Personal Finance

15 Years to Freedom

June 17, 2011

Thanks to Arohan at Personal Dividends for indirectly helping us out yet again. He’s the guy who graciously lets us guest host the Carnival of Wealth every month, and also let us write this post for his last year. It appears here in slightly updated form on Recycle Friday. Again, updates in CYC Burnt Umber. This week’s topic? Halving your mortgage. Totally legally:

It’s the modern exemplar of fiscal responsibility – the mortgage you pay off in half the time of a standard one. Granted, people who carry 15-year mortgages are generally the same ones who alphabetize their refrigerators and iron their gym clothes. But people like that are worth emulating in a society where the populace now regards mortgages and credit card debt as no more obligatory than rural speed limits.

Obviously, paying a mortgage off in half the standard time means you’re making payments twice as big, or close to it.

But you aren’t. Here are a couple of graphs that show how long it takes to start making a dent in the principal when you finance your house over 30 years, vis-a-vis 15 years. We used standard market rates, which we’ll quantify in a second. The purple line is your cumulative interest payment, which you obviously want to keep as low as possible. The purple line moves in concert with the yellow line, which is your principal balance: you want the yellow line to take as short a path as possible from the northwest corner of the graph to the southeast corner.

30-Year Mortgage

A Comparable 15-Year Mortgage

That second graph is revolutionary, and indicates how there’s not only never been a better time to buy a house (or houses) than now, but that there’s never been a better time to get yourself into a 15-year mortgage.

Around 1981, 30-year mortgages were going for 18%. Just for sheer horror value, here’s a comparable chart from then. We enclosed it in a thick red border to denote danger:

It’s true: There are homeowners whose 30-year mortgages are coming due this year, who as recently as 2008 still had less than half equity in the house. These people might be your parents. Don’t show them this article.

But getting back to the relevant charts, the first two: we’re not criticizing people with 30-year mortgages. Given such variables as human life expectancy, house obsolescence, and wages and salaries, 30 years has always been the historical happy medium for a mortgage term – not so long that you’re on the hook into your senescence, and not so short that you’re forgoing dental floss to make payments.

However, we’re in The Great 21st Century Stagnation and everything’s at least a little askew.

Here are the actual current mortgage numbers. The average 30-year mortgage right now goes for a minuscule 4.33%, which still dwarfs the average 3.85% that 15-year mortgagors are paying. The difference between the rates has never been this big. Ever.

Last summer, the median home in the United States sold for $176,400 according to the first chart on this page.

Aside: some esoterica from that chart.
the string of “N/A” in the Detroit row is amusing. What a craptastic town. Nothing there is applicable.
the numbers for Ocala and Ft. Myers seem low until you remember that the vast majority of those homes are snowbird apartments.
building restrictions in the Bay Area have had the desired effect, if the effect desired was pricing everyone out of the market.

If you bought the median house with an average-priced 15-year mortgage, how big would your monthly payments be? Here come the math:

Mortgage Payment Calculation

You really need to stop complaining. “Waah, I suck at math. I’m no good with numbers (giggle).” It embarrasses us both.

Would you say “Waah, I suck at English. I’m no good with words” in public? Of course not, you’d sound like a tard. How is this any different?

Take your interest rate, divide it into the number of payments you make annually, add 1, take to the power of (negative) the number of payments you’ll make over the life of the loan, subtract from 1, multiply by the number of payments in a year, divide into the interest rate, multiply by the amount of the loan. Wasn’t that easy? You should have learned how to do this in the 6th grade. Clip and save the formula, it comes in handy all the time.

Anyhow, your monthly payment is the product here, which is $1291.58.

10 years ago, the average 30-year mortgage went for 7.96%. Let’s plug that interest rate into the above expression and see how much house we could have bought with such a mortgage back then, given the same monthly payments.

You ready?

A house costing $176,693.34.

Yes, today you can pay a house off in half the time it would have taken to pay off the exact same house (plus a medical supply table) in 2000.

In other words, God wants you to not only buy a house today, but be free of your debt obligation no farther in the future than O.J. Simpson’s not guilty verdict is in the past.

Everything beyond this is speculation, but the Fed chairman has indicated that he wants to keep inflation low and money tight. Maybe taking him at his word is foolish, but it seems as though mortgage rates can’t fall much lower. If you’re looking at a 15-year mortgage, and the economy stabilizes between now and 2025 (which of course it will), your 178th, 179th and 180th payments could be awfully palatable and the checks downright fun to cut.

(Thanks to TheMortgageReport.com, which we didn’t crib from to write this post. But it’s one of the very few well-written and informative blogs on any subtopic of personal finance. And Dan Green, the guy who runs it, makes awesome charts.)

**This article is featured in the Yakezie Carnival-Tour de France Financial Factoids Edition**

Filed Under: Making Smart Choices, Personal Finance, Real Estate, Rental Property Tagged With: 15-year mortgage, 30-year mortgage, home equity, median price

Make more, pay less

June 15, 2011

Look closely - especially if you're at work - and you can actually see her soul leaving her body.

Dissatisfied in your job? Here’s the time-tested solution: tough it out, be thankful you have one, and come in next weekend just to emphasize the latter point.

Or you can tell The Man which orifice he can shove his company picnic and break-room coffee into, and go out on your own. Incorporate.

There are several volumes’ worth of reasons to do this. We can’t go into all of them now, but one of the best-kept secrets of incorporating is the regressive Social Security tax.

You might not be familiar with the concept of a regressive tax, but it’s easy to grasp. There are 3 species of tax:

-A proportional tax is one levied at a fixed rate. Sales tax, for instance. If your jurisdiction charges 7% sales tax, then any item subject to the tax costs 7% more than the list price whether the item goes for $1 or $100,000.

-A progressive tax means the higher the base amount, the higher the rate. Income tax in the United States (and most everywhere else, as far as we know) is an example.

That leaves the rarest bird in the aviary, regressive taxes.

You mean there are taxes where the greater the amount subject to the tax, the less you pay? That’s absurd. And illegal, right?

It’s cute that you think that. Not only do regressive taxes exist, they’re authorized by the same federal government that you entrust to have your best interests at heart. To fund the 2 biggest and least tenable programs in its tentacles – Social Security and Medicare.

Out of all the confusing, capricious, seemingly arbitrary taxes we pay, Social Security and Medicare taxes might be the most senseless.

The federal tax collectors (sorry, we don’t know most of their names, but Doug Shulman is the Internal Revenue Commissioner) take about 15.3% of your salary in the form of Social Security and Medicare “contributions”. Collectively, these are dubbed FICA – after the Federal Insurance Contributions Act. Remember, Social Security was invented because federal officials of a bygone generation decided that Americans were too stupid to save for retirement. Therefore it would take a benevolent government populated by financial geniuses to make those critical investment decisions for our grandparents, our parents, you, me, and our descendants. Medicare is essentially the same thing, but earmarked for a different purpose.

If you never look at anything but the net pay amount on your paychecks, take some time to read the other numbers. Just once. That 15.3% breaks down like this:

-6.2% employee’s Social Security taxes
-1.45% employee’s Medicare taxes
-6.2% employer’s Social Security taxes
-1.45% employer’s Medicare taxes.

Hopefully this is obvious, but you’re wrong if you think your employer pays its share of these taxes as a necessary cost of keeping so wonderful a worker as you on the payroll. She doesn’t pay these taxes, she merely collects them. You pay them. Your employer factors these taxes into your salary when she hires you. If your employer wasn’t required to pour 7.65% of your income into the subterranean trench that is the federal government, she wouldn’t. Instead, she’d much rather attract you and other employees with wage levels that are 7.65% higher than what you think you’re currently making.

How is this regressive? Sounds proportional to me.

The Social Security portion of your FICA taxes is capped once your annual income exceeds $106,800. You pay the 2.9% in Medicare taxes no matter how much you make, but the Social Security portion can’t go above $13,243.20. (Half of that levied directly on you, the other half levied on you via your employer.)

So the higher your salary – past $106,800, anyway – the smaller the proportion of it you pay in Social Security taxes. On the one hand, this gives you incentive to work hard and earn money. On the other, it’s the kind of inequality that French revolutionaries chopped off people’s heads for.

If you’re an independent businessperson, and you structure as an S corporation or a limited liability company, you can run around the system instead of through it. Incorporate, and you can pay out part of your company’s profits to yourself as salary while paying out the remainder as dividends. The former is subject to FICA, the latter isn’t.

What’s the downside?

You’d be surrendering the “certainty” of a regular, constant paycheck. As if there exists an employer who could guarantee such a thing in perpetuity anyway.

Still, it sounds promising. So why doesn’t everyone do this?

The usual reasons: fear of the unknown, lack of faith in themselves, etc. The same negative thinking that’s been holding most human ingenuity back since we figured out fire and the wheel.

Note: Some people blather that sales taxes aren’t proportional because the less you earn, the higher a ratio of your income you pay in sales taxes.
First off, sales taxes aren’t levied on income, they’re levied on sales. See “income tax”, above. Second, there’s no way around this. Unless you think state legislatures and municipal governments should mandate that merchants ask people how much money they make before determining how much tax to collect.

**This article is featured in the Carnival of Wealth #43**

Filed Under: Entrepreneurship, Finance, Healthy Living, Personal Finance Tagged With: defer taxes, Entrepreneurship, FICA, income taxes, start your own business, Taxes

My bank! My precious bank!

June 8, 2011

Presumably, they had at least $4,250,000 in the vault

What do I do if my bank fails?

Relax. You’re not going to lose your life’s savings. Worst case, you’ll only have a quarter-million dollars left in each of your accounts. Thanks to the Federal Deposit Insurance Corporation, which guarantees you that much when it shuts down a bank. Notwithstanding the debate of whether it’s the federal government’s business to protect depositors from insolvency, the FDIC hasn’t missed a depositor guarantee since its founding 77 years ago. Yet when a bank goes under, people panic – as opposed to panicking before the bank goes under, which would seem like a more appropriate time to lose one’s composure. Many people, for whatever reason, think that among all commercial enterprises it’s banks and banks alone that should be immutable and constant.

What distinguishes a bank from a clothing store or an oil-change place? A bank is a business like any other, selling a service (loans) while trying to do so for more than it costs to stay in business. If the bank fails, it liquidates its inventory and sells it to the highest bidder. Just like a failed sporting goods store or furniture retailer.

So you read that there were 154 bank failures in 2010?

Guess how many restaurant failures there were. You have to guess, because no one keeps a nationwide tally.

But banks are different! They have our money!

Actually, they loan most of it out, but that’s beside the point.

When a bank fails, the people who get hurt the most are the same people who suffer the hardest when any business goes under – its owners. If you’re conditioned to think of the “owner” of a business as someone who’s already rich and is now out one toy, think again. Most small businesses have one, maybe two owners, whose lives are inextricably tied to the fortunes of the business. Sure, the employees might now be jobless, but – they were never invested in the business in the first place. Lose your job, and that’s all you lose – not your life’s savings, not the active nest egg you were building. If you get laid off, your 401(k) goes with you. You do know this, right? You don’t? You really need to read Chapter IV of the book.

Homo sapiens embraces technology, but as a species. There are plenty of outliers – non-adopters who keep their money in something non-institutional. Millions of people, some of whom live a couple doors down from you and/or share your DNA, still don’t trust banks and think the internet is every bit as futuristic as interplanetary travel. Not all of those people lived through the Depression, either.

Still, 154 banks is a lot.

Really? How many banks do you think there are in the United States?

About 8400.

98% of which didn’t fail last year.

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Addendum! It’s like 2 posts in one today!

It’s great when people look at absolute numbers when they should look at relative ones, or vice versa. Heck, even the concept of absolute vs. relative is too much for most people to handle.

Example: Did you know that the Avocado Marketing Board estimates that Americans ate 69.6 million pounds of guacamole on Super Bowl Sunday?

Wow! 69.6 million! If that were money, it’d be more than I’d see in a lifetime! If it were people, it’s…more than would fit in any stadium I’ve ever been in, that’s for sure! 69.6 million! That’s like – the number of grains of sand on all the beaches of the world, right?

If 2/3 of the country watched the game, then that’s 5 1/2 ounces of guacamole per person. (Assuming no one ate guacamole that day and didn’t watch the game. A subset that might include just Tim Ferriss and Rosie O’Donnell, perhaps.) Furthermore, has any bowl of guacamole ever been worn down to the nubbin? Of course not. Any party you’ve ever been to, or held, the guacamole goes mostly uneaten. So it’s probably closer to 2 ounces consumed per person. But OH MY GOD 69.6 MILLION! I FEEL FAINT makes for a ostensibly remarkable superlative. Why? Because the moment a number becomes hard to visualize, people start losing control. You’ve never seen 69.6 million of anything, so it stands to reason that 69.6 million pounds of guacamole is a number sufficiently large to cover the entire contiguous United States 4 miles deep in viscous and tangy chartreuse goodness.*

So 69.6 million pounds (or as we say in Largest-Convenient-Unit Land, 34,800 tons) isn’t a big deal. It’s a very workaday deal. Just like 154 bank failures in a country with more banks than it knows what to do with.

*At least 4 people reading this, all of them female, are unsure if this is sarcasm. They’re wondering if that’s indeed enough guacamole to fill that big a volume, but see it as a math problem and have decided not to get involved. “If McFarlane’s playing with our minds, it’s probably to compensate for his deficiencies in other areas.”

**This article is featured in the Carnival of Personal Finance #313**

**This article is also featured in the Yakezie Carnival-Happy Father’s Day Edition**