So, now we have discussed all twelve steps of Money Fundamentals. You have been keeping your steady job or income producing business (Money Fundamentals, (Step 1 and 2), have been saving and keeping 10% of your income (Step 3 and 4), gotten good and tracking your money and your time (Step 5, 6 and 7), reduced everyday expenses (Step 8), have started a side business in order to make more income, doing something that is a natural talent for you, while reducing your taxes (Step 9), understood minimum insurance requirements (Step 10), learned to be frugal against the onslaught of temptation (Step 11), and eliminated all consumer credit debt (Step 12). And, in so doing, you will have earned your right to make the next wealth move.

So, we begin again, at Step 1 – but now in Real Estate! Onward! Upward!

Recommended Reading

Thomas J. Stanley Ph.D., The Millionaire Next Door (2016 Edition).

Your Credit Score

A house that you can live in is a good place to start your life in real estate acquisitions. In order to buy a house, you will need to get a loan from a bank. In order to get a loan, you will need a good credit score.

There are three credit reporting bureaus in the United States: Experian, TransUnion, and Equifax. You need to order a credit report from each company in order to correct any errors on your credit reports.

Annualcreditreport.com is sponsored by the three above listed reporting agencies. They will give you a free credit report from each of the three reporting agencies. You are entitled to one free report from each of the agencies every twelve months, by federal law (Fair and Accurate Credit Transactions Act). Note, you have to pay a nominal fee for your credit score, but the report is free. The report is what you need in order to spot any errors. Carefully review every account listed on the report and correct any errors. 

If there are blemishes on your credit, it is up to you to fix those problems. Contact the creditor and work out the problem directly with the people who say you owe money.  Contact the creditor in writing and explain your situation and why it is reasonable for them to remove the blemish. Keep communicating. Work with them; they are people, too.

They will listen to you if you show a true willingness to pay off what you owe or demonstrate why a court will rule that you do not owe the debt. The credit reporting agencies will listen to you if they believe the blemish should be legally removed. Keep corresponding with the creditor and the reporting agency and give them good reasons to remove the blemish. Do not waste your money hiring any company that says that they can fix your credit. Self-help is the key word. Confirm discussions and agreements in writing. Shine up that credit score as soon as you can. Credit issues usually are not set in stone. Even bankruptcies cannot legally be reported after a certain amount of time. Old mistakes can be made up. 

Credit Reporting Standards

Why do you need a solid credit report? Because you want to be able to get a loan from a bank, to buy a piece of real estate, so that you and your family can have a nice place to live. If you have some blemishes on your credit, don’t despair. Standards for analyzing blemishes on credit soften and harden in cycles. 

In good economic times — when the economy is humming along, or when the Federal Reserve chooses to keep the interest rates low, or when a technical innovation expands the economy, or when both aisles of Congress are getting along and pass laws to encourage home ownership — it is easier to get a loan. However, whenever there is a large contraction in the economy — a recession hits, or there is great political turmoil, or the Federal Reserve raises the interest rates, money tightens up and it is harder to get a loan.

Ms. Katherine

You have to be ready to jump when the money becomes available from the banking industry. So your credit needs to be good. But remember, you don’t need stellar credit, just good credit.

If you can clearly explain, in a letter to the lender, why there is a blemish on your credit, the lender will listen to you and make a reasoned decision. If there is a money surge, chances are good you will get the approval. If money is tight, you might not. In the grand workings of the U.S. economy, your economic class is fluid. Thank God.

Financing

Getting a loan from the bank is not as hard as you think. Conventional lending standards expect you to (1) have a steady income; (2) contribute between 10% – 20% down to the purchase of the house; (3) have credit which is good enough to lead the lender to believe that you will repay the loan; (4) and the immediate ability to pay both the principal, interest, taxes, and insurance (PITI) for six to eight months, from your steady income. That’s it.

Verification of a Steady Income 

Remember back to the first chapter of this book – you need to have work that is naturally suited to you, because it is your daily industry that will make you wealthy. You are now at the point where following that rule begins to pay off. If you have been faithfully working at your job or business and keeping your income steady, you will now be able to make your first major investment. 

You kept that job! Your business is doing well! You earned that money! Now you get to spend it in a way that will put you firmly on the road to wealth – with a piece of real estate! That is what the wealthy do – they bypass all the trinkets and beads, clothes and cars — and put their money into something that will dramatically improve the quality of their life. So, let us start talking now about real estate finance.

When analyzing a home loan application, the banks want to know one basic thing – can you pay the loan back? Banks do not want your house! They want the upfront fees and the interest on the loan they gave you. Banks do not want your house to be returned to them in foreclosure because you did not pay the loan. The last thing they want is for you to get a chunk of money from them, move into the house, not make the payments, forcing them to kick you out of the house, follow the lengthy legal process of foreclosure, and then try to resell the house to someone else. Entire banks go out of business if that happens with too many people at one time. Bankers are not in the business of making repairs on property. They are not in the business of finding buyers for houses. They just want their fees and mortgage interest. So the big issue for them is: will this person repay the loan? 

What Documents the Bank Will Require 

For Employees

The bank will require that you fill out a loan application, stating the amount of your income. For employees, the bank will require that you prove your income by providing two to three years of tax returns, with W-2 forms attached, three to six months of pay stubs, verification from your employer that you have in fact worked there for two or three years, and three to six months of bank statements.  

For Business Owners: The Bank Statement Loan

For business owners, conventional lending standards will require three years of tax returns, with a schedule showing the deductions, three to six months of bank statements, and any other means of verifying income.

For business owners, the tax return needs to show an amount of income that will support the cost of a house in the price range that you think you can afford. The traditional advice is to limit borrowing in the range of twice your annual gross income. But the bank will allow you to borrow three times your gross income. So, if you want a $600,000.00 house, the tax return needs to show at least $200,000.00 in income, after deductions. 

So, business owners face a conundrum. Business owners are allowed to take business related deductions. Business owners get the benefit of lower taxes because they can lower their adjusted gross income through deductions. But that very process makes getting a loan harder because, on the tax return, the income looks low. Employees are paid by someone else and do not have the opportunity to reduce their income taxes through deductions and so, on the tax return, their income looks high. Thus, it is much easier for an employee to get a loan than a business owner.

So what should a business owner do? Look for a lender that offers the bank statement loan. Instead of focusing upon the tax return, the bank statement loan focuses on deposits made into your bank account. This allows the bank to verify your income but doesn’t penalize you for the the deductions that you take on your tax return. The bank statement program allows all kinds of borrowers — contract workers, business owners, realtors, entrepreneurs, retirees — and self employed people of all stripes — to get a bank loan.

The lender will typically ask for 12 or 24 months of bank statements. Other typical terms also include your showing that you have been a business owner or have been self employed for at least two years. At least ten percent down is required. You must have four months of reserves for principle, interest, taxes, and insurance (PITI) for amounts under one million and six months for amounts over one million. A credit score of 620 is a minimum to qualify. These loans can range from roughly $100,000 to $1,000,000.00.

Regarding the deposits, the bank will require, for a given time frame, total deposits, minus disallowed deposits. Disallowed deposits likely will include transfers between bank accounts and large unexplained cash deposits, and unexplained sources of income. The banks are also looking for seasoned income, which means money that has been in the account for an extended period of time, and not simply deposited right around the time of the loan application.

How Much Should You Borrow?   

The next issue is how much should you borrow?  Banks will typically lend three times the amount of your gross income. For example, if you are making $100,000.00 gross income per year, the bank will lend $300,000.00 for you to buy a house. 

Should you use that ratio in looking for a house? No. If you want to become truly wealthy, you have to save and invest. You still need to live and you need to keep on saving 10% of your income. If you have an enormous mortgage, your ability to continue saving 10% will be hampered that if there is an emergency, you can fall short. It is terrible to be house poor. It is miserable to be unable to do anything, buy anything, or go anywhere because you have a staggering house payment month after month, year after year. 

Finance experts, Thomas J. Stanley, Ph.D. and William D. Danko, Ph.D., authors of The Millionaire Next Door, advise never purchase a home that is more than twice your household’s total annual realized income. [1] What is realized income? Basically it is money you have actually received during the current year. For example, if you buy a stock for $100.00 and it goes up to $150.00 but you don’t sell it, then you have a gain of $50.00 in unrealized income. If you sell the stock, and make $50.00, then you have a realized income of $50.00 in the year that you sold the stock. So realized income is the amount of money you actually received during the year. 

However, it can be hard to meet this criteria, especially if you live in a densely crowded area. High population density often leads to inflated home prices because of limited supply of homes in relation to demand.    

If you simply cannot find an acceptable property that is no more than twice your gross realized income, then an alternative rule is to borrow no more than three times your gross income. However, it is then imperative that you put as much cash as you can, down on the property, so that your payments are not too high. 

Next up is the money — you will want to read all about that in the next chapter!

And do yourself a huge favor. Order and read the book The Millionaire Next Door, from the link below. This book will blow the lid off of everything you think about the way the wealthy behave. If you do one thing today to understand how the wealthy play the game, read this book. It will change your life!

[1] Thomas J. Stanley, Ph.D., William D. Danko, Ph.D., The Millionaire Next Door, (1996) Pocket Books, p. 68.  This is an excellent book that focuses on, among other things, frugality as the primary key to wealth. 

Recommended Reading

Thomas J. Stanley Ph.D., The Millionaire Next Door, (2016 Edition).


Amazon Book Selections:

Credit Secrets: 2 books in 1 - Blast Your Credit Score Through The Roof And Repair Bad Credit By Having Everything You Need To Know Explained In Detail, Including 609 Letters Templates


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How to Boost Your Credit Score 100+ Points in 30 Days Without Credit Repair!


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Last updated on February 17, 2024