Financial Newsletter 3.23 - Armstrong Advisory Group

How Are You Rated?

We know mortgage rates have gone up. We know they have gone up a lot. We know that if you’ve been looking for a home and still haven’t bought one, you may be feeling a little down in the dumps about your prospects of buying a home this spring. But that doesn’t mean you shouldn’t be informed as to exactly how changes in mortgage rates may impact your buying power.

For the purposes of these examples, we’re going to be using data from Zillow’s(TM) mortgage affordability calculator. If you want to play around with it on your own, the link is right here. Let’s say that you have income of $70,000 per year, $75,000 saved as a down payment, a $500 per month car payment, and you are looking to buy a property but not spend more than 25% of your monthly income on the payments before taxes and insurance are included. Using this data, at an interest rate of 7 percent, a 30-year fixed rate mortgage would allow you to buy a home worth $219,045, with principal and interest payments of $958 per month.

But what happens if mortgage rates drop by 1 percent?

That drop takes your maximum price from $219,045 up to $234,832, an increase of over 7 percent, while still maintaining principal and interest payments at $958 per month. Now, it is important to keep in mind that many buyers who are needing a mortgage to buy a property would also be seeing similar increases in their buying power, but the basic idea still stands – lower mortgage rates allow you to spend more on a house without paying more in principal and interest on a monthly basis.

How have the interest rate changes in the past 18 months impacted affordability? If we could go back to 3 percent mortgage rates on 30-year fixed rate mortgages, the same person from our example would be able to spend $302,306, a full 38 percent higher than they could with rates at 7 percent. This is a key reason why home prices are somewhat under pressure right now, and may continue to feel additional pain throughout 2023 if interest rates stay high. What was affordable to families in terms of the purchase price with rates at 3 percent is dramatically different from what is affordable with rates at 7 percent. The key thing to remember is that as hard as it is to walk away from a home you love because it’s too expensive for you to buy, it’s even harder to be forced away from it after you bought it because the payments were too high and now you need to move somewhere else. Find the home that fits your budget, even if it means taking a little longer to do so.

Before May Flowers…

With concerns about a potential recession later this year or in 2024, this is a great time to consider building up an emergency fund if you don’t have one. Even without a recession, you never know when an unexpected expense may strike, and with credit card interest rates rising in recent years, having a source of safe, reliable, and stable funds that you can turn to in a pinch is a huge help in trying to minimize the cost of digging out of a tough situation.

The first thing to keep in mind with regards to an emergency fund is that you want it to be liquid. You don’t want to have something that takes weeks or months to access, you want to have money that is readily accessible to you. If an emergency strikes unexpectedly, you may not have the ability to wait for an extended period of time to gain access to these funds. They need to be easy for you to withdraw.

The second key characteristic of an emergency fund is that it needs to be stable. The stock market, with all of its volatility, is not a good place to build an emergency fund. 2022 and the start of 2023 are fantastic evidence of this. You have no idea what the value of stocks will be from one day to the next, and as such, it’s completely inappropriate to consider building an emergency fund in the stock market. When we’re talking about stability, we’re talking about places such as checking accounts, saving accounts, and certificates of deposit (CDs). FDIC-insured bank accounts are pretty much at the top of the pyramid when it comes to stability, as they are effectively backed by a guarantee through the FDIC. However, as we have seen in recent weeks, FDIC protection is not explicitly unlimited, and so you do want to make sure you familiarize yourself with how those protections work. For information on this, please visit this page from the FDIC website.

Lastly, an emergency fund must be appropriately-sized. How big does yours need to be? There is no one-size-fits-all approach to building an emergency fund, as different families need different levels of cushion. A family of two retirees collecting Social Security and living off those payments needs a vastly different amount than a family with two working parents and three kids. So here are our general guidelines:

Baseline minimum of 3 months expenses
3 additional months for each additional full-time job, 1.5 months for each additional part-time job
2 months for each additional dependent

As such, the retirees above could likely manage with a 3-month emergency fund, meaning if they spend $4,000 per month, $12,000 per month is a good place to start. On the other hand, the second family, with two working parents and three children should likely aim for closer to 15 months of expenses. In a family spending $6,000 per month, this would be $90,000.

These are just our thoughts on where families should target. If you aren’t at those levels today, that’s not a problem. No one is born with six months of emergency savings on hand. It takes time to build those funds up, and even if you just start with $5 per week, that is an additional $5 saved that you didn’t have saved earlier. You don’t have to build an emergency fund all at once, and it is completely normal if it takes you years to get there, and if you must tap into it because emergencies happen along the way. Start small and set big goals, and chip away at them over time.

What Are You Witholding?

As you file your taxes, you’ll be able to see what your tax refund or required payment looks like to close out 2022. This gives you a great opportunity to assess whether you should be updating your tax withholding for 2023. Here are some key items to consider:

Are you comfortable with the size of your refund or payment from last year? Do you want to tweak your withholding to see a different result when you file next year?
Are you retiring this year? Have you discussed with a tax professional how much to withhold from Social Security, a pension, or from your portfolio income? Have you discussed with a financial advisor how to manage the income from these different sources? If you’d like to chat with a financial advisor regarding your planning, click here to set up a time with a member of our team.
Are you starting required minimum distributions (RMDs) this year? Do you know how much you need to withhold from those distributions?
Do you have tax deductions that are ending or starting in 2023? Have you considered how to adjust your tax withholding if you are no longer seeing similar deductions to prior years?
Did your spouse pass away last year? You may now be filing as a single individual and may need to look at the new tax brackets for single filers.

These are just some of the items for you to consider at this point in time, and as always, any time you are considering making changes to your tax withholding, you should consult with a qualified tax advisor when doing so.

Give Me An Estimate

Estimated taxes are one of the ways that the federal government makes sure it can pay its bills on time throughout the year. If you are an employee of a company, you typically have your taxes withheld from your paychecks on a regular basis. Many people collecting Social Security benefits or pension benefits have taxes taken out at the source as well. However, if you have income from other sources, such as an investment portfolio, a business you operate, or real estate you own, you may file estimated taxes throughout the year in order to be in compliance with the tax code and avoid having to pay penalties for underpayment throughout the year.

If you file estimated taxes, the first estimated tax payment for 2023 is due on April 18, 2023. If you aren’t sure whether or not you file estimated taxes, or are wondering whether you should file estimated taxes this year, please consult with a qualified tax advisor.

Now Give Me Credit

One of the toughest challenges that many families are dealing with today is managing the amount of credit they have outstanding. According to data from the Federal Reserve, Americans’ credit card balances have risen by over $200 billion since May of 2021. The decisions that you make today in dealing with these debts can have major impacts on your future, in particular when it comes to future borrowing. The prime culprit here is your credit score, put together by the major credit bureaus in order to build a picture of your creditworthiness to any lenders you may work with in the future.

Credit scores have five major factors:

Payment History – Do you have any missed payments in your past? How many? Are they recent or from years ago? Your past history of paying back money lent to you tends to be a good predictor of your future behavior. Lots of people may get into trouble at one time or another, so one missed payment isn’t the end of the world, but it is a negative mark, as it does suggest that you may have had trouble paying bills, if even for a month. Longer missed payment issues tend to represent bigger problems, and as such, they will result in larger reductions in your credit score.
Current Balances and Amounts Owed – Maxed out all your credit cards and their credit limits? That’s going to hurt your score. Why? Because it suggests that if you have credit made available to you, you are putting yourself in danger of a gap in your payment history because you are borrowing the maximum amount allowed and not making a strong effort to reduce that amount or pay it off over time. This may happen to most people at one time or another. And one month of high usage won’t hurt you very much. But consistently keeping your balances near the top end of your credit limit will significantly impact your score.
Length of Credit History – Did you just open your first credit card or car loan this year? Well, you may have a great payment history and low balances, but you just don’t have much of a track record. And that matters to lenders. Not as much as your payment history or the balances outstanding, but it still matters. It may take you several years to build a strong enough history to get your credit score up as high as you want it.
New Credit – While you need to open new accounts to start building a credit history, new credit inquiries do negatively affect your credit score in the short-term. Why? Because until there is a proven track record of paying back those new accounts, they represent additional risk to lenders if you don’t pay them back. Your credit score is negatively impacted in the short term to account for the additional risk you’ve taken on recently.
Types of Credit – This is the one that can be a challenge for people starting out. Effectively, lenders want to see that not only can you pay back a credit card bill every month, but also that you can pay back loans that are larger, such as car loans or mortgages. This makes up a relatively small portion of your score, but it does create an incentive to start borrowing for things like cars and homes to boost up your score.

Now that we’ve covered what goes into your credit score, let’s look at how you boost it:

Make your payments on time. There isn’t any further explanation needed. Pay your bills when you need to.
Don’t max out your credit lines. Show that you can responsibly handle credit that is given to you, and that you aren’t simply trying to pile up unpaid bills on a credit card or home equity loan.
Get started in the credit marketplace early. Even if you don’t plan on using it very much, have a credit card opened in your 20s, as it starts to build your track record of using credit responsibly.
Don’t open new accounts within 2 years of a big purchase. If you have a big purchase coming up soon, try not to take on any other new credit within a couple of years of that purchase. It may help to boost you score a few points and potentially get you a lower rate on that loan.
Do not take out a loan just for the sake of buying a car or house. This goes against trying to diversify into different types of credit. Diversity of credit makes up 10-15% of your credit score. It’s not worth reaching to buy a car or home on credit just so you can boost your score. If it happens naturally, that’s great. But you may get into trouble trying to max out your score by taking out different kinds of credit when it’s not right for you. Unlike the previous four areas, where playing along responsibly can help you, be careful on this item.

Schedule Your Review

Tax time is a great time to look at your overall financial plan. Our financial advisors are happy to meet with you to discuss your situation and how we may be able to assist you in crafting a financial plan that is right for your situation. Click here to schedule a time to speak with a member of our team about your planning.

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The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

Armstrong Advisory Group, Inc. does not offer tax or legal advice and no portion of this communication should be interpreted as legal or accounting advice. You are strongly encouraged to seek advice from qualified tax and/or legal experts regarding any tax or legal matters relevant to you.

ARMSTRONG ADVISORY GROUP, INC. – SEC REGISTERED INVESTMENT ADVISER
The information contained herein, including any expression of opinion, has been obtained from or is based upon, sources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy, sell or hold or a solicitation of an offer to buy, hold or sell the securities, if any referred to herein.

All investments involve the risk of potential investment losses. An investor cannot invest directly in an index. Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantees against market loss or greater or more consistent returns. Bonds are subject to interest rate risk and if sold or redeemed prior to maturity, may be subject to additional gain or loss. Armstrong Advisory does not provide any tax or legal advice; please consult with your tax and legal advisers on such matters.