A friend of mine called some time ago and asked my advice for an investment. To me this did not look like an investment, but the conversation steered to the topic of How to upgrade your living situation from his current living situations from a 1 bedroom to a 2 bedroom apartment.

The conversation started like this: What do you think about this investment into a 2 bedroom apartment, priced at 85,000, same neighborhood where I live, last floor (no neighbors), etc. Once I heard this from my friend, my mind started to think about cash flow, return on investment, current interest rates, and probability to find a tenant and so on. But, I stopped and asked: Will you live in it or you want to lease it for a profit? Then things became clear. My friend wants to move into that apartment and lease his 1 bed room apartment.

It was all simpler now, the math was different, and the talking points have just suddenly changed from investment to a home ownership discussion.

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## Do you know what you are buying?

The first point I wanted to check with my friend was regarding what he is buying. What is the average price around that neighborhood, what potential does the residential area have for future development, the stability, the schools, shopping malls, etc. The good part is that I know the area, I went to school for 8 years about 1 km away from where he wants to buy the apartment.

The next big advantage he had is the fact that he lives 3 blocks away from the apartment and could check the building, neighbors, parking area, see if there were past due bills on the administration or the owner. I think there is no better thing that knowing the area and making sure that the seller is an upstanding citizen prior to making a real-estate transaction.

After we discussed downsides and upsides of a last floor apartment, neighbors, location, price versus market and the current economic conditions from my home town, then we started to move the conversation into the financial area.

## How are you funding your purchase?

Before I go into the details, I would like to point out that there are some schools of thought on what is the % of you income that you should allocate to a mortgage. The two main articles I like are slightly different, with Dave Ramsey stating that you should stop at 25% of your income for a 15 year fixed price mortgage and Investopedia where the common rule of thumb is 28% for mortgage and 36% for overall debt.

In most cases, this is the single biggest expense most of us will ever make, it makes sense to spend some proper time on the matter and do proper research.

My friend already had an idea and it looked like this:

- 15% down payment via a personal use credit with 8.75% variable interest over the course of 3 years
- 85% mortgage via a real-estate credit for 20 years with a 5.75% variable interest over the course of 20 years

I did not start to explain to him the above mentioned articles, but I started thinking about his financial situation. The acquisition was calculated for 1 single income, although things might change in 20 years. His old 1 bedroom apartment is paid off, values at 60,000 and can be rented at around 250-300 per month. With an occupancy rate of 65%, this could net him 150-200 EUR extra each month that he can put to repaying his credit.

Due to having to borrow for the down payment, he will slightly above the 36% overall debt ratio, but once that is paid off in 3 years, then he will be comfortable under the 28% or 25% recommended rate.

The advice I gave him followed the next steps.

### Use a credit broker

Yes. Credit brokers are good. At least to me they were a life boat as they helped me secure the loan I wanted for my house, after the bank with which I was originally working with, withdrew their offer as it was not profitable enough for them. I am happy to say that I get all my insurance and credit through the same broker. As a short off topic, there are some areas where I would recommend that you get insured, you can check it out in my article explaining why I buy insurance.

Going back to the credit broker. Because I did not know any credit broker from my home town, I asked my friend to reach out to one of our other friends and seek his recommendation for a credit broker. As most of his transactions are in real-estate, he would definitely have such a contact on hand. I was right, he was able to recommend a broker that was able to obtain a slightly better deal than the ones on the market.

What is important to note if that the lender is paying the brokers commission fee, thus you need to make sure that the broker you are using works in your best interest and not in the interest of receiving a 1-2% higher commission. This will be based on trust once you establish a proper relationship with your credit and insurance broker. Personally I get 10-15% discounts on the insurances I purchase, but I always have to ask: is this the best you can do?

My friend took my advice on this one, and managed to get a better offer for his needs.

### Do some math

I liked math when I was young, and there are some formulas that are relevant when taking up a credit. . Commonly it is known as EMI or Equated Monthly Installment. This is a formula that looks like this:

A = P * {[r * (1+r)

^{n}] / [(1+r)^{n}-1]}A = periodic amortization payment

P = principal amount borrowed

r = periodic interest rate divided by 100 (nominal annual interest rate also divided by 12 for monthly payments)

But I did not write this article to teach you math and formulas. You can easily use thousands of online calculators to see. Some of them also cater for inflation while some do not. If you want to see the above formula also adjusted for inflation you can check this nice mathematical example, but if you want to skip the math, then you can check this online calculator which also caters for inflation.

For the purpose of this article, I have decided to skip the inflation part and I used Dr. Calculator which I have also used in prior articles like Prepayment on the mortgage.

The reason why I say that it makes sense to do the math is simple: this will help you understand which option caters best for you from a duration point of view, but it will also show you what are the differences between 15 years vs 20 years vs 30 years or what it means to refinance.

Let’s start with a simple example: 100,000 property value with 15% down payment, 0% taxes and a 5% interest rate for a 20 year vs 30 year mortgage.

**134,630 versus 164,000**

The main part to highlight is the graph on the left. The red is the interest. I hope you notice that you pay this first and the curve is a lot steeper for 30 years than for a 20 year loan. Even if I apply a 2% inflation to both calculation, the difference between 20 years vs 30 years calculated at present value would be of 110,000 (20 years) versus 123,000 (30 years). Looking slightly better, but still in your disadvantage.

Before moving to the next example, I want to give you a tip: If you pay in advance and reduce the principal owned, it would be more profitable for you to reduce the loan duration rather than the monthly payment. Please keep in mind that this is a calculation that you need to make for yourself in case you decide to pay in advance. Personally I did both, I reduced ~3 years from my 30 year loan, but also reduced the monthly payment by ~20%. If you are not convinced, then check out these 2 graphs:

**10 k reduced length versus payment**

Just look at the savings between the two. We definitely have a clear winner if we look at reducing the overall amount returned.

Time to go back to the point. My friend decided to take a 20 year mortgage with a fixed rate for the first 5 years and a variable one afterwards. In my country, there are no current options for a fixed rate across the duration of the loan. At least, not for us retail customers. This is the math that was best for him after he consulted with the credit broker and did some calculations on his behalf.

The 2^{nd} tip which I would like to offer is the following one: Refinancing a mortgage always restarts the clock. What do I mean by this? Well… if I borrowed for 30 years at 5% rate, and 10 years later, the interest is 4%, then if I refinance my loan, then I will be in a better position. **But**, if I refinance the loan and keep the duration, then I will be paying more in interest versus what I had initially, especially if the interest rate is high. Only in grave circumstances, I would ever consider to refinance a mortgage to increase the duration than what I have left on the initial one. For any refinancing that you plan to do, just do the math and play 2-3 hours with an online calculator so that you have a clear idea about what you are going to do and gain some more knowledge on how this might affect your finances.

### Double check your finances

After you area done with the math, I would just urge you to double check your finances in respect to the calculations done. I would even start to establish an early payment plan at this point, or at least an idea.

It is important to double check as there might be last minute changes, you might find out something when doing the math that you did not take into account in the beginning or you may need to re-balance your monthly budget or skip a holiday or two in order to keep control of your finances.

## Take the decision

My friend already took the decision prior to the writing of this article. The broker helped him with the credit, he did his math and moved forward with a personal loan + a real-estate mortgage to buy the apartment. The only further advice I gave him was to make sure that he prepared an emergency budget and makes sure that it is funded to at least 1000 EUR (inspiration from Dave Ramsey) and that we puts the extra money he has towards the personal loan in order to close it down and get under that 28/25% debt rate as soon as possible.