The 4 Step Cash Flow Priority System

During our Initial Consultation, we will talk about money and how it works. I call it “The Four-Step Cash Flow Priority Model.” The goal of this model is two-fold:

To educate you about money and how it works.
To provide a road map from which to make an informed decision about your mortgage structure.

The model itself is a very conservative, common-sense approach to managing cash flow priorities. We believe that by taking time to agree on basic financial principles, we can better advise you on mortgage types and structures that at first may seem counterintuitive or even risky.

As I have observed the mortgage industry over the years, it concerned me that most loan officers tended to be order takers. You call up a lender/loan officer and the first thing they typically do is ask you what you want. You of course ask for ‘the lowest rate’ because that’s the only value you think they can offer you. The loan officer then proceeds to quote you a rate and maybe fax a good faith estimate. You could go through this process a few times with different Lenders. In addition, you may become frustrated with them because they’ve done a pretty good job of confusing you with a bunch of numbers. So you decide to use one Lender over another based on a set of criteria that has nothing to do with your long-term financial benefit.

We believe the mortgage you ultimately choose is a big decision. We believe you deserve more than just a couple of minutes on the phone and a sheet full of numbers you may not understand. That’s why we insist on making an appointment in our office. We want to give this decision the time and attention it deserves.

I have found that the best way to compare mortgages is to first talk about money in general and how it works. The mistake most people make when getting a loan is they tend to take a compartmentalized approach to analyzing the mortgage. They look at the mortgage by itself, independent of their overall financial picture. They tend to view the mortgage as a necessary evil, something to eliminate as soon as possible, instead of looking at it as a dynamic financial tool and using it as an integral part of their long-term financial plan.

We’ve developed a short Four-Step Cash Flow Priority Model that acts as a guide to help prioritize their monthly cash flow. Simply stated, “As dollar bills come into the household budget (paychecks), what is the most effective way to allocate those dollars in order of priority to create the greatest long-term financial benefit for you and your family?”




Step One: Cushion

Create a cash cushion. This means money on-hand and readily accessible for life’s little unbudgeted emergencies. We aren’t talking huge money here. For a family of four, earning $80,000 per year, $3,000 to $5,000 should cover it. If your client is self-employed or on commissions the number should be higher to account for an irregular monthly income. The purpose is to allow you to handle emergencies with cash and not fall into the habit of always using credit for these unforeseen circumstances.

The biggest point I want to get across is that personal finance is almost totally about habits and not about numbers and rates. If a person has good financial habits and they consistently exercise those habits over a long period of time, things will most likely work out for them when it comes to finances. When you consider that approximately half of all marriages end in divorce, and most indicate money as a key factor in their divorce, we can easily see how this kind of advice can impact those we serve.




Step Two: Get Debt Free

The idea here is to eliminate all non-preferred debt. This would be all debt that isn’t a mortgage. For the couple who is buying their first home, and has significant debt relative to their income, this may be a long discussion that allows you to direct them on a positive financial track that will pay them dividends for a lifetime.

I will go over various ways to pay off debts. We advise people using the “snowball technique” of debt reduction. A good resource to learn more about this is Financial Peace by Dave Ramsey. We will also items areas such as zero percent auto loans, auto leasing vs. buying, student loans, adverse credit issues, etc.

The top two reasons to eliminate these types of debts are to free up your monthly cash flow, and form the habit of saving money and earning interest instead of paying interest. The key to financial independence is for you to have control of where your money goes and then to conserve (save) and not consume that money.




Step Three: Liquidity

Many times I will write down “one year’s salary saved.” We’re talking big bucks here. This isn’t retirement savings, but true liquidity. This is money that you can access for two primary categories of reasons: good and bad. An example of a “good” reason would be to take advantage of business or investment opportunities. Most of the time, when someone is presented with an opportunity, there’s an up-front capital/cash requirement. If you have the money, you at least have the option of taking advantage of the opportunity. An example of a “bad” reason would be a major interruption of income. This would include health issues, job layoffs or any economic factor that’s outside of your control. Currently, the number one cause of home foreclosure is disability.

You will see that if you had no debt outside of you home mortgage, and one year’s salary saved in a liquid, safe, diversified place, you’d have gone a long way toward reducing or eliminating the financial stress in their life. You would also have choices that most will never have. You will be able to make decisions, both major and minor, without having finance as their number one consideration. Where could you work or live if money wasn’t a factor? What would you do with your time? How would your relationship with your spouse change?






Step Four: Pay Off Your House

Here’s where it really begins to get fun. Most people dream of some day having their home paid off. For many, this is a far away dream and it seems that more and more people are starting to doubt if they’ll ever have a mortgage burning party. Most homeowners would define “having their home paid off” as not having a mortgage. That, of course, is one way to look at it – but wouldn’t it also be true that if they had a $400,000 mortgage and also had $400,000 readily available, they would, from a balance sheet perspective, have their home paid off?

This raises some very interesting questions and opens up some powerful opportunities for. There are three areas I like to address in this step:

Down payment
Principle payments
Home Equity Management

In looking at the Four-Step Cash Flow Priority Model, we said that our monthly cash flow should first go to developing a cushion, then to paying off all non-preferred debt, then to liquidity/savings, and finally to paying off the house. If you haven’t completed steps one through three, does it make sense for you to make a down payment when buying a home? Does it make sense for you to get a loan that requires principle payments? When refinancing, does it make sense for you to leave equity in the property if you have other debts or lack liquidity?

At this point, I will remind you what will be the most important concept as we talk about more advanced equity management strategies: You must be committed to conserve and not consume your equity.

The effective management of home equity along with consistent long-term financial discipline can be the key to financial independence for you, but it can also spell disaster without a plan. The best tool I’ve found to ensure a positive outcome is to link you with a financial advisor who will assist you in developing, implementing and monitoring a plan.

I look forward to meeting you and implementing a strategy to assist you in building a secure financial future for you and your family.

Marine Buys Zero Down...No VA Loan

I'm helping a former Marine buy his first home.

The lad walked in the door, waving his VA home loan certificate, ready to buy with his VA loan.

We sat down together to explore all of his home loan options.

He was amazed, even shocked to find out that he could get conventional zero down home loans with rates and terms that beat VA loans into the ground.

Right now we are awaiting a response on an offer we made on a big three-level townhouse, on a quiet street, backing to trees.

Today's Zero Down Offer

I sat down with a nice young couple yesterday and wrote an offer on a lovely home, on a quiet street, with lots of trees.

The couple will be using a zero down home loan, and we are asking the seller to pay all of the buyer's closing costs...roughly $9,000.

I got a verbal agreement to our offer from the seller's listing agent. Signed papers will be coming through the fax shortly.

If all is accepted as expected, the buyer's will go to settlement, sign the papers, get the keys to their new house, and get $3,000 cash at the settlement table.

Young Couple Buying Their First Home

Had a long conversation with Tim and Sue yesterday about using his VA zero down loan guarantee, versus conventional zero down home loans.

Both options are good options.

The VA loan allows wider qualifying lattitude when it comes to carrying other debt, and forgiving recent credit dings such as a late payment from time to time.

The conventional loan programs typically offer lower interest rates, more flexibility in payment options, and significantly lower closing costs.

I showed them five different options on a spread sheet so they could choose the loan they felt most comfortable with.

In the end, they preferred one of our zero down conventional home loans, paying interest only, giving them a payment $600 a month less than the VA loan.

Next, I showed them how they could make regular monthly payments, and accumulate $7,200 a year automatically in their investment account.

Million-5 Zero Down

We are helping a couple sell their home and purchase a majestic custom home for $1,500,000.

A million-and-a-half dollars.

Zero down.

Husband and wife are both doctors earning substantial income, and they have substantial savings.

The mortgage will give them a significant tax cut.

More important, their cash will keep working at a high rate of return.

Think about it for a moment...

Their average annual return on their investment portfolio over the past decade was twelve percent (12%).

The mortgage interest rate is six and a quarter percent (6.25%).

Their after-tax interest rate on their mortgage will be around four percent (4%).

Why would they take cash earning 12% out of their investments for a down payment when they can finance the down payment at an after-tax rate of 4%???

If they did so, they would lose 8% per year on the cash they put down.

If they put down, say, $400,000 in cash and financed $1,100,000, they would lose $48,000 in return on their investment.

The savings derived by reducing the loan by $400,000 would be just $16,000.

Bottom line, take the $48,000 lost investment return, then subtract the $16,000 mortgage savings, and you'll plainly see that making a large down payment will cost them $32,000 a year.

They will lose $32,000 a year if they make a $400,000 down payment.

A zero down home loan will maximize their return on investment.

Todd and Jane Buy First Home Zero Down

Todd and Jane were referred to me by Erik Spencer.

Todd and Jane were ready to buy their first home. Loan rates are stable, home prices are stable, and the market offers plenty of lovely homes for sale.

They have strong income, and promising careers. They have been diligent about contributing the max to their company sponsored 401K plan.

However, with all of their saved cash locked up in their 401k, they THOUGHT they didn't have enough cash to own a home... until they were referred to me.

Their goals were simple: find a lovely home, in a safe area, with zero down, and a payment that wouldn't leave them house poor.

After looking over their loan options, they selected an 80/20 loan that combined an interest-only first loan with a low interest rate second loan.

After a few hours of house hunting, they selected a beautifully updated townhouse in Burke Center. We made an offer to the owners that asked the sellers to pay ALL of Todd and Jane's closing costs.

They settled (closed) on their new home last week. They got their home with an affordable monthly payment, and they got cash back at closing... $1,046 cash back.

Congratulations Todd and Jane!