How one Divorce learned that owning costs 10K per year less than renting and how to buy a home with only 3.5% down.
Sooner Than They Thought!
The clients were spending $1700.00/month on rent ($20,400.00 per year). The house is in a great location, but has only one bath and the two youngest kids shared a bedroom. The strain of the custody battle left the client with limited funds to come up with a down payment and to cover the closing costs. Additionally, the client’s credit score wasn’t as high as it used to be. To make matters worse, the ex-wife refused to remove our client from the loan on the old house and he didn’t want to spend more time and money to have his name removed. He wasn’t sure he could qualify with 2 house payments. He was pretty sure that all of these factors would make it impossible to purchase a home.
The first thing we want to do is educate our clients on the benefits of home ownership. In this case, the rental expense was $20,400.00 per year. 100% of the housing expense is a sunk cost and will never be recovered. We took some time to show the client how a home appreciates and how a portion of every mortgage payment is applied to the principal balance in the form of equity using a simple mortgage schedule.
In this case, a 1700 mortgage payment would qualify them for a home in the $240K range including taxes, insurance and MIP (at 4.9% APR). Using a conservative estimate of 4% appreciation per year, a home will increase in value by 9600 in the first year. Additionally, the principal portion of the loan payment will reduce the loan balance by about 4K after 12 payments. While these funds are not immediately accessible as cash; it’s important to recognize that these funds accumulate in the form of equity which has real life value. Said simply, equity works like a savings account that is funded by the already existing housing expense. This has the effect of reducing his housing expense to 6800/year.
Here’s the comparison:
- Rent: 1700.00 X 12 = $20,400 per year as a renter.
- Mortgage: $1700.00 X 12 = $20400.00 per year as a homeowner.
- Less ~$9600.00 in appreciation (@ 4% appreciation)
- Less ~$4000.00 in principal Reduction (@4.9% APR)
- 20400 – 9600 – 4000 = 6800
- Cost is still $20400 but borrower keeps an additional ~13,600K equity that’s not available to renters.
The next thing that we had to do was work on the credit. In this case, the borrower’s median credit score needed to be raised by a couple of points to get him the best rate possible. We told him how the rapid rescore system works and though every case is different, we were able to pay off a credit card for less than $100.00 to achieve the desired results.
The last issue was to overcome his down payment issue. He had saved up about $7500.00 (first, last, deposit and moving expenses) as he was going to have to move to a larger home no matter what. What he didn’t know was that this was more than enough to purchase his home with an FHA loan. These loans require 3.5% down but can be used in conjunction with down payment assistance and seller contributions. He already had enough, and it was a lot less than he expected.
The borrower was able to purchase a home MUCH faster than he initially planned. He has also learned how to be much more efficient in his savings as he’s now keeping ~$13,600 of his housing expense in the form of equity. His credit score has improved, and he’s learned a solid approach to strategically pay off his debts moving forward. Additionally, we have worked with him to develop a strategy to pay off the home early so that he doesn’t have to spend a fortune on compound interest over the next 30 years.
I’m so glad I decided to talk to Kyle even though I wasn’t sure I would be able to buy a home. I’ve learned a great deal and I feel really good about my financial plan going forward. I’ve worked with a lot of banks and lenders over the years and none of them have provided any of the insight given to me by Kyle and his team. He’s the only person I’ll recommend when it comes to mortgage planning.