Financial Samurai » Debt

Should I Refinance Now? Does A Bear Poop In The Woods?

admin — Mon, 19 Jul 2010 09:00:40 +0000

Written by: admin on July 19, 2010.

You guys know that the one and only data point I track religiously is the 10-year yield right? Well, after the 10 year yield dipped below 3%, I went to the bank with a buddy of mine to go see how much money we could borrow. The wiry banker sat us down like a loving couple and asked us to go through our finances at which point I kindly stepped out of the room and let him go first. Five minutes later, he came out with a grin on his face, so I curiously went in.

I proceeded to disclose some of my finances, and he proceeded to tell me some curious news. “Look here Sam, you can borrow up to $1.5 million dollars at a 5 year fixed rate at 3.75%!”

Holy moly really? You mean little old me, just like that can borrow that much money at that low of a rate? “So what’s the catch?”, I ask.

“Zero points, and $2,500 in closing costs. But don’t worry, we are giving you a $500 credit for being a preferred member, and frankly, if you guys both take out loans, I’ll throw in another $500 credit,” said the banker.

“Done! Where do I sign?, I ask as I think about the new Audi R8 I plan to buy with just $150,000 of the $1.5 million. Or maybe I should be more conservative and spend $100,000 on the new 2011 Porsche 911. Or actually, I heard the 2011 BMW 335i coupe is coming out for only $55,000 this fall. With all the money “saved”, time for a bachelor’s trip somewhere fun! (I’m still thinking to myself here).

NOT SO FAST FOOLIO!

Unfortunately, things aren’t that easy. I’m not eligible to borrow $1.5 million to buy anything. I’m only eligible to borrow up to $1.5 million if I want to buy another piece of property or refinance my home. Good thing I’ve got a mortgage at 4.625% to refinance, and that’s exactly what I’m going to do.

An interesting thing to note for those who have variable rate mortgages is that if it starts floating today your interest rate will be only 3.5%. But, if you can lock in for another 5 years at 3.75%, might as well do so now.

The amazing thing about this year vs. last year when the 10-yr yield was also below 3% is that banks weren’t lending. The 10 year treasury rate actually dropped to 2.25% in October 2008 but nobody could get a loan, and if they did, spreads were egregiously wide (6% for same loan), it didn’t matter! My how things have changed.

A QUICK EXAMPLE

Let’s say my mortgage is $1.5 million at 4.625% for illustrative purposes. My monthly payments would be around $7,712 a month in principal and interest. Just by having a 10 minute conversation, and filling out some paper work with minimal cash out of my pocket, I’m able to refinance a jumbo loan of $1.5 million down to 3.75%. The result is a $812 a month increase in cash flow as the payment drops to $6,940!

Now lets take a look at the principal and interest breakdown of $7,712 a month at 4.75%. About $5,781 goes to interest and $1,931 goes to principal. At a 3.75% interest rate, your monthly payment drops to $6,940 with just $4,680 in interest and a healthier $2,260 in principal! In other words, not only do you pay less overall for better cash flow management, you pay less interest a month and more principal.

In percentage terms, even though your overall monthly payment just drops by just 10% ($7,712 a month down to $6,940) your monthly interest payment goes down 21%, and your principal payment goes up 20%. Funny how math works.

AMERICANS FLUSH WITH CASH

10 Year Treasury Yield Historical Chart

The refinance wave is coming again and that means more money in consumer’s pockets. In my example above, one has $812 extra cash to buy a new iPad every month for the next 5 years if so desired. One could also use the money to buy two round trip tickets to Hawaii, eat 15 steak dinners, lease a $60,000 automobile for no money down, or pay down more debt every month as well. Oh the possibilities are endless!

Of course one shouldn’t start spending frivolously, but the point is there will be a consumption boom as hundreds of thousands of people across America see a nice uptick in their monthly cash flow. Given ~68% of Americans own homes, and consumption accounts for over 60% of GDP one should feel encouraged that our economy is not going to fall off a cliff again!

Readers, anybody still on the fence about refinancing after reading this article? Do you need a hard kick in the pants? Do you think a refinance wave is going to sweep the nation again? How’s the property market in your neighborhood?

Note: It’s advised to match the fixed rate portion of your loan with your intended length of ownership. In other words, if you plan on moving in 5 years, get a 5/1 ARM. If you plan on holding your property forever, a 30-year fixed mortgage might be the way to go.

Also be aware that you need a loan-to-value of 80% or less, and likely a 710+ credit score to take advantage of current low rates. This irony of monetary policy is that it may very well benefit those who need help the least. Another post will touch upon this topic.

Please follow the 30/30/3 rule for home buying and don’t blow yourself up, so you don’t blow us up. Thanks!

Regards,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS or E-mail feed.

Who Needs A Job When You Have A Private School Degree

admin — Fri, 28 May 2010 09:00:00 +0000

Written by: admin on May 28, 2010.

Pick any private school. The cost is about $200,000 over four years. These figures don’t surprise anybody anymore given the ever rising application volume to storied institutions such as Harvard, Yale, and Princeton. That said, there have to be some who believe $200,000 for a private school is a hard pill to swallow over an excellent public school for just $40,000.

With an estimate 17% of people aged 20 through 24 unemployed, swallowing a bowling ball may be easier than finding a desirable job post graduation. Let’s say you are one of the unlucky few who can’t find a job after a $200,000 education. Does it really matter? Let’s think about why it doesn’t really matter from the eyes of several recent graduates.

THE BOY WHO WAS FORCED TO GO

Jimmy graduates from Columbia this year with a degree in History, European History to be precise. Despite his best efforts to land a summer internship last year, none were available, so he decided to go Euro-railing with his buddies for three months. What a blast, as he traversed the continent and collected bottle caps and coasters from every bar he patroned. The total cost of his trip, including airfare, food and lodging was a mere $10,000, just 1/5th what his parents pay for 9 months of school! What a bargain he reasons.

Everything is a bargain to Jimmy because he doesn’t have to pay for anything. He was happy to attend a SUNY school for a fraction of the price, but his parents pushed him to attend Columbia. In return, they would pay for everything, so long as he promised to just do well. The pressure Jimmy faced was immense. How could he live up to his parent’s expectations? He knew he couldn’t.

With Jimmy’s fancy Columbia degree, he reasons that he’s held up his end of the bargain. He didn’t drop out and instead flourished with a 3.7 GPA and a cum laude designation on his diploma. Yet, with no job waiting for him at the end of the rainbow, is all for not? Not so says Jimmy. The diploma is worth it, and if people don’t want to hire him, it’s their problem and not his.

You see, Jimmy’s parents are multi-millionaires who live in a $2.5 million dollar house in Greenwich, Connecticut. His father is the CFO of a Fortune 500 company and his mother has never worked a day in her life. In fact, the nanny who raised Jimmy since birth is still living with his parents even though they are empty nesters. Someone has to clean up the 5 bedrooms and run errands.

Like Jimmy’s mother, he never needs to work either because his trust fund can easily support him for the rest of his life. Jimmy is not unique, because all of his friends at Columbia are wealthy. Just by graduating, Jimmy and his friends legitimize themselves to the world. To think about starting at the bottom of any corporate is beneath them, when they are the sons and daughters of business leaders. Hence, who needs a job?

THE WOMAN WHO PAYS HER WAY

Now lets compare Jimmy with Allison, who paid her way through Columbia. She too, could have decided to attend a school 1/5th the price, but she did not. Instead, she chose Columbia out of the belief she would get a superior education, and land a dream job in marketing. With over $100,000 in student loans, Allison is suffocating from debt, and her repayment starts 6 months after graduation. Allison has no job offer either, and has decided to wait tables until she does.

Allison doesn’t want your pity, so don’t give her any. She made the choice to spend $200,000 on education even though her middle class parents, who earn a combined $80,000 a year couldn’t afford to offer much help. Only a small few get to attend such an elite university, and for that, she feels proud to have the opportunity. Some day, she will see the benefits of her Columbia degree, just not now.

Unless the right job offer comes a long, Allison is happy waiting tables. She won’t settle, even though it may seem like she already is. If a year goes by without finding her perfect job, she’ll just go to graduate school for another $50,000 a year. Allison knows she’s smarter than most people and has a tremendous amount of pride. Don’t pity Allison for not finding work, because she’s content with her own choices.

THE SUPERSTAR

Sandeep stands above Jimmy and Allison for his brilliance. He won the National Spelling Bee at age 9, finished multi-variable calculus by the 10th grade, and is on the US national juniors squash team. Sandeep has a full ride to Columbia and like Jimmy, doesn’t have to spend a dime.

Despite Sandeep’s achievements before and during college, he too, cannot find a job as a strategy consultant. Sandeep doesn’t care, because he had a grand old time playing squash, experiencing the NYC night life, and learning something new on the side. Besides, what’s $200,000 when none of it came out of his, or his family’s pockets? Absolutely nothing. As far as Sandeep is concerned, his dream job hasn’t found him yet.

Mentally, Sandeep figures that he can take the next four years off since he worked so hard during the past four years. Maybe he’ll go explore the world and live on a shoe-string budget. Maybe he’ll try to become a squash pro in Europe. The uncertainty of his future excites him, especially since he’s armed with a free Ivy league degree!

CONCLUSION

People who go to private schools aren’t stupid, nor are they irrational. Even under the most difficult scenario where one has to pay their way such as Allison, she doesn’t want your pity. They knew what they were getting themselves into, and took a risk with their finances in order to experience “the best” education in the world.

The reason why $50,000 a year tuition exists is because enough people believe it’s worth it. If not, tuition prices would adjust accordingly. Hence, there’s really no need for mass media schadenfreude gleefully reporting that private school kids aren’t finding jobs. There’s no need for concern either. The only people making noise about a tuition bubble are parents who probably can’t afford $50,000 a year, but who believe their kids deserve the best, whatever that is!

Readers, why do you think people make such a big deal about private school tuition? Harvard could charge $100,000 a year today, and there would be more demand than seats.

Who are the people feeling sorry for private school kids without jobs?

Do you think private schools are worth it over public schools?

Regards,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS or E-mail feed.

5 Money Habits I Learned That Will Never Make Me Rich

admin — Fri, 23 Apr 2010 13:27:35 +0000

Written by: admin on April 23, 2010.

Here’s an insightful post from Allan from The Philippines. He shares with us his story about growing up poor and working his way up. It’s always great to read about international perspectives. Hope you enjoy!

They say we are creatures of habit. This is especially true when it comes to money. When the going gets tough, it is easier to resort to what’s comfortable. When that happens, your own money habits take over. The only question is – will your money habits get you through and make you rich?

Money Habit # 1 – Playing with money

Learning my money habits started when I was still a young kid playing outside the house on a sunny afternoon. The first money habit I learned was playing with money. Yes, literally. But not with actual money. My friends and I would play games betting on carefully folded cigarette packs looking like play money. A red Marlboro is worth PhP 50 (US 1$). A green local brand “Champion” cigarette is PhP 5 (10 cents). A Philip Morris cigarette pack is worth PhP 100 (US $2).

It was all play money then. And it was easy to get. I only need to wait for my father to finish his cigarette pack and I’d be on my way to earning my (play) money for the day. Sometimes, we even played with coins, taking turns and rolling them on the floor like a dice. Playing with money was fun!

Somewhere between playing with other kids and being conscious on what’s cool, I learned that money can buy me things. But since we were poor, I had to make do with my worn out clothes. After some time I’ve already outgrown it so much, I already looked like Winnie the Pooh.

It’s not so much about other kids having better clothes. It was more because I was not able to play outside as much as the other kids. My mother would always remind me to do my house chores. Wanting to go out and play instead, I would reason out “how come the other kids are not doing any chores?” To which my mom lovingly responded,

“Because we are not like them. They can do whatever they want because they are rich. We are poor. ”

That was the first time I realized we were different from other people. We were poor. I began to notice how worn out my clothes and shoes are. I remember even going to school with no shoes on.

That’s one lesson I took to heart. If you don’t have money, you are poor. If you are poor, you need to work to have some money.

Money Habit # 2 – Working for money

Growing up with a family of farmers, I knew how hard my parents worked just to put food on the table. My mom would sometimes ask me to help out in harvesting tobacco leaves at a nearby town. She’d motivate me by paying for every tobacco leaf I was able to harvest. With promise of a paycheck, I willingly agreed to go.

The next day, I woke up early in the morning, went with her to the farm, and started plucking tobacco leaves left and right. After hours of standing under the grueling heat of the sun, I managed to harvest loads of tobacco leaves. That day, I went home enduring an aching back and torn muscles. But I was happy. I was able to help out my mom and it also made me PhP 100 (2 US $) richer. That’s actual money, not a Philip Morris cigarette pack. :)

It was hard work. I was so tired I thought I was going to get sick the next day. Good thing I was able to watch my favorite TV show that night – a Japanese game show called ‘Takeshi’s Castle’. I was able to laugh it off and sleep soundly that night.

One thing was clear from then on. I must first have to work before I can expect to earn money and get paid. If I don’t get paid, I don’t have any money to spend.

Money Habit # 3 – Spending money

After graduating from College, I was fortunate enough to get hired by a multinational IT company as a Mainframe Programmer for a monthly salary of PhP16,000 (about US $320). It was big money for me then, coming out straight from College without any working experience.

When I got my first paycheck, I was so thrilled. I thought it was the best time of my life. Why shouldn’t it be? I had money to buy what I could not afford before. Even if it’s just a new pair of shoes. Even if it’s just occasional dinner out with friends. Even if it’s just a nice shirt or two. After all, the money I earned was finally my “own”. It was liberating.

But not for long. The more I consumed, the more I realized I wanted more. I wanted more money to buy that new mobile phone. So off I went and tried the only way I knew how to make more money then – work hard on my job. As a result, I got promoted almost every year and my paycheck steadily increased. Sooner than later, I realized that even with the higher pay, it seemed like it was still not enough. I was still always short of cash.

That’s when I realized, there’s actually another way to get more money – borrow.

Money Habit # 4 – Borrowing money

Once I started earning quite a bit, I got comfortable spending for stuffs. It got to a point where I bought something even though I didn’t have the money to pay for it. I only had to use my new credit card.

In one day, I bought a new washing machine, a refrigerator, a gas stove and a new pair of shoes all at the same time. Worse, all the balance had to be paid off at the end of the month. I didn’t know there’s a thing called “monthly installments” then so I never bothered to ask. All I cared was showing off, pretending to have a lots of money using my new credit card. Looking back, it was one of the most stupid thing I’ve ever done in my life.

Even if I wanted to, I couldn’t pay ALL of the balance after a month. In the first place, the reason I used the card is because I didn’t have the cash. I tried to pay as much as I can but after months of painfully paying a little bit above the minimum I was getting nowhere near paying the balance off.

To make matters even worse, I got myself in deeper trouble by doing cash advance on my credit card just to have the cash to pay for my rent. I paid the hefty cash advance fee with a sinking feeling in my stomach. I had no choice. I could get thrown out of the apartment if I didn’t pay up. It was a humiliating and painful experience for me. From then on, I bowed not to allow myself to experience the same thing again.

Money Habit # 5 – Saving Money

The next day, I went straight to our company’s cashier and signed-up for an automatic savings program. The program automatically deducts a percentage of my paycheck and transfers it into my savings account.

I started with only 2% of my paycheck enrolled into the savings plan. After 3 months, I increased it to 5%. Another 3 months and I increased it again to 10%. After a year I felt comfortable enough to increase it further to 20%. In my mind, if the money does not reach my hands, I won’t be able to touch it. I won’t be able to spend it.

I was still paying off my debt at this point but the automatic savings plan was a big help on my confidence. It was liberating to know that I had some money saved somewhere, even if I don’t see it.

After years of saving, I was finally able to pay up my credit card debt. I was so scared of debt, I immediately had my credit card cut off the day I paid the whole balance. I felt finally free after a really long long time!

Months of saving through the automatic savings plan was a big help in building my emergency fund for around 6 months worth of expenses.

This proved to be a great thing since a few months after, my sister slipped while walking through our staircase and sustained a head injury. I was shocked. With adrenaline rush kicking in, I managed to bring her up to the hospital. To this day, I still thank God that this happened when I already had a bit of money saved up. I was able to buy the necessary medicine. I was able to pay for the hospital bill. I was able to pay for the operation. More importantly, my sister got well without any complication. I can’t imagine how it would have turned out had this happened while I was still heavily in debt.

Why these 5 habits will never make me rich

Looking back, I certainly have come a long way as a young kid playing with cigarette packs pretending they’re money to now a debt-free IT professional with an emergency fund able to help out his sister in an actual emergency.

In all honesty, I really think these 5 habits alone will never make me rich. I’m still a long long way to go from financial freedom. Saving money is good, but making it grow is another thing. At least it’s a good starting point. I’m eager to learn the money habits of investing and starting on my journey to becoming truly rich. When that happens, I’ll have another 5 money habits to share to you.

About Allan: Even with the insider knowledge of working as a mainframe programmer for a credit card company over the past 7 years, he still got burned with credit card debt. Alan is trying to learn better money habits and sharing them through his Rich Money Habits blog.

The Good Times Are Back Again – The Indulgent List Of Things

admin — Wed, 21 Apr 2010 09:00:04 +0000

Written by: admin on April 21, 2010.

Look around. What do you see? I see packed buses, traffic jams, busy open houses, expensive restaurants with only 9pm seatings, and friends finding new jobs again. Double dip recession? I don’t think so. With the Dow over 11,000 and the S&P 500 over 1,200, it’s as if last year was just a bad dream.

Yet, it is exactly during good times, when we must be more diligent about our finances. It’s so easy to forget how bad things were and stray. Rather than spend more money, save more money during upswings so that we can spend more money during downturns.

When times are good, it’s not necessary to spend more money to create any sort of additional fulfillment or pleasure. We’re getting paid more, the opportunities for promotions are greater, and the demand for our services surpass our supply.

In essence, we feel good because we feel wanted again. It’s when a downturn hits when money can help balance the mood out a little with some retail or food therapy, or maybe even a vacation. In essence, spend money counter-cyclically for better returns.

DAY DREAMING TO RELIEVE DESIRE

There’s an exercise I like to do every now and again, and it’s called “Indulgent Reminding.“ In one minute and not a second longer, type out all your material wants within reason if you didn’t have to worry about money.

My Indulgent List Of Things:

* Two Tennis Racquets ($400)

* 5 tailored three-ply dress shirts ($300-500)

* Sports jacket (blazer) ($500-$800)

* A couple tailor made suits ($1,000-2,000)

* Brown loafers & dress shoes ($200-1,000)

* Digital SLR Camera ($1,000)

* Macbook Pro 13″ ($1,200)

* 42″ LED TV ($1,200-$1500)

* Panerai Submersible Stainless Steel Watch ($8,000)

* Audi S5 Coupe in Silver or Black ($60,000)

* A vacation for two to Greece ($10,000)

* A weekend getaway to Napa’s Auberge Du Soleil with full spa experience for two ($2,000)

In one minute, I’ve been able to come up with $85,000 worth of stuff to spend on! It gets me giddy thinking about all the goodies I must admit. The feeling of splurging without having to actually spend money is what financial daydreaming is all about!

After you’ve written your list, try to come up with several conclusions as to what these things reflect. My list says I like action and appreciate expensive adventures. Pretty standard guy stuff frankly, not to mention pretty shallow stuff too! $8,000 watch? Come on!

Now see if you can come up with a new list with a much cheaper set of things. See how many of the items you can also happily do without. Looking over my list again, all I really need are a new pair of brown loafers since my current ones have holes. Ahhhh, saving $84,700 sure feels great!

CONCLUSION

I don’t know what it is, but I get the greatest satisfaction out of using things I already have, over and over again until they die. Take my car Moose, for example. He’s 10.5 years old now, with a finicky CD player, and a broken electrical passenger seat. With 130,000 miles, it brings me greater satisfaction that he can still bring me from point A to point B just as well as a car 10X the price.

Once you start buying things out of pure desire it’s hard to stop. Marketers are brilliant at getting you to buy more than you really need. From shoes, to sporting equipment, to clothes, it’s a never ending list of things you can buy. You’ll never be satisfied. Hence, best to just use what you have, and do a little day dreaming to keep your desires at bay!

Readers, when times are good do you feel you tend to spend more or save more?

What are the things you like to do to keep your wants and desires in check?

Anybody else have the condition of really loving the stuff they already have?

Keigu,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS or E-mail feed.

Sometimes Saving Money Is About Principle

admin — Fri, 05 Mar 2010 16:00:34 +0000

Written by: admin on March 5, 2010.

For the past two years I’ve taken the bus to work after driving for 7 years prior. The company removed our free parking benefits and I wasn’t about to pay $350/month to park in a garage just 5 miles away.

I have a love hate relationship with the bus. When it’s raining, and I have to stand outside shivering, I hate it. When the bus skips my stop every so often, I hate it. When the bus driver slams on the brakes a couple feet away from the stop light and we all go flying, I hate it. When the bus is packed like sardines, but there are some very attractive riders I need to squeeze next to, well, I guess it’s OK.

My VIP Pass aka monthly bus pass costs $60, while taking a cab to and from work costs $30. Hence, the cost breakdown is simply $60 for a bus, $350 for parking, and $600 for a cab every month. Out of principle, I wasn’t going to spend 5-10X more on transportation if I could just ride the bus.

WHAT A DUMMY

A funny thing happened to me yesterday. I tried to cheat. Because I was going to work midday, and the express bus wasn’t running anymore, I decided to drive. I got into Moose, drove downtown and left him at my fitness club just five blocks away from my office. The plan was to work for 6 hours, take advantage of the “free parking”, and drive home.

After a hectic day of work, it was so refreshing to come back home and relax. Oddly enough, there was something that felt off and I just couldn’t figure out what. CRAP! I left Moose at the club because I took the bus home instead!

What’s more stressful is that I’m really only supposed to park at the club for a couple hours. They tow and ticket sometimes if the rules are violated. Even though it was dark and freezing, I just couldn’t bring myself to pay $15 to take a taxi to pick up Moose. My objective that day was to save money and time by driving in the first place!

CONCLUSION

If I took a cab, my $60 monthly transportation fee would jump 23% to $75 ($15 for cab), and I wasn’t going to let that happen. With a full belly from dinner, at 7:30pm I decided to bike through the hills, and between the lanes of traffic to save Moose from the pound. Sometimes saving money is just about principle.

Readers, do you think I was foolish to not just spend the $15 to get in a cab and go back downtown given the inconvenience and danger of riding my bike at night? Have you ever done something as stupid, and out of principle decided to go the less convenient route?

Regards,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS or E-mail feed.

Home Mortgage Refinancing Tips For A Smarter You

admin — Tue, 02 Mar 2010 09:00:44 +0000

Written by: admin on March 2, 2010.

The beauty of an economic downturn is cheap credit. It’s ironic, because cheap credit is one of the main causes of this collapse in the first place! That said, for those of you with mortgage debt, now is a great time to call your local bank and check up on rates. Refinancing can be a daunting process, but it shouldn’t be with the right representative and proper frame of mind.

As I’m currently thinking about refinancing one of my rental properties, now is a good time to share with you some key things to think about and assess. Hopefully by the end of this article you will be able to make an informed decision and save lots of money as a result!

INFLATION

Knowing when to refinance is like being a bond trader. Bond traders obsess over inflation assumptions, and you should have at least a basic assumption as well. Clearly, there has been tremendous monetary expansion recently, which should ultimately lead to higher inflation. Basic economic theory says that for every new $1 dollar bill printed, there will be a $1 increase in prices in the overall basket of goods eventually. The key word is eventually, which could be decades away.

People have been waiting for higher inflation, and therefore higher rates for the past decade. Ironically, those with short-term fixed mortgages (ARMs) are this century’s winners, because rates are resetting at equal to lower levels than when they were originally fixed!

Inflation has been coming down now for over 25 years, and I see little reason to expect inflation to suddenly jump higher given the tremendous output gap in the economy. If inflation does start rising, at least you know that your assets are by definition also rising in nominal value.

The figure to watch is the 10-year US treasury yield. Currently at 3.65%, the yield is hovering close to the lows of the past decade. Meanwhile spreads between treasury yields and bank mortgage rates have narrowed since the crisis. Most long term duration mortgages are related to the 10-yr bond yield, hence whenever you see the stock market crashing,watch bond prices rise, and yields fall. This is the exact time to call your mortgage broker.

DURATION

Now that you have made an assumption on inflation, you should consider matching your fixed rate duration with the time you plan to hold or pay off the loan. For example, if you plan to hold onto your property forever, but need as long a time to pay off the mortgage as possible, it behooves you to take out a 30-year fixed mortgage. Your base case scenario is that in 30 years, you will pay off your mortgage in full, but I suggest you pay extra when you can to save on long term interest costs.

On the other hand, if you plan to only keep your property for 5 years, or plan to pay off the mortgage in 5 years, it makes more sense to take out a 5/1 ARM (adjustable rate mortgage), especially if you think inflation stays benign.

Given the yield curve is upward sloping, longer duration loans have higher interest rates. This is a tautology for the most part, except during times of extreme economic duress, where the yield curve flattens, or inverts given people want their money as liquid as possible. Assuming a normal upward sloping yield curve, you will pay a higher rate for a longer duration mortgage.

Current 30-yr conforming mortgage rates are roughly 4.75%-5.25%, while 5/1 ARMs (5 years fixed and floating thereafter) are at 4-4.25%.

REFINANCING COSTS

The are a bunch of costs that go into refinancing which unfortunately eat into the savings of refinancing. The way to think about costs is to get the total cost of refinancing divided by the monthly savings of refinancing to see how many months it takes to break even.

For example, let’s say it costs $3,000 to refinance a $400,000 loan from 5.25% to 4.25%. Your monthly payment goes from $2,375 down to $2,135 for a savings of $240. Take the $3,000 in refinancing costs divided by $240 = 12.5. In other words, it takes 12.5 months for you to start benefiting from a refinance.

If you plan to take 360 months (30 yr fixed) to pay off your mortgage, your actually savings would be $83,400 (347 months X $240) making the $3,000 cost to refinance a no-brainer. Ironically, you save less if you pay off your loan quicker from a refinancing stand point.

You should also ask your broker what the cost would be to refinance at a higher rate. In this example, you could get a “credit” to your costs if you refinanced for 4.75% instead of 4.25%, thereby having less money leave your pocket. The general rule of thumb is that if you plan to stay in your house for over 5 years, and it costs no more than 20 months until you break even, you should refinance.

30-YEAR FIXED vs. ADJUSTABLE RATE MORTGAGES

The benefit of a 30-year fixed loan is that you know what your payments are for 30 years. The payment will never change, only the mix between principal and interest. As a long term fixed loan, you pay up for the “privilege” of security.

With a 5 year ARM for example, you pay a lower interest amount in exchange for not knowing what your mortgage rate will be in year 6. Good thing is that there is generally a 5% cap increase. The bad thing is, your payments could literally more than double going from a 4.25% interest rate in this example to 9.25%!

If you took out the 30-year fixed mortgage, in year six you will still be at 5.25%. Hence, having a strong belief where inflation and therefore interest rates are going is important.

People think that adjustable rate mortgages are dangerous and bad. It’s just not true. An ARM is a wonderful option to save you money by allowing you to pay a lower interest rate if you believe inflation is benign, and if you only plan to hold the property for a shorter number of years. ARMs generally come in 1, 3, 5, 7, and 10 year durations.

PITA FACTOR (Pain In The A** Factor)

It would be nice if one could just snap one’s fingers and change the terms of the loan. Unfortunately, it’s not that simple and you need to spend at least 5 hours of your time speaking to your mortgage representative and preparing and signing the paperwork. A good agent should be able to tell you all the necessary documents you need to get things going.

The process generally takes about a month given the bank needs to pay off the loan, send an appraiser to figure out the loan-to-value ratio, check your income and assets, go through the title company to get the proper documents, pull insurance records from the homeowner’s association, and get you to sign everything.

The less you make, and the less busy you are, the more you should look into refinancing! If on the other hand, you’re happy with your loan, don’t have a lot of time, and make a ton of money, your time is worth more than the headache you will go through to save $16,000 bucks in the example above.

PUTTING IT ALL TOGETHER

If your mortgage rate is currently above 5%, consider calling your local bank’s mortgage department and asking what their latest rates are at various durations. The phone call is free, and you will potentially save thousands over the years.

To recap: 1) ask for rates 1% lower than your existing mortgage rate, 2) match your fixed rate duration with the length you plan to pay off the loan and/or own the property, 3) Calculate the break even duration by adding up the cost of refinancing divided by the monthly savings, 4) Consider refinances the loan if the break even duration is below 20 months (lower the better) and you plan to hold the loan for longer than 5 years.

If anything is unclear, please feel free to ask! I’ve been involved in a dozen loans with various types of properties, and perhaps I’ll be involved with one more very soon.

Keiju (Regards),

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS or E-mail feed.

Do “C” Students Deserve “A” Lifestyles?

admin — Mon, 01 Feb 2010 09:00:42 +0000

Written by: admin on February 1, 2010.

Back in the 9th grade, I remember goofing off quite a bit with my buddies. We skipped class, stayed out late, and essentially did a lot of stuff that was detrimental to our grades. Despite working with plenty of Spanish speaking colleagues during my part-time job, I still only got a “C” in Spanish because I didn’t care. All I wanted to do was have fun, and fun is what I had!

My parents spoke to me one evening and asked, “How are you ever going to be a great business man if you can’t even get an “A” in math? Do you think award-winning scientists get “C’s” in high school chemistry? Do you think Andre Agassi doesn’t practice hard every single day?”

The questions stuck with me because ever since I was 12, I wanted to be a “business man.” I remember getting picked up in a sweet Mercedes 300 SEL by one of my father’s friends to take us to their mansion party. The whole experience with the infinity pool, car, food, and servants made me want to do what they did, whatever that was!

After the pep talk, I began caring about my grades through college. I didn’t want a silly thing like grades to get in the way of my dreams.

THE QUESTION TO ASK ALL PEOPLE

It’s pretty rational not to study, because studying sucks. Most people are probably “C” or “B” students given the law of natural distribution. Hence, do “C” or even “B” students deserve “A” lifestyles? If you were a mediocre student, who went to a mediocre school, who works at a mediocre job, why do you think you deserve more than a mediocre lifestyle?

THE SOLUTION

To get people out of debt, we need to make people realize they are unworthy of the stuff they buy, even though they see their neighbors live it up. Maybe their neighbors all got straight A’s at some prestigious university and are doctors? We can’t compare ourselves to others, because we don’t know for sure what others make.

Given we have such an omnipresent government, perhaps they should make it mandatory for everybody to have their grades and universities revealed before they are allowed to purchase anything. For example, only people with 3.5 or higher GPA’s are allowed to buy Armani clothes and Mercedes Benzos. 3.0 GPA folks, sorry, only Gap and Hondas for you! The government can regulate spending by those who need the most regulating assuming there is a correlation between grades and commonsense of course. Just imagine if we had this big brother program for potential home buyers 10 years ago. We’d all be saved, right?

CONCLUSION

In reality, all we can do is be cognizant of our own achievements and spend accordingly. If we can knock some reality into the average person, then maybe, just maybe people will spend in-line with their incomes.

Let all the go-getters who are passionate about everything they do soak in all the success. Let those who never complain and work when others are playing make all the money. The rest of us can just kick back, whine about why life isn’t fair and tell ourselves why we deserve better.

Readers, do you believe that a main reason for tremendous consumer debt is because there are delusional people who think they deserve more than they can really afford?

If people want all the fancy things in life, why don’t they just work harder in school, be the best employee, or invent something successful to accommodate their desires?

What GPA did you get in HS/College, and will you be justifying your spending habits in the discussion below?

Keiju (Regards),

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS or E-mail feed.

Book Review & Giveaway: “Your Money Ratios”

admin — Thu, 07 Jan 2010 09:00:19 +0000

Written by: admin on January 7, 2010.

Publisher: The Penguin Group. Hard cover. 257-pages. Price: $26.

Author: Charles Farrell, JD., LL.M., investment adviser with Northstar Investment Advisors, in Denver. He writes the “Retirement Roadmap” column for CBS Moneywatch.

Review: “Your Money Ratios” sings to me! For someone who loves using ratios such as the 1/10th rule for car buying, and 30/30/3 rule for home buying, I absolutely adore this book. Charles’ writing style is very balanced and easy to understand. When it comes to math, many people, including myself fall asleep. But, if you can just do simple division and multiplcation, this book will keep you on the right path towards financial security.

Charles’ “Unifying Theory of Personal Finance” is his core philosophy that all decisions you make should help move you from being a laborer to being a capitalist. In other words, make money work for you, and not the other way around. It’s important that with every single monetary decision you make, you ask yourself will this help you become a capitalist or not.

Capital To Income Ratio

The first ratio Charles introduces is the Capital to Income Ratio (CIR). Capital is defined as the savings in your 401K, IRA, annuities, CDs, cash value of your life insurance, savings, equity in commercial and rental real estate, and the fair market value of any business interests. Capital does not include the equity in your primary residence because it does not generate income. The real return of your home is the rent-free use of the property once you pay off your mortgage.

The underlying goal is for everyone to have a CIR of 12 by age 65 i.e. $1.2 million in capital if you average $100,000. With a CIR of 12, one should be able to retire financially secure while living off 80% of your pre-retirement income due to the returns from capital and social security. While working we probably live on about 60% of your actual income due to expenses such as one’s mortgage, which will no longer be there when we retire.

Your finances hit a tipping point when your Capital to Income Ratio hits 2. At a CIR of 2 your earnings from you capital will generally add more to your wealth than the amount you save each year. Over a 40yr savings cycle, you contribute 30% 70% are from earnings.

The Savings Ratio

To get to a Capital Income Ratio of 12, Charles highlights on two savings rates: Save 12% of your annual income ever year from ages 25-40, and save 15% every year after wards. The math works, and obviously the math works even better if you can save more of your annual income.

To clarify, the Charles’ 12% and 15% savings ratios include your 401K contribution.. Charles believes that your 401K is key to financial independence due to employer matches and tax free contributions.

I challenge readers to max out their 401K and save an additional 12-15% of their gross income. Mentally write off your 401K amount, and pray it’s there at age 59.5. My strong belief is that your net worth is an illusion, except for the cash and most liquid of assets.

Your Debt Ratios

One needs to differentiate between income-producing debt and income-reducing debt When you take on debt, you need to leave enough for you to meet the savings ratio Owning a home and paying of your debt increases your retirement income and helps move you from laborer to capitalist. “Deemed Income” is the investment income you get to keep in retirement because you don’t have to use that income to pay a mortgage or rent.

Education debt, is good debt, but aim to keep it to 75% or less of your average 10 year gross income. Financially, it is better for your kids to take on the debt than you provided they stick to the Education Debt Ratios.

Charles, like others believes there is an education bubble. Tuition costs are ridiculous and will eventually fall because income growth doesn’t support the cost. Charles advises not saving for your kids education before you save for your own! If you don’t save enough for yourself, your kids inherit your financial burden and have to take care of you. Your financial independence is a great gift to your kids.

Your Investment Ratio

It’s all about playing offense (stocks) and defense (bonds) to come out ahead. Charles recommends a permanent 50%/50% allocation your entire working life. I find this too conservative. I like following your age as a percentage to allocate to bonds i.e. if you’re 35, somewhere around 35% of your investments are in fixed income securities.

Charles is super risk adverse because he wants to avoid big losses. As an investment adviser, and given his age, I have a feeling he has seen tons of carnage over these past two investment cycles. A 50% portfolio decline requires a 100% increase to get back to even. A 80% portfolio decline requires a 400% increase!

Social Security – The Point of Contention

Charles fears Congress will go overboard in fixing SS, and create one large wealth-transfer. Despite the “fix”, SS will survive. Lower paid workers get much more out of the system than higher paid-workers, based on their actual contributions. It’s important for everyone to understand the basics of SS, to not change the program from a long term retirement program into a welfare program.

Your FICA tax is 7.65% from you, 7.65% from employer of which 12.4% goes to SS, and 2.9% goes to Medicare. You need to work for at least 10 years for a covered employer before you can receive benefits. Cap is on $106,800 of the income you pay, thank goodness for many. SS adjusts for inflation is great. And if you’re married, your spouse has the right to benefits equal to the higher of his or her OWN benefit, or one half of yours. Not bad!

By the way, if you were born after 1960, the full-retirement date to receive social security benefits is 67! You can decide to take reduced benefits starting at age 62.

Conclusion

“Your Money Ratios” has the potential to be one of 2010′s best sellers in the personal finance space. I love everything about the book, from the tone of the author, to his simple instructions, to the way the book is packaged. There’s no doubt in my mind that if you follow Charles’ instructions, whether you are 25 or 45, you will be able to reach financial independence by 65. Go to your local bookstore or Amazon and check it out!

Go to www.yourmoneyratios.com, type in the code 778811 to check out your ratios and see where you stand!

BOOK GIVEAWAY RULES: Two Books To Win!

* Comment on: What your current Capital to Income ratio is, and whether you think it’s realistic to reach a CIR of 12 by age 65. Feel free to provide your thoughts on why you are satisfied or unsatisfied with your current status and what the right CIR is. Are you maxing out your 401K, and if so, how much more of your gross annual income are you saving? Do you believe full Social Security benefits will exist in 25-30 years?

* Twitter: Retweet and share with your friends. Ideally, you will read the review and share your comments.

* Enlist: Sign up for our e-mail or RSS feed. Let us know in comments.

* Do all three and you have a higher chance of winning. I really want this book to go to someone who really wants it, and will read every page and take it to heart.

* Winners to be announced in the next Katana.

Keigu,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Twitter @FinancialSamurai and subscribe to our RSS feed.

Are Credit Cards Weapons Of Mass Financial Destruction?

admin — Wed, 16 Dec 2009 09:00:28 +0000

Written by: admin on December 16, 2009.

The answer depends on if your name is Saddam Hussein, although proponents would say no proof was ever found! You hear so many stories of consumers up to their eyeballs in credit card debt, and I’m just wondering WHY? Credit card debt is the most expensive debt out there, second only to usurious rates of loan sharks.

Perhaps the reason why is because credit cards are ubiquitous. According to the US Census Bureau, there were 173 million credit cardholders in the US in 2006, using 1.5 billion credit cards? That’s right, the ratio is almost 10 credit cards to every one user, with transaction volumes of over $2 trillion a year! No wonder the US consumer gets in trouble, and why credit cards are such big business!

My view on credit cards is quite simple: Use credit cards only to your advantage, and never let them take advantage of you! Whenever you see your credit card misbehaving, you should think to yourself “Bad boy! Bad, BAD!” I think my wife tells me this sometimes, but I try and tune it out.

Joel is hosting a $500 American Express giveaway, and gosh darnit, I’m entering to give myself a chance to win. In “You’re Rejected! How I Use Rejection To Motivate Me Every Single Day,” we discuss how success is a numbers game. The more you put yourself out there, the higher the chance you have to succeed. Here’s my attempt to win and use the proceeds to buy toys and clothing for underprivileged children this winter in San Francisco. The program is called “Toys 4 Tots.”

TWO MISSLES IN MY WALLET

My first card is the American Express Corporate Card necessary for business bookkeeping purposes. You see, all client expenses must be paid for by my Corporate AMEX card so the company can match costs with profits. Makes, sense. Too bad I have to pay the bill every month, and then get reimbursed, thereby creating unnecessary delays, negative working capital, and occasional late fees. There was a time when having an AMEX Corporate Card was very cool (your early 20′s), but it soon gets old. At least their service is solid.

The second card is my personal Citibank Home Rebate card which gives me a 1% rebate on all purchases to pay off the principal of my primary residence. I’ve had the card for six years, and the card has paid off more than $1,700 worth of principal already. What’s more interesting to note is that based off a 5-6% mortgage interest rate, the real savings is thousands and thousands more because of interest saved over time.

Of course, nothing is perfect. I woke up one day to find my 6.99% Citibank Home Rebate Credit Card rate jump to 14.99% duringthe height of the recession last year. Funny, because the 10-yr yield was still in the low 3%-range, and the Fed Funds rate was below 1%. This pissed me off, and I immediately called them to lower the rate. Again, don’t let credit card companies and banks take advantage of you.

PACKING AN A-BOMB

If someone were to kidnap my pet rabbit and force me to sign-up for another credit card to save his life, I would have to pick the Visa Black Card. The selection of credit cards Joel provides is impressive, but only the Visa Black Card is well, black. In addition, the description says “Membership limited to only 1% of US residents!” Don’t you want to feel special if you pack a new financial weapon of mass……… joy?

WEAPONS FOR PEACE

A credit card is a wonderful financial tool if used properly. I put everything on my personal credit card because 1) It helps record all my transactions which are divided into different categories I can review every month, 2) The 1% home rebate saves me money, but is not the primary reason for use, 3) I don’t like carrying over $100 in cash, and 4) A credit card provides consumer protection against fraud and defects.

But I must ask again, why on earth would you EVER not pay off your bill in full every month? Not doing so is akin to pulling the grenade pin and not letting go! Did you know that if you paid off $999 of your $1,000 balance, most credit cards will charge you interest on the full $1,000 balance? Credit Card companies are marketing geniuses. Make sure you’re Albert Einstein.

The credit card companies already make a small commission off the vendor every time you use the card, don’t let them charge you interest as well! Credit cards are not weapons of mass financial distraction if used properly. Instead, they are a necessary part of day-to-day transactions, and there seems to be no turning back.

OTHER HANDY USES FOR CREDIT CARDS:

1) Spatula when there’s a hole in the wall to fill with caulk.

2) Ninja star when I’m in a dark alley and someone is coming after me.

3) Babe magnets at a bar when I tell the bartender to “leave it open.”

4) Lock pick when I leave my keys in the house.

5) Tooth pick after a good ‘ol San Francisco crab feast.

Readers, do you think those vehemently against credit cards are weak because they cannot control their own spending habits?

Why wouldn’t everybody want to own at least one credit card due to the free 30 day borrow, fraud protection, and convenience?

Why do people continuously let credit card companies take advantage of them like masochists?

Do you think this post can win the challenge given it’s a dedicated post (vs. just a mention in a wrap), provides some educational value, contains a little bit of humor, doesn’t mince words, follows instructions by providing a link to one of the credit cards on Joel’s list, and more importantly, helps provide toys and other benefits for children?

For more info on the challenge, check out Joel’s CC AMEX giveaway challenge.

Keigu,

Financial Samurai – “Slicing Through Money’s Mysteries”

Twitter @FinancialSamurai and subscribe to our RSS feed.

The Public Loves Wall Street Again!

admin — Mon, 07 Dec 2009 09:00:36 +0000

Written by: admin on December 7, 2009.

What is this blasphemy you say? One of our main tenets is to observe what people DO with their money, and not what they preach. The public clearly loves Bank of America and Wall Street again because how else would Bank of America be able to raise $19 billion from us, to pay us back?

In an “Open Letter To Vikram Pandit, CEO of Citigroup” we urged Vik to sell the 34% government stake back to the very public that bailed Citigroup out before year-end. Why? So Citigroup can pay their employees big bonuses in 2009 by saying they are no longer under the government’s stewardship. Sure, paying back $45 billion in TARP sounds like a lot, but Bank of America just did it!

In fact, joining Bank of America are Bank of NY Mellon Group, Goldman Sachs, JP Morgan, Morgan Stanley, and State Street who’ve all been able to pay back their TARP loans and pay their people handsomely this year. This begs the question, what’s wrong with Citigroup, one of my main “go broke banks” used to optimize my finances.

SORRY, I DONNO

Unfortunately, I’m not a banks analyst, nor do I care to comb through Citigroup’s financials to figure out whether they have the means to pay back their TARP loan. Maybe they are really suffering, that’s why their share price is stuck around $4. Or, maybe their share price is stuck around $4, because management hasn’t made any noise about freeing themselves from government control! It makes you think whether being under government control is good for capitalism doesn’t it?

The main irony of Bank of America’s recent $19 billion capital raising, is that the money comes from the very public who bailed them out in the first place. Money just goes from your left pocket, back into your right pocket. Some call this “robbing from Paul to pay Peter.” Bank of America calls this, “Thank you citizens of America for hooking us up again!” A friend of mine from BOA ML was wondering this weekend who this year’s Ken Lewis (aka Great Savior) would be. Little did he know it would be all of you.

CONCLUSION

We’re very pleased by Bank of America’s ability to raise $19 billion so quickly because of three reasons: 1) It shows there is tremendous amount of liquidity in the system, 2) Risk appetite is back even for banks who have rallied 100% from their lows this year already and 3) The public no longer has their silver-tipped pitchforks out to spear an innovative industry responsible for employing hundreds of thousands of innocent people.

Citigroup, you still have about 10 working days left to raise money from the public to pay back, the public. Kuwait’s sovereign wealth fund just offloaded $4.1 billion worth of Citigroup shares, whatcha waiting for?

Readers, why do you think the public has been so quick to forgive Bank of America and the other TARP money institutions? Or, do you think we have an error of correlation here, and those investing another $19 billion in BOA are not the same people who are still against TARP institutions? If this is the case, was it really our money who bailed out these banks in the first place?

We’re hosting another book giveaway this week, and every week for the next four weeks so stay tuned!

Keigu,

Financial Samurai - “Slicing Through Money’s Mysteries”

Twitter @FinancialSamura and sign up for our RSS feed.

Why Becoming Debt Free Is Not A Great Idea!

admin — Wed, 21 Oct 2009 08:00:18 +0000

Written by: admin on October 21, 2009.

We Don't Need No Medicine!

I’m pleased to bring you a guest post by faithful reader and commenter, Larry Ludwig (bio below). He writes a thought provoking piece about challenging the norm of becoming debt free. You’ll be smarter after reading this, guaranteed! Enjoy, and as always, feel free to debate away! Rgds, Financial Samurai

You’ve heard the financial gurus like Dave Ramsey perform pasectomies on his show and Suze Orman with her numerous “I have 50k in debt” guests. The gurus all say, debt is bad, credit is evil, and being debt free is nirvana, yada yada yada. While I do think as a whole Americans have too much consumer debt, the goal of being completely debt free is actually a terrible idea. Let me be specific: buying things that depreciate with debt is bad, that big screen TV, new clothing or car. Most of the financial gurus do not make this distinction and make all debt to be “evil”.

I believe Rich Dad/Poor Dad Robert Kiyosaki has said it best, “There is good and bad debt and being debt free is more risky than having good debt.”. Now before you go off on my recommendation of Robert and his questionable background, I believe his statement is sound and correct.

The primary reasons are:
•   Opportunity Cost
•   Asset Allocation
•   Inflation
•   Tax Deductions
•   Arbitrage
•   Leverage

OPPORTUNITY COST
In my case my wife and I just refinanced our house with a 30-year fixed rate at 4.875%. A great rate and will be probably not see rates lower in our lifetime. While we could pay off or accelerate the payments it does not make sense to do so. Why? Our actual mortgage rate after taxes is 3.26%, a very easy rate to beat with investments (especially pre tax) and in addition the average rate of inflation is also 3.26%. With both taxes and inflation are expected to be higher in the future and it’s possible the actual mortgage rate will be even lower. It’s better to take the freed money that would have been tied into the house, and invest in other assets. In today’s environment you still can beat the above-mentioned rate. Another way to look at, with inflation we will primarily paying only principal in real dollars with very little in interest payments. Your primary residence should not be looked at as an investment and if the numbers make sense take mortgage pre-payment dollars into other assets.

ASSET ALLOCATION
Let’s assume you take the financial guru’s advice and either pay off your home mortgage or accelerate payments. You will then have the proverbial “too many eggs in one basket” being your house. Most families that take this advice then cannot afford to build up an emergency savings or put money in pre-tax or after tax investments. You’ll have too much of your dollars tied into one asset. Should pricing go down like we have seen in the past 2 years than you’ve lost real money. If you lost your job it would be much harder to get the equity out of your house to use in an emergency. Pre-payment of your home mortgage should always occur last after any pre-tax deductions (IRA, 401k), or emergency savings. Even then, depending upon your real mortgage rate, it may not make sense to ever pre-pay.

INFLATION
Inflation has been called the “silent tax” and lurks at night eating away at your money. With our fiat currency and monetary policies, inflation is something our government wants to ensure always happens and at all cost. You not only want a ROI (return on investment) but a return OF your investment in real dollars. An example of this is a bank CD generating 4% a year interest, yet inflation is at 5%! While it’s great you have a safe investment, you are loosing %1 of your real money buying power.

Now you say what does savings have to do with borrowing? Everything. In general our government’s monetary policy is punishing savers, while helping debtors every way it can. This has become painfully obvious in the past year. You see this in every news headline and policy our previous and current administration has done. Inflation is especially obvious with people on fix incomes (i.e. retirees). By having low fixed rate loans you are paying with future dollars that are worth less than currently.

The $64k question is what will happen 10 – 20 years in the future? Will we have a Japan style deflation?   Will stagflation of the late 70’s come back again? Will hyperinflation like Zimbabwe occur? There are a number of factors to consider:
•   China and Japan will keep buying our debt? Will they just stop or slowly decrease their purchases since a devaluation of our dollar will hurt their exporting. The latter situation is more than likely
•   Foreign countries that are buying our debt are now only buying short term debt. (less than 10 years). When this debt comes due, this could have massive issues for us.
•   How with our government pay off the existing debt? Based upon interest alone we getting close to 40% of our yearly tax revenue.
•   Will our government stop spending like drunken sailors with debt expected to pass 100% GDP in 2011? Unlike Japan, we do not have a country of savers to fall back upon.
•   Will our government stop creating policies that will hurt small business?
•   We are base currency for other countries, but for how long? If dollars start coming back to the U.S.A what would that do to the value of our currency?
•   For the time being forget about the new health care bill, how will our government be able to fund the existing programs Social (In)Security, Medicare and Medicaid?

While there is no assurance of what the future holds, the question is do you want to ignore the risks, or hedge your bets? I choose the later with some assumption inflation will be higher than what we’ve seen for the past 30 years. Even so since 1914 the average inflation rate has been 3.26% and since 1971 (the year we completely came off the gold standard) it has averaged 4.48%, so always keep these numbers in the back of your head when debt taking on debt AND investing. By taking on low fixed rate debt, this is one simple method to hedge against inflation.

TAX DEDUCTIONS
The Government wants you to be in debt. That’s right, why else would they have tax incentives like “Cash for Clunkers”, first time home purchase, and for businesses deductions on equipment purchases? The only logical reason is they want you to take on debt. This is related to the government’s monetary policy mentioned previously. So if you are in the higher income brackets it makes more sense to use the tax deductions to your advantage. This is especially true on assets that generate income or increase in value over time. It’s also important to note, don’t take on debt just for the tax deduction alone.

ARBITRAGE
Arbitrage is just a fancy term making a profit from the difference in market prices. I just received a credit card offer for 0% interest for one year, with check writing expenses it was 2.99% fixed for one year, much lower than any other of the current credit card rates we have. In the next year it’s expected all credit card transactions are going to go up dramatically. With that said if I take a one-year low interest loan and make 6% in a safe investment I’ll come out ahead with a 3% difference. This example assumes inflation and taxes paid are 0%, not completely realistic but you get the idea. While there is some risk involved (as with any investment) the risk is somewhat low and will take my chances on this type of arbitrage.

Let me also add another form of arbitrage we saw in the previous years with one of our credit cards. We had a 4.99% “fixed” rate credit card that also offered great card rewards. I recently calculated any interest we paid, minus all of the gift cards we received. It turns out the credit card company paid us over $600.00 in the 3 years we used it and this is after any interest payments incurred! So our interest real rate on this credit card was negative. Not a bad deal if you ask me.

LEVERAGE
I’ve seen articles that state rental housing is a poor investment compared to stocks or bonds. They use the typical statement of housing matches inflation or slightly less. While this is true, it does not take into account the use of leverage.

Lets use an example of putting down 20% on a $100,000.00 rental house. We’ll assume over time the house increases in line with inflation, and use 3% a year. So in the first year it increased from $100k to $103k, assuming the property is cash flow positive, the property increased in value 3k without doing anything. With your $20k investment, just increased to $23k or a 13% increase. So with leverage you made more money with the assistance of inflation.

Using leverage while does increases risk, it can be used to your advantage. Too much leverage (like many of the failed banks) can destroy you. So the question becomes how much leverage do you take on? For housing the typical 20% down payment makes sense and should be the bare minimum. For other assets it really depends upon your risk tolerance, asset allocation and long-term goals.

IN SUMMARY
I’m not saying go out to Macy’s and Best Buy max out your credit cards on deprecating assets. I am saying use debt to your advantage. Leverage assets that in the long run increase in value and/or generate passive income, while using cash to purchase deprecating assets. Don’t assume that all debt is “evil”. When using debt and risk management properly, it is one of secrets of becoming wealthy. If used improperly can enslave you for the rest of your life.

Larry Ludwig - Started Empowering Media in 2001, a managed hosting provider offering system administration consulting and web hosting services. He lives in Long Island, NY is married to Jeanne and has two children. His “hobby” is investing and reading personal finance books.

You can reach him via Twitter @lludwig

Get An Umbrella Insurance Policy – Your Teenager Is Going To Bankrupt You

admin — Tue, 20 Oct 2009 08:00:53 +0000

Written by: admin on October 20, 2009.

I was driving downtown to drop my wife off at the museum when a car started drifting dangerously into my lane. I beeped the horn to alert the driver and when I drove by, the teenage kid in the back seat flicked me off! I didn’t have a long annoying horn, nor a machine gun type rat-ta-tat-tat beep. All I did was beep once so we wouldn’t collide. The father was reading a map and driving at the same time.

I have to admit that my blood started to boil and I was tempted to blast him a new one when their car stopped next to me in front of the light. Instead, I buzzed down my window, stared intently, and told the kid, “Don’t embarrass your parents. I beeped at you guys because you were halfway in my lane and didn’t even know it.”

The dad was still clueless as to why I was talking to his punk kid and he also rolled down his window to ask, “What’s up?”

“You’re kid gave me the finger, that’s what’s up. You’ve got yourself a live one,” I said. The mom in the front passenger seat started questioning her son and then started screaming at him. She apologized on his behalf and said in an exasperated voice, “Teenagers!”

In my earlier days, I may have got out of the car and lost it. Maybe we’d have a rumble in the middle of the street, I don’t know. What I do know is that teenagers create a ton of trouble and are one big fat liability for parents. I should know, because I remember almost burning down our apartment when I tried to set my bed on fire! If your teenager gets into a car accident and injures someone, the parents are the ones liable for all the damages!

UMBRELLA INSURANCE POLICY (AKA EXCESS LIABILITY INSURANCE)

MSN Money

An umbrella policy is simply an added insurance policy that kicks in after your auto and home-owner’s insurance runs out. Some people make the mistake of getting an umbrella policy that matches your assets and no more. But what if you have $500,000 in assets, and someone sues you for $1 million for slipping on your front steps? It’s better to get an umbrella policy with coverage at least 50% more than your total assets.

You spend your entire life building your assets, you owe it to yourself to protect your financial health with an umbrella policy. We’re in lawsuit happy land, so better safe than sorry, especially if you’ve got a teenager! If you entertain a lot, have a home business with clients coming and going, or drive constantly for work, these are other reasons why you should consider an umbrella policy.

FALL OPEN ENROLLMENT

In a good way, it’s nice having very little to your name as an adult. If you’re found liable of something bad and lose in court, what are they going to go after, your underwear?

Now is open enrollment season to make insurance choices for next year. Study your employee benefits carefully, and do your best to forecast your anticipated healthcare and insurance needs. Are you getting Lasik corrective eye surgery? Max out your Flex Spending Account (FSA), which is a pre-tax expense. Anticipating visiting the doctor next year to check out a chronic knee injury? Perhaps go from a high deductible medical plan to a low deductible plan since you may need surgery. Make sure you have long term disability in case you get injured and can’t work for months. Furthermore, get as much supplemental life insurance as possible if you have dependents. Lack of insurance is one of the leading causes for financial ruin, so make sure you have at least the minimum coverage to protect yourself if disaster strikes!

Be well! Do you know where your teenager is?

Keigu,

Financial Samurai – “Slicing Through Money’s Mysteries”

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