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Boosting Investment Power, Part Two: Debt-to-Income Ratio

This blog post is a continuation of RPM East Valley’s prior posting, “Boosting Investment Power, Part One: Credit Score”. This discussion includes methods for clients both current and future to strengthen their monetary prowess. To read the introduction and what has been written so far, click here.

Debt-to-Income Ratio

One of the most fundamentally essential factors of investment power is the proportion of debt one has occurred in comparison to the amount of money they bring in. Many assume that if income is high, it’s an automatic green light for investing, but if the amount of debit against the credit is substantial, that can stall progress on a real estate venture.

Using a fictitious character, Jim, we’ll demonstrate how to calculate your Debt-to-Income Ratio:

Let’s presume that Jim has worked a steady job for a long time, has climbed the ladder a ways, and makes $7,000 per month. This constitutes his ‘Income’. However, the ‘Debt’ portion of the ratio refers not to the sum accrued amount of debt, but to the total monthly payments he is required to make.

Here are Jim’s monthly bills: $2,000 mortgage, two $350 car payments, $400 in student loans, and $500 in credit card payments. The math would calculate as follows:

Total Monthly Payments ($3,600) divided by Total Monthly Income ($7,000) equals 0.5142,which translates to:

51.4% Debt-to-Income Ratio.

The general rule of thumb is a desirable DTI Ratio is less than 50%, obviously the lower the better. Jim’s example goes to show that although one’s income may be high, if debts are also high, lenders and investors will become aware of that, and will factor into one’s ability to utilize real estate.

 

 

Boosting Investment Power, Part One: Credit Score

For our current and potential clients reading our blog, we want to do everything we can to help them succeed in their real estate endeavors. Perhaps it goes without saying, but one of the key pieces that clients bring to the table is their overall investment power.

By investment power, we mean the ability and opportunity available for a client to invest in rentals, property management, and the like. An assumption is commonly made that the amount of cash in one’s bank account or on a pay stub is the one and only bottom line, but there are several factors that go into just how aggressively and effectively individuals and families can work and thrive in real estate.

This post is the first of a four-part series discussing methods both future and current clients can strengthen their monetary prowess:

Credit Score

A lot of confusion, as well as unnecessary hype, exists around credit scores and what they do. What a credit score is, simply put, is a way for banks, lenders, landlords, etc. to determine beforehand just how likely you are to pay them back, and if you’ll do so on time; they want to measure the amount of risk they are taking by giving their money to you in order to transact real estate.

Ranging from 300 to 850, credit scores factor in things like:

  • the types of credit people use,
  • their payment histories,
  • how much they owe,
  • how long they’ve been using credit,
  • and so on.

Try to keep scores above 600, and above 700 is considered investment-ready by many real estate firms.

Libraries of books have been written on earning and keeping good credit, but as a general rule of thumb, the bulleted list above are metrics used in calculating scores, so use these four areas as focal points for areas of improvement. Payment history and amount owed account for well over half of the entire score, so invest the time and energy to pay down as much as possible…in a consistent manner.

Principles of Real Estate Investment: Principle Five

This blog post is a continuation of a previous Real Property Management East Valley posting entitled “Principles of Real Estate Investment: Principle Four”, discussing fundamental principles of effective buying, selling, and managing property.

Principle Five:  Market Conditions

Although few things in life are absolutely guaranteed, it is important to understand that the real estate field is not designed to succeed and make money only in an appreciating market. Even though the market is of course changing, if a system is built where the bulk of the profits being made come almost exclusively from the assumed notion of property value increasing via larger markets, that takes much of the control and profitability out of an investor’s hands.

When making decisions, particularly initial, first-time decisions, it is important to note that investment, particularly in real estate, is most definitely intended to work in just about any market. Working under the assumption that it doesn’t puts too much to chance, and begins to resemble gambling far too much.

A good way of assessing this principle is by calculating how much the market would have to go against you for you to lose significant profits; if the amount is fairly substantial, you can feel good about the fact that your system is sound (in that it’s not solely based on the market). If only a slight dip or bubble in the market would potentially ruin your plans, consider revising or replacing your proposed strategies.

For principle five, the question about market volatility that needs to be asked revolves around strategic evaluation:

Will the strategy or investment work in any market, or is it heavily dependent upon market appreciation?