Step 5: Letters and Numbers

Reading, Writing, and Real Estate

• Money: 0
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• Time: 45 minutes

There's going to be some math and vocabulary homework today! Pull up a calculator and scrap of paper. If you're in the digital mafia, set up a spreadsheet. 

Vocabulary: 

Don't try to memorize these, just absorb:

DTI - Debt to Income Ratio.

Your DTI is a statistic that estimates your monthly "buying power" or you ability to afford another major expense (such as a rental property). Most real-estate statistics are based on a monthly cycle. You pay rent and bills every month, so this should feel pretty typical. 

To find your personal DTI, make a list of these monthly debts:

• Housing (rent or mortgage payment)
• Credit card payment/s (remember from Step 1, you have reduced your card usage, right?)
• Student loan payment
• Car loan

For most people, that's it. You don't need to list utilities or grocery bills or other everyday expenses here. DTI includes only "official" debt that can be documented in your credit report*. Other less common items might be alimony, child support, or other legally required monthly payments. If you have these, add them to your list. 

(*DTI is different from a budget. In your budget, you absolutely should include gas, groceries, insurance, child care, and all your monthly life expenses. DTI uses a different formula to calculate a specific type of statistic.) 

Next, find your monthly Income: This is BEFORE taxes and deductions. Look at your paystub for your gross income. If you get paid every 2 weeks, multiply the number by 2.16. 

If your pay is irregular such as sales commissions or freelancing, do your best to estimate your average monthly income BEFORE taxes and deductions. 

Total Monthly Debt ÷ Income = Your personal DTI. 

Write down your number. You want this number to be below 0.45. Lower is better. If it's greater than 0.45, you need some more financial prep, more on that later. But keep working through today's tutorial. 

Personal Funds

We'll need a ROUGH estimate of how much you have available for a down payment, and your "safety reserve." Go online and collect your recent statements, and write down your current balances in: 

• Checking account
• Savings account
• Investment Stocks/Bonds
• Retirement accounts*

*We are not proposing that you tap into your retirement! But banks like to see that you have funds available in any form, so retirement accounts look great on your application, even when you don't actually spend the money.  

Safety Reserves

Go back above to your total Monthly Debt. Multiply this number by 3. These are you "Safety Reserves". Banks like to see that you have at least this much saved up somewhere in your finances.

 THESE TABLES ARE WRONG SHOULD BE 1500

Starting Point

Here's the last math problem for today:

If your Starting Point number is 0 or negative, start saving more right now (LINK).  but keep working ahead. 

< $15,000: You aren't ready... YET! But you can be (LINK TO BUDGETING)

$15,000 - $20,000: You should be careful about buying a rental property. It can be done, but you may be stretching yourself too thin. Are you disciplined enough to reduce your spending habits? Can you pay off some credit card debt? Or can you save aggressively for a few months and get some more safety reserves?

$20,000 - $40,000.  You're in decent shape to buy a rental property. Just be aware you will be spending a significant portion of your savings, so be smart and curb your excess spending and don't take on any more debt. Save up some more and practice good habits over the next few weeks of the Baby Steps program. 

> $40,000. You could possibly buy 2 or more rental properties at this stage. Let's start with 1, but you will be a very appealing client when you start applying for loans! Make sure your credit score is high too and you'll be great. 

If some of your personal funds are in retirement accounts or stocks and bonds, you'll need to liquidate some of them to get at least $15,000 into cash. You don't need to sell anything yet, but think about your options. It's usually better to sell stocks and bonds than retirement funds. Talk to an accountant or retirement planner before you think about tapping into your retirement funds.

Backup Plans

If you don't have the recommended amount in your Starting Point number or Safety Reserves, there are other options. Remember, there are 2 sides to the DTI equation, you can save up more money or you can reduce your monthly expenses (or both!). You could borrow money from family or seek out an investment partner. More on those topics will come in later posts.