It’s been a while…

Sometimes, life just gets in the way of being able to blog.  For the time away, it’s been the result of building a new house, and going through the process of financing and underwriting a mortgage, along with the home improvement projects that come with the new digs. That said,  understanding the mortgage process,  and most importantly, repayment is the biggest financial decision of people’s lives. What most people don’t realize is, that with a bit of planning and diligence, you can make your way out of a mortgage much quicker than most people can even fathom.

Before we get too far down the rabbit hole, let’s understand that there are a few goals that everybody should have when they get a mortgage. The first is to get out of private mortgage insurance (PMI), which can raise your monthly payments by nearly $300-$400 a month, depending on the home and the mortgage that you have.  The second goal should be to make sure you have a homestead exemption and assessment freeze on your property, as doing so will save you from increased property taxes, and could even result in reduced escrow payments. The third and final goal should be to pay down the principal of the mortgage by as much as you can each month.

While the first two goals are easily accomplished with a new appraisal and some paperwork, the third goal is something we like to call a habitual lifestyle change.  Owning a home means you don’t have to worry about your rent ever going up, and your monthly expenses drop to just your property taxes and HOA dues, if applicable, once the mortgage is paid off. Knowing this, going in to the process, you have to prepare to make a pretty substantial monthly payment, and thinking about adding to it can be difficult at times.  A better way to think about it is this: for the first year, every dollar you pay on your mortgage will yield  almost four in returns as a result of fewer mortgage payments, less interest, and less mortgage insurance.

One way to look at the mortgage is basing projections off a higher estimate. As an example, if you got a rate of 4.5%, you could project your payments for a 4.75% or 5% mortgage, and use those as your baseline, or prepare for the 4.5% at lock-in time, and, if you are fortunate, see your loan drop to 4.25% before closing. The end result would see you paying a bit more each month, but allow you to ave a significant amount of money in the long term.

 

Your Financial Calendar.

financetiger_calendar

The good folks at Learnvest put together a good, comprehensive calendar to help you keep your financial house in order. This is a great calendar that is a very worthwhile addition to your personal finance arsenal, with the understanding that not all items apply to every single person.

Let’s take a look at their recommendations for the next two months:

May:

1)      Check your Credit score with CreditKarma.

2)      Check one of your credit reports via annualcreditreport.com

3)      Search for Scholarship opportunities for the upcoming school year,

June:

1)      Re-Evaluate your budget and make changes as necessary.

2)      Pay Taxes if you are self-employed, own a business, or do freelance work.

3)      Look into reimbursements from your company’s wellness plan for things like your Gym Membership. Schedule an annual checkup to keep tabs on your health.

While all of these are good pieces of advice, there should be a couple other items on the list as well. While scholarships may not apply to everybody, a great bit of advice for this month is to make a call to your credit card company and ask for a reduced interest rate. With your credit report in hand, as well as your credit score, you’re in a very well informed position to know if there are other options available. Calling your credit card company to ask for a better rate, or even a promotional interest rate is a great way to attack debt, and move yourself into a better financial position.

Additionally, If you haven’t already, go ahead and sign up for both CreditKarma and CreditSesame. Both of these sites will let you see one of your credit scores (Transrisk from CreditKarma, and Experian’s from CreditSesame) for free, and you can update your score monthly from both services. Like we’ve said, don’t become a slave to your credit score, but knowing what it is definitely doesn’t hurt you.

Understanding Your Paycheck

Quite often we find ourselves focused on what to do with the money we have, and we often don’t take the time to look and see what we have taken out before we even see the money.  Eventually when tax time rolls around, we see it as a time of feast or famine where we might get a little bit of extra money to splurge with. While that definitely isn’t the responsible behavior we like to encourage, there is a time and a place for that discussion. More important to the discussion is understanding how your paycheck works, and how to make sure you set up your deductions so that you only pay the correct amount of taxes, no more and no less.

First, take your paycheck and subtract your pretax deductions (Health Insurance, Retirement Plan, FSA, etc.) then, follow these steps:

1)      Multiply your income by the Social Security tax rate. As of 2013, the rate is 6.2 percent. For example, if you earned $3,900 per month, you would pay $241.80 in Social Security taxes.

2)      Multiply your income by the Medicare tax rate, which is 1.45 percent as of 2012. Continuing the example, if you had a monthly paycheck of $3,900, $56.55 would be withheld from your paycheck for Medicare taxes.

3)      Multiply the number of personal allowances you claimed on your W-4 form. Each allowance decreases the amount of your paycheck that is subject to income tax withholding. As of 2012, the annual value of each personal allowance is $3,800. For example, if you claimed three allowances, the total value would be $11,400.

4)      Divide the value of your personal allowances by the number of pay periods per year. In this example, since you are paid monthly, there would be 12 pay periods per year; you would divide $11,400 by 12 to get $950.

5)      Subtract the value of your allowances from step 4 from your paycheck to find the amount of income subject to tax withholding. Continuing the example, you would subtract $950 from $3,900 to get $2,950.

6)      Use the federal tax withholding tables to find out how much money is withheld from your paycheck for federal income taxes based on your filing status. For example, if you were single and had a monthly income subject to withholding of $2,950, you would have $379.40 withheld for federal income taxes.

7)      Repeat with your state and local income tax withholding tables if you live in states or localities that charge an income tax. These tables are available from your state or local department of revenue.

If you want to speed up the process, there are also paycheck calculators online. Paycheckcity provides a calculator that is generally accurate up to about $10 per paycheck, which is accurate enough for estimation, but you should always be aware that they are normally subject to your company’s HR department’s own calculations and can vary slightly based on the software they use.

Until Next time, go snack on some debt!

Sunday Morning Game Plan: Debt Payoff

financetiger_gameplan

 

Last week, we discussed building our debt trackers. By now, you should have a track of debt, and be able to review your financial situation for the week.  With that in mind, we’re going to look at two methods for paying off debt, Snowball  and Avalanche, and their similarities and differences.  These two methods provide a foundation for debt elimination that many people use to make progress on the path to being financially independent.

First, we have the snowball method. This approach involves taking your debts, and ordering them from smallest to largest in terms of their dollar values, and paying them off in that order, rolling the payments from the completed debts into the next. The idea behind this method is that the psychological aspects of eliminating smaller debts provides people with enough gratification early on in the process that they will stick with it long enough to pay off their debts.

Alternatively, the other approach is the avalanche method, which orders debts by their interest rates. Like the snowball method, rolling the payments from completed debts into the next debt until all debts are paid off.  While this method is less likely to result in paying off some debts quicker, the advantage is that it reduces the amount of interest paid, and the amount you pay overall.

An example of this would be saying you had $1500 per month set aside for paying off three debts: Two Loans (with interest rates) of $10,000 (5%) and $10500 (7%) and a $78,000 (3.65%) mortgage. The snowball method would tell you to concentrate your additional money each month on the $10,000 loan, while the avalanche method would tell you to pay off the $10,500 loan first. The difference between the two methods would be about $129.00 saved in interest. If you’d like to try this out with more simulations, unbury.me has a calculator available where you can plug in all of your debts and see how it works for your personalized situation.

 

Managing Your Finances: Accounts With A Purpose

 

When it comes to personal finance, most people only have one or two bank accounts: either just a checking account, or a checking and a savings account.  For some people, this is fine, but more often than not, it makes it very easy to get into financial trouble, either due to a forgotten transaction, or an account not being updated at the right time.

Rather than dealing with the headaches of having to account for everything, and hoping that nothing was forgotten that could cause an overdraft with your car payment, rent, or any other bills, it probably is a good idea to look for a local credit union or two and open an account. In addition to easier budgeting with dedicated accounts for each bill, there is an added bonus that these accounts offer: access to lower loan rates, and higher interest rates on your deposits.  Taking advantage of both of these can make a huge difference in your monthly balance sheet, especially when you want to get out of debt faster.

This method of account management can be called things the silo method, or the envelope account method.  The fact is it’s just more of an advanced version of the envelope method, where you keep your money in cash, and use envelopes to budget your monthly expenses.  This method provides an additional layer of reporting for you, allowing you to see exactly how you spend your money by utilizing online banking tools, while also keeping things in a setup where you can begin scheduling automatic payments on your bills and build an emergency fund on auto pilot.

The most difficult step for most people here is going to work and requesting the new direct deposit sheets from HR. Normally, it only takes a few minutes to fill out the forms, and many companies even have an online option now, making it easier than before.

With setup complete, let’s take a look at a case study:

Dexter receives $1000 bi-weekly in take home pay from his job at the Miami Police department. He has two condos, each with a monthly mortgage payment of $300, a $30 electric bill, a $40 gas bill, two credit cards with a monthly average spending of $100 on each, $150 in student loans, and $175 in his car payment. Here’s his plan:

Check 1 Check 2

Mortgage

$300 $300

Gas/Electric

$40 $40
Credit Cards

$110

$110

Student Loan/Car $175

$175

Remaining $375

$375

 

 

 

 

Now that he has a plan, he sets up his direct deposit to go to each of the accounts, with the higher bill as the amount deposited each paycheck.  This leaves him with a buffer for when the bills like gas or electric are a bit higher, while also giving him the opportunity to build up his emergency fund and pay down his installment debts.

People Will Hear What They Want To Hear

A co-worker of mine, Dan, just started looking into personal finance, and he took the Dave Ramsey program this past weekend. Today, he presented me with this gem, “FinanceTiger, you should just stop paying on your credit cards and go cash-only like I am.”

Interested, I asked him his line of thought.

“Whatever debt I have, I’m stopping all payments on it, and I’m going to let my lawyers handle it.”

“You have lawyers?”

“Yeah, the guys over at [debt settlement company name redacted] told me to do it. Since Dave Ramsey said I should get rid of my debts as quickly as possible, this is going to be great. I don’t get why people say getting out of debt is so hard. Since I got this program, I’ll have knocked out almost $25,000 in debt in two months. I should go buy a house next month.”

Rarely am I speechless.  If I were in the upper Midwest, I think the phrase to say would have been along the lines of “Oh, Dan, I don’t think that’s a good idea” which is roughly translated from Midwestern to American English as “Dan, you are an effing idiot.”

So, what’s going on? Is Dan going to get this sweet deal, and get out of all this credit card debt? Nope. Dan is a sucker.  Dan has likely been victimized by one of what seems to be a million “debt settlement” companies.  These companies will find suckers (like Dan) with over $10,000 in unsecured credit card debt and get them to stop paying the credit card companies, and pay them instead.  After a few months of collecting Dan’s money (6-8, usually), they’ll get in touch with his credit card companies and settle for as little as possible, while keeping the rest of Dan’s money for themselves. Dan will then get a 1099-C from the IRS for the difference between the settlement amount and the  actual amount he owed. Most banks won’t even deal with the settlement companies, and opt to instead get a civil judgment against the borrower that can then be enforced as a lien on real property.

The good news is that Dan knows this now. The bad news is that his plans for the next 8-12 months are shot.

Until next time, snack on some more debt (and don’t be like Dan)!

Savings vs Debt Paydown

JC Writes:

My girlfriend is currently sitting on about $5,000 in savings while she has about $5,000 in credit card debt. With an interest rate on the card around 20%, it really bothers me that she hasn’t paid it off, while providing the reason that she’s scared something might happen, and she’ll have nothing in savings.  How can I explain this to her? There has to be an emotional part of this, but I want to show her that she can be debt free and get on with life.

This is a bit of a doozy. We’ll be the first ones to admit that providing unsolicited advice to somebody else face to face on what to do with their finances, no matter the good intentions can often result in hurt feelings. While you can take solace in the fact that you are right that she should be kicking every cent she has at that toxic debt, it’s also important to remember that she also has a fear in the back of her mind that a financial crisis of some sort could hit, and she doesn’t want to be left holding the bag.

One thing your girlfriend should understand is that by carrying this debt while she has the money to pay it off in savings, she is losing $875 per year, assuming she is getting 0.5% interest in her savings accounts.  Keeping this up for 5 years would nearly destroy her savings, and leave her with nothing to show for all of the effort.

This is the kind of situation where the emergency fund comes into play. With the smaller emergency fund of about $1,000, your girlfriend can use $4000 and pay off 80% of the debt, letting her keep some peace of mind, while also managing to save her about $720 in interest in the next year.  After this, the next step would be to tackle the remaining $1000 of credit card debt as aggressively as possible. If she puts $200 a paycheck towards it, she’ll be free from it in 5 paychecks, and she can work on re-building her emergency fund back up to $5000.  This would likely be the best of both worlds, because it would provide a second benefit to her of ensuring that she has the money available from the budget to not only take care of her expenses, but also to save money for the future,  After her 5 paychecks, she probably wouldn’t even miss the money from her paycheck, and she could go on  to applying to to her retirement savings.

 

Until next time, go snack on some debt!

 

 

How Debt Holds You Back

Nearly everybody has debt of some sort, whether it’s student loans, credit cards, car payments, or a mortgage, it’s debt and it needs to be dealt with in one way or another. While debt can be a useful tool in the short term, it can be quite crippling to your long term prospects for retiring.  While different debts can be classified by how they are used, the better way is to classify them based on their interest rates, and classify the interest rates into several categories:

  • Toxic Debt – Any debt over 10% should be in this category.  This generally will include some car loans, private student loans, and credit cards.
  • Borderline Debt – Debt between 5 and 10%. You can expect to see federal student loans,  car loans, a few credit cards, some mortgages and personal loans here.
  • Constructive Debt – debt under 5% will fall in this category. Primarily you’ll see mortgages and car loans here.
  • Zero-interest debt – Self Explanatory. These usually are only temporary rates, however.

So, what do we make of each of these categories? Given the list, it’s pretty easy to take a top-down approach and just pay things according to the category they fall in.  The trick to these is to manage the zero-interest accounts by making the minimum payments, and budgeting for them to be paid off with a lump sum a couple weeks before their interest period ends (to account for any potential problems in processing).

By taking a look at all the statements and interest rates, you can usually also find a second important item: interest paid. Take a good look at the amount of interest you’ve paid each year, and add it all up.  This is the amount of money that can potentially be saved for retirement, once the debt is eliminated. For a more aggressive approach, add up all the monthly payments made in a year, and this can be used as a potential retirement savings. With these two numbers, you can compare them to your take-home pay, and see how quickly you could retire and maintain your current lifestyle by getting out of debt.

Savings Percent

Years to retire after debt elimination

5

66

10

51

20

37

40

22

50

17

75

7

 

This table provides a very interesting look at the way debt is preventing you from retiring.  By taking a more aggressive approach, and modifying your lifestyle to spend less, you could get out of debt, and then retire seven years later. Even better, that would put you in the driver’s seat with the rest of your life. It would no longer be about working a job you hate, as you’d be free to leave any time. You could decide to start your own business doing what you love, without worrying about whether or not you could pay the bills on your current salary.  You would be free, and that’s something very few people have the ability to say.

Until next time, feast on some debt!

Personal Finance 101 – Banks vs. Credit Unions

When the time comes to open a savings or checking account, most people don’t realize the impact of their decision, or the number of options they have in the process.  While most people will go to the bank that their parents patronized to open their accounts, there are many better options out there,  and often there is quite a bit to be gained from joining a credit union  over patronizing the bank.

Go back and read that last line again. Notice the difference in wording?  This is a very important difference, because when you are part of a credit union, you own part of the nonprofit entity, whereas with a bank, you are paying them to provide you with a service. Don’t believe me? Call up your local Wells Fargo, Chase, or Bank of America branch and ask them what the interest rate on their free checking accounts are.  The answer is easy: It’s 0.00%. When they offer interest, it’s normally with an average daily balance of $5,000 or more. Contrast this with a credit union, and it’s easy to find free interest checking accounts with a rate of 0.5%  up to 4% .

On the flip side, look at loan rates. You’ll often find better interest rates at your credit union than you would at a bank, including single-digit interest rates on your credit cards, as well as car loan rates  under half of what you could find at a dealership (depending on credit).  By combining these two, you’ll save more in the long run, earning interest on your deposits, and pay lower rates on the money you borrow.

Bank

Credit Union

Ownership

Stockholders

Members of the community

Interest on Checking

0.00% (some rare exceptions)

0.1%-4.0% (Varies by area)

Credit Cards

Retail Rates, Up to 29.99%

Average between 8-17%
Auto Loans

As low as 3.59%

As low as 2.79%

 

As you can see above, credit unions win out on the major categories for financial services.  One place where banks can have an edge, however is nationwide availability. It’s quite easy to find Wells Fargo branded ATMs on the east and west coast, and while you can use the ATM, you usually will be charged a fee by its operator. As a result, many credit unions will offer ATM fee refunds when you meet the qualifications for their interest checking (normally 10-15 debit card transactions, electronic statements, and direct deposit each month), making them a bit more appealing at the end of the month.

Overall, moving your finances to a credit union is one that makes sense for your wallet. You can even find some that have less-frequently seen features like free coin counting, and even student loans at better interest rates than you might see elsewhere.

Until next time, go find an interest rate you can sink your teeth into!

People and Money

So many times, financial decisions are made out of emotion, rather than out of our best interests. When you’re in a relationship, you can find yourself in a situation where one person views the other as too frugal, and one views the other as too wasteful.  There are some things you can do for peace of mind in this situation, with the best being separate bank accounts. At first, this idea hits many people as a trust issue, and they get emotionally hurt by the idea that not sharing bank accounts means not trusting each other.  This is quite the opposite of reality. Separate bank accounts actually say, “I trust you enough to have your finances in order that I don’t need to watch over them.”

Often times, a solid compromise is to sit down and build a budget. Take the total of the monthly expenses, divide them in half, and have each person put their share in a joint account for bills each month. This allows you to each have your own accounts, as well as a joint account.

Aside from bank accounts, emotions come into play with many financial decisions, especially when it comes to major purchase, like homes and car. Family adds an additional wrinkle when the subject of co-signing a loan comes up.  The short answer to the co-signing question is always “no,” with the reason being that it has no upside, and could result in being stuck with a major debt.  In the long run, saying no to co-signing on a loan will result in fewer hurt feelings than a defaulted loan with somebody stuck holding the bag.

The approach to loaning money to a friend or family member should always be that the money being given is a gift. To think otherwise will usually end badly.

In all of these situations, there is a very common thread: making good financial decisions for yourself hurts other people’s feelings. Often times, the next phase that comes out of many people’s mouths is “You’re being selfish.” This is something nobody likes to hear, and it works to chip away at your resolve. The best thing to say is you’re sorry that they feel that way, and you both should move on to another subject. No good will come from making the conversation go on longer.