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Before You Buy a Home The Dollar Stretcher by Gary Foreman gary@stretcher.com Dear Gary, I am hoping that in one year I will be buying a condominium. I have found the area of town I want to live in and found the condo complex that I can both afford and enjoy. I have bought a home before so I won't qualify for any first time buyers deals. I am embarrassed to say that when I bought my first home, my husband and I were disgustingly naive. I am no longer married and I want to be totally prepared to search and purchase within a few months of my lease expiring. I have almost $15,000 saved for a down payment. These condos are in the $95-$100,000 range. But, I don't have any idea what I should be doing besides continuing to save money. Should I be looking for a mortgage this early? What should I be doing at this point? Do I need to get a realtor, even though I know basically where I want to live? I have less than a $800 debt but my car is 11 years old. I think it will easily last another two years and maybe longer. Any information would be appreciated! Debbie in Nashville, TN Debbie is off to a good start. She's identified the major areas needing her attention. First, she will want to get her financial house in order. Debbie has already begun saving for a mortgage. She'll want to continue that. A larger down payment often means lower mortgage rates. She needs to figure out how large a mortgage payment she can afford each month. Experts advise that the mortgage, taxes and insurance be limited to around 25% of her monthly income. But a lot depends on other expenses like her car. She doesn't want to commit to a mortgage payment that will make it impossible to buy a car later. She'll find mortgage calculators on the web. Bankrate.com has some good ones. They'll translate a given mortgage size and interest rate into monthly payments. The mortgage will probably be more than she's paying for rent. Beginning now she should set aside the difference every month. That way she'll adjust to the new level of expenses before she buys. She'll also be setting aside some extra savings to help cover moving expenses. Second, Debbie will want to do some things early to make the actual buying process easier. She'll need to check her credit report. Approximately one in four people have errors in their report that are large enough to deny them credit or cost them a higher rate. It can take six months to get an error corrected. If Debbie has unused credit lines or credit cards she might want to cancel them. Large amounts of available, unused credit will hurt her mortgage rate. She'll need to collect some financial records prior to purchase. Pay stubs for the last 3 months. W-2 forms for the last two years. Recent bank statements. Also a listing of all of her financial assets and liabilities. Now is the time to learn the differences between fixed and variable mortgages. She'll also want to study some of the lingo so she'll understand the decisions she's about to make. Find out about escrow accounts and private mortgage insurance. Some lenders require them. Finally, there are some things that relate to the physical property to consider. Debbie has already found her neighborhood. Otherwise she would want to consider what communities would be best for her lifestyle considering tax rates and whether they're close enough to public schools, transportation and shopping. Debbie has also found a condo complex. She might want to visit with some of the owners and ask how happy they are. She will need to decide whether to use a real estate agent, a buyer's agent or just go it alone. An agent could help Debbie with many of these steps. If she's short on time or doesn't feel capable she might want the help. Depending on what she decides and the laws of her state she might also need to line up an attorney. Before buying she'll want to check out homeowners' insurance. Her lender will require her to carry insurance. Better to compare rates now while she has time. Before the closing a home inspection will be required. Now is a good time to find an inspector. Check their state certification and references. As Debbie knows, buying a home is a complicated process and takes some work to do it right. She's wise to start early and make it as smooth as possible. We hope that she finds the perfect condo for her needs and the whole transactions goes smoothly. Gary Foreman is a former Certified Financial Planner and purchasing manager who current edits The Dollar Stretcher website www.stretcher.com and email newsletter subscribe@stretcher.com Permission granted for use on DrLaura.com More >>

Repaying Charged-Off Debts The Dollar Stretcher by Gary Foreman gary@stretcher.com I am curious as to whether or not charge-offs can continue to accrue interest. I was always told "no" but today an attorney for one of those "third party collectors" told me "yes". I had already paid $900 into the charged-off debt and then that collector dropped us after I confronted them about some shady practices - they withdrew funds without my authorization - and a new law firm picked it up and tacked on another $1500 above what I'd already paid!! The first law firm didn't charge interest but this one is. Any information you can offer would be most appreciated! Jennifer Sounds like Jennifer is in a tough spot. To make the best of the situation she's going to need to learn a little about what a 'charge-off' really is, how collections work and whether the lender can charge interest on the debt. When Jennifer borrowed money from a company she created an expectation of future income when the debt was repaid. That's an asset of the corporation. When a company 'charges-off' a loan, they're saying that they don't believe that they'll ever be able to collect the debt. So they 'write-off' the asset. It's an accounting entry that reduces their profits and taxes. They'll also report the charge-off to the credit rating agencies. That makes it more difficult for Jennifer to borrow money later. An overdue debt can be shown on your credit report for 7 years after the account became delinquent. But, that's just the accounting aspects. What happens to the debt in the 'real' world? Just because a debt has been charged-off does not mean that Jennifer still doesn't owe the money (plus interest and penalties). What she owes depends on the original loan agreement, state law concerning the Statute of Limitations (SoL) and the federal law governing collections. The original terms from the loan still apply. All that fine print that no one reads becomes important now. Generally it gives the lender quite a bit of latitude to charge interest and penalties. Next Jennifer needs to find out the statute of limitations (SoL) on her debt. In most cases it's between 3 and 6 years. State law and the type of debt will determine the SoL. The SoL says that after a certain period of time that the debtor is no longer legally required to pay a debt. There are actions that Jennifer could take that would restart the clock on the SoL. Making a payment, signing an agreement to pay or even admitting that the debt is valid could be enough to stop or reset the SoL clock to zero. She'll need to do a little research to learn the SoL in her state. Her phone book should have a number for the state's information operator. They should be able to point her to the state agency that can explain the law. Two notes about SoL. Even though the SoL says that a debt doesn't have to be repaid it's not illegal to attempt to collect it. And, if the lender gets a judgement against the borrower there's no SoL on the judgement. Jennifer also needs to know a little bit about collection agencies. Some work for a percentage of any money that they're able to collect. Others buy a group of bad loans for pennies on the dollar. Then they keep everything collected. Since they own the loan, they're also allowed to re-sell it to another collection agency. That could explain why Jennifer has heard from more than one agency. They're also sometimes affiliated with law firms so that they sound more important. Whoever owns the loan, original lender or collection agency, is allowed to keep charging interest and penalties per the original loan agreement and applicable laws. Anyone trying to collect the loan is supposed to obey the federal Fair Debt Collection Practices Act. But, as you'd expect, some will bend or even break the collection rules. It's no surprise that they tapped into Jennifer's bank account. She might have given permission without realizing it. They will also try to garnish her wages or put a lien against any property that she owns. There are, however, laws that keep them from just taking anything they find. If Jennifer does agree to settle the debt by paying a portion of it, she needs to get a release from the agency saying that the balance of the debt is forgiven. She should look for the words "payment in full". Once a debt as been reported as written-off, paying it will not wipe away the bad comment in her credit report. It will look better, but only slightly. It's possible that the original lender may agree to remove the item if a partial payment is made. But, only the original lender may do that. Not an outside collection agency. Hopefully Jennifer will be able to close this unfortunate episode and never have to revisit the issue again. Gary Foreman is a former financial planner who currently edits The Dollar Stretcher newsletters and website: www.thedollarstretcher.com You'll find hundreds of articles to help stretch your day and your dollar! Permission granted for use on DrLaura.com More >>

Credit Card Surprise The Dollar Stretcher by Gary Foreman gary@stretcher.com My husband and I were holders of a Visa Platinum card with a fixed 5.9% interest rate. Our account was recently sold to another credit card company and we have been informed that our rate is now variable meaning we could be paying as much as 18% and that includes our balance transfer which were purchases made with the understanding it was at the lower interest rate. Is this legal? I am currently shopping around for another card with a comparable interest rate. Anne Sounds like Anne feels betrayed by Visa. And, that's understandable. She thought that she had agreed to a specific interest rate for the life of the account. But that wasn't really the case. There are surprising differences in credit card accounts. And most of us aren't aware of them. So let's take a look at fixed and variable rate credit cards. Unfortunately for Anne the new card issuer can change her rate. It's perfectly legal. In fact even her old credit card issuer had the right to change the rate. It just happened that they never did. A fixed-rate account is really mis-named. It's not like your mortgage or an auto loan where you can expect to pay the same rate for the life of the loan. The Truth In Lending act only requires that card issuers give you 15 days notice if they're going to change the rate on a 'fixed-rate' account. Some states have laws that require a longer notice. But you're still vulnerable to rate changes. A more accurate title would be that they're an 'almost fixed-rate account'. Her new card issuer has given Anne a variable-rate account. And, as you might expect, the rate fluctuates. Variable-rate accounts are tied to a published index. Most use the federal funds, Federal Reserve discount rate or the one, three or 6 month Treasury Bill rate. The index is used to calculate the interest rate charged the consumer. You will be charged a rate that's higher than the index. Dig through the fine print to find the formula. Expect a variable-account rate to change fairly often. The rate might not be significantly different, but it can change each month. The card issuer must tell you when you open the account how the rate will be determined. Unfortunately, it's not going to be highlighted for you. In most cases, the card issuer would be happy if you never read the disclosure statement. If the truth were told, most of us don't really like to read those statements, either. But you need to know the minimum and maximum rates that can be charged on a variable-rate account. Remember that a high minimum rate means that you don't benefit if general interest rates drop below a certain point. Those aren't the only circumstances that could cause Anne's rate to change. Both fixed and variable rates can change if she's late with a payment. And all her accounts could change. Not just the one that was late. Some cards will also allow a higher rate to be applied if Anne goes over her credit limit. A 'credit limit' isn't really a ceiling on how much you can borrow. Many accounts will let you charge beyond your limit and then assess 'over limit fees' and a higher rate of interest. What can Anne do? She's already pursuing one option. That's to transfer the balance to a new fixed-rate account. Of course that's no guarantee that the rate won't change later. And some fixed rate cards charge higher rates than variable ones. If she has the money, she can pay off the balance and notify the card issuer to close the account. A final alternative would be to use another account for new charges and pay off the Visa account as soon as possible. The bottom line is that what Visa did might have been misleading, but it was legal. And, we can all learn from Anne's experience. Whether you have a fixed or variable account, don't count on your interest rate staying the same. There are no guarantees that will happen. Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website: www.stretcher.com and newsletter subscribe@stretcher.com More >>

Canceling Credit The Dollar Stretcher by Gary Foreman www.stretcher.com Dear Gary, I want to reduce the available credit on some credit cards and also cancel other credit cards. What do I say when writing to the creditor that will cancel the credit card and leave favorable information on my credit report? How do I reduce my available credit line and look good to the credit reporting companies? Jonnie Jonnie's on the right track. Keeping your available credit to a reasonable level is a good idea. The days when a wallet full of credit cards indicated good credit are over. Today lenders use a formula that includes how much credit you have available for use. If you apply for a home mortgage or auto loan the lender is going to add up all the available credit that you have and compare that to your income level. They don't want you to buy a car today and then charge a bunch of stuff later. That makes it more likely that you'd have trouble making the car payments. What the potential lender thinks of your credit affects how much you'll pay in interest. The better your credit report, the lower the rate they'll offer. One way to look better to lenders is to close unused credit card accounts. That's what Jonnie is doing. But it's important to do the job properly. An account is not closed just because the card is collecting dust in the bottom of your purse and hasn't been used in years. You must notify the card issuer and specifically tell them that you want to close the account. In many cases you can do that by calling the customer service number on your card or monthly statement. You can also mail your request to them. Use the address provided on your statement. One interesting thing to note is that you can close an account while it still has a balance. You'd stop using that card but would continue to pay on any balance remaining until the entire amount is paid. You don't need to give the card issuer a reason for closing the account. It's your right to choose not to do any more business with them. They may offer a lower rate if you stay. And, if that's attractive, you can leave the account open. But in Jonnie's case a lower rate wouldn't help her reach the goal of reducing her available credit. Once the account is closed you need to make sure that the credit report notes that the account was "Closed by Customer". That means that you asked to have the account closed, not the credit card company. Generally when the card issuer closes an account it's because the customer isn't a good credit risk any more. You don't want to leave that impression. Closing an account does not remove it from your credit report. It will remain for seven years. You do not have the right to have the closed account removed from your report. There was a time when having closed accounts did make it harder to get credit. But customer closed accounts are much more frequent now. With everyone searching for lower rates, lenders expect to see a number of closed accounts. Many no longer even consider the number of closed accounts in the formula that they use to rate potential customers. While we're on the subject, we should note that the card issuer can also close the account whenever they want to. Even if you've never been late with a payment. The reason is simple. The law isn't going to force them to do business that's not profitable for them. In some cases people who always pay their entire bill are being cancelled just because the bank isn't making money on them. Jonnie also has the option of contacting the creditors and asking them to lower her available credit limit but leave the account open. If you've been good about making payments, many card issuers will automatically increase your limit anytime you approach it. You don't have to accept the increase. You can ask them to lower the limit and they will honor your request. Once Jonnie has contacted her creditors she should wait a few weeks and then check to make sure that her instructions were followed. To do that she'll need to get a copy of her credit report. It's a good idea to get a copy at least once a year anyway. Unless you've been denied credit (and hopefully that's not the case) you will need to pay for it. The cost is generally $8.50. There are three large credit rating companies. You can contact them at: Equifax 800-685-1111; Experian 888-experian National Consumer Assistance Center(Formerly TRW)800-682-7654; or TransUnion 800-888-4213. Jonnie is being wise in managing her credit. It's an asset just like your checking account or retirement plan. A little effort now could reward her with lower interest payments on a home or auto loan. Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website You'll find hundreds of free articles to help stretch your day and your budget. Visit today! Copyright 2002, Dollar Stretcher, Inc. All rights reserved. More >>

Reverse Mortgages The Dollar Stretcher by Gary Foreman gary@stretcher.com Gary, I am almost 80 years old, a widow, excellent health, no debts, my house is paid off, worth close to $200,000. I live on my social security with a small savings backup, and I manage to make my taxes and maintain a car and live well. My children think I should take out a reverse mortgage and spend the money doing some traveling. As they are all doing well and do not expect or want me to just save the house for them. Are there any pitfalls in this? Betty Yes, Betty, there are some pitfalls. Any time that you put your home up to secure a loan there are dangers. They may be reasonable risks to take, but you need to know them. Let's take a moment to understand reverse mortgages. Then we can better explore the risks and benefits. A reverse mortgage seems strange at first. The purpose of a reverse mortgage is to convert the equity in your home into cash.Like a regular mortgage, you're borrowing against your home. And, when you sell you'll need to repay any balance on the mortgage. But instead of borrowing all the money at the beginning and then paying it back each month, this time you'll borrow a little at a time and not repay the mortgage until the house is sold. In that way it's the reverse of a traditional mortgage. Now the risks. The first problem is that they're somewhat complicated. And that can be a real issue for borrowers as they get older. Betty might understand everything today. But it's not unreasonable to expect that she won't be as sharp mentally in ten years. Then there are expenses much like a regular mortgage. Betty's house will need to be appraised. There will be an origination fee. If Betty does borrow against her home, she needs to maintain enough equity for future needs. Her monthly living expenses could increase faster than her income. Or she might need to move into a nursing home. Her home is her only significant financial asset. She needs to guard it's value carefully. One payout option allows you to take fixed monthly payments for the rest of your life. That does protect you from losing your home during your lifetime. But it also means that you'll only get the fixed income amount. And inflation can shrink fixed income streams. The other disadvantage is that you might not live that long. The mortgage company could be 'buying' your house fairly cheaply. Once Betty takes out a reverse mortgage she can pretty much expect to have it until she sells the home or dies. The reason is simple. She's unlikely to have enough money to pay off the mortgage without selling the home. So what are the benefits to a reverse mortgage? A reverse mortgage would allow Betty to borrow against her equity as often as she likes. She could borrow for a trip or any unmet living expenses. Since she's borrowing the money it's not considered taxable income to her. That can make a reverse mortgage better than selling stocks that have appreciated. Any stock gains will trigger income taxes. If Betty wants to get a reverse mortgage she'll need to meet with a HUD approved counselor before you can get a reverse mortgage. You'll find a list of approved counselors at http://www.hud.gov/offices/hsg/sfh/hcc/hccprof14.cfm Before she actually applies for a loan and incurs those costs, Betty should compare the rates to other sources of cash. The closer to age 62 the easier it is to find other cheaper places to borrow. Betty might want to check out something called the "Home Equity Conversion Mortgage" (HECM). It's a federally insured mortgage. For more information she can call HUD at 1-888-466-3487 She'll need to decide whether she wants a one time payout, the ability to borrow whenever she wants, or a set monthly payout. Single purpose loans are generally the least costly. But over 60% of homeowners choose to use a line of credit type payout. Ultimately the home will be sold. At that time the value of the home will be broken into three parts: the amount borrowed, the costs associated with that borrowing and leftover equity that will go to Betty or her estate. The best way to compare reverse mortgages is to answer three questions about each mortgage. How much money would you get? How much would it cost you? And how much equity would be left when you sell or die? Should Betty use a reverse mortgage? A little travel sounds nice. But she might find a home equity loan a little easier to manage than a reverse mortgage. Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website www.stretcher.com copyright 2002, Dollar Stretcher Inc. All rights reserved. Permission granted for use on DrLaura.com More >>

A New Air Conditioner? The Dollar Stretcher by Gary Foreman www.stretcher.com Dear Dollar Stretcher, Our house and the central air conditioner is at least 12-14 years old. Our serviceman has told us that the compressor unit is too small for our house and the original builder should have put in a larger unit. We are considering having the AC unit changed to a new, more energy efficient model that would be the correct size for our house. My question is - where can I get information to compare costs of running the two units, so we can decide if a new unit would be worthwhile, financially? Donna Highland IL For many in the U.S. this has been a scorching summer. Fortunately, about half of all homes have central air conditioning. The bad news is that it does cost money to run them. Central air conditioning and heat pumps rank third in total residential energy usage. Only heat and water heating consume more. Let's take a look at three topics: air conditioner efficiency, selecting the right size air conditioner and buying a new system. An air conditioner's efficiency is measured by it's SEER (Seasonal Energy Efficiency Ratio). The Department of Energy defines SEER as the total cooling in BTU's divided by the watts consumed. A higher SEER indicates a more energy efficient system. Until 1979 the average central home air conditioning system had a SEER of 6.0. In the '90's a minimum standard of 10.0 was set. New, even higher standards, are being debated now. As you might expect, an air conditioner with a higher SEER will cost more. The DOE estimates that a unit with a SEER of 13.0 will cost about 15% more than one with a SEER of 10.0. But that 13.0 unit will provide 30% more cooling per watt consumed. Will a more efficient unit save enough to pay for the increased cost? The DOE thinks so. They figure that operating the 13.0 SEER unit vs. a 10.0 SEER one will save $113 more than the additional cost to purchase it. If you have web access you'll find the DOE's fact sheet on air conditioners at www.eren.doe.gov/erec/factsheets/aircond.html Not for Donna, but if you live in a warmer climate you might even want to consider a higher efficiency unit with an SEER of 15.0 or more. It will cost more, but could pay dividends in areas requiring heavy air conditioning usage. Remember that SEER only measures the efficiency of the air conditioner. It doesn't take into consideration how well your home is insulated, the condition of your ductwork or other factors that affect cooling. Determining the correct size is a harder problem. Air conditioners are rated in Btu's/hour or in 'tons'. A ton is 12,000 Btu's/hour. A bigger air conditioner is not necessarily a better air conditioner. If a unit is too big it will cost more to buy, more to operate and won't do as good a job dehumidifying the air. According to The Consortium for Energy Efficiency (CEE), a national, non-profit public benefits corporation, a properly sized air conditioning system can reduce energy usage by up to 35%. Determining the correct size isn't easy. It's not just a matter of calculating the volume of air that you need to cool. The climate, style of your home, number of windows, amount of insulation, weather stripping and shade as well as other variables all effect the size of the unit needed. It's hard to do the calculation yourself. You really need a professional. In fact, the industry has created a formula that considers all the variables. The easiest way for Donna to get an idea of the correct size is to get three bids on a new system. Not only will that allow her to compare prices, it will also give her three estimates of how big a system is required. Before calling for estimates she should do any insulation upgrades or weather-stripping since that will effect the calculation. She'll also want to check with the local electric company before making a purchase. Many offer rebates when you buy a more energy efficient air conditioner. Don't forget to consider the repair record and the warrantee offered by the manufacturer. Should Donna replace her air conditioner before it quits working? According to the DOE, a 13.0 SEER unit would only reduce the electric bill by $42 per year vs. a 10.0 SEER unit. Of course that's an average. If Donna's unit has a SEER of 8.0 and she replaces it with one at 12.0, she'll reduce her cooling bills by one third. At 12 to 14 years old, the air conditioner is nearing the 15 year average life span. Donna might be wise to start shopping now while she has time to make a careful selection. Even if the new unit doesn't pay for itself right away it could be a wise purchase. Gary Foreman is a former purchasing manager who currently edits The Dollar Stretcher website www.stretcher.com/save.htm Copyright 2002 Dollar Stretcher, Inc. All rights reserved. Permission granted for use on DrLaura.com More >>

Figuring Appliance Electricity Usage The Dollar Stretcher by Gary Foreman gary@stretcher.com Dear Dollar Stretcher, Can you tell me approximately how much it costs to run two box fans for 24 hours a day, 7 days a week? Also, what about a small high velocity floor vfan and long shop style fluorescent bulbs? The barn where we have our injured horse has its electricity connected to the rental house. I paid $30 for the extra use of electricity for the fans for July. They said their bill went from $70 to $170. Of course we have been under a major heat wave and they have two or three window A/C units. But they seem to think it is our fault. Please help. Thank you! Carl A landlord, tenant spat! They sure can get nasty. Fortunately, Carl can use some basic math to help find a reasonable solution to this one. Let's begin by understanding the question. Carl will need to know two things. How many kilowatt hours each item uses and how much does a kilowatt hour cost where he lives. Once he knows that Carl can calculate how much each item will cost to operate. His answers won't be exact, but should be good enough to prevent a shouting match with his tenant. A watt is the standard measure of how much electricity is used. A kilowatt is simply 1,000 watts (kilo = 1,000). A kilowatt hour (kWh) is a kilowatt used for one hour. On most appliances you can find the wattage on it's nameplate. To calculate the kilowatts used by an appliance, divide the wattage by 1,000. So a 200 watt appliance would be 200 divided by 1,000 or 0.2 kilowatts. A 1,500 watt hair dryer would use 1.5 kilowatts. Now let's see if we can figure out how much each item is using and what it costs. To do that we'll need to know the price for a kilowatt hour of electricity. The U.S. average runs about 7 cents per kilowatt hour. Carl can check his electric bill. It will show how much he's paying per kWh. We'll start with the box fans. According to the Central Iowa Power Cooperative the typical box fan is rated at 200 watts. So if a kilowatt costs 7 cents per hour, the fan would cost 20% of that or 1.4 cents per hour. Extend that out to a month and it works out to $10.08 per month if it runs round the clock (1.4 cents x 24 hours x 30 days). Two fans would be about $20 per month. Now for the high velocity floor fan. Carl will need to check the wattage. We found one that consumed 135 watts. So at 0.135 kilowatts per hour that would cost $6.80 per month if used continuously. Carl might find that the fan is rated in horsepower (appropriate in this case!). If so, he can convert. One horsepower is equal to 0.75 kilowatts. Next the lighting. Pacific Gas and Electric estimates that the fluorescent bulbs run about 1 cent per hour for a 4 foot bulb and 2 cents per hour for an 8 foot bulb. So if Carl has an 8 foot bulb he'd consume $14.40 each month. Of course, once he knows the wattage and his electric rates he can do his own calculation. Let's total Carl's electric usage. We've got two box fans at $20, the high velocity fan at $6.80 and $14.40 for the fluorescent lights. Or a total of $41.20 per month. How does that stack up to the tenant's electric usage? The Nebraska Public Power District estimates a window air conditioner (12,000 BTU size) will cost an average of $19.50 per month to operate. So three of them could easily consume $60 in a month. And perhaps much more in a 'heat wave'. One problem with measuring the air conditioner is that it's not continually on. A 1,000 watt unit might only be running 15 minutes per hour on some days. So it's only consuming 250 kilowatts per hour. Of course in a heat wave it might be on almost continuously. And the older and less efficient the unit is, the longer it will stay each hour. So the only way to know for sure would be to watch the unit for an hour or two and notice how many minutes per hour that it's really running and then do the calculation. The bottom line is that both Carl and his tenant are contributing to the $100 increase. Hopefully a little math can lead them to a reasonable compromise. Gary Foreman is a former purchasing manager who edits The Dollar Stretcher website www.stretcher.com and ezine subscribe@stretcher.com Permission granted for use on DrLaura.com Copyright 2002, Dollar Stretcher, Inc. All rights reserved More >>

Low Overhead The Dollar Stretcher by Gary Foreman gary@stretcher.com When I was a boy one local department store had a jingle that featured the repeated chorus of "low overhead, low overhead". They claimed to offer lower prices because they kept their 'overhead' down. If they spent less on rent and other fixed expenses they could make a reasonable profit at a lower price. I was too young to remember which store ran the ads. So I don't know how low their prices were or whether the ads filled the store with expectant shoppers. But I can tell you that the concept is correct. And the same idea applies to our family finances. The lower your 'overhead' is the more likely that you'll avoid financial troubles. Let's see how this works. First, what is 'overhead'? In the retail store it would be the cost of rent, lights, insurance and payroll. Everything it takes to open the store to the public. Your family overhead is made up of all the money that you've committed to spending before the month begins. We'll visit the Smith family for an illustration. How your family compares to theirs isn't important. Just grasp the concept involved. In fact, you might want to jot down your own expenses to see what your 'overhead' figure is. The Smiths have a 30-year, 6% mortgage for $150,000. That requires a payment of $899 per month to cover principal and interest. Like all homeowners they'll need to pay property taxes and insurance. The combined expense adds another $2,400 each year. Or $200 per month. Naturally, the Smiths will need electric, water, sewer and perhaps gas or oil for heating. Some months are worse for heating and air conditioning. But the average is $300 each month. If we total that up, the Smiths have committed to spending $1,399 each month to keep a roof over their heads. Remember that's not including any maintenance, repairs or upgrades. We're just trying to identify how much they've committed to before the month begins. Next, transportation. Like so many of us the Smiths own two cars. Fortunately, they only have one car payment. Their Dodge Caravan will cost them $453 for 48 months. Insurance and registration for both vehicles totals $1,600 a year or another $133 per month. So the cost of owning the two cars is $586 per month. Again, we haven't included the cost of gasoline or repairs. The Smiths also have some credit card debt. They're carrying $8,000 at 14% interest. That costs them $93 each month in interest expense. Despite more than one attempt to quit, Mr. Smith still smokes cigarettes. Not a heavy smoker, but he still goes through a carton every two weeks. Add another $48 a month to the 'overhead' column. Mrs. Smith does her part, too. Each Friday for years she's been going out for lunch with some long-time friends. Usually they pick a moderately priced restaurant, but it still averages $9 per week by the time her portion of the tip is included. So that adds another $36 to our 'overhead'. So how much are the Smiths committed to spending before the month even begins? Their total overhead is $2,162. Next let's see how that affects their finances. First, we'll look at how much income it takes to cover the overhead. The Smiths are in the 27% tax bracket. They also pay 7.65% in Social Security taxes. Fortunately, where they live there's no state or local income tax. To cover the $2,162 in monthly overhead they need to earn $3,308 each month. Or a $39,700 each year. Look at it another way. The Smiths combined income last year was $76,500. So of every dollar they make 52 cents goes to cover expenses that they have very little control over. So what can we learn from the Smiths? Just like the retail store, we need to pay the 'overhead' first. Before we think about rewarding ourselves with new clothes or vacations. The more money needed for overhead, the harder it will be to feed our family, save for retirement, spend money on entertainment or anything else. The question to ask before making any ongoing commitment is do I want to add this monthly expense to my overhead. Is it really more important than all the other things that I'd like to spend money on. Not only was "low overhead" a memorable jingle, it's also a good way to look at your family finances. Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website www.stretcher.com You'll find plenty of practical ideas to stretch your day and your budget!copyright 2002, Dollar Stretcher Inc. all rights reserved. Permission granted for use on DrLaura.Com More >>

401k Employer Contributions The Dollar Stretcher by Gary Foreman gary@stretcher.com Gary, I have a question relating to my 401k. What is your opinion of contributing to this fund if my employer does not match contributions? Two of my coworkers had their financial planners tell them that it isn't worth contributing. Their reasoning is that the amount the employer has matched offsets the amount of the taxes due when it's time to take the money out. Without the employer matching, there isn't this advantage. They suggested that my coworkers invest in IRAs instead. I would be interested in knowing your thoughts about this. Diane Good question! I'm always reluctant to disagree with a financial planner. If they've done their job properly they know a whole lot more about the client and how a particular strategy will affect that client. So I can only speak in general terms. Diane will need to decide whether it makes sense for her specific situation. Of course, that's true with financial advice that's given to others, too. It might be good for them, but not for her. There are three different times where the IRS can tax your retirement savings. The first place is when you make the money. Normally you'll pay taxes on the money you earn this year. Some retirement plans allow you to deduct any contributions from your taxable income. So you avoid paying taxes now. The IRS can also tax your savings during the years that it's invested and earning money. For instance, interest earned by your savings will be counted as ordinary income for tax purposes. That can be a big drag on the growth of your investment. If taxes take 20% of your earnings, a 10% investment return is reduced to 8%. Both 401k and IRA's avoid this problem by letting your money grow without any taxes. The final place that the IRS can tax your retirement savings is when you take the money out of the investment account. As Diane points out, her 401k money will be taxed when she takes it out of the account. Back to her question. Why would the planners suggest an IRA over a 401k? If they're talking about a traditional IRA it can't be the taxes. Because the taxes work the same. You get a deduction today and pay taxes when you withdraw. It could be that they're advocating a Roth IRA as a substitute for the 401k if the employer doesn't contribute. With a Roth IRA you don't deduct contributions from this year's taxes. It does allow the money to grow and be withdrawn without further taxes until you remove the money. But a Roth has lower contribution limits than a 401k. The 401k will allow her to save a greater amount each year. One benefit of a 401k plan that doesn't show up in the numbers is that it doesn't require Diane to take action. Many people will struggle to find money for an IRA and end up not saving anything for retirement. And, it's vital to save for retirement. In real rough terms, for every dollar that you want in annual retirement income you'll need $10 in savings. So if you want an annual income of $40,000 you'll need to save $400,000. This will probably get me in trouble, but it's dangerous to depend too heavily on Social Security. There really isn't any Social Security trust fund despite what the politicians say. The money that's deducted from your paycheck isn't sitting in a bank waiting for you to retire. It's already been spent by other government agencies. All that's left in your account is a government IOU. And to pay that IOU they're counting on tomorrow's workers to continue to pay Social Security taxes. To make matters worse, it won't be too many years before there's only two workers for every retiree. In fact, if a private corporation had this plan there would be calls for a Congressional investigation. Can Diane simply calculate which retirement program will produce more money when she retires? Unfortunately, what Diane assumes about the future will have a major impact on the final answer. Taxes aren't the only variable. To do the calculation, you need to make assumptions about the rate of inflation, the earnings of your investments and the tax rates for every year up until retirement. If you know all that, forget retirement planning and just head for the nearest horse track! She shouldn't the lack of an employer contribution keep her from saving for retirement. A 401k plan with employer contributions can be a great retirement savings tool. But one without can play a role, too. The bottom line is that Diane probably can't know the absolute best answer. The most important thing is that she regularly save for retirement. The worst thing that she could do would be to not have any retirement plan because she's not sure which one is the best. Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website www.stretcher.com copyright 2002 Dollar Stretcher, Inc. All rights reserved. Permission granted for use on DrLaura.com More >>