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Lately, the media has been dominated by the compromise on US federal tax policy that has been brokered by President Obama that will lead to an extension of current income tax rates, lower estate and payroll tax rates and an extension of unemployment benefits.  It is very likely to pass almost intact and free up the logjam that has hampered this lame duck session of Congress.

Uneven Recovery

From the point of view of a resident of Main Street, the economy is still ailing.  Consumer demand is still off.  A stubbornly high unemployment rate persists.  Real estate values continue to drop in most markets and at best have settled in at levels not seen in nearly a decade. In general, it’s not a pretty picture.

On the other hand, business profits, productivity and cash (now sitting at about $2 Trillion) are up. And this has been reflected on Wall Street by a healthy rise in most major indices.

So the prescription for getting out of this funk is a familiar one: Low taxes leads to growth.  Sometimes, though, conventional thinking can be dangerous.

Economic Theory

From a purely economic theory point of view, there are really only three participants in the economy who can spur demand and ultimately growth: consumers, businesses or government (at all levels).

With consumer spending hampered by unemployment and nervousness about what assets, income and jobs that they may have, you can’t really expect consumers to be leading us to growth.

While businesses have the cash and the profits, they seem to be in wait-and-see mode “keeping their powder dry.”

So that leaves governments at the local, state and federal level. Unfortunately, most local and state governments don’t have the resources or the legal authority to continue deficit spending so that leaves us dependent on the federal purse to help spur the economy.

Tax Package as Stimulus

The tax package compromise as proposed is not perfect.  Like any piece of legislation, it is a mash-up (though the versions seen on Glee are usually much more fun to watch).  It certainly provides the potential for much-needed economic stimulus.

By putting cash in the pockets of the persistent unemployed, it will help keep households running and bolster their local economies when cash is circulated.  By reducing payroll taxes on those who are working, it will also lead to direct spending in much the same way that the under-reported stealth “middle class tax cut” of 2010 did.

By patching the Alternative Minimum Tax (AMT) for another year, more than 21 million households were protected from an unexpected hike in their personal tax burden (estimated at around $3,000 to $5,000 for each family) which might have choked off funds available to circulate in the rest of the economy for goods and services.

The big question will be whether the upper income brackets will use their tax breaks on income and estate taxes to pump up the economy.  Certainly, it could help with high-end consumer goods, vacation homes, and furnishings.  But as much as these purchases will help jewelers, real estate agents, car salesmen and clothing retailers, there’s only so many shoes, watches, cars and homes that someone can consume.

Good Politics May Make for A Bad Economy Long-Term

But will this create jobs?  How quickly can an expected $100,000 cut in income taxes for the richest 1% of Americans translate to business investment that creates jobs?  And at the end of the day, does this potential added economic activity keep us on track for growth?

These are the kinds of questions that probably prompted credit analysts at Moody’s Investor Service, a credit rating company, to put out a cautionary note about the possible negative impact on federal finances with its ultimate impact on consumers.

From a purely political point of view, this may be a good deal.  From a short-term economic stimulus point of view, it provides some benefits.  In the long-term, though, there is a real risk that the nation’s strained finances will take a hit to its credit rating leading to higher borrowing costs for the government directly and for all consumers seeking credit as well.

The Rich (And The Government) Are Different

Why?  Well, ask any mortgage borrower.  When you have pristine credit, it’s easier to borrow money at the most favorable rates.  Over the long-term, borrowing $200,000 at 6% will cost you more than borrowing the same amount at 4.5%.

On the other hand, when a borrower’s credit score is lower – even by a little – then the options available can dry up or cost more.

This is what may happen as we move forward and digest the impact of this tax plan.  It ultimately is kicking the can down the road for others to deal with.  The estimated price tag on the plan is between $700-billion and $900-billion to be added on top of a trillion-dollar plus federal deficit. And the proposals for cutting the deficit prompted much gnashing of teeth and proclamations of lines in the sand indicating that there is no likely easy compromise on their recommendations especially in a grid-locked Congress next term.

US Credit Score on Watch List

Is there an immediate problem?  No.  As long as we still have investors who are confident that they will get paid back on the money that they lend us through their purchase of our government’s debt.  Unlike the mortgage borrower in my example, the government can vote to increase its credit limit and authorize the printing of cash. Not something that your typical consumer or state government can do.

And investor’s in the marketplace seem to be OK with that as seen by the cost of insuring against default through derivatives. An insurance contract to protect $13.-million worth of U.S. government debt currently costs €41,000 a year, according to data from credit-information firm Markit Group. That is down from €59,000 in February of this year, and far less than in early 2009, when it cost €100,000.

But this can turn on a dime.  Ask those folks in Greece.  They are painfully aware what can happen when investors and banks lose patience and pull the plug and the credit line.

Yes, Greece is not the US, which has the benefit of being the world’s reserve currency.  But that should not lead us to complacency and hubris.  We need more than conventional thinking and political party maneuvering.  We need the kind of shared sacrifice that the Greatest Generation exhibited which won the peace in a global conflict and pulled us out of the other greatest global economic calamity of the last century.

Either we need to make the tough choices now while we can or we will be forced to pretty much at gunpoint down the road.  That’s not a pretty picture nor a way to grow in the long-term.

Maybe we can get the folks from Glee to work on a musical mash-up of sorts that will make this happen.

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Let me offer the classic unsatisfying answer:  It depends.

Before you offer your John Hancock you should understand the risks involved.

Just like any other financial decision, it’s best to try to do this without the emotion, drama and angst that can complicate a relationship.  Easier said than done, I know.

But like your investments, you should do your own due diligence and follow your own values.

Sometimes it’s absolutely necessary to get a cosigner for a loan, credit card or apartment lease.  The best terms are offered to those with the lowest credit risks.  A credit card issuer, mortgage lender or landlord will rightly offer someone with an established good credit history and deeper pockets a whole lot better set of terms than a newly minted college grad or someone with a bunch of blemishes on their credit report.

I remember a favorite uncle of mine.  He was single, very responsible with money, a great saver.  He once went to buy a car but needed a younger nephew to consign for him for the auto loan because our uncle had no established credit.  He had paid cash for everything all his life making him an invisible man to a loan underwriter.

I also remember once walking across campus and a friend stopping me as I passed the financial aid office.  He asked me for a favor.  He needed a cosigner for his student loan and it was my lucky day to be the guy to help him.  Don’t worry about a thing, he told me.  I’m good for it, he had said.

Luckily he was but that’s not always the case.  The FTC reports that three out of four cosigners are asked to pay because the primary borrower hasn’t.

Know the Risks

There are risks in life and in every decision we make.  It’s not a matter of avoiding all risks but managing them, understanding them. Don’t just think that you can walk away once you’re on the hook for the loan.  Just because your signature may not appear first doesn’t mean that you won’t be the person they turn to collect the debt.

Landlords typically require a parent to cosign on an apartment for a child.  They know if the kid skips or the keg party gets too wild that Mom and Dad will not want to risk their good credit and will be there to cover the bill.

Remember that each loan or credit card you have will have an impact on your own credit score.  The payment history and amount utilized compared to the maximum line of credit can have a potential adverse impact on your own credit score.

And the amount of the debt will be counted as if it were your own.  This may make it difficult or impossible to get a loan when you need one.  I had a client who had cosigned for a car loan for her adult son.  The son has made every payment on time.  But when his mom applied for a home equity line of credit the car loan fixed payment was included in calculating the underwriter’s debt ratios.  Combined with her other debts it was enough to push her over the maximum qualifying debt ratio allowed resulting in a loan decline.

Put Yourself in the Lender’s Shoes

If you treat this like an investment or a loan, you should be prepared to ask questions.

You should be asking the same sort of questions that any would.  Why do they need the money?  What’s the default risk? Can they afford the debt?  How will they manage to pay it back?

Curb Your Enthusiasm … Set Limits

Like all financial decisions, consider the risk and find ways to limit it.

For a credit card you can request that the limit be set low so that the card can only be used for emergencies and not big ticket discretionary purchases that will leave you on the hook.

For apartment leases with roommates, make sure that all the parents are also listed on the lease so you’re not the only one that the landlord will call when there’s a problem.

For other large ticket items requiring a loan, consider being listed on the title for the car for example.  If there is a default, you’ll have the right to sell the car.

At the very least you can ask to receive duplicate statements so that you can monitor that payments are being made as promised.

For larger loans like a mortgage, you may even want to consider offer your help in the form of an intra-family loan.  There are services that will manage the payment processing so that it avoids getting ugly if there ever is a payment problem.  Just remember that if you choose to lend a hand to someone to buy a home in this way, they will need to declare it on the application as a debt and they’ll have to qualify for the new loan with this payment as well.


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Secrets are dangerous.  Money secrets can be the worst kind for families.  What should you do if you have a child struggling financially or just needs a helping hand when it comes time to buy a home?

The trend toward “boomeranging” among newly minted college graduates to return to the family nest is a well-known phenomenon. With persistently high unemployment and an ongoing crisis in real estate, it’s now not uncommon to hear of adult children with families of their own seeking a helping hand from parents.

This is certainly not something that was on the radar screen when thinking about retirement.  But more often I’m hearing of parents at or in retirement helping out their adult children who in turn are trying to help out their college age kids, too.

In the past, when I was a mortgage banker I would often need to ask about the source of a down payment for a home purchase.  Many times I would hear that mom and dad or a grandparent or uncle would be helping out to fill in the gap.  Sometimes I would make the suggestion and probe to find out if there was any chance for a family gift.

Because of lending rules, there was a certain way that such gifts needed to be documented.  On more than one occasion, I would find a family member who was not just reluctant but downright belligerent about sharing any information needed to document the gift.

Other cultures while just as secretive were more willing to provide such a helping hand. I found that it was especially common for those who were part of first generation immigrant families to gift money to family members literally from money stashed away in coffee cans and mattresses.

Many people may find it easier to talk about health or sex problems than to talk or share information about money.

Unfortunately, this kind of climate perpetuates poor money management skills.

If you’re in the fortunate position to have extra resources to help a child or family member, then you should consider it a “teaching moment.”

Yes, there are those who will say that it’s your money and you don’t have to tell anybody about what you’re doing.  But consider this:  You could be sowing the seeds of some kind of rift between family members if not know then later when you pass away.

The key here is communication. While you don’t have to tell your children to the penny what kind of gift you’re planning, you should inform them so as to avoid hard feelings later.  Your kids probably know that you wouldn’t offer if you couldn’t afford it.  They may even recognize that one child is in tougher straits than others or that they have other resources as a safety net such as their own in-laws if need be. But don’t assume anything. If they have your best interests at heart, then they may just want confirmation that you aren’t putting your own financial security at risk.

Back to the teaching moment.  Here is an opportunity to ask questions that may help them think about what they are doing.  Are they short on cash because of something beyond their control or do they have trouble handling money?  Are they gambling or overindulging?  You could impart some added wisdom from experience here such as when my aunt told my mother about how she always saved any raises she got instead of counting on it for spending money.

I’ve had a couple of clients who invested money in their son’s businesses.  Each formalized it with a loan agreement and an equity stake. If it’s a business, then treat it like one.

If it’s help for a home purchase, you could help provide some perspective.  Is this really a good neighborhood to invest in? Are there problems with the property that will become an issue when trying to resell later? (Think here about the time you bought the house with the shared driveway).

Remember to be equitable with your family.  You don’t have to offer help in equal amounts since every child’s circumstances is different.

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As noted in previous articles and posts, whether or not your student qualifies for federal financial aid for college will depend on the Expected Family Contribution (EFC) calculation.

Typically, almost all assets and income are included in this calculation by financial aid officers.  There are exceptions to all rules and in this case, federal aid formulas (under the “Federal Methodology”) exclude home or family farm equity, money accumulated in tax-deferred retirement accounts and cash value built up in a life insurance policy.  The cash values of fixed and variable annuities are also excluded.

Since these assets are not counted in determining aid, some families may be tempted to consider “asset shifting” strategies.  With such techniques, a countable asset like savings or investments through a brokerage account are used to acquire one or more of these other non-countable asset types.

Friends and clients have attended financial aid workshops sponsored by college aid planners or insurance agents who recommend purchasing annuities or life insurance.  Sometimes these strategies involve doing a “cash out” refinance or drawing on a home equity line of credit. Tapping home equity to fund a deposit into an insurance or annuity vehicle may benefit a mortgage banker and insurance agent but is it in your best interests?

Asset Shifting to Qualify for More Financial Aid: Is it worth it?

Well, that depends on what side of the table you’re sitting on.

Yes, it’s true that anything you can do to reduce your expected family contribution may help boost the amount and type of aid your student may receive.

On the other hand, remember these points:

  • Family assets are counted at a low contribution rate of 5.6% above the asset-protection allowance calculated for your family circumstances.
  • If you put money into a tax-deferred account, it’s locked up.  Access to the funds before age 59 1/2 results in early withdrawal penalties in most cases.
  • You may have to pay to borrow your own money.

Granted, socking away money into tax-deferred vehicles may make sense for you.  And as I’ve noted before, paying for college is as much a retirement problem as anything else so anything you can do to provide for your Golden Years can be a good thing.

But don’t get tempted into long-term commitments to cover short-term financing issues.

By shifting assets you lose access and flexibility for the cash.  If employing such a strategy reduces your emergency cash reserve, then you’ve increased your risk to handle unexpected cash needs.

Cash Value Life Insurance and the Bank of You

Cash value life insurance accumulates its value over time.  Starting a policy within a couple of years of your student’s college enrollment is not going to help you.  During the initial years of such a policy very little cash is built up as insurance expenses and first-year commissions paid out by the insurer to the agent are very high which limit the amount of paid premiums that are actually invested for growth.

But consider this:  For some who have existing policies or are looking for a way to build cash over time that offers guarantees and is potentially tax-free, then by all means use life insurance.  There are strategies commonly referred to as the Infinite Banking Concept or the Bank of You which champion life insurance as a way to build and access your own pot of money available to you to borrow for almost any purpose.

There are many attributes to life insurance that make these concepts useful

  • Tax-free dividends,
  • Access to money without credit or income qualifications or delays from a traditional bank,
  • Guarantees on the cash value from the insurer.

But one downside is the cash flow needed to actually build up a pot big enough to tap into for buying a car much less paying school tuition.  You would in all likelihood need to divert all other available cash and stop funding any other tax-deferred plans to build up the cash.  And then there is the time line needed.  To effectively build up the cash, you really need to bank on at least 5 years before you have a Bank of You to tap. This is why such a solution is not recommended for those with students about to enter college.

Bottom Line:

Don’t let the financial aid tail wag the retirement planning dog here.  Only use these tactics after consultation with a qualified financial professional, preferably one who has no vested interest in whether or not you purchase a particular product.

 

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Mortgage interest rates continue to be at historic lows.  Rates for 30-year fixed rate loans are hovering in the 4% to 4.2% range. There’s no real whiff of inflation in the air that could lead to a spike in interest rates any time soon.

So should you refinance?  Crunching the numbers is crucial.

When I was a mortgage banker, the rule of thumb would be it made sense when prevailing interest rates were 2% or more below your current rate.  With the availability of zero point and zero closing cost loans, it even made sense when the rate was a mere 1/2% difference.  It was common for homeowners to get calls from their mortgage brokers alerting them that the rates had dipped and they should refinance even before the homeowner may have made their first mortgage payment on their new loan.  It was even common for mortgage brokers to keep current copies of income, credit and asset verification forms on file in order to start a new application quickly.

Things have certainly changed since the refinance booms of the 1980s and late 1990s.

Property market values have fallen throughout many parts of the country.  The number of jobless are at historic highs.  Credit has been strained by more than two years of economic crisis and now malaise. Banks are in much less tolerant moods now to offer special deals or bend the rules when underwriting a loan.

Since buying and owning a home is one of the largest investments for many, it pays to consult with a professional who can help you sort all of this out.

Break Even

One of the first things that an adviser can help you do is make an informed decision about how this refinance will impact the total picture for your personal finances.

Paying off debts and consolidating credit cards may look good but if you’ll just end up running up the tabs on these accounts right after the refinance, then you’re no further ahead.

Assuming you will not be tempted into debt again, then you need to figure out what the refinance will cost compared to the potential interest savings.  The “break even” point in terms of months or years is calculated by dividing the costs by the projected savings.

For example, if you took out a $400,000 loan three years at a 30-year fixed rate of 5.5%, then your principal and interest payment(P&I) is $2,271.16 per month.  After three years of payments, your balance is about $382,905 if you made no additional payments to principal.

Let’s assume that the prevailing rate now for the same loan term is 4.5% and your new loan will be just enough to pay off the old balance and any closing costs for this loan.  Assuming a new loan amount of $395,000 to cover 1 point (or 1% of the loan), plus the various fees and the payoff balance of about $385,200 (payoff balances are higher than statement balances because of accrued interest), then the new monthly payment is estimated at $2,001.41 for P&I.

The $9,800 in closing costs divided by the estimated monthly savings of $269.75 translates to a break even of 36 months. So if you think you’ll likely remain in the home for at least 3 years, then it may mean more cash flow into your pocket.

Selling or refinancing before then means that you will not be better off and your actual effective interest cost for borrowing (the Annual Percentage Rate) will actually be much higher than the stated coupon rate.

What’s not taken into account by this calculation is the additional interest that you are going to pay because you will be extending the term of the loan by three years. Sure, the new loan will be written for a 30-year term.  But so was the last one you had started three years ago in this example.  So instead of being mortgage-free in 2037, you’ll be paying on this loan until 2040 if you don’t refinance before then or sell the property.

Try a Different Term

Just because you’ve always had a 30-year fixed rate doesn’t mean that you have to always get the same term.  Usually, a term of 20-year or 25-years is offered at the same interest rate.  Assuming you can handle the higher payment for the shorter term, it may make sense.

In this example, a 25-year term fixed rate loan at 4.5% for $395,000 will mean a P&I payment of $2,195.54 each month.  Compared to the original loan payment of $2,271.16, this means your monthly cash outflow will increase by $75.  But you will save two years in interest payments over the old loan.

Cash In or Cash Out

Instead of “cashing out” equity and walking away from the closing table with a check, it’s becoming common to see people “cashing in” and come to the closing table with a check to pay towards the loan payoff.

This may be because the homeowner wants a lower payment.  Or it could more likely be because of the drop in property value and the lender’s loan-to-value limits.

In either case, you now need to consider whether locking up this cash by paying it to the bank makes sense. Will it still leave you with sufficient emergency cash reserves? Besides flexibility, what else are you giving up?  Could this money be invested somewhere else and what could you expect as a return?

This is the kind of comparative analysis that a qualified financial adviser can provide when making such financial decisions.

Home Equity Value: Another Potential Problem

These are best case scenarios.  What happens if the property value has dropped?  If you had less than 20% equity in your property when you bought or last refinanced, it’s quite possible that you may not have enough equity to do a refinance.  Or you might be underwater with your current loan above the market value.

Even if there is equity to do a refinance, there are new risk-based lending guidelines that require the lender to tack on an additional amount to the interest rate or the closing costs or both if the loan amount is higher than 75% of the appraised value.

And depending on the area, some lenders are not taking the appraised value provided by the appraiser without reducing it by a 5% “haircut” which may make it economically unfeasible to do the loan or qualify under the lender’s counter-terms offered.

Staff Crunch, Delays and Legal Issues

Given the low rates, lenders are swamped with applications and may not be able to process an application within your rate lock period.

And recent issues regarding the proper filing of mortgage documents that is now resulting in some homeowners challenging their foreclosures could spill over to good credit quality borrowers as well.  In addition to the drain on lender resources to fix this problem, it could delay conveyance attorneys or title companies in tracking down the records needed to do a proper title search.

So should you refinance? If it fits into your financial plan, then yes.  If you don’t have a financial plan, then call a qualified adviser to get one before trying to figure all this out on your own.


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Given the roller coaster ride that stock market investors have experienced and the negligible rates offered by banks on savings, it’s easy to see why someone might want to use their cash to pay off their mortgage.

Being debt free is not only noble but can provide a buffer in tough times since you’ll have one less cash outflow each month.

For every dollar you pay off in a mortgage, your rate of return is equal to the amount of interest that you’re saving. This is measured by the interest rate (net of the amount that is deductible of course).

So in this example, you could be “earning” 6.125% (less the deductibility of the mortgage interest based on your tax bracket).

Compared to other savings alternatives, that’s a great return. And compared to other equity investments it can seem a lot less volatile.

But before you drain the cash reserve, let’s look at this more closely.

  1. Tying up a lump sum of cash in a property can be risky. You may come up short on emergency reserves by using the bulk of it to pay off the loan.  Will you have enough cash to cover 12 months of your living expenses?  Will you have enough to cover operating expenses for the properties if they were vacant or you lose your job?
    • Considering that in this case you have three other investment properties and your primary residence, there is always the likelihood that you might need cash for an emergency repair or the cost of compliance with any changes in building codes or prepping a vacant unit for a new tenant or even to cover the carrying costs while a unit is vacant.
  2. Real estate is an illiquid investment. Once you send in the check to the bank you no longer have the cash readily available for use either to pay for ongoing expenses, cover emergencies or for other investment alternatives that may come along.
    • What if a really good deal on another investment property came along?  Depending on your market, you could find a very inexpensive property to buy that could more easily cash flow now but without the cash you’re out of luck. Sure, you’ll have more equity but to tap into it will require a bank to agree to give it to you which is more difficult on investment properties and your primary residence may not have enough equity to allow you to get a home equity line of credit (HELOC) or home equity loan to recoup the cash you may need.
  3. Property prices are still in flux.While savings bank rates are abysmal, losing money is even less appealing. By investing more in your property, you could actually see a negative return.  In some markets, real estate prices are still going down so it is conceivable that you could turn each $1 paid in principal into 90 cents.

What Are the Alternatives?

Consider a non-bank financial firm that is offering one of those ultra-high yield money markets for a good portion of this reserve fund.  It’s accessible and won’t cost you anything to hold and they tend to offer higher rates than most brick-and-mortar banks.

You could also split off a portion of the funds and find a ultra-short term bond mutual fund.  Average yields are about 2%.

For a small portion (starting at around $2,500) you could even use a convertible bond fund.  These are hybrid investments combining the fixed income of a bond with the potential capital appreciation of a stock.  These types of investments have held up well when interest rates rise because of Fed action or inflation.

For more information on these, you could check out my article posted on www.ezinearticles.com here.

Likewise, you could also consider other types of short-term bond investments like mutual funds that target floating rate notes.  These types of commercial loans are regularly reset and are a good way to hedge against inflation.  Since there is credit risk, you don’t want to put a whole lot of eggs in this one basket but 5% to 10% of your funds is prudent for you to consider.

As in all things, read the prospectus and speak with your adviser to determine if these are right for you in your situation.

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