Live Debt Free

Pay off debt. Save. Give. Live your mission.

Debt Score – What Is It and Does It Matter?

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Many people have at least some idea of what their credit score is, but how many people know their debt score?  I stumbled upon the concept the other day and found this free tool to calculate my score… I figured I’d pass on the info for anyone interested.  I scored a 28, which was an “A”.  🙂

What is a debt score?

What's your Debt Score?
The Debt Score was developed by Oweing.com as a way to educate borrowers on how much debt is appropriate for their age, income, and education level.  The method for calculating your debt score is similar to the method used by mortgage lenders to calculate debt to income ratio.

What is debt to income ratio (DTI)?

The two main kinds of DTI are expressed as a fraction (e.g., 28/36).

The first fractional number, known as front-end ratio, measures the percentage of income going toward housing costs.  The second fractional number, known as back-end ratio, measures the percentage of income going toward all recurring debt costs, including housing.

The importance of your debt score

Let’s be honest… our credit score serves lenders more than it serves us.  It tells us if we can get credit but doesn’t help us determine how much debt is considered healthy for our age and income level.

Enter the Debt Score…

Most of us carry different types of debt at various stages in life.  For example… when we’re just starting out we may have student loans and credit card debt, then down the road we might acquire auto loans and a home mortgage.  Regardless of the type of debt or how old we are, it will always serve as an obstacle between us and financial freedom.

Your Debt Score helps reveal if you are carrying an unhealthy amount of debt for your age and income level, what debts are particularly troublesome, and what you can do to fix it.

Especially for those who got into debt early… knowing your score can help you get it back down to manageable levels.

What is my debt score?

I signed up to find my score and see how my Debt Free Adventure was progressing.

Here is a screenshot showing my results and how they arrive at the calculation (click to enlarge):

Debt Score
Click to enlarge

I received a 28 overall – which is an “A”.  My score showed me I’m doing well on housing and lifestyle, but that need to work on my student loan debt!

Looks like I’m doing pretty well… how about you?

Share your score in the comments.

What's your Debt Score?

Taking Action to Meet Our Savings Goal

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Taking action to save money

Lately I have been talking a lot about the importance of deciding exactly what you want for your money, setting goals, and making sacrifices to reach them.  This week I wanted to show that process in action, to provide an example of how this can work.

My savings goal

This year I set a goal for myself to save $22,000 toward the purchase of a home.  In order to do this, I have to set aside $875 from every paycheck, while still paying all my other bills, and saving for expenses such as health care, auto maintenance, etc.  So far, I have managed to stay on track, and have saved over $5,000 since January 1st.

Our savings goal may be too lofty

While I have been making excellent progress, keeping up with my goal every month has required all of my surplus income.  I have a $10,000 emergency fund, so this is not a critical problem, but it does mean that if I had to draw on my emergency fund, I would not be able to replenish it and stay on track with my goal.  Additionally, surplus income allows me to budget for discretionary purchases.  What this means, is that if an emergency occurred, or my wife and I wanted to buy something, we would not be able to meet our goal.

Our sacrifice to meet the savings goal

My wife and I talked it over, and decided that we would make a change in housing to free up extra money.  Most areas of our budget are already pretty tight, but we spend $700 month for our apartment, which is a little steep.  We have lived here for a year, and have no complaints, but we initially chose it simply because it was easy to find, which was important when we moved into the area.  I was sure there had to be better deals available, and a little research revealed an apartment of the same size for only $495/month.  After a phone call, and a visit, we decided to make the change, and are now just waiting for our move in date.

Sacrifices and Gains

There are pro’s and con’s to every decision made.  Here are some of the things we had to give up, and some of the things we gained by making this move.

Cons

  • Location.  Our current apartment is right across the street from where I work in a prestigious area of town.  The new one is not in a bad area, but it is older, and will add 5-10 minutes to my commute.
  • Perceived Security.  Our current apartment is a gated complex; the new one is not.  However, we have noticed that the gate to our current complex is frequently left open for long periods, either because it is broken, or to allow for deliveries.
  • Laundry.  This is probably the biggest one for us.  Our current apartment had a washer and dryer in the unit; the new one has an onsite Laundromat.  The actual cost is negligible, but we both enjoyed the convenience of not having to leave our apartment to do laundry.

Pros – Savings!

  • Rent.  We will save $205/month just on the face rent.
  • Water.  Our new water bill is included in the price of the rent.  This will save us $12-$15 dollars a month.
  • Gas Bill.  Our current apartment has a gas water heater.  This was the only gas appliance, and the monthly base fee for gas hookup is $15, making for an average $17 month bill (even though we only used $2 worth of gas).  Absent additional gas appliances, it makes sense to have only one utility bill, and the new apartment has all electric appliances.
  • Internet.  Our current apartment required that they provide any Internet service.  They charged us $45/month for the slowest service.  The new apartment allows us to get out own contract, and due to a sale, I will be getting faster internet for only $30/month (price locked in for 1 year, same as my lease)

Pressing on toward the prize

I have previously written that sacrifice is made meaningful by having a goal.  This is a perfect example, because my wife and I both hate moving.  It is uncomfortable; a lot of work, and there are some not inconsiderable downsides.  It would have been far easier to simply maintain the status quo.  However we do have a goal, debt-free homeownership, and because we kept that goal firmly in mind, we have the motivation to make a sacrifice that should net more than $3,000 dollars a year to propel us toward our objective, while also returning a surplus to our budget.  Additionally, this lower rent means we are more able to choose to stay in an apartment until we are prepared to buy.  Even with some annual increase in rent, we will avoid paying “as much as a house payment” every month.

Final Thoughts

I hope this helps illustrate how a concrete goal can lead to saving money, and maybe motivate you to meet your own goals.  If you have taken action to reach your goals lately, or plan to, we would love to for you to share your story with us.

Renting vs. Mortgage and A Solution for Mortgage Free Home Ownership

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The Lie – Renting is throwing money away

Although I am currently debt free I do not own a home, have no immediate plans to buy one, and have been renting an apartment for nearly 3 years now.

You may remember a past discussion on the topic of renting before buying a home, and while there are many factors involved in the renting vs. mortgage debate, today let’s hone in on one common misconception that often drives people into the arms of mortgage lenders:

“Renting is just throwing money away”

Well intentioned friends like to remind hapless renters like myself how much we have “thrown away” in rents over the past several years.  They are also quick to point out that had we only bought (a.k.a. mortgaged our lives for) a home, some of our rents paid would now be counted toward our net worth calculation as equity.  In reality this is misleading at best.  Actually, avoiding a mortgage has provided us an opportunity to build more equity while renting.  To prove my point let’s compare a hypothetical mortgage against my current rental housing situation.

The Truth – Renting cost vs. mortgage cost

According to Bankrate.com borrowers in Laredo, TX with credit scores over 700 can borrow $165,000 on a 30 yr fixed note for about 5% – if they put 20% down.  I don’t know a lot of first time, prospective mortgage slaves with $33,000 in their pocket.  Heck, many may be hard pressed even to have credit scores of 700 or higher.  So we will go with the default numbers in Bankrate’s payment calculator: $165,000, for 30 years, at 7%, with no down payment.  That is enough to buy a house about twice the size of my current apartment in the same neighborhood.

I currently pay $700 for a 626 sq ft, 1 bedroom apartment in a gated community, with a pool and a gym.  We are trading up to a larger house in this example, because that is what most people do.  Few go looking for a 600 sq ft house, as they usually leave apartments for more space.  Feel free to run these numbers with a more expensive apartment or cheaper house; the results should be similar.

Here is a snippet of the Amortization Schedule (click image to see the full amortization schedule.)

Our imagined loan results in monthly payments of $1,097.75.  At the first payment, only $135.25 goes toward principal. After one year of payments the equity, according to amortization schedule, would be $1,676.09 not $13,173.  As you can see… that’s not a whole lot of equity.

We THREW AWAY almost $12,000 in the first year with a mortgage; my apartment only costs $8,400!

Also, by the time the loan is paid off, $230,189.68 has been thrown away in interest paid to the bank.  That is more than the price of the house!  Mortgages steal from your future standard of living. Sure… you will get into a house sooner, but think of all the things you could buy with $230,000 if your house was already paid for!

The Solution – Build more equity while renting

The snippet amortization schedule above shows the initial & final payments on our imagined loan.  It also shows the turning point where the money I through away on interest is less than the money through away on rent.  Notice it is 15 years in the future.  That means I could rent for 15 years before buying a house and still come out money ahead, and maybe save enough to buy a home with cash.

The loan payment is $397.75 more than my current rent.  Instead of making the larger payment to a bank, I continue to pay my rent and put the difference into an Capital One 360 savings account labeled “Personal Equity.”  At the end of one year, I will have $4,773.  That is more than double the equity I would have with a mortgage, and it is also a liquid asset in MY bank account… accessible without having to sell my home or qualify for a HELOC loan.  You build your personal equity faster as you save money, I like to think of this as mortgage pre-payment.  🙂

My own personal equity grows by $875 with every paycheck.  I will have $22,000 by the end of the year.  I am also looking for a cheaper apartment, and probably will spend less than $165,000 on a house.  If I maintain my current standard of living, as my income increases so will my savings.  Eventually I will be able to buy a house with cash in the time it takes most people to pay off a car.

Final Details

You might notice I didn’t account for the mortgage interest tax deduction.  I wanted to keep the math simple, so I also left out costs for home maintenance, property taxes, or private mortgage insurance that more than offset the tax break.  These forgotten expenses will only add to the savings a renter can accumulate while those paying mortgage continue to pay, pay, pay.

For this to work you will need to secure housing below your means while you save to afford something better a few years down the road. This concept of sacrificing now to benefit later is a fundamental building block of sound personal finance.  Renting indefinitely without saving will never get you into a house, but paying a mortgage guarantees that you throw away money on interest.

There will always be a few areas with no available rental housing, but most people should be able to find a decent rental while they save for a home.  However, most people choose a mortgage over renting because they refuse to live below/within their means for a few years… never realizing how much it actually costs them in the long run.

What Do You Think?

I encourage you to visit Bankrate.com and try out their amortization calculator with prices from your area.  If you rent, take note of the difference between your current rent amount and a mortgage payment.  How much personal equity could you build in a year?  If you already own a home, try the pre-payment calculator to see if you can pay that bugger off early.

Do you believe people could ever be completely free from mortgages?  If not, why?