Tuesday, July 31, 2007

A "No-Spin" Mortgage?

I've heard Ray Vinson on the radio advertising a $72,000 mortgage loan for only $299 a month. In some of Ray's commercials I've heard Bill O'Reilly endorse Ray's "No-Spin Mortgage". Ray goes on to brag about how he's "saved" people hundreds of dollars a month.

I went to Ray's web site to see if he had any details on this wonderful mortgage, but if he had any they were well hidden. I brought out my financial analysis tool, Excel, and calculated that a 30-year fixed rate loan at the terms stated would require that the interest APR would need to be about 2.88%.

I didn't think that interest rates were that low, and at www.bankrate.com found that a 30-year fixed rate mortgage with zero points is running somewhere around 6%, or twice that. Looking around a bit, I saw an ad by Quicken Loans offering $200,000 for $585 a month. While the amounts are different the ratio of loan amount to payment is similar to that for what Ray is touting.

So I clicked on the link in the ad, and was rewarded with an explanation for the wonderful rate. In the fine print for the ad:

Rate is variable and subject to change. After the initial fixed-rate period, the rate will adjust every 6 months. The initial, minimum payment on a 30-year $200,000, 5-year Adjustable Rate Loan and 80% LTV is $583, with 3.25 points due at closing. The minimum payment is based on a rate that is implied solely for the purpose of calculating the minimum payment which in this example is 3.5%. Interest will accrue at a rate of 6.50%. Paying only the minimum payment will result in deferred interest or negative amortization since you will not be paying all of the interest that is owed each month. The unpaid interest is added to principal. Interest can be deferred until the outstanding principal balance is 15% (10% in New York) higher than the original loan amount. If the maximum limit is reached during the first 5 years, the payment automatically converts to an interest only payment. In this example, the maximum limit will be reached in the 53rd month, which is when the loan amount reaches $172,500.00. At this point, the minimum payment will convert to an interest-only payment of $1,245.50. After 5 years, the interest only payment is $1,437.11. After 10 years, the principal and interest payment is $1852.37. The Annual Percentage Rate is 7.533%. Rates could change daily. Actual payments and rates may vary depending on individual client situation and current rates. Some restrictions may apply.

So let me summarize: You're not really "saving" money on this loan. While your cash flow for the first few months after taking out the loan is reduced, you're going deeper in debt as the interest you didn't pay gets added to the loan balance. And when you took out the loan, you immediately went further in debt by $6500 (3.25 points on $200K) plus probably $2K - $3K of closing costs. The example in the fine print is also erroneous or at best confusing. With negative amortization (paying less than the interest) the loan balance will not be $172,500 after 53 months, it will be over $238K. And in reality will probably be higher when the interest rate adjusts above 6.5%.

The devil will be sure to point out all that high-interest-rate credit card debt that was retired when the mortgage was taken out from Quicken. True, you're paying a lower rate on that debt. But you're also paying interest on the $6500 in points you added to the loan, and will be paying interest for another 30 years or so. Perhaps even when you think you'd like to be retired. And if you refinanced from a mortgage that had a lower rate, you're paying a higher interest rate on that amount as well.

Plus, someone who would be suckered in by this deal probably will forget about the forthcoming doubling to tripling of their mortgage payment, and run up the balances on the credit cards, again. When their mortgage payments balloon up, they'll really be in a pickle and this time could find themselves on the street when their house is foreclosed. Learn more about these loans from this Federal Reserve pamphlet or this one.

If you're contemplating such a loan -- don't do it!!! Look for an alternative. Eat Ramen noodles for awhile and pay down the credit cards directly. If it's too late and you already have one of these loans, stop making only the minimum payments. Stop using your credit card and pay them off as quickly as you can. After your credit cards are taken care of, put all the payments against your mortgage so that you finish paying it off sooner. Read more about Dave Ramsey's debt snowball.

If your monthly payments are less than the interest being charged by the mortgage company and the credit card companies, you're not "saving" money. You're getting deeper and deeper in debt.

Is Ray Vinson's mortgage like this? Can't say for sure since he won't tell us. But I sure know which way I'd be betting. I think Bill O'Reilly's "No-Spin Zone" is really "Only-Bill-Gets-to-Spin Zone" but that's off the topic. I'd be interested to hear from someone who's has a mortgage brokered by Ray, either from Vinson Mortgage or from American Equity Mortgage.

In any financial transaction, be sure to find the fine print and read it carefully. And this goes double if you're looking at a "No-Spin" mortgage from Ray Vinson.

Sunday, July 29, 2007

Flat Panel Giveaway

Leave a comment at http://www.5minutesformom.com/2032/insignia-37inch-flat-panel-lcd-hdtv-contest/ to enter a giveaway contest for a free flat panel TV from Best Buy.

Saturday, July 28, 2007

Your Poor FICO Score can Cost You, Even If Debt Free!

It is discussed in this article on Yahoo Finance that your FICO score can result in increased premiums for auto insurance.

Furthermore, the Supreme Court recently ruled that the insurance companies aren't required to notify you that your poor FICO score has resulted in a higher premium charge.

The Yahoo Finance article goes on to give some standard advice, such as paying your bills on time, and not canceling credit cards that you've held for awhile.

This is all good advice. Additionally, you should obtain your credit scores annually at this site and not the one that advertises on TV as being "FREE". You can get one report from each of the 3 major agencies each year that truly is free. And you can space these reports out every 4 months as I previously discussed so you can more rapidly detect errors. And if you've never checked your credit report, you may find some surprises -- such as incorrect information that can be corrected.

No, your FICO scores are not free. But following good practices and correcting erroneous credit reports can only help your score.

Thursday, July 26, 2007

Tracking my Net Worth

Many bloggers publish their net worth figures. I will not be providing figures, but do show the graphic to the side to illustrate my method. The graph tracks my net worth over the last several years and separates it in to categories.

Starting from the bottom of the graph:
-- The blue area is cash and demand deposits.
-- The area above that is government savings bonds, which are almost as liquid as cash.
-- The yellow area represents the value of stocks held outside of retirement accounts.
-- The green area is the value of my titled property (house and vehicles) less any loans (none).
-- The dark red area is the value of my Roth IRAs.
-- The pink area at the top is the value of my tax-deferred retirement accounts, traditional IRAs, 401(k)s, and the cash value of my company pension.

By doing this, I can see liquid assets on the bottom, retirement assets on the top, and property assets in the middle. Or you could view it as short term on the bottom, long term at the top. There is some debate in the personal finance blogosphere as to whether or not the value of your house is really part of your net worth. I think that it is, but its liquidity is low. And if you do sell where are you going to live -- in a tent at a rest area or under a bridge? I think you should have an awareness of the portion of your net worth tied up in your property, but keep it in perspective.

Were I to report figures, they would be lower than what most people would report. Most people would simply add up the market value of their stocks, their 401(k) balances, market value of their house, etc. However, I discount account balances to be more realistic:
-- My government savings bonds are discounted by the taxes on accrued interest, at my current marginal rate.
-- Stock values are discounted by capital gains taxes.
-- My car values are the blue book wholesale value. The value of my house is estimated at 75% of the tax appraisal, to account for real estate commissions, fix up costs, etc, and any error in the tax appraisal (though it is usually about right).
-- My tax deferred savings is discounted as though I had to pay taxes at my current marginal rate. My actual tax rate in retirement may be lower, or contrary to most popular opinion may be higher. But it makes this year's decision as to whether to fund a Roth IRA or tax-deferred savings neutral with respect to tracking net worth.

My method isn't perfect. If it were, I would include the value of my household goods. But why bother? How much would I really get for them at a garage sale?

But in the end, it's like any good net worth tracking scheme. It allows me to get a sense of my progress.

Saturday, July 21, 2007

My Guest Post on MoneyNing's Blog

Today, I have a guest post on MoneyNing's blog concerning the bi-weekly mortgage payment scheme. Thanks to David for hosting me.

While some of the content on my blog is of greater interest to boomers looking forward to retirement (or dreading it if they've been a grasshopper instead of an ant), I think that some of my content is of general interest. For example this one on savings rates and compounding.

So please look over my blog, and leave a comment if something interests you. Thanks for stopping by.

Thursday, July 19, 2007

I Just Obtained a Free Copy of my Credit Report

I take advantage of the free credit reports available from http://www.annualcreditreport.com/. I do not use the other site that has "free" in its URL instead of "annual" and is advertised on TV. The reason I don't the "freecreditreport" site is that it really isn't free. I regard having to remember to call and cancel and waiting on hold for who-knows-how-long as a cost.

I space my reports among the three major credit reporting companies. I hit Transunion in March, Experian in July, and Equifax in November. This gives me a sample every 4 months of my credit. Since the calendar says that it's July, I pulled my Experian report. As expected, all it has was all both of my credit cards and showed them as being paid current.

The law allowing you to obtain one free copy each year of your credit report from each major credit reporting company has been on the books now for about 3 years. If you have not taken advantage, I highly recommend that you do so. The first time I did, I found errors on all three reports that I was able to have corrected and negatives that I was able to have removed.

With me having paid off my mortgage, owning my cars free and clear, and not carrying credit card debt, and not anticipating being in the market for loans, why should I care about my credit report?

Things could change. I could find myself changing employers and moving to a different city. The prospective employer might pull my credit report to check on my character. Were I to rent an apartment I could have my credit report checked there also. Even if I don't encounter such disruption in my life, my auto insurer bases premiums on my credit report. Were someone to steal my identity, I would find out much sooner than if I waited for the identity thief's charges to work their way to a bill collector.

Sunday, July 15, 2007

Delaying starting Social Security Benefits One Year

Scott Burns has an excellent article on his Asset Builder site where he discusses that for him as part of a married couple, delaying the beginning of Social Security benefits will result in an increased monthly payment. And that to buy an equivalent inflation-adjusted joint-and-survivor life annuity on the open market equal to the increase in monthly payment would cost much more than the Social Security benefits he lost during the one-year waiting period.

A little background for those unfamiliar with some of the concepts. Social Security benefits based on your earnings increase the longer you delay the commencement of benefits, up to the age of 70. Someone whose Normal Retirement Age is 66 will receive a monthly benefit that's 8% higher if he waits until the age of 67 to start benefits. Also, Social Security benefits also are increased with inflation. A lifetime annuity is one which is purchased with an initial contribution, and then the annuitant receives a monthly payment for his lifetime. Some annuities are offered with options, such as return of principal, that are not equivalent to Social Security. One option that is equivalent to Social Security is joint-and-survivor life. The annuity can be structured to pay a certain amount to the annuitant, and if he dies then all or a portion will be paid for the lifetime of his survivor (named at the purchase of the annuity). Under Social Security, when one of a married couple dies, the survivor continues to receive the larger of the two Social Security checks (unless the Government Pension Offset provision applies).

Let's consider a married couple, in which the wife has earned a Social Security benefit equal to 50% of her husband's. She can draw a benefit based on her own earnings, when her husband retires they also receive his benefits. If the husband dies, the widow no longer receives her own benefit but continues to receive her husbands. If the wife was a stay-at-home mom and has no benefit based on her own earnings but will also receive spousal benefits of up to 50% of her husband's benefit, depending on her age of retirement. However, spousal benefits can't start until her husband also draws his Social Security. In either of these two cases, the widow's benefit is equivalent to her continuing to draw her own benefits plus 50% of her husband's.

In the table below, I have some figures as to the monthly check from an annuity or Social Security benefits not taken during a waiting period. For example, a value of 0.005 would mean that for an annuity contribution of $100,000 a monthly check of $500 would be paid that would be adjusted upward for inflation. Social Security values are for those whose Normal Retirement Age is 66. Annuity values are obtained from Vanguard's web site, see Scott's site for a link.

Monthly return from annuity principal
Age SS Male Female Joint
62.00 0.005556 0.004747 0.004320 0.004224
62.92 0.005236 0.004892 0.004439 0.004336
63.00 0.006944 0.004905 0.004450 0.004346
64.00 0.006410 0.005064 0.004580 0.004469
65.00 0.005952 0.005222 0.004710 0.004591
65.92 0.005585 0.005367 0.004830 0.004704
66.00 0.006667 0.005380 0.004840 0.004714
67.00 0.006173 0.005588 0.005014 0.004874
68.00 0.005747 0.005796 0.005187 0.005034
69.00 0.005376 0.006004 0.005361 0.005194
70.00 0.005051 0.006211 0.005534 0.005354

The return for delayed Social Security varies because of the formula used to compute benefits. For example waiting from age 66 to 67 increases benefits by 8%, but waiting from age 69 to 70 increases benefits only 6.45%. This is not actuarially correct since 1 year is a higher portion of your remaining life expectancy the older you get.

As a single male, the spousal aspects of Social Security do not effect me, and there fore my payments under an annuity are 12-15% higher than they would be if I provided a 50% survivor's benefit to a wife of the same age. Therefore, the advantage to me for delaying Social Security is less than for a married man. Even so, I come out ahead up until the age of 68, after which I come out ahead because of the actuarially incorrect computation of Social Security.

For a single female, the advantage for delaying benefits is extended to the age of 69. That's because an annuity payments are lower to a female, not because of male chauvanism but rather because a female has a longer life expectancy.

For a joint-and-survivor annuity with the wife getting 50%, the payments are slightly below that of a single female, so the advantage for delaying benefits also ends at about age 69. This assumes that the wife is exactly the same age as the husband. The payments will be decreased for a younger wife, with greater reductions for a greater difference in ages. Also to be considered is whether the wife has a benefit based on her own earnings that's higher than the spousal benefit. In that case, the survivor's benefit is less than 50% so an annuity payment would be higher than that in the table, and the advantage for delaying benefits decreases.

For a couple with a stay-at-home wife, the advantages for delaying benefits are the same as a single male up until the wife reaches her Normal Retirement Age. After that, any disadvantage quickly disappears because spousal benefits are not increased for waiting beyond Normal Retirement age -- but they are decreased for taking benefits before the Normal Retirement age.

Hopefully this along with Scott Burn's article will provide some food for thought. I urge you to learn more about how your benefits are computed from the Social Security Administration web site, the links on Scott's article, and some study of your own situation. There are other factors to consider, such as whether your Normal Retirement age is close to 65 or to 67.

Friday, July 13, 2007

Should you convert ALL of your retirement savings to Roth?

Recently on The Simple Dollar blog, there was a discussion about future tax rates. Gail posted the comment:
"I am 56 with all my retirement funds in both Roths and traditional IRAs. I am working on a 10 year plan to complete converting all my traditional IRA funds to Roth IRAs by the time I qualify for regular Social Security. Why? Two reasons, neither very complicated. First, regardless of tax rates, I prefer knowing that I won’t have to worry about paying taxes at a time in my life when I may not be able to afford it as easily as I can now. (Same reason why I paid off the mortgage on the house). Second, assuming my investments outperform me, my children will not need to pay taxes on the Roth when they inherit and begin withdrawals.

I believe that Gail's plan to convert all of her tax-deferred retirement savings goes against her goals. While I believe that marginal tax rates will increase in the future, I also believe that there will be a certain amount of Adjusted Gross Income which is not taxed -- your personal exemptions and standard deductions. In 2007, the amount of AGI not taxed is $9800 for a single person 65 or older.

For this discussion, let's assume that Gail's investments do slightly better than the inflation rate. For this discussion, the dollar figures will be in 2007-equivalent dollars. Let's say she has $100,000 in traditional IRAs, and that her marginal tax rate is 15%. If she converts it all to Roth IRA, then it will cost her $15,000 in taxes, leaving her with $85,000. If she follows the 4% rule-of-thumb for withdrawals, then she would withdraw 4% of $85,000 or $3400 of it. And yes, all $3400 of that money would be tax free. In reality, the added taxable income from the conversion likely would put her into the 25% or higher bracket, leaving her with less money, only $3000.

Now let's say we were able to persuade Gail to leave the $100,000 in traditional IRAs. She reaches retirement with $100,000 tax-deferred, pulling out 4% or $4000 the first year. Will she pay any taxes on that amount? At first glance, $4000 is less than the $9800 sum of standard deduction plus personal exemption, so you'd expect that no taxes are due. However, the possibility of part of her Social Security being taxed should be considered. If half of her Social Security benefit + all of her other taxable income exceed $25,000 then she would have to add some of her Social Security to her Adjusted Gross Income (AGI). Let's say that she gets $1500/month or $18000/year in Social Security. Half of that ($9000) added to the $4000 equals $13,000. So none of her Social Security gets added to her AGI, and since her AGI of $4000 is less than $9800, she pays NO TAXES anyway.

But we're not done. While I expect standard deduction and personal exemption values to be indexed for inflation, the $25,000 test amount is not indexed. Let's say that over the next couple of decades, inflation doubles and erodes this to the equivalen of $12,500 in 2007 dollars. In that case, she would have $250 of Social Security added to her AGI, resulting in an AGI of $4250, none of which would be taxed.

Let's say that inflation continues for another decade and erodes the test amount to the equivalent of $6250. In that case, $4950 of Social Security will be added to the $4000 resulting in an AGI of $8950. Still less than $9800, so none of it will be taxed.

So by not converting all of her traditional IRA money to Roth IRA, Gail has extra money ($4000/year instead of $3400 or even less if taxed at greater than 15%). As far as the taxes to the heirs, if she converts the money to Roth IRA -- sure, it won't be taxed. But there will be less of it to not be taxed. Said another way, if she leaves it as tax-deferred savings, her heirs would have to pay taxes but would have more money to start with which to pay the taxes. Will they be better or worse off? Depends on Gail's tax rate now Vs their tax rate when they inherit it.

A more important consideration than optimizing taxes for your heirs is ensuring that you're not a burden on your heirs in the event that you don't die. Keeping some of your retirement savings as tax-deferred (traditional IRA or 401k) is a good strategy to increase money available for spending in retirement and reduce the likely-hood of having to depend on your heirs.

However, if you have too much money in tax-deferred savings, some or all of your Social Security benefits will be taxed. At the initial level, $1 of taxable income can result in $.50 of Social Security being taxed, and with additional income $.85 of Social Security can be taxed for each $1 of other income. This effectively raises a 15% tax rate to either 22.5% or 27.75%, and a 25% tax rate to either 37.5% or 46.25%. Not very attractive if you saved only 15% or 25% in taxes during the year that the funds were deferred. And if marginal tax rates increase, it's even worses.

Because of the taxation of Social Security benefits, I am converting tax-deferred savings to Roth IRAs. But I still intend to keep some amount of retirement savings as tax deferred.