People of all walks of life have lost sight of the American dream of owning a home. What seemed so simple for previous generations is slipping further and further from our grasp. The housing crisis is now as much psychological as it is financial.
So what shall we do? As I see it, there are two choices broadly framed. We can continue to bemoan our fate, strategically default, and sink further into depression. Or there is another more powerful course to take – taking action.
It will take enormous patience, financial discipline, and positive thinking. What we face is similar to breaking a unhealthy psychological addiction that transfers from one generation to another. The cycle must and can be broken.
To break the cycle, I will address those factors that homeowners directly influence. The value of homes is one variable completely out of your control. One of the myths of home ownership is paying down your mortgage builds home equity. Paying off your mortgage balance lessens debt, a great goal, but that is it. If your home is worth 200k making a mortgage payment does not increase its value. The number of underwater homes (those with negative equity) with current mortgage payments should be proof enough to dispel the mortgage/equity myth.
Ok, so here we go. Let’s look at some practical steps all homeowners can take to help end the housing crisis.
Assess Your True Cash Flow
This first step is arguably the most necessary. One of the problems with applying for and receiving a mortgage is lenders use your gross income and only your credit report debts. We all know that monthly expenses extend way beyond that limited view. The income used to pay bills each month is your take home pay.
Let’s take a more realistic and strategic approach. Take an inventory of all your monthly expenses– housing, car payments, true credit card payments (not just minimum amounts), food, insurance, kids’ expense, entertainment, savings, and anything else you spend consistently on a monthly basis. Divide that amount by your net family income. So for instance if your total expenses are $5000 each month and net monthly income is $10,000 (just an easy example) the true debt to income ratio is 50%. In reality, I expect that number to be between 80% and 100%.
If your true monthly expenses are in excess of 70% of take home pay, or lower, it’s time to create a way that lowers that percentage one percent at a time. I told you the strategy will require patience and discipline!
Consolidate or Pay Off Bills
Yes this is part of step two, but a little different than you assume. Conventional thinking usually steers us in the direction of paying off all our bills in a mortgage refinance. I fundamentally disagree with this strategy on two accounts. One is a much smaller debt lumped into a mortgage, that is heavily loaded up front with interest, takes years to pay off. The length of mortgage debt is also extended well beyond your original term. Second, it is very easy to fill up those credit cards again. In the end, the risk of a financial calamity is increased.
What I propose is a more modest strategy. Three ideas come to mind. First, prioritize revolving bills, like credit cards, and pay down the highest balances first. This part may be done by reallocating money meant for smaller debts. Slightly above minimum payments can be paid while the larger debts are attacked. Second, examine the possibility of getting a personal loan at the lowest possible interest rate to consolidate all revolving credit debts. Paying off $5,000 or $10,000 is easier than a $200,000 mortgage. Then third, keep the minimum number of credit cards and cancel the rest.
Get Control of Mortgage and Other Debts
The last step will be the hardest and yet the most crucial. Mortgages, and other debts, need constant management. Homeowners have been conditioned to manage their mortgages through refinancing. May be one, possibly two refi’s are warranted. The biggest and more likely risks faced by all of us revolve around sudden life events that often financially devastate families. A change in interest rates will never help us manage these crises.
The creation of an emergency preparedness fund is a necessary step to proactively address life’s sudden changes. Many will say this cannot be done and that is one view to take. But the flip side of the coin is if families buy life and health insurance, starting this type of fund follows suit. In fact, a whole life insurance policy may serve as an emergency fund. By loading up a whole or universal life insurance policy with cash, you not only get a modest return on your investment, but many agencies allow customers to borrow against the value. This idea is merely a suggestion. A savings account also works. Whatever it takes to grow a fund, no matter how slowly, solely dedicated to preparing for and surviving a life event.
One can say my strategy is purely gloom and doom. I like to think its a reality that must be faced straight on. Divorce rates are well in excess of 50%. Car accidents happen all the time. We all surely know that the loss of income or your job is common place. Kids get seriously ill. No one wishes bad things to happen to anyone. Personal responsibility must start at home.
We all have big financial challenges. I am no different than anyone else, especially coming out of the mortgage industry. Sharing ideas is one way to make all of us more financially sound.
After all, just think how good it will feel to build up an emergency debt fund that allows you to potentially pay off your mortgage ahead of time or to weather a life crisis. These are simple tips, but ones well worth considering regardless of your financial situation.