Naturally, I assumed you would want to know more of their story, so I asked if they would agree to an interview. Good sports that they are, they agreed. Thank you John and Lisa! Here is their story:

When did you get serious about getting your finances under control?

Our finances have never really been out of control, but after listening to the Financial Peace seminar it became obvious we needed to get out of debt.   We found paying interest for “stuff” to financial institutions was making us have to work harder and enjoy our family less.

How did the car purchase itself go?

Quickly. haha The oddest part was writing a check out of our personal account and driving away with only a receipt.

Did you struggle with the decision to pay cash?

Not at all.

How do you feel about it now?

Great and in control.

How have your lives changed since you decided to get rid of your debt?

We feel more secure and stable. We know that no matter what happens, we will have our basic necessities protected. It makes not following the Jones’ much easier. We are no longer enslaved by the atmosphere of consumerism.

How much debt have you paid off in the past few years?

We have paid off $130K (including the home) since starting. We also have paid cash for all needs since deciding to not take on debt. It has been 3 or 4 years.

What has been the most difficult part of this journey?

Weekly budgeting and controlling daily spending. We still haven’t mastered this yet.

Have the two of you been on the same page throughout the process?

Yes, both of our families discouraged borrowing. So we were raised with the same similar mindset toward family finances.

How have you differed?

Not much. We have had to redirect each other at times, but it wasn’t a struggle.

What has been the key in working together?

Having the same goal and desired outcome. We want to play with our kids more. We work so we can live, not live so we can work.

I know you have one daughter who has graduated from college and two preteen daughters at home. How has this focus on your finances affected them?

We are fortunate to have healthy incomes, so the burden has not been too great for them. But they are getting an education along the way. They are also not kids that place a lot of value on “stuff”.

Do you think your journey has been a good influence on them?

Absolutely and for Kathe too. She had to struggle through college and manage her finances well. She did not take on school loans or credit card debt for her bachelors degree. She worked throughout college and finished in 4 years. She drove the same car she had in high school. She lived on campus and worked campus jobs. She aggressively pursued opportunities for stipends, grants or other positive financial assistance programs.

What is your biggest financial challenge going forward?

Staying comfortable in the stock market with investment strategies. Lost $7200 over the last 3 months in my 401k. Wisest investment for us to date has been property.

Do you believe you will stay debt free for the rest of your lives?

ABSOLUTELY!! We are even looking to downsize our housing to a more modest and realistic size.

Anything else you would like to add?

We think the work you are doing is very helpful for people and we are thankful for our experience with you.

Concluding thoughts

You have just read a real life story of a family who is debt free (having paid off $130,000 in debt) and committed to staying that way. John and Lisa are passing this legacy on to their children; their daughter worked and sacrificed to make it through college with no credit card or student loan debt. My hunch is that their two younger daughters will do the same.  My congratulations to John and Lisa: you are doing it right!

How about you?  Do you pay cash for your cars? Are you debt free?  Are you working toward becoming debt free?  How are you progressing?

photo credit: quaziefoto

If you are experiencing any trouble with your current mortgage payment, then mortgage loan modification may be a favorable option for you. Often termed as loan modification, it is a restructured payment agreement  between the mortgage lender and the borrower with revised interest rates and terms. The purpose is to help the borrowers stay current on their mortgage payment. It is a better alternative to bankruptcy or foreclosure.

Right time for loan modification

It would be the right time to go for your loan modification when you do not qualify for mortgage refinance, yet you wish to lower down your monthly mortgage payments. Also, if you have already fallen behind your monthly mortgage payments and want to stop foreclosure on your home, then it is better to think of mortgage loan modification.

How to qualify for mortgage modification

There are 6 basic qualifying factors that your lender will evaluate before granting you a mortgage loan modification. The factors are summarized in the following lines.

1. The nature of your financial hardship (such as job loss, sudden medical expenses, etc.)
2. You have missed mortgage payments for 3 consecutive months or more.
3. You have not filed bankruptcy.
4. You occupy the mortgaged property as your primary residence.
5. You are willing to work with your lender for an alternative payment option.
6. Your lender will also evaluate your future financial situation and equity in your property.

The lender will approve your loan modification only if he finds that you will be able to make the monthly payments, which will also favor the interest of the lender in the long run.

Documents required for loan modification

The primary purpose of documentation is that the lender wants to evaluate your financial condition along with assessing the risk associated with your loan modification. The required documents are listed below.

1. Letter explaining your financial hardship.
2. Your detailed monthly expense report and your budget.
3. Proof of your current income and your capability to make the modified mortgage payment.

Benefits of mortgage modification

When you are experiencing loan problems, mortgage modification is beneficial for you in a number of ways. Have a look at the following points that highlights the benefits.

• Your mortgage loan will become current.

• You will be able to reduce your interest rate and monthly payments.

• Your loan will also include your past due payments.

• You can extend the term of your loan.

If you find it difficult to negotiate with your lender regarding the loan modification, then you can contact a loss mitigation specialist or an attorney, who will communicate on your behalf.

Readers: Have you ever made a loan modification?  How did it go?  How did it help?  Would you recommend a loan modification to others?  Why?

By having a plan, you can pay off your house (and everything else) early.

“It seems like we will be making house payments forever. We owe $140,000 at 6% interest and are paying $1000 a month. How much sooner could we pay it off if we started paying an extra $100 a month?”

The above is a hypothetical question, but it could be you. There are two answers: the quick one and the “dig deeper” one. By clicking a few buttons on a financial calculator we discover the quick answer is 21 months; paying an extra $100 will reduce the payoff from 20 years to 18 years and 3 months.

COULD you pay off your house early? Sure. But SHOULD you?

Let’s dig deeper. Do you have other debt? Do you have any savings? Do you have an emergency fund? Are you on target with your retirement investments? Do you have children who will need some help with college funding?

Being as this is a hypothetical case, let’s say you are paying $300 a month at 12% APR on $5,000 on credit card debt and $500 a month at 8% on an $8,000 car loan. You have $2,000 in a savings account, nothing set aside for emergencies, you are on target with retirement investments and you have two children, ages 4 and 8. Your challenges are to not only get your house paid off, but also get out of debt, build an emergency fund and make plans for your children’s education. Don’t get overwhelmed. You can accomplish all of these and still pay your house off early by setting priorities and taking things one step at a time. Let’s develop a plan.

Clearly Communicated Budget

Yes, the dreaded “B” word…you knew it was coming. But until you are in control of your money, you simply cannot develop any type of a plan. It is essential that you and your spouse communicate openly while developing this budget. Discuss hubby’s dream bass boat and your dream kitchen. Leave nothing out now because it will surface later. Let’s assume you two worked together and decided that by eating out less, simplifying your vacations, getting a smaller tax refund and cutting back on Christmas spending, you find $500 a month positive cash flow.

Small Emergency Fund

Life happens, so you need a small emergency “buffer” fund. Simply label that savings account as an emergency fund and agree not to touch it for anything except emergencies. Voila! Your small emergency fund is complete.

Get Rid of Credit Card and Car Debt

We will come to paying your house off early in a minute, but let’s first free up more cash flow by attacking your credit card debt and car debt in that order. Keep making your regular car payment while bumping up your credit card payments to $800 a month (the $300 you were already paying plus the $500 you found in your budget). In seven months, when your credit card debt is gone, add the $800 you were paying on the credit card to the $500 you are paying on your car. With new payments of $1,300 a month on a car debt (now down to $4,800), it will be gone in about four more months. Are you still with me? You have just paid off your credit card debt and car loan in only eleven months. By doing so, you have bumped your cash flow from $500 a month to $1,300 a month. Congratulations!

Time for a Big Emergency Fund

Grandma called it her “rainy day fund” for good reason: rainy days come. A big emergency is a higher priority than paying off your house early because when emergencies come, you need readily accessible funds. More equity in your house would not help if you lose your job tomorrow. Depending on your number of income streams and volatility of your job, you need at least three months of expenses; many financial planners recommend six months and some nine months. Let’s assume your expenses are $3500 a month and go for a six month emergency fund. Your goal therefore is $21,000, so you need to save $19,000 to add to the $2,000 you already have. At $1,300 a month, you will need at least 15 months to achieve this goal. After only 26 months, you have paid off $13,000 in debt and saved another $19,000. You are on fire!

Retirement

You said that your retirement was on track, so I am taking you at your word. If it wasn’t, you should be investing enough of this $1,300 cash flow each month to bring your retirement investment level up to 15% of your take home pay.

Kid’s College

Your two children are now 6 and 10. You could start making huge house payments now, but, because that added home equity cannot be easily converted to cash, college funding becomes a higher priority. For sake of discussion, you could achieve a $40,000 nest egg for each of them at age 18 if, assuming an 8% return, you start investing $300 a month for the oldest and $220 a month for the youngest. Check into a 529 plan to get some great tax breaks.

Finally! Pay the House Off Early!

You have been making $1,000 a month house payments all along, lowering your mortgage balance to about $132,000. Your monthly cash flow is now $780 a month ($1,300 a month less your college investments of $520 a month). If you decided to use all of the $780 to pay extra on your house, it would be paid off in only 7 years and 9 months – a total of 9 years and 11 months from the time you started your plan. At that time your payoff schedule was 20 years. You are awesome!

Summary

Our hypothetical family was able to pay off $13,000 in debt, save for a $21,000 emergency fund, plan for their kids’ college and pay their house off 10 years early. How did they do it? By creating a budget, sacrificing and developing a plan. I have a hunch that if you follow their lead, you would also see amazing results.

Note: I wrote this post originally for Christian PF.

photo credit: The-Lane-Team

Readers:  Have you paid off your house early?  What tips do you have for others considering it?

I wish that I could say that every story has a happy ending, but life is real and story book endings don’t always happen. You may remember reading The Sad Tale of Clarence and Evita, an encounter which left me some morose.

However, some do turn out well. I received a phone call the other day from a very happy young man (we will call Carl).

Carl, “Joe, I called to thank you for helping us.” His voice was tingling with excitement.

“Hey Carl. What’s going on?”

“I just want you to know that, other than our house, we are debt free! The feeling is just indescribable!”

“Awesome!” I countered. “Did you just now pay off your last debt?”

“We sure did. We followed the plan that you helped us with and it worked. We are building up our emergency fund and getting positioned to invest for retirement. But the best part is this: now that we don’t have debt, Penny (not real name) is able to cut back her work schedule to two days a week. She has always wanted to stay home with the kids and that is becoming a reality. Joe, we both want to thank you for your help.”

“Carl, you are welcome. But all I did was help point you in the right direction. You and Penny did all of the hard work. Congratulations. I am thrilled for you!”

This 30 year old couple, with three young children, had discovered the freedom that getting out of debt brings. When they first met with me a little over a year ago, they had over $35,000 in car debt, credit card debt and student loan debt.  Admittedly, a big chunk of paying off the debt came by selling some stuff, but the point is this: they did it.  Why did Carl and Penny succeed when so many don’t? I believe these four factors were huge:

They were highly motivated.

They didn’t like their lives like they were and were extremely focused on change. In fact, their first words to me were, “We don’t like where we are and are ready to do whatever it takes to change.”

They worked as a team.

Carl and Penny were absolutely on the same page. Their communication was open and clear. Neither hesitated to speak up when they disagreed, and they talked things out until they did agree. Their respect for each other was always obvious.

They had a clear goal.

They had had enough of debt. Their goal was to get it out of their lives. Both understood Proverbs 22:7 “The rich rule over the poor and the borrower is a slave to the lender.”

They were ready to sacrifice.

For Carl and Penny, eating out was a big money drain. Carl would eat lunch out nearly every day and, because of Penny’s work schedule, eating out as a family was convenient (and costly). But Carl started bringing his lunch to work and they planned eating out as a family for special occasions. They also agreed to forgo their vacation in order to pay off their debt.

I wish I could say that I had a huge part in helping them, but all I did was point them in the right direction and encourage them along the way. They are a very happy family right now, and I am happy for them.

photo credit: lioliz

Readers:  Have you worked through debt in your lives?  What would you say was the greatest factor in your success?

Geraldine’s humor is timeless because so many of us can relate to it. For example, have you ever bought a new car and then wondered what possessed you to do it? I doubt if it was the devil, but the devil’s first cousin, car fever, will have the same results.

What Does YOUR Geraldine Car Look Like?

• Have you been bitten by the “car fever” bug?

• Do you currently own a car you wish you had never bought?

• Are you asking yourself if you should try to sell it or just live with it?

This post is designed to help you think through this dilemma.

Start by asking yourself these questions:

How much do I owe on it? If you paid cash, then you are probably not facing a financial crisis necessitating the sale of the car. If you simply don’t like the car, then take your time, sell it and pay cash for another one. If you are in debt, move on to question two.

How big a burden is this car on my budget? If one hiccup in your life will cause you to start missing payments, then you need to amputate this car before that hiccup occurs. Even if you are easily making your payments, you still might be deceived into thinking all is well. Long term debt on a depreciating asset such as a car is a formula for staying perpetually in car debt. To break that cycle, you need to get the car paid off in 24 months or less and then keep driving it while you save cash for your next car. If you are on track to do so, then keep the car and enjoy it. If not, you should seriously consider getting rid of it.

If I am seriously considering selling, how do I go about it? Knowledge is power. First, you need to learn if you are upside down (owe more than the car is worth). Check Kelly Blue Book to learn the private party value* of your car. If this value is less than what you owe, you are upside down. *Use private party value because you are money ahead selling the car yourself.

But how does this work? Here is an example: You owe $22,000 on your “Geraldine” car and you could sell it for $18,000 (private party sale on Kelly Blue Book), thus putting you $4,000 upside down. If you decided to buy a $3,000 car (we will call the “beater”), your new debt would be $3,000 plus $4,000 = $7,000. You are still upside down, but you have eliminated $15,000 of debt.

How do I go about selling a car I am upside down on? Unless you have an extra $4,000 available, you will need to borrow it in order to get the title released. So where do you borrow the money from?

Start by checking with the title holder. You have done your homework, so explain your rationale. In effect, you are asking for an unsecured loan on your upside down amount. Most lenders are not thrilled by this, but explain that this same amount of the current loan is already unsecured and you are simply asking that they move this amount from a more expensive car to a less expensive car.

If the title holder balks, don’t give up. Try your credit union or your home town bank, explaining that you will be moving your business to them. If you simply can’t find financing, consider other options such as selling stuff (Craigs List or Ebay or yard sales) or temporarily working a part time job.

Are you ready to get your Geraldine car out of your life? Good! Doing so will not only be a huge relief, but will teach you to never again succumb to car fever. Still, you need to go into this decision with both eyes open, so the following pros and cons will help you preview the reality of your decision:

The Good

• Less Debt. You have just reduced your total debt by $15,000!

• Out of debt quicker.  From our example, with an 8% loan and monthly payments of $400, your Geraldine car will be paid for in 5 years and 9 months. Your “beater”, on the other hand, will be paid off in only 19 months.

• You will stay out of debt. Once the beater is paid off, you could save $4,800 toward another car by making payments to yourself for one year. Assuming your beater would bring $2,000, you could upgrade to a $6,800 paid for car. Had you stuck with your Geraldine car, it would have depreciated to about $12,000 by now and you would still owe $13,300 on it.

• Peace of mind. You will know that you have taken the steps to undo that Geraldine decision. This is a great feeling.

The Not so Good

• Inconvenience.  Selling your car and buying another is a hassle.

• A downgraded drive. Face it: your Geraldine car is nicer than a beater will be. Be prepared for it.

• Less dependability. No doubt your beater will have some issues. You need to be realistic in assuming that it will not be as dependable as a newer car.

• More maintenance. With less dependability comes more maintenance.

• Friends won’t understand. Reality? Yes. Negative? Not really. Just be prepared for it.

One Final Reality Check

You may not be able to arrange the necessary financing. Why? Either your credit score is not adequate or you are too far upside down. Should this be your scenario, you will need to strategically pay down all other debt in order to free up enough cash flow to make huge car payments. Keep the car until it is paid off or you will be swimming in car debt for years to come.

Readers: Have you ever regretted a car purchase? What did you do and how did it work? What tips would you offer?

This post was originally a guest post for Frugal Dad.

photo credit: Buburooz

Strategic Default, according to Wikipedia, is “the decision by a borrower to stop making payments (i.e. default) on a debt despite having the financial ability to make the payments.”    This practice is particularly associated with residential and commercial mortgages in which, because of a substantial drop in the value of the real estate, the property is worth less than what is owed against it and is expected to remain so for the foreseeable future.

According to a recent study by the Chicago Booth/Kellogg School Financial Trust Index, nearly one-third of all current mortgage loan defaults are considered strategic.  This number has increased from 22% in March, 2009.

How can this be?

Did you get that?  ONE-THIRD of mortgage loan defaults are by people who can afford to make the payments but choose not to.  How can this be?

One reason, according to the study, is the increasing perception by borrowers that lenders are less likely to go after borrowers who walk away.  The study indicated only 54 percent of homeowners believe the lender will pursue the borrower, compared to 56 percent only three months earlier.   The likelihood of strategic default increases by 23 percent when homeowners learn that a neighbor with negative equity has received a partial loan for forgiveness.

A quick summary

Here is my understanding: home or business owners have borrowed money against their property and now, when the property has lost value, are reneging on paying the loan, even if they can afford it, because they believe the lenders will not pursue them.

Is this a strategy to consider?

I say NO for the following reasons.

You are being short sighted.

Your house is an investment.  Millions have learned from this recession that real estate investments, like mutual fund investments, can go down in value.  Many who saw their 401(k)s plummet in value panicked and bailed out at the very worst time: when prices were low.  Don’t do the same with your house.  No one knows when real estate values will rebound, but historically houses have appreciated in value.  Getting out when at the bottom of the market is not strategically savvy.

Your lender will come after you.

Don’t think that walking out will somehow magically make your life better.   Maybe nothing will happen immediately, but you had better be looking over your shoulder.  Mortgage recoveries, according to a Bloomberg report, rose 48 percent to a record $1.01 billion in the first nine months of last year compared with the year-earlier period.  Foreclosure will eventually happen, including legal action to collect the shortfall between your debt and the sale price of the house.   This could include the garnishing of your bank accounts or your pay check.

You will trash your credit.

Foreclosure is right behind bankruptcy in great ways to ruin your credit rating.  You don’t want that foreclosure following you around on your credit report for years to come.

You signed up for the ride.

Even if none of the previous reasons can dissuade you, it is just plain wrong to not pay a debt you signed up for and can afford to make.  Keep making your payments so you can look yourself in the mirror and be proud of what you see.

Closing thoughts

I am not unsympathetic toward those whose homes have plummeted in value during the recent recession.  Many have simply been dealt a bad hand.  However, true character is defined by how people respond to difficult times.  A strategic default is a fancy term for intentionally breaking a contract because it doesn’t suit you at the time.  I wonder: what else would you also bail out on when things don’t go well?

Hopefully, you don’t want to find out.  Do the right thing now so you can stand tall in your own eyes.  That is your only choice.

Readers:  Have you ever done a strategic default?  How did it turn out?  In what ways was it like or different than what I have described in this post?

What are your thoughts on the moral implications of a strategic default?

Investigate Every Option Before Deciding on a Reverse Mortgage

photo credit: get directly down

Part one of this four part series explained the complexities of a reverse mortgage. Parts two and three gave the advantages and disadvantages respectively. And now, in part four, we arrive at the crux of the reverse mortgage issue: is it for you?

First, however, let’s review the definition and essential facts:

Definition

A reverse mortgage is the opposite of a traditional mortgage. With a traditional mortgage, the borrower builds equity in his house by paying down a loan taken against the house. With a reverse mortgage, the borrower gives up home equity in exchange for payments from the lender.

Essential facts

• The home owner must be at least 62 years old to qualify for a reverse mortgage.
• The home must have substantial equity.
• Credit scores are irrelevant.
• Any previous mortgage will be paid off by the reverse mortgage.
• You can receive your payments by lump sum, monthly payments, line of credit or any combination.
• The borrower retains the title on the house, meaning that he is responsible for all taxes, insurance and maintenance

Now: is a reverse mortgage for you? If you are seriously considering one, I assume the following:

• You have a cash flow problem.
• Staying in your own home is very important to you.
• Leaving an inheritance is not important to you.
• You clearly understand how a reverse mortgage works.
• You have read parts one, two and three of this series.

Are you ready to pull the trigger? Slow down. The reverse mortgage may be a good choice for you, but because this is a decision that is nearly irreversible, make sure you clear the following hoops:

Make a budget.

You wouldn’t be considering a reverse mortgage if you didn’t have a cash flow problem, but it is possible that living on a written budget could solve that problem. Furthermore, if you aren’t great at managing money, the added income from the reverse mortgage could dissolve. Put the reverse mortgage on hold, work out a written budget and live on it for three months before considering the reverse mortgage again. Most people find money when they manage it. At best, you might resolve your cash flow problem without needing the reverse mortgage. At worst, you will be in a better position to manage the new income from your reverse mortgage.

Make sure you are not planning to move.

Once you sign up for the reverse mortgage loan, your home equity drops immediately because of closing costs. Because you are not repaying these closing costs, interest will be compounded against these charges as long as you are in the house. Moving normally is not a viable option once the reverse mortgage starts.

Consider waiting anyway.

The older you are when you start the reverse mortgage loan, the greater the percentage of your home equity you will be able to tap. If waiting is an option, strongly consider it. Signing up prematurely will cost you.

Examine other options.

I realize that staying in your home is important to you, but you should nevertheless compare the reverse mortgage loan to selling your home now and purchasing something smaller or more efficient. This option would utilize 100% of your current equity (compared with a 30%-60% in a reverse mortgage loan) and would leave you with 100% equity after you relocate.

Make sure you know:

• How much cash you can get by selling your current house.
• How much you would pay for a smaller home.
• How much money you could earn on the nest egg that remains after you have downsized.
• Another option: consider renting and living off the proceeds of the sale of your house.

Concluding thoughts

If you are considering a reverse mortgage, make sure you look before you leap. Why? Because the equity you are giving up makes the decision fundamentally irreversible. It is a BIG decision.

Therefore, be sure to check all alternatives first. Living on a budget, for example, might give you the cash flow you are looking for. Even if living out your life in your current home is a high priority to you, go ahead and run some numbers to learn how much you could reasonably net if you sell and repurchase a smaller home. The possibility of owning a smaller home and having $50,000 or $100,000 cash in the bank might influence your decision.

A reverse mortgage may be your best option, but only after you have ruled out every alternative.

I hope these thoughts help you with your decision. If you have further questions, please enter them in the comment box below and I will do my best to get you some answers.

Learn More About Reverse Mortgages – these links will help:

• Federal Trade Commission
• About.com
• AARP
• Reverse Mortgage Disadvantages

Have you or any of your family members had a reverse mortgage?  Did you understand it?   Any surprises?  Would you recommend it to others?

This post was included in the following Carnivals:

Baby Boomers Blog Carnival hosted by Baby Boomers US

photo credit: jessicafm

My friend Larry recently asked me a good question that led to a challenging question: “Joe, isn’t it true that everyone needs to be putting aside money every month for a car fund?”

Joe, “Well, yes. Although some may be wealthy enough to have a nest egg generating vehicle purchase money, the vast majority of us need to be constantly saving for our next car purchase.”

Larry, “I know you are big about saving for car purchases. But I have been able to get a zero percent loan on the last couple of new cars I bought, so what is the difference in borrowing at zero percent and saving up to pay cash?” (That was the challenging question)

I admit that Larry caught me off guard. He is a sharp guy who would immediately challenge any noble idealism I might purport about debt being bad. He needed objective rationale.

So, scrambling a bit, here was my response, “Larry, I have found that when I save and pay cash, I am much more selective about what I buy. That cash is something that I have worked and scrimped to save, so I shop very carefully. On the other hand, when I borrow money to buy a car, I don’t see the money come out of my account, so it just doesn’t seem as real. I will therefore pay more, buy newer and get more options. In short, I spend more when I borrow than I would paying cash.”

“Oh. I hadn’t thought of it that way.” Larry was slowly nodding his head. “That makes sense.”

So I suppose I was able to give a decent answer, but Larry’s question made me think. Are there other reasons not to borrow money for a new car, even at zero percent interest? I think there are. Here are some thoughts:

Depreciation

New cars depreciate faster than used cars. Yes, you get a new car guarantee and a new car smell, but you are paying for it. According to SafeCarGuide.com,  “New cars lose an average of 20% of their value the instant they are driven away from the dealership. When coupled to the annual yearly depreciation of 7% to 12%, your first year’s loss is anywhere from 25% to 35%. That translates to a loss of $6,000 to $8,000 loss on a $22,500 new vehicle, or a $10,000 to $15,000 loss on a $40,000 one. And that is for a vehicle that is only driven the average of 13,500 miles. If you drive more than that, your depreciation will be greater (35% to 50% for the first year)”

I think you get the point. That zero percent loan is costing you between $500 and $1,000 a month in depreciation costs for the first year alone.

Risk

The zero percent loan could spellbind you into buying too much car. If life happens (injury, job lay off, etc.) and you can’t make your payments, Mr. Tow Truck will show up and get your car. You will still owe on the negative equity even if you no longer own the car. Zero interest sounds pretty hollow once repo man shows up.

May be paying more for car

You may well be paying for that zero interest loan via higher sale price. Yes, dealers are offering deals to move new cars, but they aren’t stupid. That same car might have sold at a lower price if the financing would have included some interest payment.

The cost of dealing with a dealer

New cars, of course, must be purchased from dealers, but that is part of the problem. For sake of discussion, I compared the Kelly Blue Book retail price of a 2007 Cadillac Escalade ESV, excellent condition, with the private party price of exactly the same vehicle. The retail price of $42,440 is $3,600 more than the private party price of $38,840. My point is that you pay a premium simply for buying from a dealer. You also pay more sales taxes in many states. For example, in Illinois (where I live) the taxes for that $42,440 vehicle purchased from a dealer are $2,652.50 compared to $1,500 if purchased from an individual.

Lost opportunity cost

Larry and I started this conversation by agreeing that everyone, whether they are making payment on a loan or saving to pay cash, needs to budget a set amount for vehicle purchases. Even at zero percent interest, the new car buyer is going to pay more per month than someone (like me) who saves up and pays cash. How much is this difference and what could that money be doing if it weren’t going for cars? This number will vary greatly from person to person, but if we assume a $25,000 new car every five years compared to a $10,000 used car every five years, and factor in depreciation for each, the new car buyer will pay about $220 a month more. The lost opportunity, if invested at 8% annual growth for 40 years, is $768,000 dollars!  How many of us could use that much extra cushion in our retirement portfolios?

Concluding thoughts

While a zero percent loan on a new car sounds good, there are many downsides. If the owner buys a new car just to get that zero percent loan, he is probably buying more car than he would by saving and paying cash. Even though he isn’t paying any interest, he is paying for depreciation, sometimes as much as $1,000 a month for the first year. Other downsides are risk and the higher costs of purchasing from a dealer. In addition, the lost opportunity cost can be substantial over a lifetime.

According to “The Millionaire Next Door” by Stanley and Danko, 76.5% of millionaires buy used cars instead of new.

Hmmm. Maybe that is how they became millionaires.

How do you plan for car purchases?  Do you save and pay cash or do you borrow?  What have you found to work best for you?

This post was included in the Carnival of Personal Finance hosted by Amateur Asset Allocator

It was also included in The Best of the Best in Money and Personal Finance hosted by Len Penzo dot Com

Reverse Mortgages Can Be Very Confusing

Now…lest you infer from the title and opening vignette that I am dead set against reverse mortgages, please understand that this post is part of a four part series.

In “Reverse Mortgages, Part One: Digging Beneath the Surface”, we attempted to demystify reverse mortgages. Reverse Mortgages Part Two explained some advantages of reverse mortgages. Part four of the series will be a summary post.

So…before we investigate the disadvantages of a reverse mortgage, let’s review the definition and essential facts:

Definition of Reverse Mortgage

A reverse mortgage is the opposite of a traditional mortgage. With a traditional mortgage, the borrower builds equity in his house by paying down a loan taken against the house. With a reverse mortgage, the borrower gives up home equity in exchange for payments from the lender.

Essential Reverse Mortgage facts

• The home owner must be at least 62 years old to qualify for a reverse mortgage.
• The home must have substantial equity.
• Credit scores are irrelevant.
• Any previous mortgage will be paid off by the reverse mortgage.
• You can receive your payments by lump sum, monthly payments, line of credit or any combination.
• The borrower retains the title on the house, meaning that he is responsible for all taxes, insurance and maintenance

Now: what are the disadvantages of a reverse mortgage?

• Hard to understand

Reverse mortgages are confusing. It seems like you are getting a loan without having to ever pay it back…not true. The loan options themselves are confusing: lump sum, line of credit, monthly, or combination? The interest rate you are paying is confusing: does it apply only to the loan amount or to all other fees as well? I do not say that the complexity of the reverse mortgage transaction should rule it out; I am saying that you should never buy anything you don’t understand and this complexity makes it a disadvantage.

• They are expensive

A reverse mortgage is more expensive than a traditional mortgage. Why? Because the lender is taking the risk that, should you live to be 100 years old, he will not receive any payment for that entire time. He is also risking that the house will appreciate in value over those years. How do he cover this risk? By charging service fees, higher interest rates and greater closing costs.It is not a panacea

Some would have you think that “letting your house pay you” will simply be a dream come true. Not necessarily so. You still own the house, meaning you are responsible for all taxes, insurance and maintenance. In fact, failure to perform basic maintenance could nullify the reverse mortgage agreement, meaning that all loans would come due. If that were to happen, would you be able to pay those loans? Probably not, or you wouldn’t have needed the reverse mortgage in the first place.

• Little or no inheritance for kids

This may not be important, but reverse mortgages will consume most or all equity in the home, leaving little for the descendents.

• Could affect other benefits

Although the reverse mortgage is a loan and therefore not considered income, it could (according to Consumer’s Union) nevertheless affect your eligibility for some federal or state assistance, including Medicaid or Supplemental Social Security Income (SSI).

• Reverse mortgage sales people

While the reverse mortgage industry has reined in most of the culprits who would prey on senior citizens, there are still some that need watching. Many do not understand the loan themselves, so they either skirt your questions, give you wrong answers, or need to “get back to you”. Others simply say whatever it takes to get the sale.

• Limits future choices

A reverse mortgage today could give you less choices sometime in the future. For example, what if the day comes when you are no longer able to take care of the house? Without the reverse mortgage, one choice would be to sell your house and purchase a smaller house or a condo. However, the reverse mortgage may have drained the equity you once had and greatly eliminated those choices. You need to think clearly about the “what ifs” of a reverse mortgage.

Learn More About Reverse Mortgages – these links will help:

Federal Trade Commission

About.com

AARP

Reverse Mortgage Disadvantages

* denotes fictional names

Have you or any of your family members had a reverse mortgage?  Did you understand it?   Any surprises?  Would you recommend it to others?

photo credit: aturkus

This post was included in the following Carnivals:

Carnival of  Money Stories 2 hosted by Len Penzo dot com

Baby Boomers Blog Carnival hosted by Baby Boomer US

Carnival of Financial Planning hosted by The Skilled Investor

photo credit: Maxwell GS

When Donald Franklin became a widower he wasn’t prepared for the financial consequences. He and his wife Wilma had become accustomed to both of their pensions and both of their social security incomes. However, his survivor benefits paid him only half of her pension and none of her social security. Donald not only lost his wife; he lost about one third of their combined retirement income. With full equity in their house, Donald decided to use a reverse mortgage to boost his income and allow him to stay in the family home where he and Wilma had lived for the past 45 years. Could Donald have made better financial arrangements? Maybe, he just couldn’t bear the thought of living anywhere other than his beloved home place, and he was happy with the way it worked out.

Now…lest you infer from the title and opening paragraph that I am pounding the drum for reverse mortgages, please understand that this post is part of four part series.

In Post One, “Reverse Mortgages, Part One: Digging Beneath the Surface”, we attempted to demystify reverse mortgages.    If you want to better understand reverse mortgages, you might want to read Part One before continuing with Part Two.

Parts Three and Four will be “What Are The Disadvantages?” and “Is a Reverse Mortgage for You?” respectively.

So…before we investigate the advantages of a reverse mortgage, let’s review the definition and essential facts:

Definition

A reverse mortgage is the opposite of a traditional mortgage. With a traditional mortgage, the borrower builds equity in his house by paying down a loan taken against the house. With a reverse mortgage, the borrower gives up home equity in exchange for payments from the lender.

Essential facts

• The home owner must be at least 62 years old to qualify for a reverse mortgage.
• The home must have substantial equity.
• Credit scores are irrelevant.
• Any previous mortgage will be paid off by the reverse mortgage.
• You can receive your payments by lump sum, monthly payments, line of credit or any combination.
• The borrower retains the title on the house, meaning that he is responsible for all taxes, insurance and maintenance

Now: what are the advantages of a reverse mortgage? We will start with general advantages and then give some scenarios where a reverse mortgage could help.

General advantages of a reverse mortgage

Increased income
If the homeowner has great home equity but is struggling to make ends meet, a reverse mortgage will boost that income.

Assurance of staying in home
As long as the homeowner stays current on taxes, insurance and maintenance, he can have the security of knowing that he will never be forced to move out of his house.

No monthly mortgage payments
The reverse mortgage loan will not need to be repaid unless the homeowner decides to move or sell the house.

Tax free money
Because the reverse mortgage is a loan, it is not considered taxable income.

Easy qualification
Qualification is easy because income and credit history are not considered.

Maintain independence and self esteem
The income from a reverse mortgage will not only help a senior stay in the home, but the financial independence could eliminate the possibility of asking for help from children.

Possible Scenarios Where Reverse Mortgage Could Help

Survivor spousal income is not enough.
This was the case with Donald Franklin. When both spouses are drawing Social Security income, the surviving spouse only gets the higher of the two pensions…not both. If one is drawing a pension from a previous job, that pension is commonly reduced by 50% for the surviving spouse. This reduction in income could be partially or fully replaced by a reverse mortgage.

Leaving the home equity as an inheritance is not important.
Perhaps there are no children. Or maybe the home equity is simply not important to the children. Either way, using the equity while the homeowner is alive could be a good option.

Prevents emotional trauma of moving
If one or both homeowners have an emotional attachment to the home, a reverse mortgage could assure them that financial issues will not force them to leave the home. For some senior citizens, moving from their beloved home place could be extremely traumatic.

Prevent foreclosure
If the homeowner gets behind on mortgage payments, and if the home has great equity, a reverse mortgage will pay off the existing mortgage, eliminating not only the possibility of foreclosure but future mortgage payments

Have you or your family members used reverse mortgages? Were there any surprises? Would you (or your family member) recommend a reverse mortgage to a friend?

Learn More About Reverse Mortgages – these links will help:

• Federal Trade Commission
• About.com
• AARP
• Reverse Mortgage Advantages

This post has been featured in the following  carnivals:

Baby Boomers Blog Carnival hosted by Baby Bo0mers US