because real estate values/equity are difficult to determine exactly and because most of the time, it is not possible to adjust your allocation %’s in real estate because you cannot simply leave a house for another one.

2) Not including home equity in asset allocation percentages unless it is an investment property (so not including including your primary residence).

This approach of excluding your primary residence from your asset allocation decision making is taken because of the fact that you NEED a place to live, and you cannot simply exchange your home for shares of a mutual fund if your allocation %’s change.

3) Include all residences, investment properties, and REIT investments as a “real estate” category in your asset allocation strategy.

This approach is generally taken to have a conservative strategy that ensures that all assets are captured. However, since it is a little harder to follow, it is generally the least popular strategy.

MyMoneyBlog – Home Equity in Asset Allocation
BusinessWeek.com – Home Equity in Asset Allocation?
Investment News – Including Home Equity in Asset Allocation

Which approach will I take?
I believe that for my needs, situation, and investment style, I am going to choose to follow Approach #1 – not including my future home equity in the property I am planning to purchase this fall – with a slight adjustment.

Why is this exactly?
In short, home equity in a single house cannot be considered exposure to real estate because it is not diversified enough.

A passage on pages 282-285 of one of my favorite asset allocation books titled, “What Wall Street Doesn’t Want You to Know,” by Larry Swedroe does a great job of breaking this down in to terms the layperson can understand.

In the book, Swedroe describes that your home is clearly real estate.

However, it is very undiversified real estate in the following ways:

• It is undiversified by type (aka office, warehouse, industrial, multifamily residential, single family residential, hotel, etc) and owning a single family home only gives you exposure to a small piece of the overall real estate sector.
• It is undiversified geographically (meaning that real estate prices in different areas of the country vary greatly due to what employers are present there and how well they are doing – just think of if you lived in a small town where 90% of the wealth comes from one manufacturing company, and that one company shuts down. Real estate prices will plummet).

So, because the home you live in is very undiversified and have trust deeds associated with it, counting it towards the real estate portion of your overall asset allocation would be as foolish as a Pfizer executive counting a large quantity of Pfizer stock as their sole exposure to large cap US asset class. They are really not diversified one bit.

Since owning even one share of an index real estate investment mutual fund, such as a REIT that Vanguard, gives you broad exposure to all types of real estate across many different regions, this should be the route that is chosen to represent the real estate portion of your asset allocation picture.

So, how will I treat/consider my home purchase since I am not including it in my asset allocation mix?
Just to recap – in my mind, I want to purchase a home vs. rent one for the following reasons:

1. I am always going to need to live somewhere.
2. To take advantage of the tax benefits associated with home ownership, such as tax deductions for property taxes and interest payments (see information at the following link – My Money Blog – Tax Benefits of Home Ownership)
3. To gain some equity and increase my net worth while making my cost of living payments.

On a similar note, I would want to invest in additional real estate properties to take advantage of tax benefits of home ownership, such as being excluded from paying capital gains on profit from selling the property (described in previous post at link above).

Given the considerations above, here’s the way I will treat home equity:

• Shoot for getting as close as possible to paying a 20% downpayment, since this reduces cost by having to avoid Prive Mortgage Insurance.
• Sign up for a bi-weekly mortgage payment plan and pay off mortgage according to that schedule (see post at following link for more information My Money Blog – Biweekly Mortgage Payment Plan), according to the My Money Blog – Account Hierarchy.
• Track my home equity as part of my net worth, but not in my overall asset allocation targets.
• Continue to pay off my biweekly payments on my mortgage through graduate school, aspiring to obtain 40-45% of my net worth in property ownership, as recommended by the article from Business Week (see link above for more details).
• A number of years down the road, if it becomes apparent that the % of my net worth that is represented by property ownership dips too far below 40%, I would then use that % as a starting place to make a decision if I would want to invest in additional rental property.

So, I hope this investigation/discussion helps guide you through some of the tough decisions you will have to make regarding how you will treat home ownership. As always, please let me know if you have any questions.

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

How to Improve Your Chances of Being Approved For a Home Mortgage Loan

In a previous post (see link below), I discussed several techniques/tips that you can use to get a feel for how much of a home loan you can afford.

My Money Blog – How Much House Can I Afford?

However, this post was written with the assumption that you have the ability to be approved for the home loan.

Since not everyone is fortunate enough to fall under this category, I figured it would be a good idea to devote a post to explaining the various ways to improve your chances of being approved for the quantity of home mortgage or reverse mortgage you desire.

Ways to Improve Your Changes of Being Approved for a Home Loan

• Obtain a free copy of your credit report and review it 
• For information on how to obtain a copy of your credit report, please see my previous post at the following link –  My Money Blog – Monitor Your Credit Report Closely.
• After obtaining a copy of your credit report, review it for any errors or misrepresentations, as I describe in the blog post above.
• If you do not have much of a credit history, you will want to build some for yourself! For information on how to build up your credit score from nothing, see my four part post series at the following link – My Money Blog – Build Your Credit Score From Nothing

• Start saving up cash reserves for a down payment in your high yield taxable money market account
• This topic will be discussed in detail in a future post. However, for now, let’s just say that you should shoot for having a 20% down payment. 

• Try to reduce the amount of debt you are currently carrying. 
• As we saw in the post about how much of a mortgage/house you can afford, banks will look to make sure you do not have more than 40% of your total income in debt each month. By paying off your debt, you are improving the way you “look” financially to creditors.
• Additionally, as we have discussed previously, you will want to aim for paying off your high interest consumer debt first (and especially credit card debt).

• Do not lie on your mortgage pre-approval application.
• This may seem like a given, but it is especially important to be open and honest about your financial situation. Besides, by telling the truth, you are safeguarding yourself against the possibility of getting in over your head on a home loan.

• Have a firm handle on the current snapshot of your finances and what funds are and will be available to you.
• Before applying for a mortgage, you will want to make sure you calculate the value of all of your investment and debt accounts in order to determine your total net worth. You will have to write all of this information on your mortgage application anyway.
• Additionally, make sure to make note of the amount of cash reserves you have on hand that would be available for a down payment. 
• Also, be sure to include any potential sources of gift money that may become available (example – $$ from your parents, $$ inheritance money from a relative, etc).
• Know if you will be planning to use your 401k or IRA funds to help with your down payment. See the post at the following link for more information – My Money Blog – Innovative Ways to Obtain Funding For a Downpayment

• Get all of your documents in order
• You will want to make sure you have the following documents on hand:
• W-2’s
• Proof of two years of residence history and employment
• Copy of your current paycheck
• Tax returns from the last 3 years

• Get a co-signer on the loan
• As a last resort for if your finances are less than ideal, you can have a second person co-sign on the home loan. However, this will make them financially liable for the loan amount, so you will probably want to avoid this option if at all possible.

I hope these tips help, and as always, please let me know if you have any questions.

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

How Much House Can I Afford and How Much House Can I Qualify For?

It is such a difficult and loaded question isn’t it? But, just how much of a house can you afford?

Since this is one of the first questions that you have to answer when you begin your quest for home ownership, I figured I would investigate this matter to try to internalize it, and hopefully, help all of you in the process!

Start With Your Monthly Income
As you might have guessed, the best place to start finding an answer to this question is your current monthly income (gross – before taxes). The approximate value of the mortgage payment you can comfortably afford (allows room for monthly debt and living expenses) is 28% of your monthly gross income.

Calculate the Mortgage Amount that You Can Comfortably Afford
To assist you in calculating the amount of a mortgage that you can afford, I created the Google Docs spreadsheet at the link below.

Google Docs – How Much Mortgage Can You Comfortably Afford?

After clicking on the link, save a copy on of the spreadsheet on your hard drive so that you can edit it. Next, enter the following details according to your specific situation, or just leave them as the default values.

• Term of the fixed rate loan
• Interest rate you assume you will get on the loan
• Your gross monthly income – this is your income before taxes are taken out.

For my specific situation, in graduate school this fall, I will be making $23,000 per year from my research assistantship (monthly gross income of $1917). This means that I can afford a mortgage payment of $537 per month, without assistance from family. Very nice!

By running the Solver calculation as described above, Excel tells me that I should be looking for a home mortgage loan of no more than $95,535 so that I can still live comfortable. This seems reasonable for sure!

Now, remember, the mortgage payment will include four components – mortgage interest, principal, homeowners insurance, and real estate taxes. Additionally, the mortgage amount does not include the down payment on the house. Keep these things in mind as we are discussing this topic.

How Much of Mortgage Can You Qualify, or be Approved, For?
For this section, I have to start by explaining that mortgage brokers and real estate agents are almost always compensated on a % basis.

And, as such, they financially benefit by putting you in a more expensive house – and even a one that is more expensive than you can afford. Of course, this is just another reason why you want to make sure you choose carefully when selecting professional help. However, what are the financial ramifications of this, and how do you determine the biggest house that you can possibly qualify for?

So, while the 28% rule described above is the suggested mortgage amount that you can afford comfortably, as it turns out, mortgage lenders can actually lend you money such that your total monthly mortgage payment + other consumer debt equals 40% of your gross monthly income. Note: this is just debt – it does not include living expenses (food, etc).

To assist you in determining the loan amount that you can qualify for, I created the Google Docs spreadsheet at the link below. At a high level, it works by calculating the loan amount you can obtain so that the monthly loan payment added to your existing debt is equal to 40% of your monthly gross income.

Google Docs – How Much of a Home Mortgage Can You Obtain?

To use it, perform the following steps:

• Click on the link above and download a copy of the spreadsheet on your hard drive so that you can edit it with your specifics.
• As before, enter the interest rate, loan term, and monthly gross income fitting your situation.
• Additionally, in the purple highlighted cell area to the right of the ammortization schedule, enter the quantities of your monthly debt.
• The spreadsheet will then automatically calculate the maximum amount of a monthly mortgage payment that you can qualify for.
• Next, using the Excel Solver or Goal Seek function, specify that you want to set Target Cell G361 (for 30 year mortgages) or G181 (for 15 year mortgages) to a value of “0” by changing cell A2.
• This will then find the home mortgage loan amount that will cause you to completely pay off your loan principal by the end of the loan term.

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

Comparison of Bank Savings Programs

We hear the catchy jingles all of the time on the radio from Bank of America, Wachovia, and others. So, I figured it was about time to devote a blog post to evaluating these programs in general and performing a comparison to see which program comes out ahead!

Let’s get started.

Comparison of Bank Savings Programs

• Bank of America’s Keep the Change program – Bank of America – Keep the Change
• The Keep the Change program works as follows: each time you make a purchase with your debit card, the balance is rounded up to the next dollar, and the difference is transferred from your checking account to your savings account.
• For the first 3 months after you sign up, Bank of America matches 100% of the fractional Dollar amounts transferred to your savings account. After that, Bank of America matches 5%, up to an annual maximum match of $250.
• Bank of America does not offer a promotional APY interest rate for signing up for an account.
• It is also important to note that the matches are only paid once per year (we have to keep Time Value of Money in mind)

• Wachovia’s Way to Save program – Wachovia – Way to Save Account
• For every purchase that you make with your debit card and for every automatic bill payment, the program automatically transfers $1 from your checking account to your savings account.
• After the first year of opening the account, Wachovia will give you a one time bonus of 5% of your savings account balance, up to an amount of $300.
• Offers a promotional 5% APY interest rate for the deposit balance during the 1st year of signing up.

Now that we have the specifics of the details of each program, let’s now go through a scenario to see which program comes out to be a better deal. To view the scenario analysis, click on the Google Docs link below to access the spreadsheet I created.

Google Docs – Comparison of Bank Savings Programs

In this analysis, we’ll assume that a person, Joe, makes one purchase every day for two years in $0.01 increments between $1 and $2. We will then analyze the follow characteristics that would result at the end of the two year period using Bank of America’s Keep the Change program and then using Wachovia’s Way to Save program

1) The total account value
2) The total amount of free money (either from interest or matched by the programs) the Joe would receive.

Note: These calculations do not include the regular interest rate received as part of the savings account used. However, promotional interest rates are included.

By examining the spreadsheet’s calculations, we see that Bank of America’s Keep the Change program yields approximately 3X more free money ($65 vs. $19 with Wachovia’s Way to Save program), mainly resulting from the 100% match during the 1st 3 months that the account is open.

However, we also see that the total savings account value is approximately 1.7X greater with Wachovia’s program than with Bank of America’s. This is mainly due to the $1 increments that are transferred from your checking account no matter what value purchase you make.

Do I Use These Programs?

The short answer to this is “no.” I do not use these types of programs for several reasons.

• I like to be in total control over every Dollar (and fractional Dollar) I invest and save. I do not like the idea of quantities being subtracted out of my checking account without me being the direct (even though it is for a good cause) initiator. I do not mind this for expenses such as rent and internet bills, but it is different when it is something related to my savings goals.
• I feel like these programs are great for people who seem to have trouble saving money. In my case, since I am already saving approximately 50-60% of my income, it really isn’t too much of an issue.
• The interest rates associated with Wachovia’s and Bank of America’s savings accounts are very low (0.1%) when compared to the high yield money market savings account I use (Dollarsavingsdirect.com – currently at 1.30% interest rate, see the following link for additional information My Money Blog – Savings Account Options)
• I prefer to use my Chase Freedom^SM or Chase BP Gas cash-back credit cards for all of my purchases. With these cards, I get anywhere from 1-5% cash back for all purchases. (see the following link for details My Money Blog – Favorite Cash Back Credit Cards). With a debit card, I don’t receive any cash back benefits.

Will I Start Using These Programs After Doing This Analysis?

The short answer to this question, unfortunately, is also “no.” By running a quick calculation, I found out that by using my cash back credit cards, I would get $21 in free money simply by making the 2 years of purchases in the spreadsheet. This fact, along with the other resignations described above, are not, in my opinion, worth the hassle of using a different debit card for all of my purchases.

Key Takeaway


After studying these more in-depth, I definitely have a greater appreciation for how they work. Even though they are not the best fit for my situation, I am convinced that they are VERY useful for many people. I will keep them in mind as a option for recommending to friends that are looking for a good savings instrument.

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

Tax Benefits of Home Ownership

In my opinion, there are only four instruments remaining accessible to the average citizen that provide the opportunity for significant tax savings/advantages. These four instruments are listed below:

• Retirement accounts (401ks, Traditional IRAs, SEP IRAs, and Roth IRAs) – see My Money Blog – IRA Posts and My Money Blog – 401k Posts)
• Owning your own business – see My Money Blog – Starting Your Own Business
• Education savings accounts – see My Money Blog – Give Your Child A Financial Head Start in Life
• Home ownership

Note: While trusts can be a very effective shield against Uncle Sam’s “claw” reaching in your wallet, they are generally only used by wealthy people. As such, they will be the subject of a future post.

As you can see, most of the instruments above have been discussed in previous posts. However, I have yet to describe all of the fantastic tax advantages that come from owning your own home that are definitely NOT available to us as renters. This will be the topic of today’s post.

So, just what are the tax benefits of home ownership? As it turns out, there are two categories of benefits – short term and long term. Let’s look at the short-term benefits first.

Short Term Tax Benefits of Homeownership

The main short term tax benefit associated with purchasing a home relates to the mortgage “points,” or pre-paid interest, that is paid at the time of closing on a home mortgage loan. These can be deducted from your taxable income the year that you first get your mortgage.

In addition, you can also obtain tax credits for “green” building/home improvement initiatives, such as the current 2011 home improvement tax credit.

Long Term Tax Benefits of Homeownership

• Tax free capital gains
• As a refresher, capital gains taxes are taxes that the government charges on profits made on investments such as stocks, mutual funds, etc. For these instruments, if you sell your shares for a profit after holding it for less than a year, you have to pay 30% of the proceeds in taxes (15% if held for longer than 1 year).
• Primary Residence Rule – Under the current tax law, if you sell your primary (place where you have lived at least 2 years out of the last 5 years – this means that you don’t have to have lived there consecutively) residence, you don’t have to pay ANY capital gains taxes to the government on the first $250,000 in profits ($500,000 for married couples filing jointly). 
• Rental Property Rule – Fortunately, the government has also created a way to avoid having Uncle Sam taking out capital gains taxes from selling rental property. This is made possible by what’s called a “1031 tax free exchange.” The rule states that you will not be charged any capital gains taxes if you use all of the proceeds from the sale of a rental property to buy another rental property within 180 days of closing on the previous property. 
• And, the icing on the cake is that you can do this multiple times, as long as you follow the primary residence rule above. This means that you can sell your house, move to a larger one, and use your old home as a rental property!
• This is a very powerful thing! Let’s take a look at a quick example.
• Let’s assume that Bob and Kat (married) purchase good size home in 1970 for $80,000. They sell the house 40 years later in 2010 for $550,000. This represents a profit of $470,000. Not too shabby, right? Under the current tax law, they will pocket the entire amount. However, if they did have to pay long-term capital gains taxes, they would only receive $399,500. Which $ value would you prefer………?
• In addition to tax free capital gains, capital expenses can be added to the “basis” (or cost used for official tax purposes) of your property. Capital expenses are permanent improvements made to the property. Examples would include building a pool, adding on another room to the house, etc. And, by increasing the cost of the property for tax purposes, this then decreases the profit that you must pay taxes on when you sell the property (if it exceeds the tax exempt values stated previously).

• Mortgage interest
• Mortgage interest is 100% federal tax deductible on the 1st $1,000,000 of your home mortgage. For the common consumer, whose house will undoubtedly be less than $1,000,000, this means that you can deduct ALL of your mortgage interest on your home! This is quite a gift from Uncle Sam!

• Property tax 
• Additionally, 100% of property tax payments for your home are also tax deductible. While the exact property tax rate changes depending on location, the national average property tax is 1.5% of the property value every year.

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email

Just Sold My Remaining Individual Stock Holdings Today

When I updated my financial goals (see link below) on 7-April-2010, I mentioned that one of my short term goals was to focus more on selling off my remaining individual stocks because 1) they were purchased either before I came to the realization that it is foolish to invest large amounts of money in individual stocks or 2) they were purchased as a learning tool by means of “play money” (to learn what play money is, see the post at the following link, My Money Blog – Play Money), and I am no longer monitoring and/or learning from them.

My Money Blog – Financial Goals

In accordance with my goal, this past Thursday, I sold off all of my remaining individual stock holdings in my Zecco.com and Sogotrade.com accords.

How did I fare on these holdings?

Well, I figure that since when tax time rolls around next year, I will have to calculate my “gain” on these stock sells anyway. So, might as well do it now so that you all can see how bad individual stocks are as an investment for an individual investor (Granted, I am no full time stock researcher. But, this is my biased opinion).

The link below contains a spreadsheet where I calculated my returns for the 10 stocks I sold on 4/7/2010.

Google Docs – 2010 Individual Stock Gains (Losses)

As you can see in the spreadsheet (green highlighted cells), my total return for holding these stocks from 8/22/2006 through 4/7/2010 was a loss of $26.20, or a loss of 2.8%. Add on top of this the commissions I paid to buy and sell the stock and any capital gains taxes that would be involved, and this makes for one truly awesome performance right!?

To complete the picture, let’s take a quick look at how the market did in this period. During this time, the S&P500 index did not perform well at all; it began at 1304 and ended at 1217, or a loss of approximately 7%. So, the good news is that I did beat the market performance during this time! woohoo! I just did better than 70% of the Wall Street professionals!

However, once we employ the power of dollar cost averaging (buy the same dollar value – I used buying $100 of shares of the S&P500 fund as an example in my spreadsheet – of a mutual fund each month as is done automatically with 401k accounts), we obtain a return of positive 3.6% (shown in yellow highlighted cells). This is quite amazing!

So, let me get this straight. We see a higher return by simply having your mutual fund account buy a set dollar value each month in an index mutual fund. You don’t have to look at it, know what’s going on in the market, worry about your asset allocation percentages, perform dollar value averaging, or do anything for that matter! And, you will get a higher return than I did for all of the effort and money I put in to stock newsletters, books, etc.

Genius right? Hardly. In fact, it’s widely known in the asset allocation/index mutual fund world that your investing should not be exciting. It should be easy, boring, and not a good topic to bring up at parties. However, it takes great discipline to do this.

Clearly, if I had mastered this discipline 3-4 years ago, I would not be writing this post! Live and learn right?

Side note: Recently, while reading the book by author Larry E. Swedroe titled “The Only Guide to a Winning Investment Strategy You’ll Ever Need,” I came across the interesting fact below about the efficiency of markets in responding to changes in information (in other words, further reinforcing the idea that it is very hard to make superior returns investing in individual stocks):

• In the stock market, the window in which investors can profit from new information coming to the market is only 40 seconds! This is truly incredible to me!

Keep on learning!

Jacob

To receive updates on topics such as this one as soon as they are published, click on the link below to subscribe to My Money Blog:

Subscribe to My Money Blog via Email