This week on Life or Debt: The McCray & Gucatan Family

Wela Financial Advisors on what we saw, what we learned, and what we should do on this week’s episode of Life or Debt on Spike.

The McCray/Gucatan family has found themselves in serious cash flow issues due to financial decisions made throughout the years, both independent of one another and together as a couple. Bottom line, they need to clean up their financial baggage before trying to pack in the same suitcase!

Filing for Chapter 7 bankruptcy may be the best possible solution for Pat as she has personally guaranteed business debt and this will allow for a complete liquidation and financial re-set. Scot needs to look at Chapter 13 which is a reorganization of debts and would allow him to potentially keep his home and avoid foreclosure. In order to qualify for Chapter 13, however, Scot will have to move back into his main residence to avoid it being classified as an investment property which you can’t maintain in this type of bankruptcy proceeding. This is a serious lifestyle consideration as he won’t be living in the same residence as Pat and the kids. Tough decisions, both financially and emotionally, must be made!

Both Scot and Pat have been making great income so this isn’t a story of low wages but rather too much SPENDING. Pat and Scot need to develop a realistic budget they can stick to. With household income as high as theirs is, there’s no reason to rack up the amount of credit card debt and other personal loans. Yes, they do have a lot of mouths to feed but this comes down to prioritization. Mink coats and $1,000 car payments can’t come before the necessities of basic living. So while living within a budget is paramount to their success, the question we must ask is how do we decide whether or not to rent or buy a house?

At the end of the day, cash flow and flexibility are KING! How much can you afford to pay for the place you live? In today’s low-interest rate environment buying has never been so affordable but that still doesn’t mean it is right for you. How much can you realistically put towards a down payment? 5%? Or the recommended 20%? What kind of commitment do you want? When you buy, you’re on the hook for the life of the mortgage. When you rent, you’re typically only locked in for a year before you can make a change. These and many other decisions play into the answer of whether to rent or buy.

If you're currently facing the question of whether to buy or rent your next residence, here are a few articles that may help you decide.

Renting Versus Buying A Home

Podcast: The Hidden Costs When Budgeting For Your New Home

Buying A New Home - How Much House Can I Afford?

A Starter Home That Ignites A Future Flame

When Good Debt Goes Bad

When You Should Not Buy A House

when-to-not-buy-a-house-600x398 The other day I had a great learning experience when working with one of our clients. Our client was deciding whether or not he and his wife could afford to purchase a new house, and reached out to me to learn if he was financially prepared. Unfortunately, after reviewing his situation I told him he was not able to buy a house because he was carrying other debt that would hold him and his wife back from having any flexibility with their income streams. It was the perfect example of why we need to be careful with how much we leverage ourselves with debt.

At Wela, we follow the TSL budget - Taxes, Savings, Life. It's a rule of thumb that says that you should spend 30% of your income on taxes, 20% on savings and 50% on life. If you are able to maintain this rule of thumb, then we believe you are in a solid financial position.

The family I was working with brings in about $100,000 a year. They wanted to buy a house, and the price of the house was actually a steal. The mortgage payment would be well within reason based on what they make each year. The problem was that they are currently servicing other debts - student loan and credit card debt - which has a monthly payment that is only slightly less than the current mortgage payment. If they were to buy the house they would be putting 36% of their income, $36,000 every year, towards debt servicing. This is in the maximum range of what we feel comfortable with at Wela. So, I had to tell him that from a financial standpoint it wasn’t a smart decision to buy the house.

We always try to figure out how to balance both consumption and frugality at Wela, but sometimes it just doesn’t work. The reason it doesn’t here is because if they bought the house and had that much debt to service they would be tying up too much of their after-tax income to debt servicing. They would be putting themselves into a situation  where they'd have to incur more debt in an emergency which would be a major financial setback. The best thing for them to do is to really focus on paying off their debt as aggressively as possible. Instead of putting money towards a mortgage, they need to put their extra cash flow towards reducing their other debts as quickly as possible. We recently released an ebook on starting a 30-Day Economic Shutdown. This could be a good way for this family to jump-start debt reduction.

Let's look at this family's proposed budget in terms of the TSL budget. If this family had 36% of their income going towards debt servicing along with 30% going towards taxes and even just put 10% towards saving, they are left with a minimal amount of cash flow for living expenses like buying food, gas, car insurance, utilities, etc. On top of this, if they own a home then they also have maintenance costs. Heck, on $100,000 income we are talking about having $2,000 a month for life expenses, and they are already spending about $1,700 on necessities outside of rent. On top of all of this, the couple is currently expecting their first child. These numbers just make their budget too tight. Could they buy the house even with the other debt? Yes, but it would really squeeze them, and the first mishap that arises with the house or anything else could likely lead to them incurring more debt.

This example just shows that even if you are able to borrow… like this client who would likely be approved by the bank for the mortgage… doesn’t mean that you should borrow. The ability to borrow money versus if you should borrow money are two drastically different situations and deserve two different criteria. Here is a situation where they could borrow, but they shouldn’t.

If you have a similar question, or would like advice on your financial situation, create your free Wela account and start your game plan. Our advisors analyze your financial situation based on the information that you provide and then speak with you about your questions, goals and actionable steps for your situation. Try it out today.