Passive Family Income » personal finance

How to Create Your Own Mortgage Escrow Account

John S. — Thu, 12 May 2011 11:41:44 +0000

There are plenty of good reasons why a homeowner may want to setup a mortgage escrow account when taking out a new home loan. A mortgage escrow is an agreement between a homeowner and a third party in which money is deposited into an account each time a house payment is made. Funds from this account are then used to pay for expenses like property taxes and homeowners insurance, which require lump sum payments once or twice a year.

Making escrow payments each month offers plenty of advantages to homeowners. They are setup to cover large payments, such as property taxes, which can help the homeowner budget appropriately to cover these infrequent (but large) expenses. A mortgage escrow account also prevents from any late penalties or fees as the third party service assumes the responsibility of making the payment on time. Plus, the account is always funded and the third party will adjust your payment requirements based on increases or decreases in your property taxes and homeowners insurance.

For many homeowners, a mortgage escrow account is a convenience they are willing to pay for. However, for other opportunistic homeowners, a mortgage escrow account can be viewed as a missed opportunity to earn extra income.

How to Create Your Own Mortgage Escrow Account

Setting up and managing your own mortgage escrow account is an easy way to earn a little extra income. If you are thinking of refinancing your existing home or taking out your first mortgage, here are some steps you can use to setup and manage your own mortgage escrow account.

1. Decline Mortgage Escrow from Lender

The first step in setting up your mortgage escrow account is to decline this service when asked by your lender. Whether you are taking out a new mortgage or refinancing an existing loan, you will need to decline this service.

Make sure you are comfortable with managing your mortgage escrow account on your own prior to declining the service. While setting up your own account can allow you to earn extra income, there is a convenience to going with a third party to manage your funds.

2. Design Your Escrow Account

After you have made the decision to manage your own escrow, one of the first actions you need to take is to decide what the account will fund. Most escrow accounts managed by a third party pay for home related expenses like property taxes and homeowners insurance. While there are other expenses that can be funded through an escrow, those are the main two. I am currently building my own account which will fund my annual property taxes (due every November) and my insurance (due every February). I have also considered adding my HOA account to the mix in the near future.

It is also important to recognize when your payments you are trying to fund will be due. For example, my current property taxes are due once per year every November. The first home that my wife and I purchased paid winter and summer property taxes. Find out the frequency and dates of when these expenses are due. This information will be important in setting up your account, especially if your taxes are due in the next couple of months.

3. Estimate Monthly Payments

If you plan to manage your own mortgage escrow account, then you need to estimate how much money to allocate each month. The frequency of when you allocate funds does not have to be monthly, just as long as the total for the year covers the annual expenses. It is also a good idea to factor in when your property taxes and homeowners insurance payments are due when starting out, so you have enough funds to cover these expenses.

Refinancing
If you know how much you pay in property taxes and homeowners insurance, this should be an easy step. Simply take your total annual expenses and divide by 12. I prefer to add another 5% – 10% into the monthly amount to provide a little cushion. For example, if you pay $5,000 per year in property taxes and insurance, your monthly payment would need to equal $350 – $365 (based on the extra cushion).

New Homeowner
If you are a new homeowner, then you will need to estimate what you think you will pay in property taxes and insurance. Your insurance company should be able to provide you with your annual payment, but you may need to research your property taxes. If you are buying an existing home, then you can look up what the former homeowners paid in past years on sites like Zillow.com. If it is a brand new home, look at comparable homes in your area to get an estimate.

Once you have your estimated annual property taxes and insurance information, sum the total and dividend by 12. I would suggest adding a 10% cushion starting out if you are estimating your annual property taxes. For example, if you estimate your taxes and insurance will cost $5,000 per year, then you need to allocate about $458 each month.

4. Find a Good Online Bank

Once you have calculated your estimated monthly escrow payment, it is time to find a place to invest the money. Starting out I would suggest a low risk investment such as a high yield savings account. While interest rates of savings accounts remain very low, it is important not to risk these funds. As you begin to manage your account you may find more profitable opportunities to invest your money.

I prefer to use an online bank (ING Direct) to fund my mortgage escrow account. Each month I have $400 automatically transferred from my checking account to my online savings account. My suggestion is to find an account where you can setup an automatic transfer each month to avoid any hassles. Our account is funded the same day that we send in our monthly mortgage payment to make it simple.

5. Manage Your Mortgage Escrow Account

Now that your account is setup and being funded, most of the work has been done. However, there are still times when you will need to monitor and manage your account. First, you will need to make sure to pay your property taxes when they come due from this account. Remember that you are forgoing the convenience of having a third party pay your taxes in return for extra income. Make sure you pay your bills on time to avoid any late fees or penalties.

If you are paying for homeowners insurance through this account, then make sure you have it on your calendar when this payment is due. The same can be said for any other payment you wish to fund through your mortgage escrow account. Remember that the purpose of starting your own account is to make some extra money, not spend it on late fees.

Property taxes tend to go up and down for most homeowners. In the event your taxes go up, then you need to adjust for this increase in your monthly escrow payments. It is important to monitor any increases to ensure your account is fully funded. If your taxes go down, then you could adjust your account as well, although I prefer to keep my payments the same since I am earning the interest and not the bank.

Final Thoughts

Managing your own mortgage escrow account is a way to earn extra income on your money. For a few hours of your time each year, you can quickly setup an account and begin to earn interest off your money instead of a bank or mortgage lender. While some homeowners prefer the convenience of having a third party manage their escrow, those looking to build some wealth may decide to setup their own account.

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What is Debt to Income Ratio?

John S. — Tue, 19 Apr 2011 11:23:54 +0000

The debt to income ratio, also known as DTI is a financial calculation commonly used in the lending industry. The ratio measures the amount of debt a person or household holds compared to the amount of gross income that is brought in. The ratio helps lenders determine the probability of a borrower being able to repay a loan.

One of the most common uses of the debt to income ratio is when you go to purchase a home. Banks and other mortgage lenders commonly use the DTI to determine mortgage affordability. Borrowers with a higher debt to income ratio are considered more of a risk to lenders. This is because there is a higher likelihood the homeowner will not have enough money left over each month to pay their mortgage.

Borrowers with a lower ratio are more likely to get approved for a loan as opposed to those with a high number. A homeowner with a low ratio should have an easier time paying their mortgage each month. Of course, there are other factors lenders use when approving a loan, but a low DTI will help your chances of landing a mortgage.

Types of Debt to Income

There are two variations of the debt to income ratio that are used by lenders when reviewing a mortgage application. They are commonly referred to as the front-end DTI and the back-end DTI.

What is Front-End DTI?

The front-end debt to income ratio is a calculation that specifically highlights how much of a household’s income is used towards housing costs. This would include items such as monthly mortgage payments (principal and interest), mortgage insurance, hazard insurance, property taxes, and any homeowners’ association fees. These total household expenses are divided by gross income for the month to calculate the percentage.

What is Back-End DTI?

The back-end debt to income ratio is the percentage of monthly gross income that is used to pay other forms of recurring debt (other than your home). Items such as credit card payments, car loans, student loans, child support, etc. should be included in this calculation. Generally, monthly utility bills and groceries are not included in the back-end calculation.

How to Calculate Your Debt to Income Ratio

If you are thinking of purchasing a home, it is probably a good idea to estimate your debt to income ratio before applying for a mortgage. It is actually very simple to estimate your own DTI. As mentioned earlier, there are two different ways to calculate your debt to income ratio – front-end and back-end.

Calculating Front-End DTI

The first step in calculating your front-end debt to income ratio is to account for all of your housing costs. If you are a current homeowner, this should be easy since you should be making monthly payments already. For those who are thinking of buying a home, then you must estimate what you think your monthly housing costs will run.

Let’s assume that you currently have a monthly mortgage payment of $1,050, pay $50 per month in hazard insurance, and pay $3,000 per year in taxes. Based on the payments listed above, our total monthly expenses to own the home total $1,350. This includes principal and interest payments, along with insurance and taxes prorated on a monthly basis.

If you and your spouse combine to gross $6,000 every month, your front-end DTI would equal 22.5% ($1,350/$6,000).

It is important to note that the debt to income ratio uses gross income (before tax calculation) as opposed to net income. Since you don’t actually bring home your total gross income each month, a smart homeowner will factor this information as well when deciding how much of a home they can afford.

Let’s assume that after all payroll deductions and taxes, your combined take home income is $4,250 each month (instead of $6,000). The actual debt to income calculation rises to 31.7% ($1,350/$4,250).

Calculating Back-End DTI

The calculation for back-end DTI is very similar to the one mentioned earlier, except for the type of debt you are including. Recurring debt payments, other than household expenses, should be included in this calculation.

For example, let’s assume that the homeowner above does not carry any credit card debt, but has two car payments to make every month. Assuming the homeowner’s carry no other debt, they only need to account for their car payments to calculate back-end DTI.

If both monthly car payments totaled $650 a month, their back-end DTI would equal 10.8% ($650/$6,000) based on gross income. When we run the calculation against net income, the result would increase to 15.3% ($650/$4,250).

Final Thoughts

One of the most important factors a lender will examine on a loan application is your debt to income ratio. This number is an important indicator to a household’s ability to repay a loan. A borrower with a high DTI has a greater probability of not having the available cash flow to repay a loan, such as a mortgage.

It is important to know your debt to income ratio if you are considering purchasing a home. Calculating both your back-end and front-end DTI’s will provide some insight into how much of a home you can afford. Remember that the lower your overall debt to income ratio, the more positive cash flow you will have each month. More cash means a higher likelihood you can repay your debt each month and avoid a financial meltdown.

What is your Debt to Income?

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Billiards: A Personal Finance Lesson in Disguise

Derek (Staff Writer) — Fri, 14 Jan 2011 11:04:39 +0000

I was probably about 7 or 8 years old when my Dad decided to purchase our very first pool table – it only cost him $25. The rubber was dangling from the rail in a few areas, and some of the pockets were cracked, but with a few touch-ups from my mom, that table was in perfect playing condition. By watching my older brothers, I soon learned how to hold the stick and make a proper stroke. Little did I know that learning this game would give me insight to my future financial actions.

Learning the Game

My sister, who is only 18 months older than me, often challenged me to a game. Since we were both beginners, here’s how the game would go. The balls would be scattered on the table and I would decide which one to hit into the pocket (or try to anyway). I’d hit the cue ball toward the targeted ball and maybe hit it in the pocket. Then, my cue ball would bounce wildly around the table and come to rest at a random spot. This sequence would be repeated over and over again, by both my sister and I, until one of us finally hit the eight ball in and ended the game.

Improving Our Skill

I grew older and discovered that hitting the cue ball with all my might may not be the best strategy. I began watching professional billiard players on T.V. and carefully watched their eyes as they lined up their shot. I quickly learned that the professionals were not even concerned with the shot at hand. They were concerned about the placement of the cue ball for their next shot! And actually, many of them would plan all of their shots before they even stepped up to the table!

How in the World Does This Relate?

The correlation between billiards and our finances are actually very simple. The billiards player that only plans one shot at a time will always lose to the player that plans every shot before they take their first. It only makes sense right?

The same is true for personal finance. Those that only live for today will never see the riches that await the long-term planners.

The short-term planners will often talk about a hot new stock pick or a business venture that sounds too good to be true. These individuals are looking to strike it rich overnight and can only see the opportunities that are right in front of their face. When one fails, they just bounce off the rail and find the next one.

The long-term thinkers do not often succumb to the pressures of “get rich quick” schemes because they already have their plan mapped out for the future. They have the end in mind and can see the whole picture much more clearly (just like the professional billiards player).

Let’s say one of the long-term thinkers has a goal to retire by 45 years of age. By viewing the entire picture, he understands that he must create a passive income in order to replace his day job. He decides that purchasing rental properties is the best method for him, and if he follows his plan precisely, he will achieve his goal. Once the plan is mapped out, the hot stock tip from his buddy will seem juvenile and reckless, and certainly won’t be tempting. He already has his plan for financial freedom, and will most likely achieve it because of this long-term mentality.

Make Sure You Become a Professional

Do not continue hacking away at your finances. Look two or three “shots” ahead and decide if your actions today will either help or harm your financial future. If they are a harm, make sure to course correct. Keep this up, and you will be a professional of your finances in no-time.

This post was written by Derek.

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Cutting Out Wasted Expenses to Save More Income

John S. — Tue, 26 Oct 2010 11:09:56 +0000

How many wasted expenses are you paying for? After sorting through my family’s past years credit card and bank statements, I have found several small money leaks in our personal finances. As my wife and I look to cut back on our spending to save more of our income, I am surprised at how these little buckets of savings can start to add up.

Monthly Expenses Cut

To date, my wife and I have been able to save a portion of our income from the following areas -

By cutting out snacks, we have been able to save $40 per month.
Checking our credit card statements saved on a $10 recurring monthly charge.
Opting for a lesser cell phone plan saved $10 per month.
A change in our grocery spending has lowered our beverage costs by $12.50, while improving the foods that our family consumes.

The next category of expenses we are cutting from our spending are tied to the costs of running our business and are detailed below.

Cutting Back on Business Expenses

We recently formed an LLC in order to separate our personal finances from our business expenses instead of treating them the same. This was done to protect our personal assets from anything relating to the business. In the past, we had accounted for our personal and business expenses from the same accounts.

Now that we have made the switch, here are the remaining business expenses that have been eliminated or moved to the LLC. The bottom line is we can now claim back this extra money each month from our personal accounts. Please note that all business related expenses relate to making money online.

Monthly Membership Subscription – Six months ago I signed up for a monthly membership service that was suppose to help me write better content for the web. I still think this monthly service is helpful, but not at the $27.00 per month that I was being charged. Maybe if I was a full time professional blogger it would be worth the money, but I just can’t justify the expense at this point.
Hosting and Domain Fees – My hosting and domain fees average $22.95 each month to keep PFI and several of my niche sites running. Now that I have separated my business expenses from my personal expenses through an LLC, I needed to move this payment out of our personal finances.
Other Hosting Fees – I was checking a recent billing statement and realized that I was still paying $2.00 per month on hosting a few obsolete domains. I had decided not to renew a few domain names several months ago for some niche sites I was working, but forgot to cancel the hosting. I was just throwing away $2.00 every month on a service that was no longer being used.

Total Monthly Savings – $51.95

Final Thoughts

With October winding down, it doesn’t seem like we will be able to hit our goal of saving 10% of our income. The original goal was to save another $400 per month so that it could be used to buy high yielding assets that would help build our monthly income. To date, we have been able to knock off $124.45.

In order to eventually meet our goal to save this extra income, it seems like more drastic cuts are warranted. I had been focusing on eliminating wasted expenses where we were paying for items that we don’t use. In order to cut more, we will have to make some personal sacrifices.

What personal sacrifices have you made to save more of your income?

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18 Tips on Using a Credit Card Rewards Program

John S. — Fri, 20 Aug 2010 11:56:18 +0000

If you are going to open up a credit card, my suggestion is to find one that offers a cash back or rebate program. While most financial experts tell you to stay clear of these type of accounts, I believe a credit card rewards program can be used to your advantage. Anyone who is disciplined with their money should have no problem leveraging these products and using them to generate a little extra cash.

My wife and I have been taking advantage of more than one credit card rewards program for years. We typically redeem over $300 per year in gift cards and cash. Using credit with high interest rates may not be for everyone, but those who are able to follow the tips below can take advantage and start taking some of that hard earned income back.

Here are 18 tips to help you get started earning back a little cash on your expenses.

Pay Off Your Balance – The most important tip is to pay off your entire balance each month. If you cannot afford to pay off your balance, then there is absolutely no reason to have a credit card.
No Annual Fee – Try and select a credit card that has no annual fee. There is no reason to open an account where you end up paying more in annual fees to maintain your account than you rack up in savings.
Pay Online – Try to pay your bill online if possible. Paying online is quicker and you will save money on annoying postage every month.
Check Your Monthly Statements – Always check your monthly statements, whether it be online or by mail. This only takes a few minutes to do each month and could save you money. Checking your statements is another reminder of what you are spending your money on.
Track Each Expenditure on Paper – It helps to stick with your budget when you keep track of every expenditure you make on paper. At first this may seem time consuming, but will really help you stay on budget every month. Be sure to balance your monthly statement against your notes to ensure you are not being overcharged.
Automate Your Expenses – Find out which of your recurring monthly expenses can be paid by credit card. For example, you may be able to automate your monthly cell phone bill to be paid through your credit card. This helps you avoid any late payments or fees from your cell phone provider while earning more cash back on your credit card.
Maximize Your Monthly Rewards – Check with your credit card rewards program to see if it comes with monthly restrictions. If you have more than one card, try to maximize your potential earnings by splitting up expenses appropriately each month.
Avoid Frivolous Expenses – Never purchase items on your credit card that you do not need or otherwise would not have bought. Purchasing frivolous items on credit is a bad financial habit that can really hurt your finances in the long run.
Setup a Payment Reminder – If you go paperless, it may help to setup a monthly reminder to pay your bill. It is vital to avoid any late fees or extra charges. Pick a method of reminding yourself that works best for you.
Look for Bonus Rewards – Some credit cards will give you additional cash back bonus for using your card during certain dates. For example, my Discover Open Roads card offers additional rewards for choosing certain gift cards compared to receiving a cash payment.
Limit Your Number of Cards – Don’t sign up for every credit card reward program that you find. Many financial experts state that a person should have between 2 to 6 credit cards. Opening up more than 6 credit cards could have a negative impact on your credit score.
Don’t Let Your Rewards Expire – Every credit card rewards program will likely come with an expiration date to redeem your points. Be sure that you know when your points are set to expire and remember to redeem them beforehand.
Shred Convenience Checks – Be sure to shred any convenience checks sent to you in the mail by your credit card company. It is important to avoid cashing any of these checks when you get them, as you will be charged extra interest for them.
Charge as Many Expenses as Possible – Most financial experts will disagree with this tip, however I like to charge every expense that I can. Since I am tracking all of my expenditures on my credit cards, I prefer to charge everything. Just make sure you don’t get charged an extra fee at a store for not having a minimum amount (i.e. $10).
Use More Points for Higher Rewards – Depending on the amount of time you have to redeem your points, holding onto them can pay off. Some credit card programs may stagger their rewards by offering better returns for the more points that are redeemed.
Look for Specialty Cards – Several credit card rewards programs promote certain types of expenses. One of the more popular specialty type of accounts are gas credit cards. These cards typically pay a higher reward for filling up your car with gas or automobile expenses compared to say groceries.
Make Online Purchases – If you do most of your shopping online, you may be able to earn extra cash back through your credit card. Many of these programs offer higher rebates from online shopping. Just make sure that the purchases you are making fall into your budget.
Combine with Online Rewards – If are making online purchases with your rewards credit cards, look at leveraging additional rebates through 3rd party sites. Swagbucks for example has its own program that can earn additional rewards outside of your credit card.

Signing up for a credit card rewards program can be an excellent way to build your credit score while earning a little cash back at the same time. I know that I enjoy redeeming my points every year for a couple hundred extra dollars in gift cards. Just remember to keep your spending aligned with your monthly budget, no matter what form of payment you decided to make.

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