IN A TYPICAL 30 YEAR MORTGAGE for $150,000 at a 7% rate with a MONTHLY PAYMENT of $ 997.95 and TOTAL YEARLY PAYMENTS of $ 11,975.40, you will pay more principal than interest only during the last five years of the mortgage!
How many people do you know who live in a house 25 years? Not many. This means that you are usually just paying interest, virtually renting, most of the time that you are in a home.
An amortization table is a form that shows how much principal, interest and escrow you pay monthly on a mortgage. Normally the vast majority of each payment goes toward interest and only around one-tenth of the annual payment actually goes toward knocking down the principal.
You could change this debt cycle by paying additional principle payments, but due to the cost of money it may be more important to use the extra money for savings, investments, and starting successful businesses. Yes, spending money has a cost and we might as well discuss it here.
Your cost of money is very essential to every financial decision you make. For example, if I proposed to lend you money at 40% interest, how much would you borrow from me? Hopefully you would reject that proposal. Your basis for refusal of that proposal is obvious to most anyone—the cost of money in this scenario is 40%.
But if I loaned you the money at 0% interest you’d be smart to borrow as much as you could get and pay me back as slow as you could because your cost of money in this scenario is zero.
Now that we’ve determined how to calculate the cost of money let’s look at how it affects your spending decisions, including everyday purchases.
Here’s a good example. Let’s pretend that you have a credit card that charges you 9.9% interest and your balance is $11,500. You find out that your next door neighbors, the Jones’s, are going on a cruise to the Bahamas and you get jealous and want to book a cruise for your family. The cruise for your family of four costs $4,750 and you plan to use part of your income tax refund to pay for it. Is $4,750 your cost of money? Certainly not. When you shell out the major portion of your tax refund for that vacation you have decided not to pay down the 9.9% interest credit card, so in the end it will cost you $4,750 at 9.9% interest to go on that cruise. In addition, if you have an interest bearing investment that pays you 6% and you choose to go on the cruise instead of taking the refund check and placing those funds in this investment, your cost of money is $4,750 at 6% interest. In the second scenario you are paying a high opportunity cost for not investing the refund check.
To be clear, every time you chose to make a purchase, even small one, instead of paying off debt or increasing your investments, there’s an additional cost you have to pay. That cost is determined by two numbers. The first number is the highest interest rate that you’re paying on a loan and the second number is the highest secure, predictable return on your money. When I say predictable I am not including the stock market. You know that I believe that entire system is a wicked game when it comes down to us outsiders. People are constantly advised to put money into 401(k)’s their whole working-lives, but their money is nowhere near secure. It is not and has never been guaranteed against loss and I believe that those that continue to put money there after 2008 will suffer the same fate again soon.
Please don’t get paranoid and stop spending because of the cost of money. That reaction will cause you to develop a poverty spirit. Just be aware of the cost and spend more wisely. I am hoping that exposing you to the cost of money will cause that very reaction.
What About Borrowing and Lending?
Before we move away from decreasing our expenses, I would like to say a few words about borrowing and lending. It is very hard not to borrow in our society. For those who did not learn to save for their expenses when they were very young, and those who don’t have rich relatives, you may need to borrow for a home and car, which are very large expenses. However, borrowing—using credit cards—for other items many times shows our lack of self-control and costs us greatly in the end.
If you only borrow for homes and cars that you can afford, you will keep your debt load low and increase your chances of obtaining wealth. Borrowing for college may be on your list, but if you start planning far ahead of time for your children’s college education, there will be no need to borrow when the time comes for them to attend college. The bottom line is: borrow as little as possible and as infrequently as possible and, most importantly, only borrow what you can afford to pay back!
As far as lending is concerned, I learned never to lend what I can’t afford to give away as a gift. When you start to use the principles in this book and your finances start to improve, people may start to notice. One important thing my Italian mentor taught me is that when I start to obtain wealth, “DON’T TELL NOBODY NUTIN.”
People are very interesting, and when you stop complaining about being in debt, start taking nice vacations, and building savings and investment accounts, people will concentrate less on asking you how you did it and more on asking you if you can lend them some money.
In my experience, and based on the experiences of friends that I have talked to, we all like to share our victories with our friends and relatives, but you need to be careful that you don’t get pressured to “share” the resulting financial blessings with others. One of the worst things that you can do is to build up a little savings and have others “borrow” it from you “just for a little while.” This scenario actually happened to me.
I had saved up $16,000 for emergencies, but because I verbally shared my financial victories with others, I let myself get pressured into lending those funds for others’ mortgage payments and other similar “emergencies.” Soon the $16,000 turned into $2,000, and I still have not received the repayments from these people. That was not money I could afford to give away, and I learned a hard lesson. Aside from the fact that I didn’t have that nest egg anymore, some of the people won’t even call me, probably ashamed to talk to me because they have not repaid me.
I had to start all over from $2,000 and build up for my wealth plan.
So the bottom line with lending: do not lend what you can’t afford to give away, and don’t tell friends and family when your savings accounts and investments are on the rise, or you may be pressured into lending some of your nest egg.
I am totally against co-signing on loans. I have seen people co-sign for grown folks who had not kept their finances in order. When you co-sign for another person, it is just as if you were buying that item yourself—you are ultimately responsible for the loan payments if the person you are co-signing for defaults.
For example, in one case a trifling couple walked away from their house and car, and left their relative with a substantial car note. The relative who received the car was not fully prepared to take over that note, and this situation was a substantial setback for her.
IMPULSE BUYING
Impulse buying kills any budget and financial improvement plan. Here are ten questions that you need to ask yourself about any purchase.
TO BUY OR NOT TO BUY
1. Do I really need it? Television, newspaper, radio advertising, and infomercials egg us on to buy thousands of items, but do we really need them? Before making most purchases, even groceries, we need to get into the habit of asking ourselves if we really need the item. It’s easy to get caught up in the hype, but if you take time to think about it instead of whipping out the credit card and calling the 800 number, you will find yourself saving and climbing out of debt. Late one night I was flipping through channels (which is a very bad idea because late night TV infomercials will get your money). There was a company that would build a new room onto your deck or patio, and I really wanted to enclose my deck. By the end of the infomercial, I had taken down the telephone number and would have called then at 2 a.m. if I hadn’t needed to check my bank balance. I was thinking more clearly at 9 a.m. and that immediately cooled my heels; I realized that I had other house maintenance projects to complete before I did anything with that deck. It dawned on me that the infomercial made me forget about
the more important projects which needed to be completed. Many people impulsively purchase items, not thinking about the fact that they are already in debt or that they have more important goals and projects to complete first.
2. Have I searched for the lowest price for this item? Even if you determine that you need the item in question, have you searched for the lowest price? Take that deck enclosure for example. If I had determined that it was a good investment, the next thing I should have done was to call other deck enclosure companies for their prices for my size deck. Companies that advertise the most often charge the highest prices, because they have to pay for all of that advertising.
I might have found a few companies with lower deck enclosure prices than the one advertised on the infomercial.
3. Is the price right for my budget? If you have placed something in your budget, you need to make sure that the price of the item you are looking at is right. If I had budgeted $2,000 for a deck enclosure and the infomercial was charging $3,000 and other companies charged $2,700, I would have needed to either find a company in my price range or wait until I had the money to get it done. Impulsively going with a company over $2,000 and not having the extra money would have taken money from some other part of the budget and thrown me further into debt.
4. Is this the best time to buy? Sometimes we just need to stop, wait, and use common sense about buying. Getting that deck enclosure in the dead of summer would be the most expensive time, because most yard work is done in the summer. I could almost pick my price in the winter because then these types of companies have less demand and are often starving for jobs.
5. Do I have the cash? The worse thing about impulse buying is when you spend impulsively using credit cards. Make a declaration that if you don’t have the cash for a thing you will not buy a thing. My family took a trip to Africa in the late 1990s, and we were on a strict budget. We wanted a video camera, but because we did not have enough cash for a video camera, we bought several instant cameras instead, with a difference of about $500. We missed a lot on video, but our instant camera pictures came out wonderfully, and we didn’t return from the trip in debt.
6. Is there a substitute for this item? Sometimes there is something else or something less expensive to purchase instead of the item being advertised for you to buy impulsively. For example, I was watching another infomercial that advertised these wonderful shoe insoles that would help with everything from posture to corns to energy. When I went to purchase them at this exclusive store, I found that they were very expensive. I hunted around and found some much less expensive insoles with equally impressive results. A little extra time and energy on my part saved me hundreds of dollars.
7. Does the item have any major disadvantages? Sometimes when we are caught up in the hype we don’t think about the disadvantages of certain purchases. Someone that impulsively buys that boat that they always wanted may not think about the fact that they have to pay for boat storage; they can’t keep it in their driveway, garage, or backyard. They may not think about having to pay for the annual boating license, fishing license, and other associated costs. Ask yourself if this item requires expensive upkeep. Count all of the cost of impulse buying; that new Corvette will not only bring large monthly car payments, but your insurance will go up about $1,000 a year and ad valorem tax may apply.
8. Have I researched the item? Many times when we buy impulsively based on advertising, we don’t research to see whether the advertised information is true. Weight loss plans that claim to help you lose 30 to 50 pounds in six weeks generate millions of dollars. People don’t research these wonder pills and end up spending a week’s grocery money on them, not knowing that some of their ingredients are very dangerous, according to the Food and Drug Administration.[1] Even if there is a secret, patented ingredient that helps with weight loss, the boxes always tell you that proper diet and exercise are essential to lose weight. If you did those without buying the pills, you would lose weight!
9. Will the item’s value increase or rapidly decrease? Sometimes impulse buying leads us away from seeing that the item we want to purchase will soon be worthless. If someone advertises a computer or other electronics at a deep discount, we need to determine whether the item is already obsolete and whether we will be able to get replacement parts after we buy. Also, you want to purchase items that have the potential to increase rather than decrease in value, like silver and gold, which we will discuss later.
10. Will the item contribute to family unity? Sometimes we want things so badly, perhaps since our youth, and we don’t stop to see how they will affect our families.
Impulsively buying that little red Corvette that you always wanted before you have the means to pay for it, or without consulting your spouse, can really wreck a family. Men sometimes go through a mid-life crisis and impulsively buy large, expensive toys to try to satisfy that forty year itch. Be careful to make sure that as a family you discuss purchases that carry large price tags. When a family eliminates impulse buying, they will be able to save thousands of dollars a year and be a happier less debt ridden family.
SECTION TWO
INCREASING INCOME
Improving Your Finances
In order for us to improve our finances, things can’t stay as they are. The definition of insanity is to do the same things over and over and expecting different results. We have been operating in insanity by going to the same job with the same pay, keeping the same spending habits, and putting money in the same failing investments that the professional gurus have been telling us about for the last five decades. It’s time to get out of the insanity mindset and our circle of sameness, and improve our finances!
It’s interesting to me that foreigners come to this country, whether legally or not, and before you know it they have a store or some type of business up and running. They hire only their relatives, who then start their own businesses. They seem to grasp the fact that in order to make it in this country, they have to improve their finances, which usually start off at zero or sometimes less. Although some come here with savings from their home country, most come with just a little money in their pockets and some even come in debt, having to pay someone for their transportation to the States.
The only way for those of us born and raised in the United States of America to really improve our finances is to reduce our expenses and/or increase our income. We have discussed decreasing our expenses. Now we will discuss increasing our income for maximum financial empowerment. This section is geared toward those of you that are very serious and want to be on the fast track to financial freedom.
Improving Your Net Worth
Most people think that assets are things you own or buy, like homes and cars. However, we know that assets are things that put money into your pocket.
Examples of real assets are:
1. Profitable rental property
2. A profitable business
3. Income investments
4. Savings
5. Precious metals
6. Agricultural land
Most people think that liabilities consist of what you owe on the things that you buy; we know that liabilities are a lot more than that. Our homes are liabilities unless they bring money to our pockets, as in the case of rental property.
People have challenged me and said that their homes are assets without being rental property. The question that I ask is, “How is the home bringing money into your pocket?” It still needs painting, roofing and other maintenance on a regular basis, and if you skip paying the property taxes to the county for a while, you will see who really owns this so-called asset.”
Other liabilities are cars, vacations, furniture, and credit cards. Some people say that our children are also liabilities, but I don’t want to say that and spark the heated debate that always occurs when that statement is made in a public forum.
Conventional wisdom says that your net worth is assets minus liabilities. Banks and other financial institutions would like you to have a hi
gh net worth or low debt to asset ratio if you are applying for a loan of any type. Therefore, I am going to show you how to calculate your net worth.
Let’s go over the placement of conventional assets and liabilities:
In the left column of a sheet of paper, list items that you are purchasing, have purchased, or otherwise own, including your home, automobile, jewelry, savings accounts and investments. Let’s say that your home cost $150,000 and, based on a recent appraisal, is worth $175,000. You would place $175,000 in the asset column.
In the right column, place all balances of items that you are purchasing. For example, the home that was purchased for $150,000 has a current balance of $125,000. The amount to list in the liabilities column is $125,000.
There are various forms or set-ups to record your net worth, but the simplest one is to place your conventional assets in the left column, your liabilities in the right column, and subtract the difference. In the example above, the assets total $175,000 and the liabilities total $125,000. Therefore, this person’s net worth is $50,000.
Interestingly enough, once you achieve a high net worth, you may not even have to worry about getting bank loans because your assets should pay for your liabilities. Many wealthy people are in this position and are able to pay cash for cars or boats; some are even able to pay cash for homes.
Our goal is to have a high net worth and start investing for our futures, so we must get out of debt, get out of debt, get out of debt!
About Increasing Income
All day financial advisors will tell you not to spend more money than you earn. When we hear that slogan we always think we have to cut back, delay purchases, skimp and penny pinch.
How to Escape the Rat Race Page 5