Reverse Mortgages

I’m not that familiar with the intricacies of reverse mortgages but one of my clients recently asked if it was a good idea for him to do one so I did some research. Here’s what I’ve learned about them so far:

When you have a traditional mortgage, you take out a loan and pay the lender payments so that after a period of time (30 years, usually) you own 100% of the home. With a reverse mortgage, you start off with a house that you own 100% and then borrow against it and the lender pays you. Now why would that be a bad thing? Because you’ve traded having no debt on your home for increasing debt on your home and when you pass away or decide to sell your home, you have to repay the loan and could end up with nothing (i.e. no home) depending on how much you owe and how much your home is worth at that time. Not to mention there are a bunch of fees involved and you’re still responsible for all the carrying costs – property taxes, HOA dues, insurance, etc.

You have to be over 62 to even qualify for a reverse mortgage so this obviously doesn’t apply to us millennials right now. However, this could apply to our parents. Most of our parents are over the age of 62 (or will be within the next decade) and they’ll likely have a paid off house. If they’re in retirement and running out of money, someone might tell them to do a reverse mortgage. And now that you know that it’s not a good idea, you can advise against it and try to convince them to consider other options instead like downsizing or selling their home and renting.

Dave Ramsey’s 7 Baby Steps

I was first introduced to Dave Ramsey in 2009, when I was still in college. My roommate at the time let me borrow her copy of The Total Money Makeover. Even though I had always been an avid saver and didn’t have any credit card debt, I wanted to learn more about money.

I didn’t retain a lot of the information I read at the time, but I remember agreeing with most of Dave’s principles. The book also helped me realize the importance of giving, which I had never thought much about before.

After reading that book, I didn’t think about Dave Ramsey or his 7 Baby Steps again until very recently.

At the end of the last year, my husband and I bought our third rental property. And when I finally filled out a net worth statement and realized just how much debt we had once we combined all three mortgages (plus a HELOC), it was a rude awakening to say the least.

Even though our net worth is still very much positive thanks to increasing home values, we don’t like having so much debt, or any debt, to be honest.

So shortly after we opened escrow, we started listening to The Dave Ramsey Show every day. Listening to all the Debt Free Screams has inspired us to finally take his 7 Baby Steps seriously and make a plan.

We are technically in Baby Step 2 because we have small car loan. But we should be able to jump to Baby Step 4 & 6 within the next 2 months (we’re skipping Baby Step 5 because don’t have kids yet) and here’s why:

Even though we have the cash to pay off the car, we are in the middle of a major home remodel for the new rental property we just bought. And since home remodels often come with expensive surprises (like suddenly all the pipes need to be replaced!), we want to have enough cash on hand to cover any of those surprises, rather than resort to borrowing more money.

Once the home remodel is compete, we should have enough cash remaining to pay off the car (Baby Step 2) and have a 3-6 month emergency fund in place (Baby Step 3).

My husband and I are currently saving about 10% of our gross income into our 401(k)s but as soon as the home remodel is done, we will bump it up to 15% (Baby Step 4). We will also be redoing our budget to make sure we can pay extra principle on our mortgages & HELOC to get out of debt faster (Baby Step 6).

Based off our current income and expenses, we are projected to be in Baby Step 6 for over 25 years (yikes!). But by reducing our expenses immediately and increasing our incomes over time, our goal is to get out of Baby Step 6 in 15 years or less. The average family takes 5-7 years to finished Baby Step 6 but since we have 3 rental properties, 15 years might be more realistic.

If all goes well, we should be financially independent the same time we pay off our last mortgage.

I know things won’t work out this way exactly because, you know, life happens. But that’s our plan and if we’re delayed by a few years, we would still be out of debt a heck of a lot sooner than if we had no plan at all.

Rich People Problems

Ever wonder what kind of money problems multimillionaires have?  I’ll let you in on a little secret…

They have the same problems as everyone else, except on a grander scale.

  • they spend more than they earn – sometimes hundreds of thousands more
  • they can’t retire when they want – some of them will never be able to retire
  • they worry about how to pay for their kid’s college education (on top how to pay for a private elementary, middle and high school that costs them at least $20,000 a year per kid)
  • they have to take out second mortgages to fund major purchases like home remodels and their children’s weddings
  • they have credit card debt

How do I know all this?  Because these are the people I work with daily.

Why am I telling you this?  To show you that the answer to most of your financial problems is not earning, inheriting or winning more money.

You know what will fix your financial problems?

  • Spending less than you earn
  • Saving for retirement (early and often)
  • Saving up for major expenses (cars, home remodels, weddings) instead of taking out additional loans

For my clients who can retire comfortably, those are always the top 3 traits they all have in common.

Getting on-top of your finances – Where to start

The best time to get on-top of your finance is any time, really, but people are most motivated at the beginning of a new year.  So here is a step-by-step guide for those of you who’ve made getting on-top of your finances one of your 2016 goals but don’t really know where to start:

Step 1)  If you’re working and have a 401(k), find out if your company has a 401(k) employer match and make sure you are contributing at least up to the match.  If they match up to 3% of your salary, then start contributing 3% of your salary to your 401(k).  The reason this is step 1 is because this is FREE money you’re leaving on the table.  Side note: It helps to know your company’s vesting schedule.

Step 2)  This step can actually be done in conjunction with Step 1.  Find out if your company has a Roth 401(k) option.  If they do, get it set up and start contributing to your Roth 401(k) instead of your regular 401(k) UNLESS your company doesn’t match Roth contributions.  In that case, contribute to your regular 401(k) first (up to the match) and then the rest into your Roth 401(k).  Reasons why a Roth is usually better for millennials can be found here.

Step 3)  Pay Yourself First

Step 4)  Pay Your Credit Card Balance Every Week

Step 5)  Track Your Spending

If you’re already doing all 5, congratulations!  You’re already way ahead of the game.  I’ll cover some more advance stuff another time like investments and insurance.

Happy New Year!

Is Refinancing Always a Bad Thing?

I was listening to a sermon about finance a few weeks ago and when the speaker referenced people who manage their money poorly, he mentioned how “they just keep refinancing…”.  I realized then that a lot of people might have a misconception about refinancing, assuming it’s always a bad thing.

When someone with poor money management skills is refinancing their home, they are most likely doing what’s called cash-out refinancing.  This means they are taking cash out of the value of their home and using it to pay down other debt (i.e. credit card debt), while starting a new loan on their home.  I found a great explanation of how cash-out refinancing can propel someone further into debt on Investopedia:

Many homeowners refinance in order to consolidate their debt. At face value, replacing high-interest debt with a low-interest mortgage is a good idea. Unfortunately, refinancing does not bring with it an automatic dose of financial prudence. In reality, a large percentage of people who once generated high-interest debt on credit cards, cars and other purchases will simply do it again after the mortgage refinancing gives them the available credit to do so. This creates an instant quadruple loss composed of wasted fees on the refinancing, lost equity in the house, additional years of increased interest payments on the new mortgage and the return of high-interest debt once the credit cards are maxed out again – the possible result is an endless perpetuation of the debt cycle and eventual bankruptcy.

Sometimes refinancing is a lot more justifiable like when you need to pay for your child’s college tuition or a large medical bill.  And sometimes refinancing can even be a good thing like when you use it to lower the interest rate on your mortgage.  Investopedia does a great job of summarizing When (And When Not) to Refinance Your Mortgage.  So take a look when you get a chance!

“Cups”

My roommate recently got a promotion and a raise (congrats again, roomie!).  And over brunch this past weekend, she asked me for advice on what to do with her new monthly surplus.  The first thing I suggested was that she should put an X amount of dollars into her savings account every paycheck.  Saving money is always the easiest when you first get a raise or any type of windfall because you’re already used to living without that extra cash.

Our conversation eventually turned into talking about the three different “cups” we could put our money in.  I literally used 3 different cups on our table to explain.

The Savings Cup

The first cup is the savings cup, which is your savings account.  This is the first cup you should consider putting any extra money in because everyone needs an emergency fund.  Emergency funds should typically cover 3-6 months worth of expenses.

The Retirement Cup

The next cup is the retirement cup.  This is your 401ks and IRAs.  The reason why this cup is second most important is because of all the tax benefits it offers.  All the dividends you receive from your investments in these cups are going to be tax deferred (aka you don’t pay taxes until later when you take the money out during retirement).  And if you’re using a Roth 401k or Roth IRA, you have the added bonus of not having to pay any taxes when you withdrawal from the account.

The Investment Cup

The third and final cup is the investment cup, which is your personal investment account at Schwab, TD Ameritrade, Fidelity, etc.  You often hear people say they put their “play money” in here.  It’s not because the “account” is inherently more risky (a common misconception).  It’s because people like to try their luck in finding the next “Apple stock” with this account.  But you could technically do the same thing in your 401k and IRA because they’re all just accounts; they hold your money and YOU decide what to invest in.  So why is this the 3rd cup if it’s almost like a retirement account?  It’s because it offers the least amount of tax benefits.  When your investments pay you dividends each year, you have to report it on your tax return, increasing the amount of taxes you’ll have to pay.

Good Personal Finance Reads

Stimulate the Economy Like a Minimalist (The Minimalists) – The Minimalists debunk a popular consumption (or lack thereof) myth.

7 Business Mistakes that Almost Sank Me (Wealth Pilgrim) – Good advice for anyone who is thinking about starting their own business.