Finance and Education

30 year fixed rate Mortgage ad"vice"

2020-07-17T20:37:00.011-07:00

Anyone buying a home should know about this term. But even after getting a total of 5 Mortgages (3 purchases, 2 Refinance) over the last 6 years I learn something new each time.

Fixed rate is exactly what it sounds like it is fixed for the life of the loan. The 30 year fixed rate tends to be the default option. Many people give unsolicited ad"vice" that you should always lock in a 30 year rate when you think the interest rates are low.

But this is not the right strategy. Why? Read on...

The decision of Fixed vs. Variable rate should be based on how long you think you will live in the place you are buying and your view of where the interest rates are going; or how long you are going to hold onto the property. If you are 100% sure you will not move from here or you have made up your mind you will hold onto this property forever that's when locking in a 30 year fixed rate might make sense. But even then you should weigh it against the Variable rate option and how much lower interest rate you are going get with this option.

Variable rate loans (7/1 ARM which is the most popular) tend to have lower rates of about 0.5% to as much as 1.25% for the initial period of 7 years (the loan payment is still calculated based on a 30 year term) and then will reset higher by upto 1% or 2% higher or lower every year with a (floor of 2% or cap on increases). Most people are nervous about this option because of the possibility of the rates going higher and default to the higher rate 30 year fixed mortgage. The risk of interest rates going higher is something that is over hyped in my experience.

Look at the chart below: Except for brief 10 year period in late 70's and early 80's the 30 year fixed rates have been falling. So, every time you looked at a 30 year fixed rate it would have been a "low" rate compared to history since the early 90's and you would have made a mistake by taking the 30 year fixed rate instead of a variable rate....You would have always been better off taking a variable rate....as you would have paid less interest and more principal in those periods.. and then could have re-financed to a 30/15 year fixed rate or another ARM...as your loan balance would have been much lower...

Also, remember that there are several fall backs when you take an ARM mortgage and you see the interest rates are going materially higher:

1. Refinance without waiting the 7 year term

2. Paying off a portion or all of the Mortgage with a 401K loan (where you pay the interest to yourself and dollar cost average back into the market at a lower point as theoretically as interest rates rise the market will fall -- see my blog on 401K loan ad"vice") , and negotiating a lower interest rate during your re-finance as you may be at a much lower loan to value ( typically banks knock of 0.25% for every 10% lower loan to value)

3. Know that there is a Cap on the rate...and if push comes to shove...you will pay the high rate for a few years before you re-finance...not the entire term.

Do not take a 401K Loan ad"vice"

2012-02-02T17:55:00.000-08:00

I have seen many money experts and the most intelligent of people trip on this one.... They say do not take a 401K Loan...In my mind 401K loan is one the best sources of funding out there.....Let me explain.

Myths about 401K loan:

1. Double Taxation : You take Pre-Tax Dollars as Loan and Pay in Post-Tax Dollars One of the biggest myths out there.....the way a 401K loan works is you take money from your 401K account (upto 50% of your 401K balance) which is pre-tax money ...and pay back through your after-tax pay-check deductions with interest (typically much lower than any bank loan ..currently 3.75% on Vanguard)....

When ever some one says this to you....simply ask them when you take a loan from a bank..do you pay in pre-tax or post-tax dollars?...clearly post tax dollars..... If they are not convinced explain it to them this way...lets say you take 10K out of your 401K account as a loan ....you are taking money that has never been taxed....assuming your tax rate is 30%...you owe 3K to the government on that money.....when you pay the 10K back you pay with pre-tax money of 14.2K.....but this money will get taxed any way...whether you paid it for the loan or not....you still owe that 3K on the original 10K you took out of the 401K account...even though you paid 4.2K on the 14.2K....the key to realize here is that....the total money involved is 10K + 14.2K = 24.2K.....both your earnings...that have to be taxed at some point in time....

Double taxation does occur on the interest portion of the loan...i.e; let say the interest is 3.75% ...you will pay $375 on 10K in a year which has already been taxed into your 401K account....but this is a low price to pay (for all the tax free gain you will get over a long period of time)...also remember the best part is the interest your are paying is to yourself not to any bank.

2. You will loose out on the market gain:

For this I would say the classic "All investment involves risk"............to explain this I would say the decision should be made on how you are going to invest/use the loan....Ways you may gain:

Down payment on a house: say this going to be a down payment on a house which will get you to 20%..then you would save a ton on the PMI (Primary Mortgage Insurance -- charged when you put less than 20%) and also on the favourable interest rates you will receive when put 20% down...

Investment return is greater than market return: If you invest this money where your retutn is higher than market or use this money to pay of high interest debt (say 15 to 20% and the market return over this year is less than this) ... you gain.

Market is flat or goes down : You will dollar cost average in a flat market and you will buy at lower prices when the market is down.............and will be better off with the 401K loan...

Only case when you will loose is when the Market goes higher significantly...but remember you will only take out a max of 50% ...so you will earn market return on atleast 50% of your money...and you will not loose out on the whole return on the remaining 50% as you will buy into the market as it is going up...and not at the highest point...so you will loose out on about half the return...

3. You will hurt your retirement income: This will only happen if you don't pay back the loan....so definitely I would not recommend taking a loan if you think you may not be able to pay it back....

In conclusion I recommend 401K loans for alternate investments to diversify your portfolio or to pay of high interest debt........

Cash Value life Insurance ad'vice'

2012-01-23T17:03:00.000-08:00

Cash Value (especially Indexed Universal Life) is one of the most talked about Life Insurance products in the insurance industry today and also a big MLM (Multi-level Marketing) operation with a promise to make you a "business owner".

Why do you need to stay away from this ? Read on....

Product	Pure Term Insurance	Cash Value Insurance	Which is better?
Description	In Term Life you pay a flat amount per month (premium) for coverage for fixed period of time (10, 15, 20, 25 or 30 years). For Example: You pay $25 per month for a 20 year $500K policy (actual quote for a healthy non-smoking male 28 years of age)	In Cash value "insurance and investment" are combined. This comes in a lot of varieties: Whole life, Universal Life, Indexed Universal Life, Variable life , Return of Premium (ROP) Term (yes!!! return of premium term is a cash value policy disguised as term) In every one of these cases you pay a premium which gets split 3 ways: 1. Upfront fees 2. Insurance cost 3. Cash value which will earn interest : The main selling point of this policy is that the returns on this cash (which are tax deferred) will more than make up for the cost of insurance and you can access this cash tax free (through surrender or a policy loan at a rate of interest determined by the insurance company)	Instead of buying a "cash value" most experts recommend "buying term insurance and investing the difference (BTID) approach". The difference can be invested in a tax deferred IRA or a regular brokerage account or a real estate

Detailed Analysis	Buy Term Invest the Difference (BTID)	Cash Value Insurance ("Trash" Value Insurance)	Which is better? (Hint..it starts with a B!)
Money Accumulation	You accumulate your money immediately in an IRA or a Brokerage account. You are compounding your money from the get go	In early years you earn very little cash value as most of it is gone towards fees and there are hefty surrender charges. This will eat into your long-term return as you are not compounding your money initially	BTID
Return on Money	You can earn an average of the market (6-8% a year) if you invest long-term and with cash flowing real estate you can generate even higher returns in the long run	Guaranteed returns are much lower (2 -4%). Also, long term returns will be lower due to low early accumulation. The argument is that these should be compared to after tax returns from BTID but there are tax strategies even with BTID like 1031 exchanges with real estate etc.	BTID
Access to Money	You have the flexibility to withdraw whenever you need the money (except from an IRA). With Real estate you can access cash through HELOC, Cash Out Refinance, or even buy a bigger property with 1031 exchange	You either need to surrender the policy or borrow at interest rate fixed by the insurance company (5-7%)	BTID
Value of Insurance	If you die, your family will get the face amount of insurance and the money in the IRA or brokerage or the real estate	If you die, Option 1: Your family will get the only face amount and not the cash value Option 2: Your family can get the cash value also but you have to pay higher for it	BTID
Cost of Insurance	Fact is most people don't die during the "Term" and feel they are paying the insurance company free money (the main reason cash value is appealing for these people) ...but what they don't realize is they are only paying a fraction of the face value. In the above example for the $25 per month for $500K policy for 20 years...you pay 25X12X20 = $6K!!!!!!!!! You can easily make up this money and more from the return when you "investment of the difference". The Insurance company will only charge for the "odds" that you might die and a small margin for pure term insurance	Fact is you will pay (about 3K) every year for this policy i.e., the cost of a 20 year term in the first 2 - 3 years!!! and will keep paying in the same hefty amount (yeah it will earn interest on it) to cover for the insurance costs which exponentially increase as you grow older...when you will not really need life insurance as you will have your retirement income and little to no financial responsibilities. Don't be fooled by the huge values shown in illustrations by insurance agents to get you buy the cash value insurance, they are hypothetical. Look at the guaranteed values, in these the cash value can actually go to zero!! even when paying 3K a year...as the low rate of return you earn coupled with high insurance cost can take your account value to zero. You will need to put a lot of money into this for it to work the way it is illustrated and "generate millions"	BTID

In spite of all this why do insurance agents recommend cash value ? Simple. They earn thousands of dollars by selling a cash value but will only earn hundreds if they sell term. I almost got suckered into a cash value life insurance and got out at the last minute after doing my research...I hope you will learn from it and not do the mistake which can cost you dearly.

Summary: "Buy Term and Invest the Difference" Cash value does have its advantages for the super rich who would like to leave a lot of cash (by avoiding taxes) to their heirs to pay their estate taxes. It for the 1% but for the 99% the best way to go is "Buy Term and Invest the Difference".

Finedvice...what it is?

2010-04-17T11:28:00.000-07:00

Finedvice is a blog I have just started to share my experiences on Finance and Education. These are two of my passions and I would like to learn as much as possible and at the same time share my learning.

The word Vice in the title suggests that there many "vices" in both these fields. I want to concentrate specially on these "vices" in this blog and hope that they will help get some ad"vice" through my posts.

Some of the thoughts I want to share here: Importance of Finance and Education.

How education goes waste?

Financial ad"vice" and how confusing it is to a common man?

Specific experiences with money and lessons learnt. Talk about every word that seems like jargon out there..... equity, stocks, credit, delinqueny, insurance, debt, mortgage..