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.