Wednesday, January 06, 2010

Baby Step 6 – Pay Off Your Home Early

Today is January 7, 2010 – Happy Birthday Dad!

Week 12 of FPU is entitled Real Estate and Mortgages. This is the class that I wish I had taken back in 1996, prior to my first home. I have recently taken a step towards this goal, but I feel it is a drop in the bucket.

Even though Dave uses the 100% down plan, this is the only area where Dave doesn’t get angry if you incur debt as long as your mortgage falls within these parameters: 15 year fixed, with payments no more than 25% of your monthly take home pay.

There is no short cut to paying off your mortgage except for big hairy payments. However, if you know how, you can still buy a house that will not own you.

How Much House Should I Buy?

In 1996, I was twenty eight years old. Cindy and I had recently returned from Okinawa where I was stationed with the U.S. Air Force at Kadena Air Base. By God’s leading, we moved to the Hampton Roads area of Virginia where Cindy took a job teaching in the Norfolk Public Schools.

We rented an apartment our first year: it would be foolish to buy a house until we knew the area a little bit better.

Our first stop was at the bank to be pre-qualified for a loan. This process simply told us how much the bank would loan us for the purposes of purchasing a home. I remember Cindy and I looking at each other with our jaws on the floor – they will loan us HOW much!?

We were young, and in love and very excited that the bank thought we were worthy/capable of such an amount of money. Now, shopping for a house became an exercise of finding a home we liked that was less than the amount the bank would loan us.

Ah, youth.

House shopping with a Payment in Mind

In order to avoid become house poor (i.e., your house is too much of your budget), you want to aim to have a mortgage payment that is no more that 25% of your total take home pay.

If I had known that, I would not have looked for how much the bank would loan me. Instead, I would have looked for how much I could pay (and still save, get out of debt, eat…you know, life).

Calculating a monthly payment is easy. The following formula and example is taken from the FPU Members Workbook.

Rate 15 Year 30 Year
4.5% 7.65 5.07
5.0% 7.91 5.37
5.5% 8.17 5.68
6.0% 8.44 6.00
6.5% 8.71 6.32
7.0% 8.99 6.66
7.5% 9.28 7.00
8.0% 9.56 7.34
8.5% 9.85 7.69
9.0% 10.15 8.05
9.5% 10.44 8.41
10.0% 10.75 8.78
10.5% 11.05 9.15
11.0% 11.37 8.52
11.5% 11.68 9.90
12.0% 12.00 10.29

The formula is:

Sales Prices / 1000 = #1000 X Factor = Monthly Payment

For example, if you bought a house for $150,000 on a 15 year fixed of 6.0%, your monthly payment would be $1,266.

$150,000/1000 = 150 X 8.44 = $1,266

The problem with this formula, for me anyways, is that it is still starting from the loan amount. I want to start from 25% of my take home pay!

Did you know that you can work the formula backwards?

Still using the numbers from the workbook, let’s say that 25% of our monthly take home pay is $1,266. How much of a loan would you be able to pay?

Monthly Payment / Factor X 1000 = Sales Price

$1,266 / 8.44 X 1000 = $150,000.

Instead of the bank telling you how much they will loan you, you will know if the house you want to buy is going to be a blessing or a curse to your monthly budget.

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