I am not in jail.

The bank vice president apologized for calling the police on me.

That’s neither the beginning nor the end of the story, but it seems to me that police involvement of any kind is a sign that your real estate deal isn’t going as well as it could.

It all began with a Citibank loan officer named Aaron who promised me a smooth closing. In my view, being questioned by a uniformed police officer has no place in a smooth closing. And that wasn’t even the worst part of it, which troubles me.  Read more

Another benefit of not having debt

I’ve written about how not having debt gives you power, though I can’t find the particular post at the moment. But I remember when I got my first mortgage. I went to a party, and my boss was there, along with my five other bosses, and the big boss got this look in his eye when I said I’d bought a house. That look in his eye said one thing: I own you, and I can do whatever I want to you.

And he did. From that day forward, all of the assignments nobody else wanted fell on me. Anything that was destined to fail went to me. And the cycle followed me from job to job, then stopped, like turning out a light, the day after my wife and I paid off our mortgage. It was the closest thing to magic I’ve ever seen. One day, I was the guy who got assignments at 3 PM on a Friday that were going to take me 8 hours to get done–and they had to be done by 8 AM on Monday, and one day, I wasn’t that guy anymore.

I tested it again this month. I turned down a job that offered me a $7,000 pay cut. Nothing unusual about that, right? Not in this case. In this case, rejecting that pay cut meant I didn’t have a job anymore. Read more

Just because you can afford it now…

Today, the sermon at church was based mostly on Nehemiah 5. Nehemiah 5 talks about the ruinous financial situation of the children of Israel at the time the book was written. Check out Nehemiah 5:4-5.

“We have had to borrow money to pay the king’s tax on our fields and vineyards. Although we are of the same flesh and blood as our fellow Jews and though our children are as good as theirs, yet we have to subject our sons and daughters to slavery. Some of our daughters have already been enslaved, but we are powerless, because our fields and our vineyards belong to others.”

In other words, in order to pay their bills, some had resorted to selling their children into slavery. Sadly, some Americans find themselves in that situation today. Or close to it. At least it’s uncommon enough that we’re offended when we hear about it. Read more

Diving into real estate

You’re not going to believe this. This week my wife and I applied for a mortgage.

Not on our primary house. We’re buying an investment property. I’m still struggling with the mortgage bit.The greatest real estate investment books of all time (for mere mortal working class people, at least) were written by a man named William Nickerson, starting in the 1950s. Nickerson took one and only one shortcut in his investing. He saved up 25% for a solid downpayment, and bought property. Usually property with something wrong with it. He liked small apartment buildings and humble single-family houses.

Then he fixed the property up. Depending on the situation, he’d sell it if it made sense, or more likely, he’d rent it out, then sell when the right opportunity arose.

And when he had enough money to buy another property, he’d buy another one. An outright sale usually would yield enough to buy multiple properties. Or if he could make a trade that made sense, he’d trade properties.

His initial $1,000 investment (which would be more like $10,000 in today’s dollars) grew to $1 million in property by the time he wrote his first book, to $3 million by his second edition in the late 1960s, and $5 million by his final edition in the mid 1980s.

Nickerson argued that his method was the safest investment in existence. He had a point. Land is the one thing God isn’t making any more of, but God is still making new people. People who need land to live on.

But how do you find tenants? What if the house sits empty for a long time? After all, my Dad rented out a property for several years and it was a nightmare. It sat empty a lot, and his tenants trashed the place.

A couple of months ago, I saw a house for rent two miles from me. The asking price was $900. Two days later the sign was gone. Now there are cars in the driveway. So someone rented it. I looked up the house on Zillow. You could buy the house for less than that, if it were available at current market value.

I kept watching. Rentals in my zip code don’t stay vacant long. So when a HUD-owned home a couple of miles away came up at a price we could afford (my wife found it), we went and looked at it. We liked it. It needs work, but that’s why it was cheap. We made an offer, and now we’re a few steps away from buying.

We have some luxuries Dad didn’t have. We’re in a hot market, so we don’t have to rent to the first guy who asks. We can get a family with references. We live close, so we can keep an eye on the place. We can use a management company to help keep everything smooth. We’ll pay more for that privilege but it’s probably worth it. And the mortgage payment is low enough that if it sits for a few months here and there, it won’t break us.

Where house flippers–at least the ones you see on TV–seem to get into trouble is dealing in big, expensive homes and being too leveraged. If the market for $200,000-$500,000 houses goes south, they’re stuck.

This house will never be on TV. Well, the Extreme Makeover guys would love to tear it down and build a sprawling, awkward castle on its L-shaped lot. It’s a low-end house, the kind of place a young family would buy or rent, live in for a few years, and then probably vacate once the kids are done with grade school–if not a bit sooner.

People want large houses in outer-ring suburbs, but they don’t need them. But a young couple that’s outgrowing an apartment does need an affordable house for a few years, and when they outgrow that, there’ll always be another family in the same situation, ready to move in.

So why don’t they just buy the house we had our eye on instead of us? I’m sure some do. But not all of them can afford the downpayment and the money it will take to fix it up.

A friend and I discussed the ethics of buying a down-and-out person’s house, back when Robert Kiyosaki was at his peak in popularity. Kiyosaki appears to have no qualms about it. We were less comfortable about that.

As far as I can tell from the records easily available, this house finished up the foreclosure process in May. A bank somewhere in New York had it for a couple of months. Then HUD ended up with it. I don’t completely understand the process yet.

As it stands now, the house is no good to anybody. HUD’s doing the bare minimum to keep it from getting much worse. It’s eating up taxpayer dollars and making the neighborhood look worse.

The best thing for the house and the neighborhood is for someone with money and who knows what he or she is doing to come in, make it inhabitable again, hopefully make it look a little better, and get someone living there just as quickly as possible.

In my wife and me, they got someone with a little money. We’ll have to learn what we’re doing on the fly.

We’re taking advantage of the former owners who got in over their heads, but when I go to work every day, I’m taking advantage of whoever made the decision to replace a working, reliable computer system based on VMS and Unix with a sprawling monstrosity based on Windows. And my wife would argue that they take advantage of me.

By buying a fixer-upper below market value, fixing it, and renting it at market value, we’re taking advantage of the house’s situation and the future tenants. But the future tenants are taking advantage of us, because they get to live in a house they couldn’t otherwise afford.

I’m not crazy about all aspects of the situation but I’m comfortable that I’m doing more good than harm.

Now, back to that mortgage question. I’m still arguing how quickly and how to pay that off. The math suggests I could ultimately pyramid at least seven properties, using rents from the first two to pay the mortgages on all of the others. And a few short years ago, a bank would have been more than happy to lend me the money it would take to do that.

One latter-day follower of Nickerson makes it his goal to pay off one of his properties per year.

I like the idea of fixing a property, holding it for as long as the tax code encourages you to hold it, then selling and using the proceeds to pay cash for more than one property to replace it. The growth is theoretically smaller, but I really don’t like debt.

But that’s really a question for another year.

I didn’t cause the depression

Various analysts are blaming the current depression on people like me. The reasoning goes like this: I have money in the bank, therefore, I should be out spending it, for the greater good, to stir the economy.

Let’s correct that right now.People like me “hoarding” cash didn’t cause this depression. I played by the rules. I didn’t lie on my mortgage application. I bought less house than the bank said I could afford, because I didn’t see how I could make that payment and still buy groceries. I bought a Honda Civic because I didn’t see how I could afford a car that cost $25,000 or $30,000 and I really didn’t see how I could afford to put gas in it. I made this decision when gas cost $1.59 a gallon in Missouri.

Basically, I made a budget and then I made the decision to stick with it. It wasn’t rocket science. Any time I thought about buying something, I sat down with a spreadsheet, entered in all the money I paid out each month, entered what I made, and figured out if the money left over was enough to buy whatever it was I wanted.

We were due for a depression, or at least a recession, at the beginning of the century. The dot-com boom and Y2K was a bonanza, but then two things happened. Y2K came and went, the world didn’t end, and people quit buying survival supplies in large quantities. Meanwhile, these startups failed to come up with viable business plans, continued to spend money faster than the government, and ended up going out of business. This hurt those companies, but it also hurt companies like Cisco and IBM and Intel, because as these companies went bust, their inventory of technology equipment, some of it unused, went on the market at bargain prices. There was no reason to buy a new Cisco router from CDW when you could buy the same thing, still sealed in the package, from a liquidator for half the price.

Then 9/11 happened and it really looked like we’d get our recession. But the government slashed interest rates, changed bank regulations, and encouraged people to buy like there was no tomorrow. GM started offering 0% financing on its cars in order to move them. Soon you could get free financing on anything but a house, and interest rates on houses were ridiculously low. And anyone could get a loan. Republicans loved it because it made the economy go boom-boom again. Democrats loved it because people at any income level could get mortgages.

But the problem was that many of these loans had onerous terms and conditions, and just because you could afford the payments one day didn’t mean you’d be able to afford them in two, three, or five years after some of the back-loaded terms kicked in. Of course, nobody worried about that because they were living the high life.

And then it all fell apart. It wasn’t quite as rapid as it seems. I think people started having problems paying their bills in 2005 or so, but it didn’t quite hit critical mass yet. It hit the smaller banks first. I know because the banks who had my mortgage kept going under, and every year or so, a slightly bigger bank would end up with my mortgage. But those weren’t any match for this monster either. Countrywide got my loan in 2007, but Countrywide wasn’t a dinky little bank. It went under, and when I made my final house payment, that payment went to Bank of America. Now it looks like even the mighty Bank of America might make me look like the kiss of death.

But that wasn’t the only problem. These bad loans got packaged up and re-sold. And somehow, these bad loans got higher grades than they deserved. A guy working as a slicer at Arby’s making $9/hour living in a $150,000 house isn’t a good investment. When everything’s going right, he can afford to make his payments, but the minute something goes wrong, he’s going to start missing payments and might not ever recover. So unless the guy gets a decent job, he’s not going to be able to afford to stay in that house. Yet somehow, a bank could package a bunch of loans like this and spin it as a grade-A investment.

Imagine me going around to my neighbors’ houses on trash day, filling boxes with trash, and selling the boxes, legally able to tell the buyer that the box contains something valuable. That’s great, until someone opens the box and realizes it’s just a box of trash.

No, this depression wasn’t caused by people like me. It was caused by people living beyond their means for too long, and not being able to pay the piper when the time came.

There’s another word for what’s happening right now, besides recession or depression. That word is “correction.” When the economy has been going in one direction for too long, it corrects itself. Sometime in the future, there will be another correction, and the economy will start improving again.

But I read my ultimate proof yesterday. Supposedly, if people like me would just spend their money, things would get better. So why does someone walk into a Jeep dealership with $24,000 in cash, intent on driving home in a new Jeep, and end up driving himself and his still-heavy wallet home in his old car?

And let’s look at people like me one other way. When I nearly lost my job in January, I had almost six months’ worth of income in the bank and a plan in place to be able to live off it for a couple of years, potentially. It wouldn’t have been a comfortable living, but it would have been doable. There would have been no need for me to go collect unemployment. I would not have been a burden on society. And when I retire, I’ll retire with enough money to get me through the rest of my life, with or without Social Security. I won’t be a burden on society either.

People who save their money might not spend it at the most opportune time for everyone else, so they might fail to even the economy out like a capacitor evens out electrical power. But they are never, ever a drag on society.

How does the live-within-your-means movement apply to the current recession?

Joseph brought up some good points in the comments for the previous entry, and I don’t think a short response does them justice. He wants to know what the personal finance experts have to say about the current economic crisis.

Suze Orman actually went on TV a few weeks ago and called it an opportunity of a lifetime. I’ll explain.Joseph says this feels different from other recessions. I think it’s because it is. It’s more like 1929. The major difference is what people were investing in.

The biggest problem in 1929 (besides the crash) was that Herbert Hoover didn’t realize until it was too late that we had a big problem on our hands. That’s not the case this time. Although Bush and McCain were denying it for a long time, both readily admit now that we have a problem.

The cause of our problems today is twofold. One, we should have had a recession in 2000-2001 and we didn’t have much of one. The Fed lowered interest rates to stave off recession, and the result was something of a boom. Both political parties blame the other for this, but basically, under their encouragement, everyone and his uncle was willing to loan people way more money than they could realistically pay back. (Republicans liked this because it was deregulation; Democrats liked it because minorities who previously couldn’t get loans suddenly could get them in spades.) Then, when too many people failed to pay those loans, the banks ran out of money, so now we have banks failing.

I remember seeing Suze Orman come on TV on Sunday morning years ago and warn this was coming. The reason was simple: Too many people were in over their heads in debt, and eventually it was going to catch up with us. She even had the timeframe about right.

It didn’t take a prophet to see it. We started having problems when large numbers of adjustable rate mortgages started resetting. One month, people could make their payments on everything. The next month, their mortgage skyrocketed and there wasn’t enough money left to buy a day’s supply of Ramen noodles, let alone make car and credit card payments.

Soaring gas and food prices didn’t help either, of course. Then again, that’s all interconnected too. Back in 2001, Ford and GM started offering 0% financing, and their primary products were big gas guzzlers. Increased consumption raised fuel prices, which in turn raised the price of everything.

But for those who are able to pay their bills and keep their jobs, the opportunity of a lifetime is nigh.

Stock prices are down. Nobody knows if they’ve hit bottom yet or not. But they came back after 1929, and they’ll come back after this crisis too.

My grandfather was a wealthy man. He started his medical practice sometime during the Depression. He died in 1980, long before I could have a meaningful conversation with him about money. I can only speculate how he made his money, because the living relative who might have firsthand knowledge isn’t especially honest or reliable. I believe he bought stock in the 1930s at depressed prices sometime after he graduated from medical school. While those investments certainly didn’t pay off immediately, by the time the ’50s and ’60s rolled around, he still owned that stock, which he’d bought at Depression prices. At those prices, he might as well have stolen the stock.

I believe the same opportunity exists today. This isn’t the time to cash out your 401(k) accounts–it’s time to max out your yearly contributions, if you can afford to.

A similar situation is beginning to exist in real estate. If William Nickerson (the original make-a-fortune-in-real-estate guy) was still alive, he’d be having a field day. Nickerson made at least $5 million in his lifetime by buying distressed properties and turning them around. Before this crisis is over, there’s going to be a lot of distressed property that needs fixing up.

The bottom line is that the people who have no debt, or who have a reasonable amount of debt under control don’t have anything to be afraid of right now as long as they’re able to stay employed. They have numerous opportunities, in fact.

For one, they’re in an ideal position to convert pre-tax retirement plans into Roth IRAs, which are tax exempt on the back end. You take a tax hit when doing that, but this is the time to take that hit–prices are down.

Two, they can buy stocks and/or real estate at depressed prices, hold on to those assets, and in 20 years they’ll be rich. Once again, let’s go back to 1929. The Dow Jones Industrial Average peaked that year at around 380. If you take the worst case scenario, buying at the peak and then crashing, it took 25 years (1954) for the DJIA to get back above 380. But once it did, it stayed above that level for good.

But aside from that extreme scenario, it’s very difficult to find any 10-year period where stocks didn’t make money.

About a year ago, the DJIA was near 14,000. Today it’s below 9,000 and threatening the low 8,000s. There’s no historical precedent for it to drop lower and stay lower, and there’s no historical precedent for it to stay stuck at any level either. There’s every historical precedent for it to reach 14,000 again, and it’s much more likely for it to do it in less than 7 years than for it to take 25 years like 1929. Between now and then, individual companies will go under, but that’s why you don’t invest solely in one company. Buying an index fund that tracks the S&P 500, for example, spreads your risk over 500 large companies. If General Motors evaporates, you lose a little. But if GM gets its act together and the stock soars, you share in the gain.

Finally, when it comes to real estate, all those people who had bad mortgages have to live somewhere. It’s a terrible market to sell, but if you’re inclined to buy properties and rent them out, the environment is ideal for that and will be for a very long time. People who have enough saved up to pay cash can pretty much monopolize this game for a while, since loans are hard to come by.

There’s a positive for the country as a whole too. Did you get sick of the rest of the world buying up our companies because their economies were booming while ours stagnated? Now everyone’s in the same boat as us, so we’ve probably seen the end (at least for a while) of ruthless international conglomerates buying U.S. companies and then slashing everything that moves.

Overall, I do think this bust is a net positive for society, and not just for the reason I just mentioned. I read not long ago that many people under 40 consider the American Dream a birthright, not something that takes work and ambition. Society as a whole has been using borrowed money to artificially raise lifestyles up into the next-higher income tax bracket. Today’s crisis may put an end to that, and ultimately, that’s good for everyone, although it will be painful in the short term.

Paid in full.

This week, my wife and I drove to the bank and signed some papers initiating a wire transfer to our mortgage company.

Yesterday, I had the satisfaction of logging into the mortgage company’s web site, clicking on my account, and seeing the words “paid in full.”

I moved into this house in October 2002. Five years and eight months later, I own it outright. Between the house and our cars, my wife and I have paid off nearly $180,000 in debt in those five-plus years.We aren’t completely debt-free yet. We still have some student loans from my wife’s college education.

Some would argue we should have paid those before the house. I opted against it because one of the loans has a very low interest rate (lower than the house), and because the payments are small. If I walk into work tomorrow and find out I no longer have a job (that very thing happened to me not once but twice in 2005), I can easily make those student loan payments. Scraping together enough for a mortgage payment is harder.

But I’ve gotten ahead of myself. Here’s how we did it.

The debt snowball
The trick is to make your minimum payments on all debts, but pick one debt to pay off first. Then scrape together some extra money to pay it off sooner.

In my case, I started with my car. The payment was about $300. I tried to pay at least $600 on it. Sometimes I paid $900. When I got my tax refund, I paid a whole lot more than that.

By mid-2005, I owned the car outright.

By then I was also married, so we turned our attention to my wife’s car. Her payment was also about $300. So we paid $300 plus $600, the amount I’d been paying on the other car. I had a better job that summer, and we had my wife’s income too, so it wasn’t all that long before I realized we had enough surplus piled up in the bank to pay that off too. So we did.

And that left the house. The mortgage payment was around $1,000. So we paid $1,900. When we started making more money, we increased that. In recent months, I’ve been paying $3,000 on the house since I now make quite a bit more than I made in 2005.

Last month, I noticed we were very close to having enough in the bank to pay the house off while still leaving a comfortable emergency fund. I called the mortgage company to find out exactly how much we’d need to do it, and to get payoff instructions. I figured out that every month we didn’t pay the house off was costing us more than $200. So scraping was worth it.

Finding extra money
I’ve always been a tightwad (just ask my family), but in my late 20s I fell into some bad habits. I didn’t rack up debt, but I definitely wasted more money on conveniences than I needed to. I saved a lot of money the last five years or so by packing a lunch and bringing my own coffee and breakfast to work.

Do the math. I used to spend $2 on coffee and breakfast, plus $5-$6 for lunch. Call it $8/day. Figure 240 working days a year, and that’s $1,920.

I figure I whittled my daily food bill down to about $3 per day, so I saved $1,200 per year. That’s $4,800 over the course of four years. That alone allowed me to pay the house off at least nine months early.

Don’t let other people spend your money
But this is the big one. Everyone has their own ideas what kind of car you should drive, what home improvements you should be making, and other status things that really don’t matter that much.

I drive a 2002 Honda Civic with more than 100,000 miles on it. I know some people look down on that. But the car is still in nice shape, still runs like new, and has never needed anything more than routine maintenance. Plus it consistently gets 35 MPG.

If I had traded that car in after driving it for three years like the marketers say you’re supposed to, it would have slowed down the house payoff by six months. Had we done the same with my wife’s car, we could make it a year.

Frankly I’d rather have the house. In fact, if I could turn back the clock to 2003, I wouldn’t buy the same Civic I bought then. I would have been better off buying an older one that I could pay off more quickly. I could have saved an extra $4,000 or even $6,000, and we would have had everything finished a couple of months sooner.

So what about the cars now? Well, what about them? Remember, I was used to paying $3,000 a month on the house, and that obligation is gone. A year from now, there’ll be enough cash piled up in the bank to buy two cars outright if necessary. Not that I expect to need that, since Civics are famous for going 200,000 miles and beyond. The last time I went to the dealer, they told me someone had traded in a Civic with 500,000 miles on it.

As for home improvements, yes, now it’s time to do some. But why do them sooner? The boob tube tells you to do it to increase the value of the house. But why would I want to do that? So I can pay more taxes? Without me doing a thing, the paper value of this house has risen nearly $40,000 since I bought it, at least according to the county assessor. That means I paid $400 more in taxes in 2007 than I did in 2003.

Unless I was planning to move, there’d be no reason whatsoever to be concerned about property value.

On the other hand, at this point in the life of the mortgage, I was paying more than $200 per month in interest. Now that I’m not paying interest, that’s like getting $2,400 per year for free. That’s enough to finance a modest home improvement project.

But then again, if there’s something else my wife and I want that costs $2,400, we’re entirely free to go after that instead.

In what order should you pay off loans?
This is the paralyzing question for some people. Mathematically speaking, you should pay them off in order of interest. If you have a credit card balance at 19%, a car loan at 7%, a mortgage at 5%, and a student loan at 3%, then you should pay them off in that order.

I’m not enough of a math genius to run the figures, but paying them off in the worst-possible order (reverse order), generally only slows you down by a month or two.

We paid ours off somewhat less than optimally because the student loan is less paralyzing than the mortgage. The minimum payment on the student loans is about 1/5 what the mortgage payment was. When I was out of work, the mortgage was a bit of a struggle to make during a couple of those months, whereas the loans are comparable in size to a utility bill.

If nothing changes between now and then, we can have those loans wiped out in another year. If the economy tanks and I lose my job and my income drops to nearly zero, I can nurse those loans along almost indefinitely, since I have numerous options for making the $1,000 per month it would take to cover utilities, groceries, and those loans.

What about retirement?
Some people argue you should give retirement planning priority over your debts, while others say the reverse. My wife and I haven’t done much for our retirement since we got married in 2005. Frankly I can see the arguments both ways. But we’re still in our early 30s, and now we’re in position to contribute the legal limit into Roth IRAs from now until the government starts making us collect. There’s still time for both of us to pile up enough to retire.

The counter argument is that it’s foolish to invest when paying down debt gives you a guaranteed return. In this economy, given the choice between investing or paying down debt at 6 percent, what’s safer?

While there’s room for criticism if you go either way, either way is preferable to doing nothing. Unfortunately there are all too many people who have lots of debt and little or nothing saved for retirement.

Don’t refinance!
This is another big one. I refinanced in 2004. I got a lower interest rate, and I switched from a 30-year mortgage to 15. The interest rate dropped, but I got nailed for a $2,000 closing cost.

I saved $500 in interest the first year, but I didn’t have the loan long enough to recoup the closing costs.

If your mortgage is the last thing you’re going to pay off and if you can drop the rate, or if refinancing will allow you to consolidate some higher-interest debt, it might make sense to do it, but factor in that closing cost. If you can pay off the mortgage in less than five years, it makes more sense to just pay it off rather than go to the expense and hassle of refinancing.

In my case, if I hadn’t refinanced, I may have owned the house a month sooner.

What about the tax deduction?
Short answer: Forget about the tax deduction. The tax deductions for mortgages are more overrated than Derek Jeter.

Let’s say you’re in the 25 percent tax bracket. I’d have to ask my accountant if such an animal exists this year, but the numbers are convenient. If I’m in the 25 percent tax bracket and I paid $1,200 in interest this calendar year, then that means in return for me paying my bank $1,200, the government is giving me back $300.

Every other time you spend $1,200 and get $300 back, it’s called losing $900.

For the past five years, I’ve been paying a lot more in interest than I ever got back as a tax refund. Eliminating the mortgage won’t completely eliminate my tax refund, but it did eliminate that interest. In effect, by paying off the house, I gave myself a $1,200 raise this year.

So there’s no sense in keeping a mortgage solely for tax purposes. If you need tax deductions, take your tax return to a good accountant. The accountant’s fee is tax deductible, and the accountant will probably find you additional deductions you didn’t think of.

If you’re in a higher or lower tax bracket, it can make a little more or a little less sense, but you’re still trading dollars for small change in any case.

In conclusion?
There are any number of things we could have done differently. But the important thing is we now own our home and two cars outright. It’s possible that doing a few more things might have made it happen a month or two sooner. But if I’d done everything the traditional way, I wouldn’t own the house outright until age 58 (if I’d kept the original 30-year mortgage) or 44 (since I refinanced to a 15-year mortgage). Compared to 11 additional years of paying interest, what’s an extra month or two if I get a couple of details wrong?

WordPress Appliance - Powered by TurnKey Linux