There’s a difference between credit and debt

I’ve been getting increasingly annoyed about the mainstream media’s coverage of housing and the economy. Someone coined the term “credit crunch” and it gets regurgitated in every single story that happens to mention the economy. The problem is the lack of credit isn’t the cause of our current economic woes, it is just merely a side effect of a larger issue at hand in our society. The real cause of this recession can be summed up in another cute, alliterative phrase: debt deluge.

At no other point in history have we been in more debt. We just keep piling it on. Loose mortgage practices over the past couple years made it easier for people, who normally wouldn’t qualify to take on more debt, to bury themselves up to their ears. Unsurprisingly, people can’t handle the payments on the debt that they’ve acquired. Instead of blaming homeowners, borrowers, lenders, brokers, banks, realtors and everyone else involved in pumping up the housing bubble, the media points a finger to the lack of credit.

At this point everyone is being dishonest to try and deflect blame and responsibility for the situation our economy finds itself in. Homeowners should have known better about jumping head first into a steaming pile of debt. Lenders knew giving inflated, risky mortgages to people, who only a couple years ago would have been laughed out of the bank, was wrong. The government turned a blind eye to their regulatory role since taxes kept rolling in. Realtors had no qualms about selling houses at prices customers couldn’t afford because they got their cut and washed their hands of the transaction. The media won’t admit their “house flipping” shows helped contribute to the mess.

Debt is the root of our problem and it will take some serious purging to heal the damage that has been inflicted. Jobs in financial services and construction are going to be hit hard. People are going to lose their homes and ruin their credit history. Home prices will adjust to a point dictated by increased supply and lower demand. Government has to adjust spending or increase taxes. The next time you hear a reporter or politican read “credit crunch” off the teleprompter just replace it with debt deluge.

Check your credit card transactions often

I spend about 2 minutes every week checking on my finances and paying bills. Most of the time I just log into Yodlee MoneyCenter and review my transactions and make sure they are categorized right. Logged into today and found a charge from some stock photography website for $10. Called Citi up and disputed the charge and they immediately credited my account. Without careful inspection that unauthorized charge might have gone unnoticed and I would have been out $10. That $10 could have easily been $100 and if I just looked at my monthly balance I probably wouldn’t have caught the charge. Do any of you review your statements with a fine-toothed comb?

Using Yodlee MoneyCenter to track spending and aid budgeting

For a while I wasn’t really tracking how I spent money. I’d just pay my credit card balance off every month and get cash as I needed it. Before writing checks I’d just make sure I had enough in my account to cover it. All I knew was that I wasn’t spending my entire paycheck so I was doing okay. After getting married our expenses grew and I knew I needed a better way of tracking where our money went.

I tried out Quicken and Money, but they were just a complete pain to use and were overkill for what I needed. I looked for simpler software and online solutions but they all required you to manually download or enter transactions. I looked around the Web some more and discovered “account aggregation” services that grab data from your various financial accounts and stick it all in one place. A lot of banks like BoA and Citi have this as part of their online services now and other sites like offer identical services. Turns out all those sites are just branded interfaces for a back end service provided by the company Yodlee.

The same MoneyCenter aggregation service that powers the sites of a lot of banks and financial service providers is available directly from Yodlee for free. In fact, their application is better than the others because you get new features first rather than waiting around for the bank to implement them. If you are nervous about entering your login information for your bank account and credit cards just remember that this is the same service banks around the world use which says a lot.

The aggregation premise is pretty simple: you enter information for various accounts, Yodlee grabs transaction and balance information, saves it, categorizes it and then lets you run reports against it. You can see some of this in action in their demo. Overall it does a pretty darn good job at categorizing stuff like gas, groceries and restaurants, but if anything gets through you can categorize it yourself or setup categorization rules for things like car payments. You can split transactions too; if we buy alcohol or gifts I split those transactions since they are usually lumped in with other things.

Eventually all this is on autopilot and I just have to periodically check categorization to make sure stuff is in the right bucket. After building up a few months of data I can do some pretty meaningful analysis of where our money goes.  Some people are budget fanatics and others could care less, but I fall in between. My budget numbers are really just the average of what we normally spend in a category. I’ll save budgeting for a later discussion, but the important thing here is being able to track spending.

The primary thing MoneyCenter lets you do is keep yourself accountable. The MoneyCenter homepage is a view of all your accounts and their current balances; having your credit card balance sitting right next to the available funds in your checking account can be very sobering. On the other hand, having your savings and investments accounts listed can be very encouraging and motivate you to sock away more for the future. Even if you don’t bother categorizing everything, these summarized numbers can be a big help.

By categorizing everything a very useful pool of data will start to accumulate. Let’s say you want to start saving more which presents two options: make more money or spend less of what you make. One of those is easier said than done. Yodlee makes it easy to view your total spending by category and then make informed decisions. More than anything the data helps answer general questions like what percentage of my income am I spending on housing, transportation and insurance (I was a little surprised about the amount going just to these items).

Every time I talk about finances I’m not expecting people to take it as gospel or go implement my idea immediately. I’m just sharing my experience and the information I’ve gathered through research and practice. After a year long failure with Quicken I’ve been incredibly happy with Yodlee MoneyCenter. My time spent dealing with finances has gone down while the awareness of my financial situation has gone up. Just this week Sarah asked how much money we had and I was able to immediately tell her an accurate number. Anyone figure out a system that works well for them?

Yodlee MoneyCenter

Paying cash for a car vs taking out a loan

Purchasing a vehicle can be a big decision and involves a lot of money. There’s a lot of questions like whether to go used or new, buy or lease, finance through the dealership or the bank or to even pay cash and avoid payments. On the matter of automobile loans it seems like they’ve really become a part of everyday life; it would almost seem strange not to have a monthly payment. We’ve become use to the idea of a loan that allows us to enjoy a car sooner than we might have been able to. But how much do we pay for that convenience?

My Tacoma was my first new car and I did a ton of research and haggled with dealers to get under sticker as much as possible. I was still in school and had saved up a little money and my parents offered to match whatever I put down. With my dad co-signing I got a 5%, 60-month loan through the credit union. So what is that loan actually costing me over 5 years:

  • With $5,000 down payment and starting loan balance of about $15,000 = $2,025 in interest
  • Without the down payment and a starting balance of $20,000 = $2,685 in interest

Not a huge difference, but the down payment dropped my monthly payment by $100. In both situations, the cost of the loan would run about 13.5% of the loan value. You can think of that 13.5% as a hidden tax on the car, which is more than the sales tax and other fees that get tacked on. Over a lifetime those interest payments can really add up. Aside from leasing (which I won’t even touch here), buying a car outright is our only other option. So why don’t we buy new cars with cash more often?

I think the biggest impediment is our need for instant gratification. I could have “paid” $330 dollars each month into a high-yield savings account for 5 years and bought my truck without getting a loan and saving myself over $2000 dollars and earning interest on my deposit in the process. So why didn’t I? Mostly because I wanted my new car sooner than later. I could have replaced my 1988 Ranger with a newer used car and looking back I probably should have explored that avenue more. Nevertheless I ended up with a new car. Instant gratification isn’t anything new in our culture, but we should be aware of the ultimate cost.

Looking into the future, we’re going to have to make some assumptions. Let’s assume a loan length of 60 months and everytime we’re done paying off the loan we trade the car in for 40% of the original value (depreciation is a you know what) and buy a new one that cost 10% more than the previous one. The first purchase has no down payment or trade in involved. Let’s say we start young and do our car buying cycle for 50 years. We’d end up with numbers like this:

Car Loan # Car Cost Trade in Value Loan Balance Cost of Loan
1 20000.00   20000.00 2700.00
2 21000.00 8400.00 12600.00 1701.00
3 22050.00 8820.00 13230.00 1786.05
4 23152.50 9261.00 13891.50 1875.35
5 24310.13 9724.05 14586.08 1969.12
6 25525.63 10210.25 15315.38 2067.58
7 26801.91 10720.77 16081.15 2170.95
8 28142.01 11256.80 16885.21 2279.50
9 29549.11 11819.64 17729.47 2393.48
10 31026.56 12410.63 18615.94 2513.15
    Totals $158,934.71 $21,456.19

The trade-in acting as a down payment is what keeps this from being outrageous, actually these numbers don’t seem too bad. $21,500 in interest payments over a lifetime isn’t too big of a deal. Now let’s look at buying all of our cars outright. To accomplish the task of providing our own financing we have to delay our gratification and save. For the 5 years prior to a car purchase, we deposit the total cost / 60 into a high yield savings account every month, about $333 for a $20,000 car. The interest earned on the savings earmarked for a new car can be transfered to other investments for additional growth after the purchase. So by delaying the first car purchase and continuing that discipline we’ve saved $21,500 in interest payments, or have we?

What would happen if we took every dollar we would be giving to a bank in interest and invested it in a Roth IRA (all contributions and earnings can be pulled out tax-free during retirement). $21,500 over 50 years is $430 a year, $36 a month. That’s money we’d normally be giving away so why not invest it instead. Let’s say our IRA starts with a $0 balance, grows at 8% and we don’t worry about inflation yet.

Amount invested = $21,500
Simple earnings = $43,860
Compund earnings = $201,099
Total account value after 50 years = $266,459

Say wha?! That’s the power of compounding rearing its beautiful head. This is a mostly hypothetical situation, but the outcome and general idea are pretty clear. By delaying a car purchase and avoiding interest payments we are presented with the opportunity for incredible growth over the long term. Even without investing the difference you can save a good chunk of change. My scenario doesn’t take into consideration a longer period between purchases or the possibility of buying used cars, both of which would allow more income to be directed towards investments.

I’m not saying this is the absolute best way to purchase cars, but the hidden costs of automobile loans aren’t apparent until you crunch some numbers. I know some of you paid cash for your cars or even have the gall to drive cars not manufactured after the year 2000, but I hope this is enlightening for everyone. I plan on putting this into practice for our next car purchase.

Rent Vs. Buy Myths

Came across this article and it pretty much reaffirms the things I have learned over the past year:

Rent vs Buy Myths That Ruined the Housing Market

Through a lot of reading, studying and crunching some numbers I’ve changed my view of owning a home based on ideas similar to the ones presented in this article. The most important thing I’ve learned is that a primary residence is not an investment, it’s just shelter.