Three Steps to Wealth & Financial Security

by Gary Laturno

  I have seen families frustrated and even lose their home after the death of a spouse because the spouse who signed the mortgage failed to authorize the lender to speak to another individual. Here is an example. Wife signs loan documents to purchase family home. Husband and wife then take title according to different options available under state law. Wife subsequently dies. Husband contacts lender to discuss the loan; lender refuses to talk to husband, stating he was not a signer on the loan and they have no authority to speak to him.

  To avoid this situation, wife, while living, can give the lender authority to speak to the husband, her children, or another individual. To accomplish the above, call the lender; ask what they require. Typically, the lender will require the spouse who signed the mortgage to submit a document to them that includes the following: loan account number, property address, name of other person or persons authorized to speak with the lender, mortgage signer’s name and signature, and possibly the social security number. Some lenders will have their own authorization to release information forms; you may find one on their web site on line.

  After you submit this document, follow up with the lender. Ensure the authorization is on file; ensure that the bank will speak to the husband or other individual.

  If the servicer of the loan changes, for example, if the loan servicing moves from Wells Fargo to Bank of America, resubmit another authorization to the new servicer.

  Recommended reading: “The Talk You Didn’t Have With Your Parents Could Cost You”, Tara Siegel Bernard, New York Times, May 24, 2013; “Leaving Behind the Digital Keys to Financial Lives”, Paul Sullivan, New York Times, May 24, 2013

  Finally and perhaps the biggest mistake: Many Americans have no investments except their home, thinking their house will take care of them during retirement. Big mistake! “If your home is your largest investment, you are in financial trouble”. Robert Kiyosaki, author “Rich Dad Poor Dad”. If you are getting started in life, if you are in your middle years, whatever your age, do not view your home as the foundation of personal finance.

  Recommendation: Create a financial plan and diversify investments. See Parts 2 and 3 below. In Part 2 see Chapters 1 and 2, “What is the Secret to Building Wealth” and “The 25-50-25 Plan”. In Part 3 see Chapters 2 and 3, “Compare and Contrast Investment Options” and “Houses versus the Stock Market”.

  b. What Percentage of Your Income Should Go to Your House?

  “When it comes to your mortgage, it is not what you can qualify for; it is what you can afford”. Fred Holsman, Production Manager, Guild Mortgage, San Diego, CA

  “The unfortunate truth in America is that 37.5% of home owners are spending over 30% of their gross income on their home mortgage. This puts a lot of financial burden on these home owners and often leads to foreclosure.” Statistic Brain Research Institute, Rasmussen Reports, August 4, 2012 (Rasmussen Reports is an American polling and media company, Wikipedia).

  The Rasmussen data reveals – not surprisingly - that states with the highest percentage of owners spending 30% or more each month on their mortgages - California 52.2%, Nevada, 47.1% and Florida, 49.2% - had the highest risk of foreclosures and that states where a smaller percentage of owners spent 30% or more each month on their mortgage for the most part had a lower risk of foreclosures.

  Our experience in counseling distressed homeowners revealed that substantially all spent over 30% of their gross income each month on mortgages. Many had other debts such as second mortgages, credit cards and car loans. Few if any thought about what percentage of their income each month should go to a home. Few thought about other investments. The idea of a written financial plan did not enter their mind.

  The lesson: If you decide to buy a house, first put a written financial plan in place. Think about your overall financial goals and objectives. Pay off other debts and then think about buying a house. Factor in the costs of home ownership – taxes, maintenance, insurance, HOA dues and assessments. Ensure you have money left after paying for your house to save and invest, pay for necessities, and enjoy life.

  Smart financial guideline: If you want to build wealth, spend no more than 20 to 25 percent of your net income on housing each month. That is, spend no more than 20 to 25 percent of your net income on the mortgage, property taxes, HOA dues, insurance, maintenance, and the like. See Part 2, “Create a Written Financial Plan - Practice Sound Money Management” below for information on creating a financial plan, as well as the 20 to 25 percent housing guideline.

  Be especially careful about trading up to a more expensive home. See Part 3, in particular Chapters 2 “Compare and Contrast Investment Options” and Chapter 3 “Houses vs. the Stock Market” before you rush out and buy a luxury home. If your goal is to become financially secure, do not put all your money into a house. Ensure you diversify investments, and ensure your portfolio contains some stocks.

  Compare and contrast: Todd and Margaret (not their real names) live in the same entry-level home they purchased in San Diego thirty-five years ago. Over the years, they resisted realtors who encouraged them to “trade up” to a luxury home. They said “No” to lenders who encouraged them to use their home as a piggy bank. Instead, they paid off their home early, saved, retired young, and now travel the world.

  Warren Buffett lives in an entry-level house he bought in Omaha, Nebraska, fifty years ago. Buffett is our most successful investor. Is he telling us something?

  c. Should You Ask for a Loan Modification?

  “The bad news: you will lose your house. The good news: you will lose your house”. Thomas D.

  Rutledge, San Diego consumer attorney

  I talk to people every day who are desperate to get a loan modification. Here is the problem. The Home Affordable Modification Program specifies that a borrower’s payment on their first mortgage should be no more than 31 percent of their gross monthly income. But 31 percent of one’s gross monthly income is a large mortgage payment. After factoring in other costs of ownership, such as maintenance, insurance, utilities, and HOA fees, the total cost for one’s first mortgage could be 50 percent or more of a borrower’s net income. If the borrower has additional debt, for example, a second mortgage, credit cards, car loans, and the like, they will likely default on their mortgage and lose their home.

  Few people who receive loan modifications have said they now feel their financial house is in order. Their many other debts are in place; they are unable to save and invest or set money aside for their children for college. Nothing has changed. They must continue to pay for “too much house”.

  So, the bottom line: many/most loan mods – unless they involve a substantial principal reduction - continue to keep borrowers in financial distress, delaying the day the borrower must face the reality they are living in a house they cannot afford. Not surprisingly, defaults on modified loans have been high. Treasury Secretary Timothy Geithner was candid in saying that a goal of HAMP was to slow the rate of foreclosures, preventing home prices from falling more rapidly.

  d. Is Renting a Smarter Financial Decision?

  “I am a renter by choice”. Salmon Kahn, Founder, Khan Academy

  “We’ve not paid close enough attention to rental housing and the advantages of that”. Mark Zandi, chief economist, Moody’s Analytics

  According to a 2012 study by two economists, renting in the United States has historically been more affordable than buying. “I was shocked at how often renters won!” Ken Johnson, economist, Florida International University. “Our findings show that financially, if renters exercise disciplined investing over time, they can be more successful in accumulating wealth than those who own a home.” Real Estate Economics; Lessons From Over 30 years of Buy versus Rent; Is the American Dream Always Wise?” Ken Johnson and Eli Beracha, economist, East Carolina University

  “Unless you need the security blanket of owning, it is nearly always a better financial move to rent rather than buy.” David Kaufman, attorney, financial writer, and chief compliance officer of West
Court Capital Corporation, investment advisers

  What is the best decision for you? The answer depends on a number of factors, for example, the current housing market, the monthly cost to rent versus the mortgage, additional home ownership costs, how long you plan to stay in the home, and your personal financial situation, that is, can you afford the payment?. Also, consider the lost opportunity to invest any down payment money into another investment.

  Questions: If you chose to rent, will you invest any money saved? If not, a monthly mortgage payment will serve as a method of forced saving. But if you buy, will you have money available after paying the mortgage and other housing expenses to save and invest each month? Do you want to rely solely on your home for retirement? If your home is your only investment, how will you support yourself after your working years end?

  Recommended reading: “How to Know Whether it’s Time to Buy a Home – Six Considerations for Those Weighing Whether to Rent or Buy” by Amy Hoak, Wall Street Journal, November 28, 2011.

  Zillow.com has an interactive tool to assist in determining the “breakeven horizon”, that is, the time it takes for buying to become more financially advantageous than renting. To locate the Zillow interactive tool - which provides data for cities and ZIP code and neighborhood within cities - go to http://www.zillowblog.com/research/2013/05/06/2013-q1-breakeven-horizon-expanded-to-neighborhood-zip-codes/

  Rent vs. Buy – David’s story: David (not his real name) rented luxury homes in San Diego for many years. Some believed he was “throwing his money away”, but David saw it differently. His rent payment, he said, gave him the opportunity to live in a luxury home for a great deal less each month than owning the same home, and – a key to his financial plan - he faithfully invested the difference each month. David also explained that as a renter he saved in many other ways—no costs to buy or sell, no cost to obtain a mortgage, no maintenance or rehab costs, no real estate taxes, lower insurance costs, and the flexibility to move or downsize. As a renter he made no down payment, which he typically invested. His rental security deposit, he pointed out, was often equivalent to one month’s rent, small potatoes compared to a down payment. So, for David, renting was the smarter financial decision: His cost to rent was less than his cost to buy, and he saved and invested the difference. He was not, he said, “throwing his money away by renting.”

  Marcy and Antoine, a thirty-year-old couple, are deciding whether to rent or buy. Assume they are thinking about buying a $500,000 home requiring a $100,000 down payment versus a rental that would cost $500 less each month. How will they fare at the age of sixty, assuming they rent and invest both the $100,000 down payment and the $6,000 saved each year on the mortgage?

  If they were to invest the $100,000 in a total U. S. stock market low cost index fund, assuming an average annual increase of 10 percent, it would grow to $1,745,000 in thirty years – minus the expense ratio charged by the fund. (See comment below as to why I selected an average annual return of 10 percent.) $6,000 invested each year, assuming an average annual increase of 10 percent, would grow to $1,091,660 in thirty years. Total: $2,836,660.00 - minus the expense ratio of the fund.

  As the years pass, rents will increase, and at some point their rent each month could be greater than their monthly mortgage. On the other hand, ownership costs such as taxes, routine maintenance and HOA fees will go up.

  If Marcy and Antoine were to buy the home and pay off the mortgage, assuming a 3.5 percent average annual increase in the home’s value, the $500,000 home would be worth $1,403,000 in thirty years - about half what they might have if they were to rent and invest, as in the above example. In addition, Marcy and Antoine will have significant additional housing costs expenses as the years pass that would cut into their profits. For example, over a 30 year period, they may decide to add a pool, an additional room and the like, receiving a low rate of return on their investment, cutting significantly into their profits. So, whether you buy or rent and invest, you will encounter an “expense ratio”.

  I used the 10 percent and 3.5 percent figures in the calculations because stocks and houses in the United States, over one hundred years, have averaged an annual increase of approximately 10 percent and 3.5 percent, respectively. Note of course historical returns do not guarantee future results. See our discussion on this topic in Part 3, Chapter 2 “Compare and Contrast Investment Options,” Chapter 3 “Houses versus the Stock Market,” and Chapter 10 “Eight Guidelines to Successful Investing” below. Recommended reading: “Why Home Prices Change (Or Don’t)” Robert Shiller, The New York Times, April 13, 2013.

  The mortgage interest deduction: I occasionally hear people tout the mortgage interest deduction, stating that it allows them to buy and live in a more expensive home. I have yet to find anybody who sits down with a CPA to ensure they are making a smart financial decision when they make this comment and then buy a house. Low income tax payers who do not itemize deductions are unable to benefit from the deduction. High income earners often use the deduction as a rationalization to buy more house than they can afford. Recommended reading: “A Deduction Unevenly Used”, Lisa Prevost, New York Times, May 16, 2013.

  Takeaway: Do not use the mortgage interest deduction as an excuse for spending too much on your house. Because the deduction encourages debt, banks, not home owners, may be the real beneficiaries of the deduction.

  The IRS Code & the mortgage interest deduction: The IRS Code allows for a home mortgage interest deduction with limitations. First, the taxpayer must elect to itemize deductions, and the total itemized deductions must exceed the standard deduction. Thus, low income tax payers get no benefit. Second, the deduction is limited to interest on debts secured by a principal residence or a second home. (Note many members of Congress own second homes near the District of Columbia and thus benefit from the deduction. Given that members of Congress can be expected to do what is in their best interest, the deduction, it would appear, is unlikely to go away.) Third, interest is deductible on the first $1 million of debt used for acquiring, constructing, or substantially improving the residence, or the first $100,000 of home equity debt. See IRS.Gov or Wikipedia for further details.

  Recommended viewing: You Tube Video - Renting vs. Buying a Home by the Khan Academy, YouTube.com. A little background: The founder of the Khan Academy, Salmon Khan, has three degrees from the Massachusetts Institute of Technology: a BS in mathematics, a BS in electrical engineering and computer science, and an MS in computer science. In addition, he has an MBA from Harvard Business School.

  Khan has produced over 3500 video lessons on a wide variety of subjects, primarily math and science. He explains complex material in an interesting and understandable way. In 2012, Time magazine named Kahn one of the 100 most influential people in the world. Wikipedia.com.

  Khan, a renter by choice, describes his “Renting vs. Buying a Home” video as “the single most important video that anyone can watch”.

  e. Should I Pay Off My Mortgage?*

  “If your home is your largest investment, you are in financial trouble”. Robert Kiyosaki, author, Rich Dad Poor Dad

  When I teach classes on personal finance to attorneys, I am occasionally asked, “If I have extra funds to invest each month, should I use those funds to pay off my mortgage?” My reply: “Good question! Let’s discuss your question at the end of the class. I want to hear your thoughts at that time”.

  At the end of the class, or in follow up conversations after class, the typical comment: “It’s now clear. It would be a mistake to put all my extra money into a house. I need to diversify investments and ensure that some of my overall investment portfolio is invested in financial holdings”.

  So, like the students in the class, after you look at your monthly income and expenses, ensure that you have money to save and invest each month. Questions: How will you allocate those funds? What is the right balance among stocks, bonds, real estate and other asset classes in your investment plan? How important is a free and clear house? Du
ring your working years? During your retirement?

  For further discussion on this topic, see Parts 2 and 3 below. In particular, in Part 2 see chapters, “What is the Secret to Building Wealth?”, “The 25-50-25 Plan” and “Get Ready for a Longer Retirement”. In Part 3 see chapters, “Compare and Contrast Investment Options” and “Houses vs. the Stock Market”.

  *Recommended reading: “Should I Pay off the Mortgage?” Andrea Coombes, Wall Street Journal, May 23, 2013

  7. LESSONS LEARNED: BANKS

  “If you look to a bank or mortgage broker for guidance on how much to spend on a home loan, your financial problems may be just beginning”. Gary M. Laturno, Esq.

  “Bankers encourage people to borrow beyond their means, preying especially on those who are financially unsophisticated”. Joseph E. Stiglitz, American economist, professor at Columbia University and recipient of the Noble Prize in Economics in 2001

  Countless numbers of people are approved for mortgages they cannot afford. ”If the bank says I am qualified, I must be able to afford it,” from a man who earned $75,000 a year and qualified for a mortgage of $750,000, ten times his income. Unfortunately, he was forced to file for bankruptcy and subsequently lost his home to foreclosure.

  The above example is not unusual. Many are approved for mortgages in the United States to buy homes they cannot afford. But you may ask: Have things now changed? When a consumer shops for a mortgage, will they be approved only for a mortgage they truly can afford? The answer is “No”. See “Lessons Learned: FHA & VA Loans” below.

  Do not look to a bank, mortgage broker or any sales person for guidance on how much to borrow or spend on anything. Their business is to sell loans and make money - not look after your financial interests.