Tag Archives: finance

Make the move ….

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house on moundGuys, as the economy improves (if it improves) interest rates will surely rise, as they already are in other countries.

If you haven’t already done so, seriously think about buying some fire-sale real-estate and locking in the the interest rate for 30 years; one strategy – especially if the banks won’t let you take out a 30 year fixed rate mortgage on an investment – is to buy your NEXT home now (it need not be any bigger/better than your current), taking the 30 year fixed on that one, and keeping your current as a rental.

I’m not sure if that’s exactly what Lee was thinking when he asked:

Although the market in our area has held up fairly well through this housing crisis, it’s definitely a buyers market.  I don’t think I’d get top value for my home.  So, I’ve seriously been considering renting it out after we move.  If I did rent it, then I could go a couple different routes:

1. Refinance current home to 30 year (to help cash flow) and take enough cash out to put 20% down on our new home.

2. Refinance current home to a 30 year but take no cash out to get the payment down to a very low amount to have a very good positive cash flow.  Then put 20% down out of pocket on the new home.

3. Take out a home equity loan on the current home just to cover the 20% down payment on the new home loan (30 year).

4. Just go ahead and sell our current home so I can take advantage of the tax free capital gains … I could then use part of it to put 20% down on our next home … and use the remaining as a down payment on one or two rental properties.

5. I have to throw in one scenario just because of that little guy I call Mr. Conservative that sits on one of my shoulders, lol!  I could just pay my current home off within the next 2 years or so, then rent it out with a large cash flow, and use that cash flow to pay the mortgage of the new home we buy.

6. Maybe something I’m not even thinking of?

I think I see a case of paralysis by analysis coming on, so we had better head this off at the pass …

… while I can’t give direct personal advice (as I told Lee), I can point out that in cases like this it’s always good to ask yourself a couple of key questions before Mr. Conservative starts to get very vocal (in your subconscious) and you end up taking no action at all, so I suggested that Lee run some numbers:

a) What would be the situation on your current home, if you just took out a new (or refi) FIXED rate 30 yr mortgage, and put tenants in … what would be your new monthly mortgage payment and what monthly rent could you conservatively [it’s good to have Mr Conservative on your shoulders] expect?

b) After pocketing the excess of 75% of rents over mortgage from a) above – or, making up the deficit on the excess of mortgage over 75% of the rent – how much per month do you think you could save from your other sources of income assuming for the moment that you have FREE accommodation for yourself somewhere?

[AJC: the 75% of rents is to allow a buffer for vacancies and other costs of renting … just a very rough approx. for now]

Once you answer these two questions, my feeling is that the best scenario for you will become obvious … I hope 🙂

In Lee’s case, here are his current numbers:

3 bed / 2 bath 1450 sq ft. home in a great location.
Cost Basis: $158,000
Current value: $210,000
$96,000 (9 years 6 months) remaining on a 15 yr mortgage @ 4.625%
Current P&I repayment: $1,042 per month

And, if he refinanced the $96k remaining balance his bank has given him two options for a 30-year fixed loan:

$508/month @ 4.875% Closing costs: $2,000
$493/month @ 4.625% Closing costs: $2,700

For rent, Lee thinks “being ultra conservative” $900/month to $1100/month, which means:

Using 75% of excess over mortgage ($300) and assume living in FREE accommodations, I could easily save $3,000/month because that’s what I save currently even with my $1042 mortgage.  Throw in not paying our current mortgage and having $300 in additional cash flow and $4,000+/month would not be unreasonable.

For now those are the numbers, although I have to say the 75% of excess over mortgage number is probably high considering taxes and insurance on this place are about $200/month.  But as you said, these are rough numbers for now.

So, Lee is getting closer to being able to make a meaningful decision; here are the steps that I suggested:

STEP 1: OK, it seems to me that if you decided to keep your current home as a rental, you would lose money if you stuck to your your current $1k pm mortgage, and produce a positive cashflow of $100 to $200 p.m. if you refinanced.

STEP 2: It seems to me that your $3k pm savings rate will be enough to cover the expected $200k mortgage on your new home. Right? BTW: You WILL fix for 30 years, too (because this will become an ideal 2nd rental, eventually)?

STEP 3: Next, all you need to think about is how to raise the deposit; well, if you don’t have it now, go back to Step 1 and revisit these numbers, assuming that you refi, say, $150k instead of $96k. I’m guessing that you’ll be close to B/E – or, a slight monthly loss – on the rental?

STEP 4: You keep 25% of the rent (plus another $200, say) to cover taxes, ins, and contingencies PLUS you have plenty of excess monthly savings to cover you, until this ‘provisioning fund’ builds up.

Now, what do YOU think Lee should do?! Here’s what he thinks:

I think the smartest thing would be to refi without taking any equity out so that I have a nice cushion of cash flow.  I would then need to come out of pocket with the down payment for the new home which I should be able to do, and even if I need a little help, I could always get a small home equity loan on the rental temporarily.  But I feel pretty confident I could raise enough cash to cover the down payment without having to do that.

My next step…develop my plan of action.

Take Lee’s advice: model these questions to develop a plan of action that works for you … and, take it! 🙂

Speculating on your own home?

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Ryan, who is upside down on his own mortgage asks:

I agree that plenty of investments, if not most, will give you a better APR than your house, but what about leverage?

$500,000 House( $400,000 Bank’s money, $100,000 Your Down Payment) * .05(expected year 1 appreciation = $25,000

$100,000(Your would be down payment) * .15 (from a successful investment or business venture) = $15,000

This is POSSIBLY true IF you gain market appreciation; that’s called speculation.

On the other hand, if you put the same money into a cashflow positive rental, then you make money on the rents and any future appreciation is a bonus; that’s called business.

A case can possibly be made for using your own home as a ‘business’ investment IF you presume to (nominally) charge yourself market rent for the same type of accommodation …

… but, would you pay that same rent rent to somebody else?

The answer must be ‘yes’ for this to work.

If so, then compare how the property then stacks up as an investment if you were the owner and renter i.e. is the pseudo-rent greater than the mortgage?

But, there is still a catch: you also lose most of the great tax benefits of a true investment (e.g. depreciation), even though as home owners in the US you gain some (capped) tax-benefits – particularly in relation to your mortgage interest.

But, there is a solution: buy a house to rent out, and rent the identical one from somebody else!

Rent out the one that you own and rent the other one from the owner: this way, you ‘force’ yourself to treat the one that you own as a real cashflow investment and the other as a place that you live in.

What do you give up?

Probably that sense of ‘ownership’ (but, hey … you do own the identical one, right?) and security of tenure.

But, you must weigh this up against the benefits:

1. True investment ‘status’ … buy, sell, hold, refi as the numbers dictate

2. Gain depreciation benefits for anything that you add (works great if this is a new’ish house!)

3. Full, uncapped tax-deduction on mortgage interest, etc.

4. ???? [you tell me?]

In fact, if you have a friend, why don’t you each buy a house and rent it to the other? Now, that is a strategy worthy of a millionaire … in training! 🙂

The upside down car?

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carpark

Trees Full of Money shows us how to deal with a situation where we’re ‘upside down’ on our car loan:

If you can no longer afford your “upside down” vehicle, here is a a better way to get out of your loan:

Step 1
The most important step in unloading a vehicle with negative equity is to accept the situation for what it is. Saying “if I sell my vehicle now I’ll lose money” is not a plan. The quicker you sell your “upside down” vehicle, the less money you loose due to further depreciation.

Step 2
The second step in selling an “upside down vehicle” is deciding on a fair market value. Lately, the value of used vehicles has been just as volatile as the stock market or the price of oil. The fair market value of your vehicle may be significantly more or less than used vehicle pricing guides such as NADA and Kelly Blue Book suggest.

Step 3

Once you’ve established a competitive price, you need to secure funding for the difference between what you owe and what the vehicle will bring.

Step 4
Once you have met the obligations of your loan, it’s time to do a little marketing and salesmanship. I little effort in the marketing of your vehicle can pay huge dividends.

Step 5
When you have identified a prospective buyer for your vehicle, be sure to ask your bank how to proceed with the transaction. Each state has different laws so be sure to contact your state’s motor vehicle division as well.

[AJC: If you do want to sell your financed vehicle, I recommend that you read the full post here, as I have only extracted TFoM’s highlights]

But, where is Step 6??!!

It should be the one that says: how do I buy a replacement vehicle?

You see, unlike many things that you may choose to own, a car is probably a necessity … now, that doesn’t mean that you need the best car, but you do need a car that can achieve [Insert objective of choice: get to/from work; haul stuff around the farm; schlepp the kids; etc; etc].

So, what do you do?

Well, you first try as hard as you can NOT to get yourself into a financed vehicle in the first place …

… you see, almost anybody who has a financed vehicle is in a negative equity situation:

– As soon as you walk a new car off the lot it has depreciated 10% to 30%, yet you still owe 100% – deposit + payout costs on the loan,

– If your loan is longer than a year or two, the car is probably depreciating at a faster rate than you can pay down the loan.

If you’re not convinced that you are already ‘upside down’ on your loan, ask for a ‘payout figure’ from your finance company – this is the amount that they would expect in a check today to hand over the title to the vehicle to you ‘free and clear’ – and, get ready to choke! Go on, try it …

So, don’t get yourself into this predicament!

But, if that is the only way that you can get into your first set of wheels (is it really, truly the only way? Or, are you just kidding yourself?!), or you are already into a financed vehicle, don’t sweat it.

Just take a look at your current monthly payments and the payout cost … if you can payout the vehicle and buy a cheaper one with cash, go for it. But, the chances are you will need to hang onto your current vehicle, as long as you can afford the payments.

Now, if you can’t afford the payments and you ARE upside down on the loan (as you surely will be), you will need some help to negotiate your way into handing back the vehicle, walking away from the loan and finding a way to start again. Now, that’s a whole can of worms that you just don’t want to open …

… so, next time you’re thinking of upgrading your car with a nice little “low-interest dealer loan” … don’t 😉

No such thing as a free lunch …

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no-free-lunch

This concept has come up three times recently, so it deserves a post of its own!

First Time

My son asked me why he can’t buy a car (when he’s old enough) on finance, and I explained it to him…

… he then asked me the million dollar question:

What about if there is a 0% finance deal on the car? Can I finance it then?

And, my answer was:

There’s no such thing as a free lunch.

Second Time

Ryan was posting about his car and Josh commented:

I would suggest buying used until you have cash to buy a new…BMW, you have no maintenance bill for 4 years, 50,000 miles.

And, my answer was:

There’s no such thing as a free lunch.

Third Time

I wrote a post about a hypothetical real-estate deal, with the key feature of a rental return guarantee. Rick said:

The description sounds like a good deal to me for a low risk- a guaranteed 7.5% return + possibility of great appreciation. It really sounds too good to be true.

And, it is (too good to be true); you see:

There’s no such thing as a free lunch.

… really, there isn’t. Somewhere along the line you are paying.

Let’s take the last case first: guarantees are usually not worth the paper they’re written on. Especially when they are “thrown in” to make a “great deal” sound even better. In the real-estate deal the ‘guarantee’ could actually cost you money, if the developers/promoters have to borrow money against the future value of the project to make a current payment to you.

In most  new projects where, say, a 2 year rental guarantee is offered, the value of the guarantee is built into the price that the property is offered to you at … might explain some of the very dramatic rises and falls in RE values in Florida, for example.

Similarly with the second example of the ‘free servicing’, which is – of course – built into the price of the car. Naturally, if you simply MUST have a brand-new BMW then you will get the ‘free’ servicing with it. On the other hand, if you can buy a used BMW just after the ‘free servicing warranty period’ has expired, you will be buying at the best possible price point, because (in a normal market) you should expect a sudden drop in the value of the car … this sudden drop represents the real, current value of the ‘free servicing’.

If you understand this concept, then so-called 0% down deals should become obvious … YOU are actually paying for all of the interest, at commercial rates, up front!

I did some consulting work for a finance company that underwrote so-called “2 year interest free” loans on furniture sales for large retailers; they made their money because the store paid a fixed amount up front when you signed up to the deal, then the finance company HOPED that you would not be able to make all your payments on time, because the ‘fine print’ on the deal then let them charge you interest at credit card rates (19% p.a. to 29% p.a.) on the entire financed amount for the entire time that you had the “0% loan”.

Here’s the test; always ask:

… and, if I don’t take the [insert: free lunch du jour] how much do I have to pay then??

Then you can decide if the free lunch is something that you can afford!

Should you pay your children to read? I don't think so!

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I left a comment on a great post by Free Money Finance (I’ve mentioned FMF before as being a GREAT source of Making Money 101 ideas!).

Basically, FMF was commenting on an idea that has been around for a while … the idea of paying your children to read!

I have some strong thoughts on the subject of children (I approve of them), money (I approve of it), paying children to read (I don’t approve of it), encouraging children to save for ‘retirement’ (I STRONGLY approve of it) and thought that I should simply repeat my comment here:

Having kids EARN their pocket money is a great idea! As a matter of personal preference, I would prefer NOT to pay my children to learn.

Whether you pay them to work, pay them to read/learn, or just give a hand-out, what IS important is how they deal with that money.

For example: we give each child TWICE their age in pocket money every month (others do once their age a week), but they must SAVE half (not for cars, toys, or anything else … JUST for future investments) and we encourage them to SPEND the other half (saving it up until they have enough for the ‘good stuff’). Loose change is thrown in a bucket by all for CHARITY …

So far, my 13 y.o. son who supplements his ‘income’ with an e-Bay business (the spend half / save half policy also applies to his e-Bay profits AFTER funding inventory) has bought himself an iPod touch, an Apple Mac, AND an IBM laptop – all this year (he has invested his entire savings in my Scottrade account … he accounts for 0.001% of my portfolio from memory).

Do you pay your children? If so, what for? How much? And, what do you hope and expect they will do with it?

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8 Principles of Fun

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I enjoy finding videos for my ‘Videos on Sundays’ series. Sometimes they are about money, sometimes just frivolous (but, I usually try and find at least some tenuous link to the subject at hand), and sometimes about life itself.

I came across this interesting and rather inspiring piece and I thought you would enjoy it, too …

 http://www.eightprinciples.com/

… my plan was to then try and create a list called the 8 Principles of Finance to keep this post ‘on subject’ but really felt that I could leave that to you … any ideas?

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The WHY leads to the WHEREFORE leads to the MONEY …

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… and that’s what makes it all worthwhile!

I’ve been rabbiting on about getting your arms around your Life’s Dream (or Life’s Goal) as a way to understand what your Magic Number is …

… for me, these two concepts made all the difference!

 I just came across this blog post which seems to summarize it nicely …

In it Ian Ybarra says:

I’ve noticed that the more specific goals I have, the wilder the dreams I come up with, the more conscious I am of what I spend my money on. Because committing to doing what I love gives me reason for my money. Every time I’m about to waste money, I can’t help but think “I shouldn’t do this. I could use this money for something I want more.”

I agree with Ian. But, when we talk about Personal Finance, I’ve also noticed that we tend to just talk about money-related goals.

I have a different view – and it’s a view that ultimately made me rich – that money is to support your life, not the other way around!

Buckminster Fuller is generally regarded as one of the twentieth century’s greatest inventors, architects, poets, and visionaries. His theory was that your job/purpose was not to make money. It was to fulfil your life’s purpose … and the money will come (if it’s truly required)!

Precession You

This neat diagram comes from a site that explains some of  Buckminster Fuller’s theories.

I guess, what BF was saying is that our life’s purpose is not necessarily the same as chasing the goal (e.g. to get a promotion or a pay-rise; or to have a $1,000,000 nest egg by age 45; or whatever).

But, the way I look at it is just the opposite …. concentrate all of your efforts on finding then chasing your Life’s True Purpose, and your financial goal – if it is directly related to your life’s purpose – will come!

Precession You 2

So, here is my simple three-step plan for totally turning the traditional way of looking at Personal Finance on it’s head:

1. Find your Life’s Purpose – or at least find what the destination is that you are aiming at and by when (retiring on a beach by 55; quitting the rat race to help the poor in Africa;  reading every book in the library; whatever turns you ON).

2. Work out how much Passive Income you think that you will need to support that lifestyle in today’s dollars … then double that amount for every 25 years (prorate for shorter periods) until the date that you really have planned. If you intend to keep working, just subtract the income that you expect to be able to earn.

3. Multiply by 20: that is the amount that  you will need to have in passive income-producing investments to support your’ Life’s True Purpose Lifestyle by the date that you expect. This becomes your Magic Number.

4. Where will that money come from? it’s probably a larger number (maybe, much larger) than you expected. Right? If so, it will need to come from Making Money 201 strategies … if not, Making Money 101 strategies on their own should achieve your goals.

Please let me know what you think your Magic Number is (and why you need that much/little) …

What is your most valuable asset?

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I just came across an old, but still very relevant post on Free Money Finance called Your Most Valuable Asset.

FMF says:

I’ve written before that your career is your most valuable financial asset. It turns out that Money magazine agrees with me. Cool!

In the May issue, Money says:

Your most valuable asset is your earning power. Invest in it.

I couldn’t agree more. Money continues:

Anything you do to increase your salary early in your career can keep paying dividends as long as you work. Take a class, pick up a certification, improve your computer skills.

Yep, I agree. A small increase in your salary over decades can really add up. Even if you have “only” 10 years or so left in your working career, it’s still worth the investment of time and money to improve yourself in your chosen field. Doing so can have a big impact on your earnings over a decade.

Now, this is great advice … but, it’s missing a little-something …

If you truly subscribe to the ‘max your career and life will be sweet’ way of thinking [I prefer the ‘ start a business or three on the side so that you can eventually ditch your career then life might be VERY sweet’ way of thinking] then I think you at least need a ‘rule’ to tell you how much of that extra income you need to save and how much you should spend.

For example, you’re probably already ‘paying yourself first’ by automatically putting aside 10% of your salary into your 401k and/or another savings vehicle, right?

Well, if you really want to accelerate to your savings goal, then here’s the secret:

 Put aside 50% of any future pay increases towards (a) debt repayment then (b) savings as well!

Now, this sounds like a lot … and, it is (which is why it ACCELERATES your savings), but you were surviving WITHOUT the pay increase, right?

Surely, you can live off 50% of a pay increase? Think of it as a slightly disappointing pay increase, but an increase nonetheless …

If you can think like this, here’s what it can do for you:

Imagine two people each currently earning $30,000 a year who put their savings into a 401k returning 8% a year and who expect a 2.5% salary increase every year; after 20 years:

The Pay-Yourself-First-Just-10% Guy saves: $165,000

The 10% + 50%-Of-Any-Pay-Increase Guy saves:  $275,000

Once you ‘get’ the idea of going into 50/50 partnership with your future self – your current self still gets to spend it’s part of the 50% ‘pay increase’ anyway it likes (!) – you will start to actively look for ways to fuel this exciting new partnership.

Here’s how:

– CREATE MORE INCOME e.g. get a second job; send your partner back to work; start a part-time business; get creative with this!

– FIND MORE MONEY: e.g. your tax refund check; spare change; Aunt May’s inheritance; lottery winnings; any ‘one off’ or unexpected few bucks that happen to come your way; try and keep your hand out of OTHER PEOPLE’s wallets, though 😉 

This is a guaranteed get richer slow’ish formula … and, should underpin ALL of your thinking from now on, otherwise you’ll just spend the profits that come from the more advanced strategies that we’ll cover in upcoming posts …

… and, over-spending will never make you rich!

Why are you in business?

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For those of you who are in business (or aspire to be) let me ask you a straight-forward question:

Why are you (or why do you want to be) in business?

If your answer doesn’t at least include TO SELL OUT FOR $x [insert your favorite number greater than $1 million here] then you need to readjust your thinking.

You see, as Michael Gerber said in his famous (and required reading!) book The E-Myth Revisited your business should support your life … in other words, at some stage you probably want to get out of your business so that you can have your real life back (or, for the first time!).

The best way to get that life is to sell out (eventually) and retire (one day) … when and how are all subjects for future posts.

Or, you may decide to keep the business (perhaps running on autopilot, generating mountains of cash) but at least being CERTAIN that it COULD be sold anytime that you wanted for the amount that you needed to live the life of your dreams …

For now, it’s just sufficient to recognize that you should ALWAYS be thinking about your business in terms of “how much do I NEED to sell it for … and when”.

As I mentioned in a recent post, this will always be MORE than you think … and, sooner!

So, you had better get back to work!

Will low interest rates and inflation eat up the interest the bank pays you on your CD's?

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Absolutely!

Here’s how to think about banks and cash … consider your time-frame first:

SHORT TERM

If you are keeping your money in the bank to save for something important (hopefully, for a deposit on an income-producing property?) over the next few months or two or three years, then don’t be overly-concerned about the interest rate or inflation. I keep a HUGE amount in the bank right now because I sold out of some investments and am staying ‘in cash’ for a short time through the current market.

MEDIUM TERM

If you have a large’ish sum that you are building up for something major in say 3 to 5 years, then a better ‘savings account’ would be a low cost Index Fund … as you save enough to meet the minimum investment criteria, drop it in … just be prepared to hold for at least the MEDIUM TERM

LONG TERM

If you are, say, 7 to 70 years before retirement, you in the investment mode of your life, and (a) are unlikely to have your cash in the bank, and (b) are crazy if you do! Over 7 or more years, yes, ridiculously low investment returns (and, to a lesser extent inflation) will eat your future alive! Put your money into any mix of Index Funds, Business Opportunities, Real-Estate Investments, Direct Stock Investments – keep away from Mutual Funds – as suits your personality profile and desire to get rich vs merely keep up with the Middle Class Joneses.

SUPER LONG-TERM (a.ka. Retirement)

Here is where that low interest / inflation combo (even if inflation is just 2% or 3%) will eat you alive … be prepared to be retired for a long time, say 30 – 50 years (even if you die young, at least your spouse and kids will be happy with their nest egg!) … you do NOT want your money running out before you do.

If you have a lump-sum, there’s only a few choices:

– Put it all into an Index Fund and only draw down 2.5% – 3.5% each year to live on.
– Put it all into income-producing real-estate and spend no more than 75% of the rent (after paying down mortgages and building up a suitable buffer to guard against ‘problems’)
– Put it all into TIPS (inflation-protected Treasury Bonds) and happily live off all the interest that they pay you every 6 months
– Implement a Bond laddering strategy, such as the Grangaard Strategy, which claim to be able to let you live off 6.6% of your lump sum at retirement every year
– Any combination of the above that suits your needs and ‘investment personality’

Each of these strategies is relatively “inflation-proof”, in that you get to increase the amount that you take out every year as a ‘wage’ to live off, and pays more interest typically than the bank will give you (expect maybe, the bonds … you pay a ‘price’ for the inflation-hedge).

Hope this helps?