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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.

 

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)!

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.

Drawing The Line Between Frugal and Cheap

Two of my guilty pleasures are wash and fold Laundry and Toll Roads. While both of these are seen by many as unnecessary splurges, I happen to love both.  I have a sticker on my car window that lets me zoom through the toll gates without stopping, and I always find I get a little smile on my face as I zoom past all the people who are waiting in line to pay a toll. Even better, the toll provides me with an added benefit: fewer people on the road and a more direct route to get where I want to go. Wash and fold Laundry Provides me with a similar benefit: I don’t have to spend my weekend washing clothes, and making sure I get them out of the dryer in time to ensure they aren’t wrinkled.

Right about now, you’re likely thinking, “But FinanceTiger, both of these things cost money.  Why would you waste money on this if you’re trying to save for retirement?”

The answer is that both of these save me enough time that they are valuable. This is the key differentiation between being frugal and being cheap.  Cheap is the guy who washes his paper plates and hangs them to dry in his kitchen. Frugal is going to some place like Ikea and buying a set of stoneware for around $20, solving the problem of dinnerware for the foreseeable future, and for a much lower total cost.  When you’re frugal, you take into account the full cost of your decisions, when you’re cheap, you look only at saving a little money, often at the cost of your time or, as in the example above, other people’s desire to be around you.

The hardest thing for many people to understand is that you pay for things in life with two things: money and time.  There will always be more ways to get more money, but once you spend your time, it’s gone. The best reason to free up time is for new projects. In the 4-5 hours it takes to wash and fold laundry at home, I could write new posts here, work on a freelance project for a couple hours to recoup the cost of wash and fold, and hit the gym.

Toll roads are a similar situation. You’ll save gas by taking a more direct route and dealing with less traffic, while also reducing the wear and tear on your car and getting to your destination faster.  If you have a cruise card or similar, it makes the trip even better, since you won’t even have to stop to pay a toll. There are two easy ways to determine how much you save taking a toll route instead of the alternate routes. For the first one, subtract the difference in mileage between the two routes, divide by 2 and subtract the tolls – this will give you the savings in vehicle costs. For the second, look at your hourly pay rate, double it, and multiply it by the time you saved, in hours.  If these are positive, then you’re coming out ahead using a toll road.

What are the time savers that you’re willing to pay for? Let us know in the comments.

Does My Credit Card Utilization Matter?

For people new to credit, and even many that have been dealing with their finances for a while, the question of what credit card utilization rate is best comes up quite frequently.  Some people are surprised to see that their zero balances can lower their score in some instances. The reason for this is that credit scoring is a very opaque process that, for the sake of their business, credit bureaus keep tightly guarded.  Credit Utilization makes up a portion of people’s credit scores, and while it is the component of the score that a person has the most control over each month, it really only matters when you are looking to acquire a new line of credit.

The problem with credit card utilization as a factor in a person’s credit score is that it only shows the balance on a single day of the month. As a result,  this means that the only time the balance on your credit cards should be of any concern  is on the closing day of your billing cycle, which is generally 3-10 days after your monthly payment due date.  If somebody wanted to chase this golden apple, they would simply just pay their balance in full on the due date and wait for their statement to close, resulting in a zero balance being reported each month.

While this is responsible behavior, it isn’t optimal behavior, which is what a tiger will strive for. Rather than micromanaging your credit score, you should be concerned with keeping a second number as low as possible: the amount of interest you pay. As a result the optimal action in this situation is to pay the balance of purchases that are about to leave the grace period, maintaining a balance of the value of your purchases that are less than the grace period (typically 25-30 days), so that you ensure that you won’t pay any interest. As a side effect, this will also ensure that you keep your cash as long as possible, meaning you can optimize the amount of money you earn in your high yield checking account.

 

Key Takeaways:

  • Your credit report will only provide the balance of your accounts on their last closing date.
  • If you aren’t opening a new line of credit in the next 60 days, you don’t need to micromanage your credit accounts.
  • Zero Balances aren’t guaranteed to raise your credit score.
  • Utilization under 30%, on each card and in total correlate with higher credit scores.
  • Focus on paying less interest rather than raising your credit score, as this will be the most beneficial for you in the long run.

Understanding Cash Flow, or How to Make (a Little) More Money From What You Already Have.

Pop Quiz, Hot Shot.

You have the following credit cards/checking accounts with the following attributes:

Card 1: 24.99% APR, 30-day grace period, $500 limit, No balance, 1.5% Cash back on purchases, accepts balance transfers; no cash back on balance transfers

Card 2: 19.99% APR, 30-day grace period, $900 limit, Current balance of $300 (accruing interest), does not accept balance transfers

Card 3:  10.5% APR, 15-day grace period, $1500 limit, current balance of $900(accruing interest), accepts balance transfers, balance transfer rate is 13.5%, with grace period

Checking account:  2.53% APY, Calculated on the average daily balance of the account

How do you optimize your monthly cash flow over several months with an income of X dollars per month, paid in 2 equal installments of X/2 over the course of each month, when you have monthly expenses of  .75(X)?

You might be thinking, “Whoa, now. The SAT’s were a few years ago, this is awfully complex. Why would I need all this math?”
The answer of course is to maximize the resources you have. A 1.5% discount on your spending might not seem like much, but it’ll make for a nice start when you’re looking to save up.

Basically, this question is about being able to understand and allocate resources in an efficient manner. So, how do you solve this problem?

  1. Balances from Card 2 should be transferred to Card 3, and paid off on the last day of the grace period.
  2. Monthly expenses should be put on the Card 1 to earn cash back,  and then transferred to Card 3 at the end of the grace period (to avoid interest and allow for an extra 15 days grace period),
  3. The existing balances should be paid off at a rate of .25(X) per month, to minimize interest.
  4. (Optional) Call Card 1’s issuer and ask for a limit increase,
  5. After balances are paid off, you should be earning  1.0253(1/12) * (1.5 X + .26125(X*N-1) + (previous months’ interest))  each month, since you now are able to keep  your cash for ~45 days (1.5 months), and thanks to the cash back, you are spending 73.875% of your income on expenses instead of  75%. N represents the number of months since all cards were paid off. Card 2 would be kept open and paid off, both for emergencies, and to lower your utilization.

Right about now, most people are thinking, “What the What? I don’t even…”
Here’s a breakdown of what we did, step-by-step:

  1. Moved the high interest debt to a lower cost opportunity, including 15 days interest-free.
  2. Change the spending habit to put the monthly expenses on a card that gets cash back. This has the net effect of either lowering the amount you pay for things, meaning instead of spending $75 of every hundred dollars, you’re spending $73.875.
  3. Now, we’re aggressively attacking debt, meaning debt will get paid off in the shortest time frame possible with our available resources.
  4. With a low-limit card, a bit more breathing room will make sure you can afford to put as many of your expenses as possible on the card and earn cash back.
  5. This step is a projected balance for few months down the road, but here’s what’s going on:
    1. Your monthly account interest is 1/12 of 2.53% Annual Percentage Yield, so to get that, we use the compound interest formula of 1 + interest rate ^(period).
    2. We multiply our monthly account interest by the balance in the account, which is the sum of
      1.                                                                i.      1.5X – Three Bi-weekly paychecks (45 days)
      2.                                                              ii.      .26125(X*N-1) – Your Monthly Savings Rate (100-73.875=26.125) times the total number of months (N)  since you paid off your credit card debt, minus 1 (which is included in the three bi-weekly paychecks.
      3.                                                             iii.      The sum of the interest paid to you for the last N-1 months.

All of this is a very powerful system. Now, instead of paying around $30 in interest each month, you’re getting $15 from the credit card company, usually applied to the balance of your purchases. Depending on the card, your own spending habits, and the offers available you could end up with double or even triple that amount. The key to all of this is ensuring you keep your credit cards paid off each billing cycle. By doing this, you’re holding on to your money as long as possible, being paid by companies for the privilege to loan you money interest-free, and earning interest.

Until next time, eat a little more debt.

Getting Started

Personal finance is quite a jungle. Everywhere we look, there are pitfalls, unexpected emergencies,  interesting opportunities, and predators that, if given the chance, will eat you (and your money) alive.  The important thing to remember about personal finance is that it’s exactly that — personal.  Two people aren’t going to get along with the same advice, and the situations that people find themselves in aren’t always ideal.  Personally, I’ve seen the worst of things happen. Losing a job, defaulting on credit cards and student loans,  resorting to payday loans and getting caught in their trap are all things I both grew up with and saw myself on the path to before I worked my way out of the mess.  At one point, I was in a situation with a car loan for 23% because it was the only thing I could get credit on.  All of this led to quite a sobering epiphany for me: the more you try to hide from your money problems instead of confronting them, the worse they will get.

This blog is brand new, but the ability to talk about finances in a rational manner is what will make everybody involved better off. The fact is, sometimes NOT borrowing money is worse for a person than borrowing too much.  With a background in economics, I want to help people understand where they are going wrong, and move them in the right direction. Some of the information here can be labeled as controversial, but I’ll do my best to provide a heads up when I talk about something that goes off the beaten path from what most personal finance “experts” spoon feed to their audiences. For reference, I’ve put together a quick list of my own “ten commandments” for personal finance, which should  provide some insight.

  1. Be Honest with yourself and your loved ones about finances.  – Lying will only make things bad in the short run at best, and horrible in the long run at worst.
  2. Learn to understand cash flow, and how it impacts your life. –  People don’t get in financial trouble from debt, they get in financial trouble by using debt to augment their cash flow.
  3.  There are two fundamental components to getting out of debt faster: spending less and earning more. – If you are serious about getting out of any debt you have, these are your options.
  4. If you have any question about being able to afford something, you can’t afford it. – Sure, a 70″ LED TV would look great in your living room, but the $1400 it would cost at 26.99% interest that that store card will charge you is not worth it.  Would you rather work 200 hours or 253 hours for something?
  5. If you don’t have a plan, you’re falling behind. – The old saying, “Failing to plan is planning to fail” is  very true with your finances. If you want to get the most out of them, you need to have a plan. Whether you want to systematically eliminate your debts, buy a house, or retire, you’ll need a plan to get there. Living paycheck to paycheck and hoping for things to “just work out” is a recipe for disaster.
  6. Good or bad, own your financial decisions. – Whether you went and bought a boat, or you decided not to take that trip to Mexico with all of your friends, the decisions we make can go beyond our bank accounts, so the important thing to know is that you never want to deprive yourself of experiences, or be unable to make ends meet because of your decision to either save or borrow too much. As with all things, moderation is the key.
  7.  Never be afraid to ask. – When I was young and dumb, I was always afraid to talk to my creditors, so I didn’t.  As a result, I likely missed out on the chance to fix a lot of things, and pay lower interest rate. Just about everything in life is negotiable. Ask for lower interest rates for everything you have to finance.
  8. Don’t become a slave to your credit score. – A single number will not define your value as a human being.  Check your credit report every 3-6 months to make sure it’s up to date, and pay down your balances to under 10% of your utilization (with the optional step of closing your newest credit line) 2 months prior to a major purchase (Home, Car, Boat, etc.)
  9. Pay your bills on time, not early, not late. – If you have an interest checking account, paying early will lower your average daily balance for the monthly interest, and paying late will result in a late fee.  Getting in the habit of paying on the due date will make your life much easier and have a (marginal) financial benefit for you.
  10. If you can’t keep your finances straight, use multiple bank accounts or the envelope method.  – This will help you avoid overdrafts, especially if you have multiple accounts, but only one of them linked to a debit card. Personally, I use a cash back rewards card that gets my spending money transferred to it bi-weekly to pay off the balance.

If you follow these, your financial situation should improve at every turn.  The harshest truth is that the odds are highly unlikely that you will win the lottery and become an instant multi-millionaire.  As a result, it’s going to be better to do the little things right so that you can live the best life possible.

That’s all for now. Until next time, go snack on some debt!