Myths On Money

The Word on the Street

The ever-so-kind businesses are so generous as to allow us to finance large purchases at zero percent interest!!! What a sweet deal, let’s take it!

The Truth

These deceptive deals can be devastating to anyone who fails to read the fine print.

Conflict of Interest

Businesses are not your friends. They are there to make a profit, plain and simple. They do so by offering a fair exchange of goods and/or services. So, do you really think that the deals they push the most loudly are the things that make them the least money? No way! How many car commercials have you ever seen where they just tell you the price of the car? Not many. It’s always what your payment would be, or, better yet, what your lease would be. Why? Because this is where they make the most money, and at the same time, they make their product more “affordable”.

An Example

Maybe I will just let the numbers speak for themselves. The numbers you are about to see are very powerful: parents please be advised.

I love Best Buy. Truly, I do. They have great stuff. Like this TV. Very nice, wouldn’t you agree? And look, they have this wonderful financing offer. No interest at all for 36 months! Seeing as how I happen to not have $1,600 I think I will take advantage of this great deal. I mean, the payment is only going to be $45 a month. Piece of cake right? I sign on the dotted line and practically strut out of the store, confident that my financial prowess has won me a great deal.

6 months later, it’s December. It’s Christmas time! The holiday is so hectic and crazy, that I forget to make my payment on the TV on time. No biggie, I figure. I’ll just pay $90 next month, and everything will be great. I get my next bill, and get hit by the shock. My balance should be $1,330. Instead, I see a balance owing of $1,562. And my payment should be $45. Instead I see a payment of $74.80!! What happened?

What happened was the fine print. Take another look that financing offer and you will see the phrase “Interest will be charged to your account from the purchase date if plan balance is not paid in full within 3 years or if minimum monthly payments are not made.” This means that if you miss even one payment, they can (and probably will) backcharge all of the interest that you should have paid, and add it onto your balance. Then, they will start charging you their interest rate (21-30%) until the TV is paid off in full. I don’t know about you, but I have been known to be late on a payment a few times in my life. Not often, but occasionally one of my many bills manages to slip past my attention. Unless you have never ever been late on a payment (and I am not sure that’s possible!), there’s a fair chance you might be late once in those three years. So what does being late on that payment do to your bottom line? See for yourself.

6 payments x $45 per payment + 30 payments x $74.80 per payment = $2,514

So. $900 in interest just because you made one tiny little mistake, like being late on a payment. Just in case you were wondering, that is roughly equivalent to paying $2,409 on the day you buy the TV. Below is a table that shows how much the TV costs if you miss a payment at the various stages of the repayment period. Notice that the longer you go before being late, the more the TV winds up costing. This is because the interest that is secretly accruing in the background has more time to compound against you. Then, when you are late, it pounces.

So, it seems apparent that 0% financing can be a risky and expensive way to pay for things. Let’s see if we can find a better way. Suppose you just paid off your car, and now have an extra $200/month freed up. Instead of rushing out to renew that payment on a new car, you decide to reward yourself with a new TV. So, you save that $200 for just 8 months, and now have $1,600 in cash. You run out to Best Buy and, much to the dismay of the salesmen and the envy of your fellow shoppers, throw down cash for this magnificent TV. Let’s pause here and compare where you are at compared to where I was with my 0% financing deal. You have the TV, and no payment. I have the TV, and a $45 payment (for now, anyway). So let’s just suppose you decide you want to take the $45 that I am paying, and put it in the bank. If you can get a high-yield savings account that will give you 4% on you savings, then after 36 months, you would have $1,718 in the bank. So, after 36 months, I have my TV, and nothing else. You have your TV and $1,718 cash in your pocket. That’s enough to buy yet another magnificent set. Or you could keep saving…and pay cash for your next major purchase. This is how paying cash for things truly increases your wealth; if not only saves you from paying interest, if also allows your money to EARN you interest. Paying cash for cars is one of the best things you could ever do for your financial situation.

How do you start down the path of cash? Well, if you are in debt, the first thing to do is to get rid of the debt.
This will require discipline and concerted effort on your part. You may have to deny yourself some things. It will be worth it, trust me. The next step is to simply save your money each month. It’s that easy. If you do so, your money will begin earning interest rather than paying interest, and your wealth will grow.

I like this video. It kind of illustrates how personal finance can be a lot simpler than we sometimes think it is. I will let the video speak for itself.

Couldn’t have said it better myself.

The other night, I was reading Get Rich Slowly, one of my favorite finance blogs. I would like to lift a few of his comments from this fantastic post that illustrate why I LOVE personal finance, and what is truly important in our financial lives.

Freedom

To lift a quote from Get Rich Slowly:

“To me, life was all about the Stuff. I had hundreds of CDs and thousands of books. I had a TV, a stereo, a house, and a car. I wanted more. Sparky had none of these, but he had something I did not. Sparky had freedom. His frugal lifestyle allowed him to save and invest….
For some reason, I could not see the connection between Sparky’s thrifty lifestyle and his financial success. I could not see the connection between my own profligate ways and my mounting debt. I was blind.”

What is freedom? I think the idea can mean different things to different people, so I guess a better question would be: What does freedom truly mean to you? To me, freedom means that I can do as I wish. There is nothing (besides natural law) holding me down or constraining my actions. Nothing preventing me from fulfilling my every desire. Financial freedom is relief from servitude and slavery. I structure and manage my finances so carefully because I know that I am a slave, and I wish to someday find my freedom.

But slavery ended over 100 years ago, didn’t it? No, it didn’t. One kind of slavery did end after the Civil War, the kind we associate with cruelty, cotton plantations, and the Underground Railroad. But there is another form of slavery that has, rather than being stamped out, has been promoted, endorsed, and even celebrated in this country. The slavery I speak of is financial slavery, and it is a rapidly growing problem.

Think about it. Do you ever feel like your “stuff” owns you, rather than the other way around? Ever wake up in the morning wishing that you could just hit the snooze button and forget about work? What prevents you from doing so? Isn’t that what you would like to do on those mornings? I know I have those mornings. I don’t hit the snooze button for one very simple reason: I need money. I have rent to pay, groceries to buy, high-speed internet to pay for, burgers to buy, a car to fill up with gas. In short, my “stuff” is dictating my actions. I am going to work, (quite against my natural inclination) because my “stuff” demands it. So who, then, is truly in charge of your life? If you can’t take a day off because the car payment is coming due, then who is in charge of your life? Is it you? The bank? The car? Debt and excess are slavery, plain and simple.

I have structured my finances in such a way as to allow the maximum amount of freedom. I could switch to part-time work if I wanted to. I would certainly enjoy the extra free hours. I would have to sacrifice some other things to do so, though. Maybe the internet would have to go (a terrible thought!!), maybe we would have to eat ramen noodles and macaroni and cheese every day. But we could survive. We could pay our rent, keep the car filled with fuel, pay utilities, etc. The reason I could do such a thing is because I have limited the powers of my financial slave-masters. My rent is low. I have no car payment. I have no credit card debt. By stripping would-be financial obligations of their power, I have empowered myself. To a degree, at least. I would still need to work to get money, regardless of what I want. So I am not totally free, yet.

Since I only need a part-time salary to maintain my lifestyle, why do I work full-time? It’s simple. I CHOOSE to work full time because I want to get rid of all the forces that restrict my freedom. By spending significantly less than I earn, I am building my financial power. One day, that power will be enough to set me completely free. One day, I will have a home that has no payment on it, and investments that work for me to earn the income I need for my daily upkeep. When my money is working for me, rather than me for it, then I will be totally free, and I can use my time as I wish, and not as my creditors demand. That’s my financial dream. I want the right to CHOOSE to work how I want, when I want, as much as I want, for any pay (including $0). If I want to go on a vacation, I will need no one’s permission to go. I will just pack up and go. If I want to sleep in, then I will. If I wish to rise early, then I will. To be the master of my own time, to use it as I wish, oh what a joy that will be.

One of my favorite quotes, to sum up:

“Normal is getting dressed in clothes that you buy for work and driving through traffic in a car that you are still paying for – in order to get to the job you need to pay for the clothes and the car, and the house you leave vacant all day so you can afford to live in it.”
- Ellen Goodman

My friends, BE EXCEPTIONAL.

Money is not Wealth

From Get Rich Slowly:

“Please, my friends, always remember that true wealth has nothing to do with money. True wealth is built from friends and family, from experiences and relationships — it is derived from a life filled with meaning. Without these things, money means nothing. “

To this I would add that “stuff” means nothing. It doesn’t matter how shiny and new your car is. It doesn’t matter how dented and “economical” your car is either. It doesn’t matter how expensive of a gift you give. It doesn’t matter when your home was built, how big the yard is, how nice the granite countertops look. These things are not the source of happiness. Happiness comes from “friends and family, from experiences and relationships – it is derived from a life with meaning” and a life of freedom. Own your own life. Take control. Tell the advertisers that you don’t care that the Jones’ drive a better car, have a bigger house, throw bigger birthday parties. Tell the credit card companies that you will not be their slave and tell the banks that you will no longer work for them. Tell the Jones’ to join you on your way out of slavery and into freedom. As one who is living the frugal and “uncool” lifestyle, I can tell you that it is worth it. The greatest rewards are the furthest away, but the rewards of peace of mind and, yes, even freedom, that you will find the first day and onward make the small sacrifice worth it all by themselves.

The Word on the Street:

I still struggle to convince people that paying rent is not a purely wasteful practice. I have already done several posts on this topic.

The Truth:

Paying rent can be cheaper than getting a mortgage, and the difference in the cost can be invested to your ultimate gain. While I support the idea that most people would benefit from buying a home, I want to emphasize that no one should rush to buy simply because they don’t want to “waste” their money paying rent.

• A Quick Distinction
• A Waste?
• A New Perspective
• Real Estate As An Investment

A Quick Distinction

First off, I want to make a quick point of clarification. Renting an apartment can be much cheaper than taking out a mortgage, but renting a full house may or may not be cheaper. Personally, I think renting a home is not a very good decision, and should only be approached under special circumstances or at necessity. Because of the square footage you are renting, the cost to you to rent a home cannot be much less than paying a mortgage, so if you are going to be paying that much, you may as well get some equity out of it.

That said, if your rent is less than what you would pay for a mortgage, then renting is a viable option that ought to be considered.

A Waste?

So, is paying rent a waste? People often ask, “I paid all this rent, and what did I get out of it? Nothing!” But is that really true? Do renters truly get nothing from their rent payments? To answer, let’s look at a similar situation.

Suppose your family pays $200/month for groceries. At the end of the grocery run, is your net worth increased? Nope. Your net worth has decreased because you now have less money in your checking account. So buying groceries is a waste, right? Please say no. For your money, you got food, and food is necessary to life, so you could argue that buying groceries is a fantastic investment ($200 invested and you get back a month of life for your family, how can you measure THAT return?)

So it is with rent. You may not be getting any DOLLARS back, but the need for shelter is as vital as the need for food. So, for your rent, you are purchasing shelter. So it’s not a complete waste, just as buying groceries is not a complete waste. It is simply a necessary purchase.

A New Perspective

In a very real way, you can think of your mortgage payment as consisting of two parts: one part covers the cost of providing shelter, the second part is an investment in real estate. The interest that you pay every month is exactly like paying rent, with only one significant difference (to be discussed later). The principal portion of your payment is exactly like depositing money into an investment, again with only one significant difference (also discussed later). So, if your interest is just like rent, and your principal is just like an investment, then why not pay rent and make an investment? In the end, the result would be very close to the same.

Examine the chart below for an illustration of what I mean:

Notice the amount of interest paid versus the amount of rent paid. In the earler months of the mortgage, the interest is higher, leaving less to invest. But, over time, the interest expense decreases, thus freeing up more of your money to be invested in your home as equity. This is the fundamental difference between rent expense and interest expense. notice that it takes almost 7 years (83 months) for the interest expense to become less than the rent expense. So, for 7 years, you are “wasting” more money on interest than you would have on rent. After that point, the situation reverses. This is one reason why it is so important to keep a mortgage long-term; you need the late years to make up for the high expense of the early years.

So, if a portion of your mortgage is going towards an investment, what investment is it? It is your home. You are putting money into your home as equity. Simply put, you are investing in real estate.

Real Estate As An Investment

From EzineArticles.com:

Have the historical returns on Real Estate Investment measured up to the confidence it has received?

The answer is a cautious yes. Between 1926 and 1996, the annual average rate of return on Real Estate was 11.1%. During the same period the rate of inflation was around 3%. So, it was obviously a better investment to buy Real Estate than to bury cash in jars in your backyard. However, the rate of return for small stocks checked in a bit higher at around 12% while the Dow Jones Industrial Average was a bit lower at 10%. These figures would suggest that Real Estate investments were right there at a par with Stock Market Investments.

So, you can see that real estate investments enjoy similar returns to the stock market, so either investment would be a good choice. However, there are some differences between them. Perhaps most important is that real estate investments are not as easily converted into cash; this convertability is calledliquidity. If you have a large store of home equity, the only ways to access that is to sell the house or to take out a home equity loan (which would cost interest and thus reduce your net gain on the home). On the other hand, stocks (and bonds for that matter) are generally quite easy to convert into cash. The downside with stocks is that they experience a much higher degree of volatility in the short term. So they may be temporarily low in value when you have to cash them in. Both investments carry risk. The type risk each carries varies. Both investment types carry expenses. Again, the type and magnitude of these expenses can vary.

The important point to carry away is that both renting and home ownership present the opportunity to provide shelter, and that they both have room in them for you to save your investment in some kind of investment vehicle. Bear in mind also that the rent vs buy decision is not a decision that you make only once. At some point, renting may be better for you, but that may change next year or the year after. The key factor in the rent or buy decision is your time frame. If you are going to live in a place short-term, then renting is likely the better choice. If you are settling in for many years of living, then home ownership is likely the better choice.

P.S. Thanks to my Facebook Group for the inspiration for this post! Anyone is welcome to join.