MASTERING YOUR MONEY
You are to be commended for taking the time to plan for your journey to achieving financial independence.
When discussing the problem(s) preventing us from achieving financial independence I’ve often wondered “why has it been so difficult to accomplish these things when it is undoubtedly perceived as a part of the American dream?” The truth is that the answer to this question is not a mystery and is known practically by all. I call it the NOW syndrome. Some experts refer to it as the inability to delay gratification, among other things. It is no secret that we are being conditioned to want everything perceived to be worth having--right now. We need to be able to see and/or touch it in order to stay motivated.
For most of us financial independence is not in plain sight or close by any stretch of the imagination, so we lack the motivation to perform the necessary measures to achieve it.
Your mission (at least part of it) will be to achieve financial security and enjoy the fruits of your labor. One of the strategic goals to help you accomplish that mission will be to establish near perfect credit (credit score of 720 or higher).
For many of us, the purchase of our home is potentially our first real asset. If we are to accomplish our mission of financial independence, each of our major purchases, particularly involving credit, need to be made in an effort to get us closer to accomplishing our mission. In other words, we must get in the habit of purchasing assets, not liabilities. What is the difference between an asset and a liability? For all practical purposes, an asset is something that puts money into your pocket and liabilities take money out of your pocket. For example, the items we buy on credit terms like luxury cars, big screen televisions, etc. take money out of our pocket each month. However, rental property, certain paper assets, and businesses, put money into our pocket each month. (If you haven’t noticed, technically your home will not be an asset unless you rent it out. However, it is a necessity and as mentioned earlier is a potential asset so it is encouraged for these purposes).
Why have excellent credit?
Simply put, credit should not be used for consumer purchases at all. However, it should be used to acquire assets as discussed earlier. Credit can be a key factor in accomplishing our mission of achieving financial independence.
Until recently, everyone has underestimated the power of credit scoring. Eyes are now opened to the fact that credit scoring is a significant factor in many transactions, from insurance to mortgages. As a result of low credit scores, many middle-income Americans are paying higher insurance rates, higher interest rates; some have been excluded from homeownership altogether. It has become apparent that raising one’s credit score is not only the most time and cost-effective approach to achieving homeownership, it is also a viable means for middle-income consumers to realistically achieve financial security. The key to a comfortable retirement is the replacement of earned income with passive or portfolio income—income we bring home without having to physically “go to work.”
Real estate vs. “feel” estate
Which are you interested in purchasing? Many of us buy “feel” estate. We make our home-buying decision based on emotions. We want as many amenities and as much luxury as we can possibly fit into our budget which, after all, is only human. In fact, if it is determined that we can afford a $120,000 house, we usually shoot for $125,000.
As opposed to buying “feel” estate, being a prudent real estate investor demands that little or no emotion be involved; it is correctly purchased from an economic perspective rather than an emotional one.
Fact – Fannie Mae & Freddie Mac, the entities that buy our mortgages in the secondary market, will buy up to four mortgages (owner-occupied) from any individual without their being classified as an investor (a couple could originate up to eight mortgages). A Duplex or fourplex can also be purchased. The proviso is this: you must always be trading up or originating a more expensive mortgage.
For example, if you can afford $120,000, it might be wise to purchase at a lower price—let’s say $70,000. In time, even a short time, you could trade up, buying a more expensive home and renting the previous property to tenants (no one says you have to be a landlord – hire a property manager). Thus, you TURN A LIABILITY INTO AN ASSET and vastly improve your overall financial picture. That’s right! Your home, which is, for all practical purposes, a liability as it takes money out of your pocket, can be converted into an asset by renting it out for more than your mortgage payment. You have now created passive/portfolio income—the same thing the wealthy do all day long (that’s why they’re called wealthy). Ideally, you should do this as many times as governing regulations permit, which is usually about four times. Let’s say you purchased four different properties at $70k, $85k, $95k, and $110k. In five years, a five percent annual rate of appreciation would yield approximately $99,000 in total equity. This amount could be rolled over, tax-deferred, into perhaps a small apartment complex (10% down on a million). Consequently, you could potentially convert approximately $200-$500 per month in rental (passive/portfolio) income into perhaps $2,000 - $5,000 per month.
Did you ever think that when you played monopoly and bought 4 houses and traded them in for a hotel that you could possibly do it in real life? Well, you can, and all with OPM-other people’s money. The process mentioned here is simplified but entirely doable.
This is only one way credit can be used to buy assets. The question now is, are you truly interested in being able to retire or will it actually prove to be a myth?