Personal Finance and Money Management

Many Americans look forward to owning their own home one day.  It’s the mark of success to quite a large portion of the population here – it means that you’ve graduated past the renting phase in your life.  There’s nothing wrong with thinking this way at all – it’s just important not to let it blind you.

All over the place, borrowers are defaulting on their mortgages, banks are foreclosing, and property values are plummeting.  We’re just past the breaking point of the real estate “bubble”, and values are on their way down in many parts of the country.

Several of the areas where I’d like to buy a house are so overpriced that it’s only a matter of time before things cool off, and prices correct themselves.  For example, for Maryland, the state median income for households is about $56,000.  Decent sized homes in nice ( relatively safe, low crime, non BFE ) areas *start* at $300,000.  One can realistically expect to spend $400,000 to buy a nice home in such an area.

Now, bear with me, if you will.  Let’s say a particular family earns the median income of $56,000 per year.  After federal, state, and local income taxes, they’ll be looking at clearing about $39,200 ( at a 30% combined tax rate ).  That’s about $3,266 per month in after-tax income. 

Now, back to the home.  If this particular family was exceptionally good at saving, and was able to put down 10% ( $40,000 ) on their home, they’ll be financing a cool $360,000.  Assuming no property taxes, fees, or closing costs of any kind ( obscene to assume, yes ), and an interest rate of 6.5%, these folks will be looking at a monthly mortgage payment of $2275.44 per month.  That leaves them with $990.56 every month to pay for health care, food, cars, insurance, clothing, electricity, gasoline, and all the other expenses that life throws at us.  Not exactly realistic, is it?

There are worse examples, but Maryland is a close-to-home example for me.  There are many such parts of the country where home prices simply aren’t in line with incomes.  The exotic loans of the past few years helped put people into homes they cannot realistically afford under normal circumstances.  The coming months and years will see many more foreclosures, and subsequent price drops.  If you can hold out for a few more years, you may see a much brighter picture on the housing front.

Compared to May 2006, foreclosures on mortgages were up an astonishing 90% this past month.  Some parts of the country were worse off than others ( noticeably, California ), but as a whole the picture was very ugly.  Why the massive jump in foreclosures?  Well, a couple reasons.  For one, many ARM’s have been resetting.  With the rise in mortgage rates, some people’s mortgage payments are jumping several hundred dollars per month.  For those who purchased on the hairy edge of what they could afford, that spells disaster. 

For another, I feel the entire housing market is vastly overpriced.  Some people stretched themselves too thin buying a house, and even without an ARM reset, they find they are simply unable to keep their heads afloat.

Buying a home isn’t for everyone, and the foreclosure jump is proving that.  I expect many more months of the same, followed by a massive price correction in the housing market.

Here’s Suze Orman’s list of five money mistakes to avoid – targeted at men this time:

1. Funding early retirement with a home equity line of credit.

2. Not paying off the mortgage early.

3. Neglecting to make a will.

4. Refusing to take the investing long view.

5. Assuming the role of the family’s sole money manager.

Here’s my thoughts on each:

1. Fantastic tip – people use home equity lines of credit like a giant, bottomless piggy bank. Remember, you have to pay this money back at some point in time, and the interest rates aren’t altogether fantastic. There’s certainly no good reason to fund your retirement with it.

2. If you’re in a position to do so, a 15 year mortgage is a much better choice than a 30 year. Barring that, if you must go the 30 year route, pay an extra $20 or $30 each month, if that’s what you can swing. Any time you get a bonus from work, use a large portion of it on your mortgage. It will pay for itself many times over. Who wants to worry about making a big, fat house note when they’re retired?

3. If you die, who gets your assets? You don’t want them falling to the wrong people, so take the time to establish a detailed will.

4. Invest and sit back for the most part. Micromanaging your investments isn’t likely to earn you more money in the long run. In fact, it’s likely to earn you less. Leave it alone.

5. As a married couple, both of you should be on the same page financially. Granted, one person is likely to take the lead ( often the husband ), but the wife should be involved too – remembers, it’s both of your money.

Buying vs renting is one of the oldest dilemmas around. Financial gurus are very fond of saying something along the lines of “Homeowners get rich while renters stay poor.” Granted, there is much truth in this saying. Part of your house payment every month goes to paying down your mortgage. Add in home appreciation and you’re growing your net worth every month. Why wouldn’t everyone want to own a home then, you ask? Well, here’s a list of reasons off the top of my head:

• Buying costs much more every month ( mortgage + insurance + property taxes )
• Fluctuations in the housing market means your home may lose value short-term
• Repair costs can be significant in the event of a major problem
• Lawn & yardcare costs / extra work
• Energy costs will be significantly more than an apartment

In my current market, renting a nice 2 bedroom apartment runs a bit over a grand every month. To get a home that has similar features ( still have to give up some goodies, such as the gym & pool ) would cost more. Figuring in property taxes and insurance, we’d be looking at right around $1500 per month on a 30 year note – that’s a $500 per month difference. For the time being, we’ve decided to rent rather than buy – and here’s why.

I’m saving $500 every single month – and that’s just for starters. I estimate another $100 at least, in energy savings. That’s $600 per month in my pocket. Add it up, and I’m looking at $7200 per year, free and clear. And of course, if my water heater explodes, I simply call the apartment maintenance staff. They come in and take care of things while I’m off at work, and it doesn’t cost me a penny. I needn’t worry about spending my weekends mowing the lawn, trimming, edging, or shoveling snow in the winter. Granted, I’m not building any equity, and I’m not getting a big tax break due to mortgage interest, but that’s ok. I enjoy having less stress than I would as a homeowner, at least for right now in my life. I’m sure I’ll join the ranks of happy homeowners one day, but it will not be today.

A post over at Free Money Finance caught my attention recently. The post references an article in Kiplingers Personal Finance Magazine called The Invisible Rich.

The concept is very simple – people live above their means, and it costs them in the future. Many young adults drive more expensive cars than they need, and live in a bit nicer apartment than they probably should. Chances are they’ve got an awfully nice ( and expensive, of course ) television sitting in their living room, and tons of gadgets here and their. Their closet is likely filled with clothes that cost too much as well. These same people complain that they won’t be able to own a home – they wouldn’t be able to save enough for a significant down payment, let alone stroke the big mortgage payment every month.

These people live in stark contrast to ‘the invisible rich’ – the people who simply live below their means, and save money. They have a smaller apartment when they’re younger, they don’t drive fancy cars, and they keep their electronics purchases to a minimum. When they do purchase a home, it’s more modest than many, and the down payment will be sizeable. These are the people who grow their net worth every single month – not because they are ‘rich’ per se, but because they live within their means.

Where do I fall between these two groups of people? Well, I started in the first and I’m transitioning towards the second. I have tons of electronic gadgets; though I have thankfully restrained myself from purchasing a big-screen TV and home theater system. I recently sold a V-8 high-dollar sports car and bought a Honda Accord. My other vehicle is a leased Lincoln Navigator, which will be returned to Lincoln in about a year and a half once the 3-year lease is up. At that time I’ll buy something smaller, and powered by a 4-cylinder engine. Likely a Honda Civic, maybe another Accord, or possibly an Altima Coupe. I still have time, and I’m sure there will be some good, reliable, economic choices available then. Financially speaking, I should buy a used car, but I can’t bring myself to do that anymore. The risk of mechanical failure simply aren’t acceptable to me. If my car fails and I can’t get to work reliably, then I’ll sure wish I bought something newer. And I would never risk my wife in a car that had excessive miles, and I didn’t know the history of.

As far as apartments go, I live in a nice, but not extravagant apartment. I could live in a less expensive place, but it would be too crowded, and in a much less safe area. Again, not a risk I’m willing to take. My furniture is nice, and should last for quite some time. I don’t plan on making any major purchases for the next couple years ( new car aside ) , so I don’t have any big foreseeable expenses. I’m working hard to live more frugally, and put money away each month. When it’s time for me to buy a home, I certainly want to have a sizeable down payment, so I can keep my mortgage very reasonable, and continue to build savings for the future.

How about you – what category do you fit in?

In my line of thinking, there are just two types of credit card users. The first group is the most common – people who carry a balance month-to-month. These folks often pay the minimum payment on their credit card bill, whether out of ignorance or inability to pay more. Often, the balance doesn’t go down monthly; it goes up instead. These people are simply digging themselves deeper and deeper into credit card debt. Instead of credit being a valuable tool, these people see credit as a noose, and it gets tighter and tighter every day. You do not want to be this type of credit card user.

The second type of credit card user is the smart one. He uses credit to his advantage. He sees credit as a tool, and not as a crutch. He pays his balance off in full, every single month. To him, credit allows him to make one single payment every month, and track his purchases very carefully. It’s easy to see where your money is going when you get an itemized bill every month.

In addition to not carrying a balance, the second type of user generally uses some sort of reward credit card. Whether he gets points, airline miles, or even cash back, the second type of credit card user actually makes money by using his cards, instead of paying interest.

Granted, if every type of credit card user was the second type, then we’d likely see a drastic change in credit card programs and policies. Reward programs would get much less lucrative, or even disappear. Annual fees would come storming back. The credit card companies might even introduce all kinds of new, never before seen fees, just so they can earn a profit. See, the first type of user balances out the second type, and enables them to come out ahead. Even so, I’d definitely urge you to join the ranks of type 2, and avoid being type 1. If you are currently a type 1, please stay tuned for some tips to get to the other side.

One of my basic financial principles is to have at least 6 months worth of your expenses in the bank. These funds should be easily accessible – i.e. not in an IRA or a CD.

When you’re calculating how much you need for your emergency fund, add up your necessary expenses. You can skip things like cable TV, starbucks, and eating out. If you’re in a tough financial situation, you can cut back easily in those areas.

The 6 month fund is designed to keep your head above water if you lose your job. The last thing you need during a job search is scrambling to pay rent and feed your family. You should be able to fully concentrate on finding the right job.

I’m still working on this goal, unfortunately. My monthly expenses are much higher than I’d like for the time being, and that’s making my goal fairly difficult. Are you working towards this goal? Have you reached it yet?

John Chow made a very hard-hitting point recently, when he decided not to purchase a new Corvette Z06. And I quote -

‘This doesn’t mean I can’t spend $100,000 on a new car. I certainly can and she wouldn’t get mad at me for doing so. However, my financial planning background says $100,000 invested at 12% for 10 years equals $310,584.82, where as the $100,000 car is worth $10,000 in 10 years (if even that).’

That really is a novel way to look at a car. If you’re fortunate enough to be in a situation where you can afford a 100k car ( A Z06 is actually 85k ish if memory serves correctly, but we’ll go with 100k because it’s round ) , then good for you. You should ask yourself though, is the car I’m about to purchase worth $300,000? Chances are, you’ll say no way, it’s not worth nearly that much.  And if that’s the case, you really should rethink that purchase.  Having $300k in the bank is a much wiser financial choice than having a money-burning supercar sitting in your driveway, don’t you think?

Lazy man over at Lazy Man and Money has been dabbling pretty heavily in Prosper.  So far, he’s seen a 23.55% return on his money – that’s fantastic.  So why don’t I have a Prosper account set up yet?  Well, for starters, it scares the living crap out of me.  Lending money to people I don’t seems extraordinarily risky in my eyes.  Granted, the returns are potential huge, but I have a strong fear of losing my investment completely.

With any investment, there’s always that same risk, of course.  I think I may follow in Lazy Man’s footsteps and take a gamble on Prosper.  I’m going to take baby steps, however, and invest very slowly at the beginning.  If I see solid returns, then I’ll consider funelling more money that way.  Is anyone else using Prosper, and if so, how is it working out for you?

Over the course of this month, I’m going to sit down and set up several financial goals for 2007.  Having goals is necessary if you ever want to have any sort of real financial peace.   It’s important to have both short and long-term goals.  Short term goals help keep you motivated and focused on the right now; the near future.  Achieving your short term goals will keep you pumped about reaching your long term ones.

Your short-term goals should always lead up to your long-term ones; they should not be separate.  If the small goals don’t help you reach your big goal, then you need to re-do your small goals!
Finally, remember to set attainable goals.  It’s easy to set a goal of “Become a millionaire by June!”.  But is that realistic?  Of course not.  If you consistently set goals that you can’t hit, you’ll become discouraged, and won’t try anymore.

I bet you don’t know.  What’s more, I bet you’d be very afraid if you took the time to find out.  Go ahead, look over the past month’s receipts and find out.  Add up your groceries, fast food, dining out, and even the Starbucks or Seattle’s Best coffee that you enjoy.  Add that up, hit total, and feel your jaw drop.  All of us could stand to spend less on food than we currently do.  Where do you start?

• Eat out less – This is the biggest killer to your food budget.  It’s simply cheaper to eat at home – by far!
• Skip the fancy coffee – $4 per cup is brutal – that’s $120/mo if you have one daily.  Go to 7-Eleven and spend $1 instead
• Create a monthly budget – Stick to your food budget each month, even if it means Ramen noodles the last week.  You’ll learn to spend more wisely

What other ideas do you have to save money on food?

The most simplistic, fundamental thing to learn about money – spend less than you earn. As long as you spend less money every month than you earn, you will never go wrong. It’s such a simple concept – I can hear you all saying “well DUH” through the giant tubes of the internet. But the fact is, many many people don’t follow this simple rule. Spending more than you earn every month is a guaranteed way to the poor house, and possibly even bankruptcy. If you’re not tracking your spending each and every month, then there is no better time to start than right now.