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Jul 292013
 
Borrowing money is nothing new, but the many ways of getting into debt these days make it easier to find yourself in financial trouble.

Borrowing money is nothing new, but the many ways of getting into debt these days make it easier to find yourself in financial trouble.

None of us have as much money to spend on prepping as we wish.  So we’re starting a new article series to help you become more financially free, and better able to invest in more complete prepping.

Our financial lives revolve around two main factors.  The income we generate each month, and the money we spend each month.  Hopefully we spend less than we earn, of course.

The issue isn’t so much the actual numbers as it is ensuring there’s a positive gap such that you are earning more than you are spending.  If you want to widen that gap, you can do either or both of two things, and only two things.  You either increase your income and/or reduce your expenses.

An exception to that rule seems to be if you’re managing a city, county, state or the entire federal budget.  Deficit spending seems to be something that these public bodies can do with impunity, but don’t you be tricked into believing that either you can safely spend money you don’t have, or that the public bodies can, either.  Detroit declared bankruptcy last week, other cities have already done so with less publicity, and some other cities similar in size to Detroit also have massive unfunded liabilities.

The only difference between us and a public body is that the speed of our crash would be quicker and harder, and that it is our own personal money and future at risk – the administrators of public bodies are seldom personally at risk when they spend their way into deficit oblivion.

So, how to reconcile the need to not spend more than you earn with the easy availability of money to borrow?  And how to borrow money as inexpensively as possible?

1.  Should You Ever Borrow Money?

Chances are you currently owe money, like most of us.  Maybe you have a house mortgage, a car payment, a balance on a credit card, a store card, a student loan, maybe payments on some furniture or something else you financed, and so on.

Some people say you should never borrow money.  We’re not saying that, and as we said, most of us do owe money.  But we will agree that many of us should probably borrow/owe less than we do.  There are times when it makes sense to borrow money – buying a house being the classic example of that.

Sometimes you might have no choice but to borrow money, it might be literally life or death.  Medical and dental bills would be an example of that.

A third category when it can make sense to borrow money up front is when the thing you are paying for is something that will provide an ongoing financial benefit to you – an educational qualification to advance your career, or a new tool that you can use to work more productively and more profitably (sometimes a new(er) car can be justified under this heading too).

A related category would be when you must spend money up front to save needing to spend more money later on.  For example, if your house needs repainting or your roof needs replacing, you are better advised to get that done in a timely manner, for fear of having much greater costs subsequently if you delay.

There is a final, fifth category where it makes sense to borrow money.  If you are in an unusual situation where an item is going up in price at a greater rate than the cost of borrowing money, maybe it is better to borrow so you can buy the item now, rather than save and buy the item later when you have saved enough money.  This has often been true of real estate, and can sometimes be true of other things too, although be very cautious when it seems you are being presented with any sort of ‘amazing short-term opportunity to save money’.  More often than not, the deal isn’t as amazing as it seems, and the short-term opportunity might be longer term than it seems to be.

It never makes any sense for any seller to sell anything for less than its fair normal market value; if someone is trying to tell you they are selling you something for less than it is worth, you have to wonder what sort of fool they are to do that.  If something is truly worth, say, $50,000, then why wouldn’t the seller ask $50,000 for the thing?  Why would he only ask $25,000?  Yes, there sometimes are valid reasons why real true bargains come along, but be very wary of deals that seem ‘too good to be true’.

So, there are five situations when it may make sense to borrow money.  On the other hand, there are also many times when it makes no sense to borrow money at all, because the ability to easily borrow money merely tempts us into buying something we didn’t and don’t need.  A bigger screen television, for example; a newer car, a hot tub, an extravagant vacation, or whatever else it is that is currently tempting you.

Manufacturers and retailers spend billions of dollars every year tempting us to buy as much as we can – and then to borrow more money to buy more things that we shouldn’t be buying – because if we all reduced our levels of spending and consumption, our economy, which has become ever more dependent on people spending more than they should, would implode.

But don’t worry about the national economy.  You should be ‘selfish’.  Never mind about the national or international economy, and don’t think about what the other 330 million people in the US are doing.  Think only of yourself, and what is best for you – our economy can probably withstand the effects of you reducing your own level of consumption slightly.  🙂

For the future, if an item doesn’t clearly fall within the five appropriate-to-borrow-money categories above, you should discipline yourself to not buy it until you have spare available cash in your bank account to pay for it.

This will save you much more money than you think, because not only are you saving on the interest costs of borrowing money, but you’ll find you end up buying fewer things, and those you do buy will be more sensible appropriate things.  You’ll have a better life style, you’ll own better things, and you’ll have more money in the bank and fewer monthly outgoings.

You’ll also discover the joys of being able to negotiate cash discounts, of being able to buy things when they are at the lowest price, and so on.  So let’s hurry your forward on your path to a much stronger financial situation.

2.  The Subtle But Massive Costs of Interest

Some of us go to ridiculous lengths to ‘save money’ – we know a person who proudly drives ten miles to fill their car up with gas at a cheaper gas station, but (by our calculations) the cost of driving there and back exceeds the money they save each time.  There are lots of examples of people who are ‘penny wise and pound foolish’, and hopefully you’re not guilty of any of these failings, yourself.

But there is one failing that many of us have.  We are sometimes so appreciative of any source of credit that we seldom stop to look at the cost of the credit, and to comparison shop when borrowing money.  The cost of credit – the interest rate we are charged – should be as important to us as the price of gasoline or the cost per pound of potatoes in the store.

Because interest ‘compounds’, there is a huge difference in total cost to you between a higher and lower interest rate, and between paying a loan off quickly or slowly.  The best thing to do is to get your interest rate down as low as you can, and to pay the loan off as quickly as you can.

Let’s look at several different scenarios to see how this works out, using a $10,000 loan amount every time.  If your loan is more, just multiply the amounts by how many times more it is to see the impact.

Interest % Years = Monthly Payment = Total Interest Paid
21% 10 $199.93 $13,992
21% 5 $270.53 $6,232
18% 10 $180.19 $11,622
18% 5 $253.93 $5,236
17% 10 $173.80 $10,856
17% 9 $181.36 $9,587
15% 10 $161.33 $9,360
15% 9 $169.24 $8,278
15% 8 $179.45 $7,228
15% 5 $237.90 $4,274
15% 4.5 $255.78 $3,812
10.5% 10 $134.93 $6,192
0% 10 $83.33 $0

 

You’ll notice several things here.  If you halve the time it takes you to pay off your loan, your monthly payments don’t double.  The increase by more like 50%.  As for the other 50% that doesn’t increase, most of that saving is due to you paying much less interest – half as much interest, sometimes even less.

The longer your loan, the massively greater your total payments will be.  Keep your loan periods as short as you can, and any time you have spare money, use it to pay the loan down still faster and further.  Remember that each extra dollar you pay, over and above your monthly minimum, is going entirely to paying off the principal amount owing, and that once you’ve reduced the principal, you no longer pay any more interest on it in any of the remaining months of the loan.

You can also see the huge difference in total interest payments at different interest rates.  Reducing your interest rate by only a few percentage points can save you thousands of dollars over the period of your loan.

Most of all though, hopefully you’ll vividly see the massive costs associated with borrowing money.  Say you’re thinking of going on a vacation – $5000 for the two of you.  Does it really make sense to borrow that money on your credit card, and to pay it off over 5 years at 21%, making the total cost of the $5000 vacation into $8100, and to be making payments for long years after you’re returned home and already forgotten about the great time you hopefully enjoyed?

Remember the five (and only five) scenarios for borrowing money, above.  If something isn’t clearly within one of those five scenarios, don’t be tricked into borrowing money to pay for it.

Now, talking about tricking, let’s look some more at issues to do with borrowing money.

3.  Avoid Unnecessary Fees

Lenders love late fees.  They massively increase the amount of profit they make from the money they’ve lent you.  So don’t be tricked into incurring them.  Plus every late payment – even by only a day – becomes a downcheck on your credit report.

Know when payments are due, and make sure your payments are always safely and surely received a couple of days before they are due.

Banks also love the fees they charge when you go into an unapproved overdraft, and/or the fees they charge if they bounce your checks.  Many times the bounce fee can be more than the check amount itself!  There’s no excuse for writing checks when you don’t have money in your account; make sure you never end up incurring these fees.

We know one person who regularly writes checks he doesn’t have money in his account to cover, and boasts that the bank always honors his checks.  That’s very kind of the bank, but he also confirmed the bank charges $30 every time.  A $30 fee for what is in effect a one or two day loan of $100 or $200?  Say it was a $200 check for two days.  That $30 fee is the same as a 2760% interest rate, and if I ever found myself paying that interest rate, I’d sure not boast about it.

We know another person who is often late paying his water bill.  He says he only really feels the pressure to pay it when he gets a notice of pending cut-off hung on his door handle at home, and then he pays it immediately.  He says it doesn’t matter, because it is not reported on his credit report.  But what he doesn’t say is that he is assessed a $20 late fee each time that happens.

A $20 late fee might not seem like a huge amount, but what a total waste of $20 for no benefit in return.  He still had to take the time to pay the bill, but by being slack, he wastes $20.  And one time, he was out-of-town, and returned home to no water, a late fee, a reconnection fee, and an emergency call-out fee.  Almost $100 in fees.

So pay your bills on time, even the ‘nasty’ ones you don’t like (like parking tickets, before they double) and the ‘unimportant’ ones like water bills.

In general, you should have a look and see how much each of your credit cards is costing you in annual membership fees, and how much your bank account is costing you too.

Do you really need three different Visa cards – especially if they each charge you $50/year?  Almost certainly not!  We generally have one Amex card, one Visa card, and one Mastercard in our wallet.  That way, if we have a problem with our Visa or Mastercard for whatever reason, we have an alternate to use, and we also have an Amex which we mainly use only at Costco (Costco has a deal on a combined Amex/Costco card membership).

Trim down the credit cards you possess.  And choose credit cards with no annual fee, or a low annual fee.  Some credit cards charge $100 or more a year, some are free.  Unless there’s some way you’re clearly getting the value from the annual fee (maybe it gives you a free companion airline ticket or something), don’t use that type of card.  If you do need that particular card, see if you can negotiate a lower annual fee with them – you’d be surprised how much you can negotiate with the credit card companies when they think you’ll otherwise leave them and go elsewhere.

You should also look at your monthly bank fees.  Banks change their fee structures all the time, and while they send out notices of changes to their terms and conditions, who has time to read through them all and try to work out what has actually changed?  Although you might have got the best deal at the time you opened your account, almost surely, over the years, it has changed and other deals have come along so you no longer have the most appropriate account type and fee structure.

Many banks have some type of ‘free checking’ account, or if not, they very probably have a lower cost account than the one you currently have.  If you’re paying more than $10/month, go ask for a better deal.

Many people report better experiences with smaller banks and local credit unions rather than with larger banks.  If you’re looking at changing banks, be sure to speak to a small bank or credit union as part of your shopping around.

If you sometimes need emergency loans, in small amounts and for short periods, make that part of your bank shopping too – find out what their policies are and what the fees will be.

4.  Negotiate Down the Fees You Pay

If you are borrowing money through an independent mortgage broker, ask them to split their fee with you.  The chances are they are getting 1%, 2%, or maybe even more of the money you are borrowing as their fee/commission, and just like realtors will generally give back some of their commission, so too will mortgage brokers give some of their fee back to you, too.

But be careful how you approach this matter.  If you ask the mortgage broker about the fee up front, he might say ‘sure, of course’ and then present you with loan rates that he has inflated the fee, so that he can then ‘reduce’ the fee and ‘give you back’ some money but still end up with as much money as he would have got anyway!

When borrowing money, it pays to shop around and compare, and when you’ve found the best two or three, then negotiate between them to see who will trim their own margin the most.

Even if you’re not negotiating by asking for a fee giveback, you can simply instead ask for a fee reduction.  We’d not recommend you ask a full-time bank employee to share their fee with you, but you can ask the bank employee for a reduction in the loan fee.  Remember these loan officers are in the business of making loans, not refusing loans, and they have some discretionary ability to vary the rates they first offer you.

If you make a mistake and the bank charges you a bunch of fees for bouncing a series of checks, and if this is not something you make a habit of doing, go into the bank, meet a banker in person, and ask for them to reverse out the fees.  If you discover that your ‘free checking’ account requires a minimum $5000 balance, and you dropped below that, ask for that fee to be waived too – but you can only do this once or twice.  However, if you’ve been with the bank for a while, you can simply say ‘I forgot’ or ‘I didn’t realize’ and they’ll probably cooperate with you.

You might be surprised to see how quickly many institutions will take their fees off again, but you have to ask them (politely!) first.

5.  How to Borrow Money Cheaply

Just as important as paying off your debt is avoiding incurring new debt as much as possible.  But sometimes there is no alternative to needing to borrow some money.  When you absolutely must borrow money, try to do so on the most favorable terms possible.

If you have a credit card, try to never take a cash advance from your available credit limit.  This is a very costly thing to do.  You will be charged an immediate cash advance fee (usually 2% – 3% of the amount withdrawn) and then the amount instantly starts accruing interest.  Worse still, many credit cards then make all the other current charges on your card start accruing interest, too.

One way around this, if you’re short of cash, is to simply pay for more things by credit card, and pay for fewer things with cash.  You’ll probably get a month or two of time, interest free, to pay for the new charges on your card if you’re keeping it current each month.  That’s a lot better than paying all the fees for a cash withdrawal.  You’d be amazed at how much you can buy with a credit card these days.

Payday loans and pawn shops are even more expensive than credit card loans.  As nasty as they are, it is probably better to make a cash withdrawal off a credit card than to enter into one of these transactions.

6.  Take Advantage of Special Deals

Maybe you have a chance to buy something on a ’90 days same as cash’ basis.  If you see such a deal, you should consider several things.  First, ask the store if they also have a cash discount offer at the same time – maybe you can get a 5% or greater discount for paying cash (because it probably costs them at least 5% to give a ’90 days same as cash’ deal).

If they don’t, then if you can afford to pay cash for the deal anyway, you could buy it on the ’90 days same as cash’ basis, and make sure you make the payments as is needed to avoid having interest kick in, including paying everything off the day before the 90 day point.

If you need something that is offering the 90 day deal, you should take it, and understand what happens on the 91st day.  Does that mean that suddenly all the past interest over the previous 90 days will then be billed to you?  Or do the 90 interest free days remain, no matter what?

Then at the end of the 90 days, you then use a credit union loan or something like that with a lower interest rate to then pay the balance, and make your payments on the credit union loan.

Maybe you are offered a deal on a new car with 1.9% financing.  You have already saved up the money for the car, so you don’t need it.  But here’s an idea – why not borrow the money for the car, and then with the money you’ve saved up, use it to pay down any other monies you owe – even your house mortgage.  If you have a house mortgage at (say) 6%, you’ve managed to suddenly replace perhaps $30,000 or more of it with money you borrowed at 1.9% as part of your car purchase.  That’s a good deal, even after allowing for the tax benefits on the house interest.

Be careful if you use the money to pay down your house mortgage though, because your monthly house mortgage payment will stay the same, and you’ll also then have to find more money to pay for the car payment.

7.  What to Do With the Money You Save

Each time you save yourself some money, don’t spend the money you’ve just freed up, and don’t let it just disappear into all the rest of your money.

Instead, take the money you’ve just now saved and either use it to pay down the money you owe on something, or use it to build up your preps.  Either which way, you end up with a lasting benefit, and at no extra cost to you.

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David Spero[suffusion-the-author display='description']

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