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Debit or Credit?

Credit vs Debit

Imagine you’re at the checkout counter at your grocery store, or maybe a gas station. Once the teller has rung up all the items and you’re handing over the card (or swiping it yourself), you’re most likely facing a question: Debit or credit? It might also be phrased as “Do you want to enter a PIN number?” or in various similar ways. Sometimes it’s the teller asking, and sometimes it’s a machine. And you might be wondering: what’s the difference?

If you’re using a credit card, most likely the teller asked out of rote repetition, because it’s going to be credit either way.

But if you’re using a debit card, there’s an important distinction being made here. On your end of the transaction, the most important difference has to do with protecting yourself from identity theft. One of these two options offers better protection than the other, and it might not be the one you think. If possible, always run your debit cards as credit.

Why not debit? The need to input a PIN number sure makes it seem safer, after all. Here’s the thing about running a card as debit: if someone gets your card information and spends every cent in the account, you’re most likely out of luck. In most cases your bank is not required to reimburse you, though any debts incurred by the identity thief will likely be cleared. Also, inputting your PIN number offers identity thieves a chance to observe what it is. That puts them a big step closer to heading to the nearest ATM to clear you out.

Credit cards are automatically covered against identity theft, and any charges an identity thief makes will be canceled. If you run debit cards as credit, which is perfectly fine and legal, you will then enjoy the same protection. If someone were to steal the card or the account information at that point, you stand a much better chance of recovering your money. Let the financial institution eat the loss- they’re insured for it, and you put your money there for convenience and protection in any case. They’re also probably in a better position to recover from it.

Thanks for reading,

-Taylor

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Adjustable Rate Mortgages

As I’ve noted before, Yahoo News can hardly be considered a good source of quality information. Yet from time to time I browse through the articles to glance at the odd, the ridiculous, and the very occasional piece of good information.

Today, unfortunately, I stumbled upon something particularly bad in the second category: Jeff Brown is the author of the article “Why it might be time for home buyers to reconsider an ARM.” I’ve never felt compelled to call an individual out on something like this before, but the advice he gives here holds the potential to severely injure the financial stability of anyone who relies on it. It’s egregious and irresponsible.

First, what’s an adjustable rate mortgage? Also known as an ARM, an adjustable rate mortgage is a home loan that starts off low- even lower than the going rate for a fixed rate mortgage. Then, after a given period of years (which vary from loan to loan), the interest rate adjusts according to where rates are at that time.

Here are some of the supporting facts that Mr. Brown brings out in order to support his position, followed by the flaws that negate this line of thinking:

1. The current rate for a 5 year ARM is just 2.7% compared to 3.5% for a fixed rate mortgage.

  • Sure, that’s true as far as it goes. But interest rates are still down near historic lows, so once those adjustments start hitting you’ve really got nowhere to go but up. The market seems to finally be recovering, albeit slowly and cautiously, and if nothing too terrible occurs we may not be in that bad a place in 5 years…and 0.8% is a really thin buffer to be relying on in such circumstances, since good economies mean higher interest rates.

2. Annual and lifetime caps on interest rate increases mean that from the 2.7% you’ll never pay more than 8.7%, which isn’t too high by historical standards.

  • 8.7% might not be all that bad over the scope of history, but 3.5% is one of the better rates we’ve ever recorded. Why not go for the sure deal rather than risk “not especially high”?
  • That 6% maximum difference? It’s expensive. If you put 20% down on a $300,000 house and use that 2.7% ARM, you’ll pay $1,348.43 per month for five years. If the next several years after that raise your interest rate to the max, you may spend the rest of the life of the loan paying $2,254.52 per month. That’s an extra $906 every month adding up to an extra $10,873 per year!
  • By contrast, the 3.5% fixed rate will only increase your payment by $104 per month and you get the security of knowing it will never rise.

3. ARM rates are going to rise, so the time to buy is now so that the maximum rate your loan can rise to doesn’t get any higher than it would with today’s circumstances.

  • Lord, save us from terrible logic. Mr. Brown tells us to consider buying an adjustable rate mortgage because the rates will go up over the next few years… Why would you ever buy an ARM knowing that its rate will soon increase beyond what a fixed rate can get you right now? To do that is to literally volunteer to pay more money.

In the closing paragraphs of the article Mr. Brown gives a nod to most readers’ reality. He points out that ARMs are really only good for people who can pay the home off within or shortly after the fixed rate period of the loan or for people who intend to sell the home within the fixed rate period. Even then, I’ll throw a caution out: be aware of the housing market in your area. If you plan on selling a newly bought house sometime in the next three to five years, you may actually lose money because you didn’t have time to build up enough equity to cover closing costs, etc or even because the value of the home dropped in the short term. So if you won’t be there long, consider renting!

Perhaps I’ve been overly hard on Mr. Brown. But the facts are that, for the vast majority of homebuyers, an ARM will cost an arm, and maybe a leg too. In a society and publishing medium with such a short attention span, it’s my opinion that his qualifications should have been front and center, not hidden at the back.

People tend to think they have more money and discipline than they really do, and often spend too much when buying a home in the first place. The ignorant or inattentive reader runs a definite risk of hurting themselves by relying on the article’s information in the way it was presented, and I don’t like that. Frankly, given the current interest rates and economic conditions, the article wasn’t appropriate at all.

Now, to be fair, ARMs do have their place. If the situation was more or less the opposite of what it currently is, and interest rates were looking to drop on the long term, then an ARM might be valuable for its ability to follow rates down without a refinance. And Mr. Brown has a point as it comes to those who can (and will) pay their homes off early- you can save some money if you’re in that group. But odds are very high that you aren’t. If it were me, I’d get the fixed rate mortgage and suffer a little bit of extra interest while paying extra on the principal anyway and having a safety net against any future lapse of discipline on my part.

Any time you’re looking to buy a house, keep this goal in the forefront of your thoughts: What can I do in this situation to maximize my chances of keeping this house if something goes wrong?

Hope for the best while preparing for the worst and you might just avoid having the bank knock on your door someday.

 

Thanks for reading,

-Taylor

IRAs: Traditional IRAs

Image from CanIdoit.org

Traditional IRAs are the original format for the program, and were introduced in 1974. The traditional IRA is designed to shelter income from taxes in order to encourage people to save for their retirement.

How does it shelter income? A couple of ways:

  1. Tax Deferral: In other words, dividends and other gains that the investments in a traditional IRA earn are not taxed in the year they’re earned. Because they get to stick around untaxed, the account will grow faster. You will have to pay taxes on them upon withdrawal of them, though.
  2. Tax Deductability: If you meet certain requirements, income invested through an IRA can give you a deduction on your tax return for that year. You’ll pay less in taxes that year!

In a Traditional IRA, all distributions are taxed at your normal tax rate for the year you get the distribution. The only exception to this is if part of the money you contributed didn’t qualify for the tax deduction on the front end. That portion has a “tax basis” already and won’t be taxed again.

The requirements for contributed income to not qualify change from year to year, so I’ll include them in a later post.

Due to the deduction, contributing to a traditional IRA can reduce your taxes while you’re in a high tax bracket. Once you start withdrawing after retirement, those contributions and their earnings are taxed at your normal tax rate for the year you withdraw them…which should be a lot lower, since you’re not earning as much in retirement. Because of this you can get considerable tax savings. Just remember: If you’re under fifty nine and a half you’ll have to pay an extra 10% penalty for withdrawing money from your IRA.

Here’s a short example to illustrate the paragraph above:

You contribute $100 to your traditional IRA at age 40, while you’re in a 28% tax bracket. It qualifies for the deduction, so you pay $28 less in taxes!

At age 70 you withdraw $100 (let’s ignore the gains for this, but they’d be in there too) and pay taxes at your normal rate on the distribution. Now that you’re retired, your tax rate has dropped to 10% and you pay $10 in taxes.

$28 – $10 = $18 of tax savings. You paid 18% less than you might have. That can add up!

Thanks for reading,

-Taylor

IRAs: The Basics

What’s an IRA? For a lot of people, it’s just another confusing acronym the government throws around sometimes. In actuality, it’s an excellent retirement investment tool. So if you’re confused by the whole topic, read along and we’ll see if we can clarify things a bit.

IRA stands for Individual Retirement Account, which is shockingly clear and to the point by governmental standards. In basic terms, an IRA is a tax-deferred retirement savings account. It’s a tool through which you can invest in stocks, bonds, mutual funds, and other assets. Note: An IRA is not an investment itself. Think of it as a garage. The investment is the car inside, but the garage shelters it.

IRA example pic

There are actually several types of IRAs, and I’ll go through them one by one in my next mini-series. For reference, though, here’s a list:

  • Traditional IRA
  • Roth IRA
  • SEP IRA
  • SIMPLE IRA

SEP IRAs and SIMPLE IRAs are for self-employed individuals or small business owners, so most people don’t need to worry about them. Traditional and Roth IRAs are much more common, so I’ll address them first.

 

Thanks for reading,

-Taylor

Savings: For Retirement

saving, investingWhen you hear the phrase “saving for retirement,” what you should hear is “investing for retirement.” That’s the attitude you’ve got to have if you want to actually, you know, retire. Sometimes people think they can save for retirement simply by putting money in the bank. Taking the phrase a bit too literally, they just shove their nest egg into a savings account and forget about it. Let’s take a look at what that will get them.

Let’s say Tom goes to the bank and puts $1000 in a savings account so he can retire in 40 years. The savings account earns, say, 1.25% interest annually and he never puts anything else in. In 40 years Tom will have: $1,643.62

Fail.

But that example was a bit unreasonable. So let’s change it up a bit: this time, Tom’s putting in $1000 every year for 40 years. This time his retirement savings account comes out to: $52,133.18. Hmm…that’s better, certainly. But it’s not going to last him 10-30 years like it needs to.

This savings account thing just isn’t working out so well. Maybe it’s time for Tom to start thinking about his retirement in the frame of investing, rather than just saving. Let’s see how that changes things.

Tom’s gotten wiser. He knows a savings account won’t deliver what he needs, so he turns to a good mutual fund instead. A good mutual fund gives great diversity and is something of a fire-and-forget investment- you don’t need to monitor it constantly. It’s easy enough for anyone to do. So let’s say the mutual fund averages 8% return on investment over the 40 years. For the sake of example, let’s suppose Tom only invested $1000 once, like he did in the very first example. His retirement nest egg comes out to $21,724.52. It’s less than the constant investing with the savings account, but that 6.75% difference in interest rate gave him a $20,080.90 boost over the first example. Not bad. Not bad at all!

Now for the “best case” scenario amongst my four examples: Tom invests $1000 every year for 40 years and the mutual fund averages 8% again. He’ll need a bigger nest, because this retirement nest egg totals $279,781.04. That’s $227,647.86 more than the savings account earned under the same conditions!

I hope this helps you take a new look at retirement. Remember: if you’re reading this, you’re not too young to start planning to retire!

 

Thanks for reading,

-Taylor

Savings: Saving for a Specific Purpose

Image from www.valuecitynj.com

When you think about spending a lot of money for a single specific reason, you typically think of two things: your house and car(s). But there are other things that qualify. People around my age often get staggered by the cost of really furnishing a first home or apartment with furniture. People of any age often end up with sticker shock when looking into vacations.

If you’re not planning ahead, these things can cause you all sorts of financial head-aches. Or, worse, they can cause you to punt financially and to choose to go into debt in order to get what you want now rather than waiting for it. Remember this: “Maturity is achieved when a person postpones immediate pleasures for long-term values.” -Joshua Loth Liebman

Saving up ahead of time is always a better way to finance such things, whether they’re furniture or a vacation or something else. You’ll own it outright and you won’t be paying interest on it- interest that can sometimes end up costing more than the thing you purchased!

So how to do this? Set up a savings fund! This doesn’t necessarily mean going to the bank and opening a new savings account for that specific purpose (though you can, if you want). All it needs to be is an envelope, kept in a safe place, into which you put a specific amount of money every month or every paycheck. Do the math and figure out how much you can afford to save each month toward that new couch, a new car, or that nice ski vacation, then save that amount every month until you can buy it.

One last note: if you walk into that car dealership or furniture store and wave a handful of $100s under the salesman’s nose, odds are good you can negotiate a nice discount on the price.

 

Thanks for reading,

-Taylor

Savings: Emergency Funds

Welcome to Part 2 of my mini-series on savings. Let’s talk about emergency funds. An emergency fund is basically what it sounds like: an amount of money you’ve set aside to cushion the blow on a rainy day. It’s an investment in peace of mind, as compared to an investment in financial growth.

What’s a good emergency fund? To start with, $500-1000 will probably see you through until you get any debt you have under control. Once you’re financially stable, you should build up enough money to cover 3-6 months of expenses. That means you’ll need to know what you spend during the average month. It also means that if you lose your job, for example, you’ll be okay for a few months rather than being plunged into an immediate and severe financial crisis.

Image from www.bankonyourself.com

An emergency fund can cover you against all sorts of things: lost jobs, medical emergencies, wrecked cars, etc. But there are some things an emergency fund is not supposed to cover. It’s not for a new leather couch or a china cabinet. It’s certainly not for that ski vacation or a trip to the beach. It’s not for shopping sprees. It’s there for emergencies only, and if you don’t respect that it may not be there when you need it.

Resist the urge to invest the money. It’ll be a decent chunk of change, but remember that with investment return comes investment risk. An emergency fund is a safety net, and what’s the use of a risky safety net?

Thanks for reading,

-Taylor