Mortgage: Every Thing You Buy Costs Twice as Much!

I have written numerous posts recently about the house we are buying. Last week I told a colleague about our mortgage: a 30 year fixed rate loan at 5%. My colleague's advice: "don't stop living". I asked him what he meant, and he explained that in the first few years of the loan, every dollar of principal you pay back, saves you about a dollar in interest payments over the life of the loan (depending on your interest rate and length of your loan). His advice: if you become hyper aware of this you will become overly conscious of your spending. Sure you would pay a dollar for a can of soda, but would you pay $2 for that same can? By buying that soda you are spending a dollar you could pay down on your mortgage and save an extra dollar in interest. You are in fact paying twice for that soda!

Yikes. I never thought of that.

There is a huge financial incentive to do the exact opposite of what my colleague advised. Do we really need those extra channels on cable if they are costing us twice as much? Do we really need to take that family vacation? How about that lunch out? But then, there is the issue of living life...

Interesting conundrum. Any advice or opinions?

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Adventures in Home Buying Continued...

Our house buying adventure continues. In this episode: first meetings with a realtor; getting pre-approved for a mortgage; realizing that compromises are a part of the deal.

First Meeting with a Realtor - good friends of ours recently bought their first house and were so enamoured with their realtor that they convinced us to use her as well. Turns out the same realtor also helped a couple of other friends, so supposedly she knows what she's doing.

We met with her in person last Thursday and I have to say, I am not THAT impressed. Clearly she is informed and energetic, but she spoke to us as if we were unprepared and uneducated children. Lady, I already explained I am a lawyer and an MBA by training and before setting an appointment with you we read a couple of books on purchasing a house and did our homework on what it is that we want to buy. Give some respect. After that initial meeting though, she aggressively threw herself into the project and while I am traveling on business, she has been going out with my wife to see some houses. Some interesting prospects at this point, but nothing that blew my wife away. I'll get to see some of the better prospects this weekend.

Getting Pre-approved for a Mortgage - our realtor recommended a mortgage broker and I spoke with her and went through the pre-approval process. As I twittered a couple of days ago, the broker thinks that we should have no problem getting the mortgage we are looking for. Another nice piece of information, our FICO score: 799. Identical for both of us. Sweet. Maybe paying our bills on time all these years and having no debt will pay some dividends.

Compromise is Part of the Plan - here's an axiom: no matter what your budget, the house you really want is only $100K more expensive than your budget... urghh... The budget will hold. We are made of iron. We shall not fall prey to temptation. Not, I say. Not.

But it's not just the budget. Every house has something a little off. Maybe it's too close to the freeway or too far from the park. Maybe the kitchen is old or the lay-out is crappy. It's actually upsetting, but it appears that compromise is required when looking for a house. I guess the important thing is to be patient and to not compromise on those things that are REALLY important to you.

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You Gotta Know Who to Divorce...

Last week I met an old colleague and friend for dinner. This guy moved from California to Florida with his family, but subsequently he and his wife started what is turning out to be a fairly messy divorce. This story would have little to do with a personal finance blog, except for the fact that my friend recently discovered that his soon to be ex-wife has been collecting rent paid on the couple's California house, but has not been paying the mortgage on it. Apparently this has been going on for about five months. The house is now in foreclosure proceedings and my friend's credit is shot.

Of course, if he was half way responsible, my friend would be checking to make sure all was going well with the couple's various financial assets, if for no other reason than to make sure that nothing untoward was going on in the midst of a nasty divorce. But, that's who my friend is. He is a very lively, slightly less than responsible, very fun kind of guy. He is a "big picture guy" and this type of thing is too detail oriented for him.

My friend is taking this all with amazing calm and composure. Certainly more composure than I would exhibit under the circumstances. He is very much aware that his credit is essentially ruined, but doesn't feel like there is much sense in going crazy. He is now trying to work with the lenders to avert foreclosure...

It just goes to show you, you need to know who to divorce.

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Don't Finance Consumer Spending

Financing consumer purchases - either through payments or credit card debt - is a bad habit that folks should learn to avoid. Here are some of the reasons:

1. It makes you think you can afford something, which in reality you may not.

2. It reduces your future standard of living to increase your current standard of living.

3. It teaches instant gratification and reduces self decipline.

4. It gives you the illusion of paying less for something expensive, so you spend more.

5. Interest payments and fees mean that you will pay much more for your purchase than you would if you paid in a lump sum.

By the way, I am not against financing, only against consumer spending financing. If you are going to buy a house for example, financing is definitely in order. Car? I guess that depends.

I will be experimenting with short format posts now and again. Please tell me if you like this new approach and if I am achieving my goal of providing bite sized useful information.

A $10,000 Windfall: What to Do?

Last year my uncle, who I loved dearly, passed away from lung cancer - well, that's what you get when you are a surgeon who knows better but choose to smoke all your life. Anyway, in his will my uncle left me, my brother and my sister a sum of $10,000 each, and last week I received this amount by cashier's check.

The circumstances of getting the money suck, but now that I got it, what should I do with it? For now it's just sitting in my bank account earning interest at a rate of about 3 cents a decade. If we had any debt I would use the money to pay it down. But we have no debt. I am not a big believer in using windfall money to go on a shopping spree. I am not the shopping type, and we pretty much buy everything we need or want from our regular income. I suppose I could use the money to buy a new car - but my current vehicle still has 4 wheels and it moves forward when I press the gas pedal. I think the junk car stays.

I guess I could invest or save the money, that's my inclination anyway, but it seems like something is missing. There should be a bit more to this than sticking a $10K check into some index funds. I'm still trying to make up my mind. Any suggestions out there?

What You Buy Can Hurt Your Credit

In its June 30 issue, Business Week published a piece about how some credit card companies are monitoring what customers are purchasing, and in some cases reducing their credit lines accordingly. This type of practice came to light in a recent FTC complaint against Compucredit Corporation for unfair practices. If you want to read about some pretty incredible predatory lending practices, I highly suggest you read that complaint - 44 pages of double spaced, highly readable, credit card horror stories. Wow.

Anyway, the topic of this post is one specific lending practice that Compucredit allegedly followed. Here is a direct quote from the complaint (page 34):

"CompuCredit has based these credit line reductions on an undisclosed "behavioral" scoring model that penalized consumers for using their cards for certain types of transactions, including transactions touted in their solicitation materials such as cash advances and transactions with the following types of merchants:

• Direct marketing merchants
• Marriage counselors
• Personal counselors
• Automobile tire retreading and repair shops
• Bars and night clubs
• Pool and billiard establishments
• Pawn shops
• Massage parlors.

76. In some instances, CompuCredit reduced subscribers’ credit limits to levels below their existing balances and then charged over-limit fees."

Emphasis on the last sentence is mine. I want to talk about these practices on two levels. One is the high-level business practices type of analysis. The other is the actual approach that was taken. First, let's talk about this business practice in principle. Generally speaking I think that looking at behavioral data, including purchasing data, to make credit allocation decisions is not a bad idea. If someone is shown to be a bad credit risk by their very purchasing activities, should the lender be forced to keep throwing good money after bad?

Let's look at a couple of the specific examples given: marital counselors - if someone is going through some marital issues, which may or may not result in divorce and financial hardship, I think it is very reasonable to consider them a higher credit risk. The same can probably be said for pawn shops. I am guessing that few people in good financial standing frequent these establishments, and in any case, there is probably a correlation between people who patronize pawn shops and people whose financial situation is less than stellar... So, in principle, if I was running a credit card company I would certainly want to consider factors that would increase my credit risk - including the types of establishments my customers were spending my money at...

Of course, this brings us to such questions as consumer privacy and adequate disclosure. As an avid free market capitalist, I am a strong believer that knowledge is the best form of regulation. For example, once the government forced food manufacturers to disclose the trans fat content of their food, this harmful ingredient quickly disappeared from many products available on the market. If customers are clearly told that their purchasing behavior is a criteria for the level of credit they receive, and they still choose to apply for the credit card, I have no problem with this practice. In principle, at least.

Now let's talk about the specific practice. The ability of credit card companies to lower the credit line after a purchase has already been made, such that the new credit limit is lower than the outstanding balance, is preposterous. The fact that companies are then able to charge their customers an "over the limit" fee is both ludicrous and criminal. This only works in the credit card industry. Can you imagine a situation where a car dealer would be able to increase the selling price of a vehicle three months after you bought it? What if the person selling you a house was able to change his mind about leaving behind his appliances after the deal had already closed and you moved in? How are these examples any different from the credit card company changing your credit line such that you are then forced to immediately re-pay money you don't have?

Congress, the FTC, or whoever is in charge should quickly correct this situation. Credit card companies should be able to make changes that apply to future credit decisions, but never to balances that are already outstanding. Want to change the interest rate? Fine, your decision only applies to future purchases, not to ones that have already been made. Want to reduce the credit line? No problem, so long as it is not below the outstanding balance at any given time.

Guest Post: The Pitfall of Using Home Equity for Debt Consolidation

This is a guest post from Miranda Marquit, who edits debt consolidation information for DestroyDebt.com. If you are interested in publishing a guest post on Money and Such, take a look a these guidelines, and drop me a line. I am looking forward to hearing from you.

And now, to the post itself:


When you get into a great deal of debt, one of the tempting solutions is to use your home equity for debt consolidation. This can seem like a good idea, but there are pitfalls -- especially now that the housing market is struggling so much.

Advantages of home equity for debt consolidation. There are some advantages to using home equity for debt consolidation. It does make it easier to get a debt consolidation loan (if you are going that route). Additionally, you end up with a lower interest rate. An interest rate, mind you, that comes with tax benefits. So that can be a definite advantage to using the equity in your home for debt consolidation. But it may not be the best idea for you right now.

Disadvantages of home equity for debt consolidation. The biggest pitfall of using your home equity for debt consolidation is the fact that you are exchanging unsecured debt for secured debt. Unsecured debt is debt that isn't backed up by anything tangible. Creditors can try and get you to pay, and they can wreak havoc on your credit score, but that can't actually really force you to liquidate any of your tangible assets for payment. Secured debt, on the other hand, has a tangible asset to back it up. In the case of home equity debt consolidation, this asset is your home. You use the equity in your home to pay off your consumer creditors and the bank owns more of your house. This means that if you can't make payments, you lose what is likely your biggest asset through foreclosure.

Another issue is the fact that many homes are moving into the territory of negative equity, due to falling home values. You may take out a home equity loan now to consolidate your debts, but if home values fall further in the next few months, you could find yourself upside down on your mortgage. And, with home values as they are now, even a home equity loan may not cover all your debts. You may only have enough equity for 3/4 of your debt -- or less. This means that you still have multiple payments to make.

As an alternative to using home equity for debt consolidation, you can use a process of aggressive debt reduction to take care of your debts on your own (pay down the card with the highest interest rate first). Also, if you feel that debt consolidation is the easiest way, there are organizations that will help you consolidate your debt without a loan. Just watch out for high "administrative" fees and other costs. And, if you are concerned about your credit card interest rate, it is possible to negotiate a lower rate yourself. In some cases, you can even negotiate to close the account and finish paying off the balance at the lower rate.

Editor's Note: I am cetainly no expert on debt consolidation, however I do have legal training (which I have not used in over a decade). I believe that the statement claiming that lenders cannot actually force you to pay unsecured debt is not correct. The difference between secured and unsecured debt is that in the event your assets are not sufficient to cover all your obligations, creditors holding secured debt have precedence over non-secured lenders, i.e. they get paid first from their secured asset, and the non-secured lenders get whatever is left (if anything). Unsecured debt does not mean that your lenders have no recourse. They can still come after you, even though the process they need to follow to come after your assets may be more cumbersome from their perspective. Am I off on this? Anyone?

Of Real Estate and Payday Loans

Today I would like to follow up on two stories I wrote recently.

The first, is a story I wrote last week, titled How Much is Your House Worth? The article discusses a website called Zillow, which I just discovered last week but that apparently has been around for a while. The site purports to provide free estimates of real-estate values, however one of the things that I was concerned about was the accuracy of the data on the site. Well, it turns out that the Wall Street Journal went and took a sample of data from Zillow and tested it against some real world sales. The verdict? In most cases Zillow is pretty darn accurate, however there is the occasional spectacular flame-out. It's an interesting article and worth a quick read.

The second story on which I want to follow-up is one that I wrote last month titled A Payday Loan Dilemma. The company that originally contacted me and asked to advertise on my blog contacted me again last week. This time they actually left a comment in response to my original article. Here is the full text of the comment:

"It is true that cash advances and payday loans are high risk loans – for both the borrower and the lender. However, sometimes, these types of payday loans are unavoidable. Some people are unable to set up there [Sic] own emergency fund, and while responsible and making decent money, find themselves in a real bind from time to time. If these types of loans are understood and used for their intended purpose, they can be helpful and can give a person a “shot in the arm” financially to help keep up. Of course there are risks involved, which is why any borrower should always read through the site and loan agreement before taking the loan. Always ask questions. Additionally, if they do get the loan, it is best to pay it off in full or in as few payments as possible because of the interest rates."

As I mentioned in my original post, I agree that Payday loan companies do fill some sort of necessary economic niche, but 968% per year? Come on! I am sure that they could make do with a modest interest rate in the low 200s. I don't expect capitalists to be altruists. A company is in business to make money and does not really need to justify the price it is charging for its services, so long as it is facing real competition and its customers are willing to pay the price. However, I dislike companies that try to dress up their own economic interest in the guise of a public service. I also dislike companies that pretend to tell consumers to not buy their goods and services. Those always remind me of the tobacco industry. Seriously, if you don't want people to buy your product... don't sell it. Don't like this solution? I didn't think so.

Specifically, while the comment above suggests that users of payday loans should use them for their "intended purpose" and pay them off as quickly as possible. However, the company in question, like all others in this industry, profits when people do not take this sort of advice. So why the pretense?

A Payday Loan Dilemma

A few days ago I was contacted by a payday loan company that was interested in advertising on this blog. The payday loan industry has recently come under a lot of fire from both personal finance bloggers and from less respectable institutions, such as Congress. Given the request, I did some thinking and crystallized my position on the payday loan industry more fully.

First, for my international readers and for the benefit of my American readers who have never watched late night cable channels, a brief explanation of the concept of payday loans. Payday loans are basically a short term loan given by private lenders, which you are expected to pay back out of your next pay check. The interest rates on these loans are incredibly high, and can reach several hundred percent per year or more. For example, one payday loan company I found online (by clicking on their ad) charges its customers $18.62 for $100 borrowed for a period of 7 to 14 days... 968% per year... by the way, that company bills its services as "Quick and affordable cash advances". Affordable, no less.

My opinion on this industry is twofold. My gut reaction is that this industry is an abomination and should be eliminated. This is loan sharking at its worst. I mean, this industry preys upon the financially weak and on the uneducated, driving them deeper and deeper into debt and poverty. As someone who has his financial house (mostly) in order, I view the existence of this industry as an abomination.

However, as readers of this blog know, I am a free market capitalist at heart. I believe that any business transaction between responsible adults, in which no market failure can be clearly demonstrated to exist, is no business of the government. The market should rule. If there was no need for this industry, if it did not provide a valuable service to its customers, it would not survive. The industry's very existence is proof enough that it should be allowed to exist. It is very easy to be sitting in my comfy chair in my office writing this post about the evil payday loan companies, but would I be feeling the same way if this industry was my only source for getting urgently needed cash? Probably not. As much as I hate it, payday loans are probably some people's only financial option.

My ambivalence leads me to the following conclusions:

1. Regulation - the payday loan industry should be tightly regulated. While I would not support setting maximum interest rate levels, I would certainly support such things as big, bright red letters informing people of their loan's APR; requiring a 24 hour mandatory waiting period before loans are funded, to prevent people from using this very expensive capital for such frivolous pursuits as gambling; and other measures to ensure that people are aware of exactly what it is that they are getting into. Very much like the tobacco industry, I would also favor bans on advertising of payday loans.

2. Education - people must be made aware not only of the tremendous costs payday loans carry, but also of the other options available to them. It is important that people view payday loans only as an absolute last financial resort, not as a first step to take at the first sign of financial difficulty. Practically any other source of cash is preferable to a payday loan: an advance from your employer would be ideal, a loan from a family member or a friend, renegotiating the terms of payment with your creditors. For other ways to avoid payday loans, check out this link from the FTC.

3. Preparation - there are some people that are no doubt forced into a situation where they must take a payday loan through no fault of their own. However, for the most part, the best way to avoid the need for a payday loan is to prepare for emergencies. Build an emergency cash fund; live below your means; insure against your biggest risks. For the most part such preparation will eliminate the need for a grotesquely expensive payday loan.

As a bottom line, yes I think that payday loans are bad. Yes, I think that they provide a service that is essential to some people at certain points in time. The payday loan industry must be tightly regulated and controlled, but there is no escaping the fact that there are some people for whom payday loans are the only option out of a bad situation.

In case you are wondering, I turned down the payday loan company's request to advertise on my blog. Here are portions of my e-mail response to their request:

"...As you may have guessed, my opinion of payday loans is quite negative. However, being strongly on the side of free markets, I am willing to concede that your industry fills a necessary economic niche, and provides a service that a certain portion of the population requires and greatly appreciates.

Despite this, I have decided to not accept your offer to advertise on my blog. I consider myself to be financially secure, and I am grateful that I have never needed the services that your industry offers. I feel that by accepting your offer of payment I would be taking advantage of those who are less fortunate economically, and who come to my blog in search of advice and information on how to improve their lot..."

Do you think that I have made the right decision? Do you agree with my take on the industry?