I get this question a lot from people: What should I do with 10,000?
Wow.
Sometimes I don't know where to begin. Endless possibilities...remember the Rubik's cube? Young people under 25 maybe not, but your parents or older siblings might. Its a cube with 9 sections on each side that you have to turn and swivel so each side is the same color. Sounds easy? I saw a special on the History Channel called 80's tech (and also in my favorite movie: The Pursuit of Happ(y)ness) that it has 43,000,000,000,000,000,000+ combinations! That's 43 quintillion, or 43 million trillion...a huge number to be sure.
Ok, so there's not THAT many combinations or possibilities for investing 10k, but there are a few important questions you ask yourself before investing.
1) What is your investment horizon? In other words, when will you need the money. Generally, you can invest in 'risky' investments if you have a long-term horizon, but remember it is not the investment that is risky, it is the investor's knoweldge that makes the investment risky. Take on the risk you can stomach; don't put your money in stocks if risk makes you feel like you're on a roller coaster, literally.
2) Do you have a decent savings account? I think it is important to have some money in a savings account. 500? 5,000? 50,000? It is completely up to you. Maybe you're renting and don't have a need for a big savings account, or you have a home that's older and is in need of maintanence soon. Keep some money liquid for those planned and unplanned life events.
3) What interests you? This is very important; you need to identify what investments you are interested in, if any. If you don't want to learn about investing, or prefer someone else to handle the investing, be realistic about the returns you will receive. Mutual funds are huge, and can't move as quickly as a small stock portfolio. Bank products will always pay you less than they charge when you borrow, that's their business model.
If you figure out what interests you, your investment horizon, and have some savings, it should be easier to find what to invest in. Just remember that the safety of principal you get from bank products, government securities, your home (usually) is only safe for the principal, but not for your financial future. The safer your investing is today, the more money you will have to save to acheive your goals. Take on all the risk you are comfortable with, and you will stick to your plan. That is the most important thought I can leave you with my friends.
Tuesday, May 13, 2008
Monday, May 12, 2008
Refinancing an Adjustable Rate Mortgage
A lot of people today that have adjustable rate mortgages are finding out exactly how these loans work. I think for the most part they are good idea, mainly for people who will keep the home for a short period of time, have a large downpayment, or can be reasonably certain they will maintain a solid credit history so they may refinance the loan when it reaches the adjustment period. But not everyone is so fortunate.
If you are having trouble with a loan that has already reset to a higher rate, go to http://faq.fha.gov/cgi-bin/answers_hud.cfg/php/enduser/std_alp.php?p_sid=IKI2wy3j You will find some great info there about refinancing a non-FHA loan to a fixed rate after your existing mortgage has been reset, along with some other important qualifications. There are many restrictions, but this would be a great way to go if you qualify.
Another way to save yourself from an unaffordable payment is to refinance on your own. If your credit is ok, you should still be able to get a new loan, providing you have built up sufficient equity. Loan companies have become more strict in this regard, but if you have 20% equity, you should be able to find a suitable fixed rate mortgage.
If these options are not available to you, talk to your lender about your adjustable rate. Maybe you can negotiate a more favorable rate if you have maintained solid payment history with them. They will be more inclined to talk with you before any issues arise. It can't hurt to ask!
If none of these work, and you don't have a "money angel" you can obtain funds from, you may need to put your house on the market. Isn't it a bad time to sell? Not necessarily; someone is always willing to buy a house at a reasonable price, it just might take longer. I hope it doesn't come to this my friends, but the hard reality is you will need a roof over your head, and it must be affordable. There is no shame in any of this; unique economic circumstances ensure that some will be adversely affected while other prosper to some degree.
ARMs are not bad loans; just be certain that the person you receive information is not biased (listen to your loan officer, but get a second opinion to verify the validity of the information; most loan officers are fair people, but they are selling mortgages, not long-term financial plans)
Thank you for reading!
If you are having trouble with a loan that has already reset to a higher rate, go to http://faq.fha.gov/cgi-bin/answers_hud.cfg/php/enduser/std_alp.php?p_sid=IKI2wy3j You will find some great info there about refinancing a non-FHA loan to a fixed rate after your existing mortgage has been reset, along with some other important qualifications. There are many restrictions, but this would be a great way to go if you qualify.
Another way to save yourself from an unaffordable payment is to refinance on your own. If your credit is ok, you should still be able to get a new loan, providing you have built up sufficient equity. Loan companies have become more strict in this regard, but if you have 20% equity, you should be able to find a suitable fixed rate mortgage.
If these options are not available to you, talk to your lender about your adjustable rate. Maybe you can negotiate a more favorable rate if you have maintained solid payment history with them. They will be more inclined to talk with you before any issues arise. It can't hurt to ask!
If none of these work, and you don't have a "money angel" you can obtain funds from, you may need to put your house on the market. Isn't it a bad time to sell? Not necessarily; someone is always willing to buy a house at a reasonable price, it just might take longer. I hope it doesn't come to this my friends, but the hard reality is you will need a roof over your head, and it must be affordable. There is no shame in any of this; unique economic circumstances ensure that some will be adversely affected while other prosper to some degree.
ARMs are not bad loans; just be certain that the person you receive information is not biased (listen to your loan officer, but get a second opinion to verify the validity of the information; most loan officers are fair people, but they are selling mortgages, not long-term financial plans)
Thank you for reading!
Wednesday, May 7, 2008
Credit Crisis Waning?
I read an article in the Wall Street Journal today about a possibility that the credit crisis is softening, although it is not completely over. What does this mean for the average American? In the interest of simplifying things as my blog intends to do, I offer my take on the recent events in the credit markets.
U.S. Treasury Secretary Henry Paulson was quoted in the Wall Street Journal as thinking things may be improving, stating "There's no doubt that things feel better today, by a lot, than they did in March". He may be right; from an average consumer standpoint, the Federal Reserve Board lowering rates by more than 3 percentage points since last year gives him/her the advantage of borrowing at lower rates. However, I for one wonder if lower rates are always good for the economy.
Now don't misunderstand me, lower rates for borrowing certainly keep markets liquid; in other words, money continues to flow like a river uninhibited by any diversions. But I would caution anyone from borrowing large sums, say for a house, in the current credit environment for the sole purpose of lowering interest costs. While it is generally a good idea to pay as little interest as possible, if you don't already have a mortgage, I think you need another reason to get one besides the fact rates have fallen.
Has the real estate market bottomed out in your area?
Are you able to still save for you retirement?
Do you have sufficient savings if you lose your job and can't return to work for 6 months?
Do you have disability insurance if you're hurt and can't return to work?
You must ask yourselves these questions my friends. Once you have comfortable answers to these questions, borrow at the lower rates, or refinance. Just make sure if you plan to refinance, that you refinance for the remaining term of your current mortgage. Don't fall in to the trap of extending your mortgage another 30 years for a lower payment that will cost you dearly in the long run. See my post on Compound Interest Overview last week for an explanation on the cost of borrowing. (Exception: you take the savings from the lower interest cost and invest/save the money!)
Just trying to make "cents" of the financial world!
U.S. Treasury Secretary Henry Paulson was quoted in the Wall Street Journal as thinking things may be improving, stating "There's no doubt that things feel better today, by a lot, than they did in March". He may be right; from an average consumer standpoint, the Federal Reserve Board lowering rates by more than 3 percentage points since last year gives him/her the advantage of borrowing at lower rates. However, I for one wonder if lower rates are always good for the economy.
Now don't misunderstand me, lower rates for borrowing certainly keep markets liquid; in other words, money continues to flow like a river uninhibited by any diversions. But I would caution anyone from borrowing large sums, say for a house, in the current credit environment for the sole purpose of lowering interest costs. While it is generally a good idea to pay as little interest as possible, if you don't already have a mortgage, I think you need another reason to get one besides the fact rates have fallen.
Has the real estate market bottomed out in your area?
Are you able to still save for you retirement?
Do you have sufficient savings if you lose your job and can't return to work for 6 months?
Do you have disability insurance if you're hurt and can't return to work?
You must ask yourselves these questions my friends. Once you have comfortable answers to these questions, borrow at the lower rates, or refinance. Just make sure if you plan to refinance, that you refinance for the remaining term of your current mortgage. Don't fall in to the trap of extending your mortgage another 30 years for a lower payment that will cost you dearly in the long run. See my post on Compound Interest Overview last week for an explanation on the cost of borrowing. (Exception: you take the savings from the lower interest cost and invest/save the money!)
Just trying to make "cents" of the financial world!
Tuesday, May 6, 2008
Renting vs Buying
There is a lot of press lately about renting vs buying, and I have my own opinions on the subject to be sure. Let me first tell you that I am renting myself, but this blog post will be completely unbiased one way or the other. The main point will to be to illustrate how difficult it can be to make a financial decision that has outside factors influencing the decision. I am talking about emotion.
Emotion is wonderful; there would be little point to life if we did not have emotion. You buy a house perhaps because you want to feel as though you own something that no one can take away from you, or you simply want something that is unique to you. Apartments can be that way, but it is difficult to personalize a place that you see as temporary, or a place that you are at for a long time but have to abide by your landlord's rules. So I fully understand why people buy homes, and I myself would like to be in that position soon, but I live in a very expensive area (west suburban Chicago) and would like to buy in a less expensive area someday.
If your emotions tell you to buy rather than rent, then carefully consider the amount of money it will cost to buy. Most people know they will have a mortgage, but they don't always consider how much the taxes will be, insurance, PMI (private mortgage insurance, usually required for loans with less than 20% down, although there are exceptions) and the big one, maintenance costs. You may have these initially, or eventually, but they are a real cost that is hard to predict but easy to forget about.
Here is a real life example:
Rent: 1275/month for a 2 bedroom, 2 bath unit, 5 years old
Buy: Something similar in my area, a newer place 2 bed/2 bath goes for about 200-250k. So on the low end...
Principal/Interest: @ 6% for 30 years about 1200/month
Taxes: typically around 2% of home value so about 333/month
Insurance: I'd say about 50/month
Maintenance: If this is a condo/townhome, figure at least 100/month for association dues which covers most of the maintenance
PMI: Can run upwards of 200/month, we'll use 200/month for now
So in summary...
Rent: 1275/month
Buying: 1883/month, about a 600 difference
Does this mean I should buy? Well, maybe I should. But I prefer to invest the 600 in stocks and other investments. My risk tolerance is high, but yours may not be. Should you rent or buy? My friends, the decision is solely up to you, but the finance part is easy and doesn't mislead. Eventually, the rent will rise and exceed the buying cost, so if you're holding period is in the decades, you may be better off buying. Just be honest with yourself, and remember to make some of your money work for you, whether in a home, stocks, or a savings account. Any sort of plan is better than none at all.
Emotion is wonderful; there would be little point to life if we did not have emotion. You buy a house perhaps because you want to feel as though you own something that no one can take away from you, or you simply want something that is unique to you. Apartments can be that way, but it is difficult to personalize a place that you see as temporary, or a place that you are at for a long time but have to abide by your landlord's rules. So I fully understand why people buy homes, and I myself would like to be in that position soon, but I live in a very expensive area (west suburban Chicago) and would like to buy in a less expensive area someday.
If your emotions tell you to buy rather than rent, then carefully consider the amount of money it will cost to buy. Most people know they will have a mortgage, but they don't always consider how much the taxes will be, insurance, PMI (private mortgage insurance, usually required for loans with less than 20% down, although there are exceptions) and the big one, maintenance costs. You may have these initially, or eventually, but they are a real cost that is hard to predict but easy to forget about.
Here is a real life example:
Rent: 1275/month for a 2 bedroom, 2 bath unit, 5 years old
Buy: Something similar in my area, a newer place 2 bed/2 bath goes for about 200-250k. So on the low end...
Principal/Interest: @ 6% for 30 years about 1200/month
Taxes: typically around 2% of home value so about 333/month
Insurance: I'd say about 50/month
Maintenance: If this is a condo/townhome, figure at least 100/month for association dues which covers most of the maintenance
PMI: Can run upwards of 200/month, we'll use 200/month for now
So in summary...
Rent: 1275/month
Buying: 1883/month, about a 600 difference
Does this mean I should buy? Well, maybe I should. But I prefer to invest the 600 in stocks and other investments. My risk tolerance is high, but yours may not be. Should you rent or buy? My friends, the decision is solely up to you, but the finance part is easy and doesn't mislead. Eventually, the rent will rise and exceed the buying cost, so if you're holding period is in the decades, you may be better off buying. Just be honest with yourself, and remember to make some of your money work for you, whether in a home, stocks, or a savings account. Any sort of plan is better than none at all.
Thursday, May 1, 2008
Compound Interest Overwiew
Some have remarked over the years that compound interest is the 8th wonder of the world. It can be, depending on what side of the equation you're on. When you are the borrower paying interest, you may or may not realize that the amount of interest you're paying nearly meets or exceeds the original principal you borrowed. This is most common with credit cards stretched out for months, but happens quite often with home loans. Here's a quick overview of compound interest:
Compound interest is named as such because the interest is calculated on the new balance each month (sometimes daily) to determine the payment schedule. This is important to know because interest is not calculated once, but monthly or even daily. Let me illustrate the difference:
If you borrow 200,000 at a 5% interest rate to buy a home and make payments for 30 years, under a simple interest plan you would only pay 10,000 in interest for the entire 30 years or about $28/month plus the principal paydown of 556, for a total of about $583/month. Now, those who have mortgages know it doesn't work that way, but do you know why? Compounding interest. Here's how it works:
Take the same 200,000 at 5% compounded monthly. Your principal paydown (the amount paid to reduce the 200,000 each month) is still about $556/month, but your total payment would be $1073.64 for principal and interest. If you divide the amount of interest paid ((1073.64-556) * 360) you get $186,120, almost the same amount of principal! Divide 186,120/200,000 and you get a percentage of 93.06%. That's your effective interest rate over 30 years, or a little over 3% per year. Compare that with simple interest where you pay 5% over 30 years, or about 1/6% per year, and you may never look at interest the same way.
The good news when you invest, compounding works for you. If you saved $1000 and had the choice of putting that into a certificate of deposit earning 4% or a mutual fund earning 8%, the difference is astonishing. Over a 20 year period you would have $2191 in the CD, but over $4660 in the mutual fund! If you could earn 10%, you would have 6727, nearly 50% more than at 8%. Put the power of compound interest to work for you my friends.
I will include a blog about how to use a spreadsheet program like Microsoft Excel to do your own projections of investments and borrowings. Also coming soon is a wonderful take on the "rent vs Buy" dilemma. You will be amazed at what you learn!
Compound interest is named as such because the interest is calculated on the new balance each month (sometimes daily) to determine the payment schedule. This is important to know because interest is not calculated once, but monthly or even daily. Let me illustrate the difference:
If you borrow 200,000 at a 5% interest rate to buy a home and make payments for 30 years, under a simple interest plan you would only pay 10,000 in interest for the entire 30 years or about $28/month plus the principal paydown of 556, for a total of about $583/month. Now, those who have mortgages know it doesn't work that way, but do you know why? Compounding interest. Here's how it works:
Take the same 200,000 at 5% compounded monthly. Your principal paydown (the amount paid to reduce the 200,000 each month) is still about $556/month, but your total payment would be $1073.64 for principal and interest. If you divide the amount of interest paid ((1073.64-556) * 360) you get $186,120, almost the same amount of principal! Divide 186,120/200,000 and you get a percentage of 93.06%. That's your effective interest rate over 30 years, or a little over 3% per year. Compare that with simple interest where you pay 5% over 30 years, or about 1/6% per year, and you may never look at interest the same way.
The good news when you invest, compounding works for you. If you saved $1000 and had the choice of putting that into a certificate of deposit earning 4% or a mutual fund earning 8%, the difference is astonishing. Over a 20 year period you would have $2191 in the CD, but over $4660 in the mutual fund! If you could earn 10%, you would have 6727, nearly 50% more than at 8%. Put the power of compound interest to work for you my friends.
I will include a blog about how to use a spreadsheet program like Microsoft Excel to do your own projections of investments and borrowings. Also coming soon is a wonderful take on the "rent vs Buy" dilemma. You will be amazed at what you learn!
Wednesday, April 30, 2008
2008 Tax Season
Yes, the 2007 tax season is behind us, officially completed for most folks on April 15, 2007, but it is never too early to plan for 2008. In fact, 4 months have already gone by this year, and with it 4 months of possibly the same mistakes made from last year.
Did you get a refund this year?
Maybe you have heard this before, but for those who haven't, there is no such thing as a refund from the government, unless you are a low income earner who qualifies for the Earned Income Credit (go to IRS.gov for more info on that). Any amount you received from the IRS this year or in years past is simply an overpayment of tax. Just go to the bottom of your 1040 and find the amount of your "refund"; you will see the word "overpayment" to the left.
Let me explain how the overpayment is calculated. Each year you earn income, then the IRS allows you a standard deduction or to itemize certain deductions like home mortgage interest and taxes, and exemptions for yourself, spouse and each dependent, and you're left with the taxable income. Then the IRS takes the taxable income and multiplies it by the marginal tax rate (check out IRS.gov for 2008 tax tables). To simplify things, marginal simply means that the income is broken down into brackets, where the first 7825 is taxed at 10%, then the next bracket at 15% up to the highest bracket of 35%. This system ensures that wealthy pay 35 cents on every dollar they earn over a certain amount, 349,700 in 2007. Once the tax is calculated, the amount is subtracted from the amount already withheld from your checks, along with certain credits you receive for raising children, saving for retirement, etc. If the amount withheld exceeds the amount you owed, you get a "refund".
Now ask yourselves my friends; if you were to borrow a 1000 from your local bank, and they could somehow suspend payments until the loan matured in say, one year, what are the odds that they will not require you to pay interest on the loan? My guess? Substantial interest is required. But when you give the government extra money each month in anticipation of your "refund", how much interest do you earn on your money? None!
Now, I don't think the IRS should give you interest. In fact, they are nice enough to allow you to pay in only 90% of what you owe each year with NO penalties! Did you know this? That means if your tax liability was 10,000, you would only have to withhold 9,000 from your checks each year, leaving you a 1000 balance the following April. Sounds like a lot to owe? Break it down into monthly installments, and you could simply put 80 dollars away each month (You were going have that withheld from your check remember?). Also, if you always receive a refund each year, calculate how much interest you could have earned, and may in the future. Simply take the refund, say 4000, an multiply by a reasonable return, say 8% in a long-term growth fund. That's 320 dollars of interest. Now take the balance of 4320 an multiply that by 8% and you have $345.60 of interest. That's the power of compound interest, which I will discuss in a later post.
Talk to your HR people now about adjusting your withholding, or a competent accountant (hint: I am one!)
Did you get a refund this year?
Maybe you have heard this before, but for those who haven't, there is no such thing as a refund from the government, unless you are a low income earner who qualifies for the Earned Income Credit (go to IRS.gov for more info on that). Any amount you received from the IRS this year or in years past is simply an overpayment of tax. Just go to the bottom of your 1040 and find the amount of your "refund"; you will see the word "overpayment" to the left.
Let me explain how the overpayment is calculated. Each year you earn income, then the IRS allows you a standard deduction or to itemize certain deductions like home mortgage interest and taxes, and exemptions for yourself, spouse and each dependent, and you're left with the taxable income. Then the IRS takes the taxable income and multiplies it by the marginal tax rate (check out IRS.gov for 2008 tax tables). To simplify things, marginal simply means that the income is broken down into brackets, where the first 7825 is taxed at 10%, then the next bracket at 15% up to the highest bracket of 35%. This system ensures that wealthy pay 35 cents on every dollar they earn over a certain amount, 349,700 in 2007. Once the tax is calculated, the amount is subtracted from the amount already withheld from your checks, along with certain credits you receive for raising children, saving for retirement, etc. If the amount withheld exceeds the amount you owed, you get a "refund".
Now ask yourselves my friends; if you were to borrow a 1000 from your local bank, and they could somehow suspend payments until the loan matured in say, one year, what are the odds that they will not require you to pay interest on the loan? My guess? Substantial interest is required. But when you give the government extra money each month in anticipation of your "refund", how much interest do you earn on your money? None!
Now, I don't think the IRS should give you interest. In fact, they are nice enough to allow you to pay in only 90% of what you owe each year with NO penalties! Did you know this? That means if your tax liability was 10,000, you would only have to withhold 9,000 from your checks each year, leaving you a 1000 balance the following April. Sounds like a lot to owe? Break it down into monthly installments, and you could simply put 80 dollars away each month (You were going have that withheld from your check remember?). Also, if you always receive a refund each year, calculate how much interest you could have earned, and may in the future. Simply take the refund, say 4000, an multiply by a reasonable return, say 8% in a long-term growth fund. That's 320 dollars of interest. Now take the balance of 4320 an multiply that by 8% and you have $345.60 of interest. That's the power of compound interest, which I will discuss in a later post.
Talk to your HR people now about adjusting your withholding, or a competent accountant (hint: I am one!)
Economic Stimulus Checks
As our country is possibly heading into a recession (it hasn't happened yet, you need two consecutive quarters of negative GDP growth for a recession), our government is sending us a gift, specifically about $600/person. Where did that money come from? Mostly from the wealthy people who "don't pay taxes". I digress on that point, as I am a middle class citizen who is fully aware of how much tax is paid by the top 1 % of citizens, but I am focusing on what the $600/person means to our country.
You no doubt may be tempted to save that money or pay down debt. 99.9% of the time, this is a very smart move, and in this case, certainly not a bad move. The reason you should rethink this strategy is because this money is meant to be economic stimulus. Spending the gift is the smartest thing to do because this will help your local economy generate revenues, which can generate or maintain jobs, generating more tax revenue that could ultimately help your community. Politics aside, think hard about what you will do with the check. If you are otherwise in a good financial situation with a savings account, some retirement savings, and a manageable debt load, spend the money. Maybe a vacation, a new grill for summer, or take my wife's lead and buy some clothes. You will enjoy the small splurge, and millions of dollars pumped in to the economy will help everyone.
You no doubt may be tempted to save that money or pay down debt. 99.9% of the time, this is a very smart move, and in this case, certainly not a bad move. The reason you should rethink this strategy is because this money is meant to be economic stimulus. Spending the gift is the smartest thing to do because this will help your local economy generate revenues, which can generate or maintain jobs, generating more tax revenue that could ultimately help your community. Politics aside, think hard about what you will do with the check. If you are otherwise in a good financial situation with a savings account, some retirement savings, and a manageable debt load, spend the money. Maybe a vacation, a new grill for summer, or take my wife's lead and buy some clothes. You will enjoy the small splurge, and millions of dollars pumped in to the economy will help everyone.
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