Tag: Save That Money

If you’re a homeowner, you may have noticed that mortgage rates have been on the decline recently and that probably means you’ve been hearing about how it’s a prime time to refinance.

People refinance for all sorts of reasons:

• Lower interest rates, which can help you save on total interest paid over the life of the loan.
   
• A lower monthly payment, which can make what you owe month-to-month a bit more manageable, but you may end up stretching the loan term to a longer time period and therefore owe more in interest overall.
   
• A shorter term, which helps you save on interest but could mean a higher monthly payment.
   
• A fixed interest rate, refinancing from an adjustable-rate mortgage to refinancing to a fixed-rate mortgage before their original interest rate adjusts.
   
• Tap into your home equity, refinancing to tap into equity and do things like renovations.

But as with any financial decision, you need to understand how refinancing works before rushing into a decision.

How does refinancing work?

When you refinance, you are essentially taking out a new loan to pay off the old loan.

Keep in mind that you’ll likely have to pay closing fees – about 2 to 4% of the total amount you borrow – which can vary depending on the size of the mortgage and the fees you’ll be charged.

It’s always better to have cash available to pay the closing costs, but you may also be able to wrap in the closing costs in with the new mortgage.

Questions to ask yourself before refinancing

How long do I plan to stay in this home? If you’re only planning on living there for a few more years, the cost of refinancing may not be worth it. You’ll want to calculate your break-even point: how many months you need to remain in your home before the monthly savings on the new loan exceed the closing costs you’d have to pay. 

How much equity do I have currently? As you make mortgage payments and your home’s value changes over time, the amount of equity you have in the home will also change. Many lenders prefer you have at least 20% equity in your home before you refinance. Some will approve you with less, but you may not get the most favorable terms.

Am I currently paying for PMI? If you have a loan with Private Mortgage Insurance (PMI) and have at least 20% equity, refinancing to a conventional loan may allow you to drop the monthly PMI payment. You may also be able to get rid of PMI by having the home reappraised too, which is much more affordable than refinancing.

How close am I to completely paying off my current mortgage? If you’ve been paying on your mortgage for a while and only have a few years left, it may not make sense to refinance. No sense in trying to save on interest when you’re so close to paying it off.

What mortgage terms would I qualify for now? It might be in your best interest to refinance so you can shorten your loan term from a 30-year rate to a 15- year mortgage at a lower interest rate. Of course, you could always self-amortize the remaining payments (make extra payments to have the loan paid off sooner) if you have the discipline to do so.

How to refinance

Refinancing is just like applying for a mortgage. Go online and get quotes from a few different lenders. Choose one that is offering the refinance options you are looking for at the most reasonable rates.

Once that’s complete, you’ll pay closing costs, sign the necessary paperwork, and begin making your new mortgage payments.

For most Americans, going to a dealership to pick out a new car is a special moment.

Usually, there is a reason behind it — a treat to yourself for getting a promotion, an upgrade for a growing family, or maybe just a mid-life crisis — and the feeling you get when finding “the one” is hard to beat.

But before you give in to your impulsive drive, it’s worth taking a look at the true cost of that new car smell.

First, be careful about framing

Would you rather spend $999 now on the new iPhone XS or only pay $41.99 per month for the next 24 months?

$1,000 out of pocket right now sounds like a lot! But heck $42 per month, that’s just giving up dining out once or twice a month. Easy!

Choosing the subscription-based method seems like it’s easier, but after it’s all said and done, you’ve actually spent more money than if you would have just paid for it upfront.

You need to keep in mind that auto-dealers will play the same framing game, but the numbers are on a much greater scale.

ONly $50 more per month

Let’s say you’ve used an online calculator and found that you could borrow $25,000 for around $466 per month on a 5-year loan at 4.5%, which fits into your budget. Keep in mind the total amount you’ll pay over the life of the loan is $27,964 ($2,964 in interest).

You go to your local dealership to look for cars in the $25,000 price range when a salesperson approaches you and asks, “what are you looking to spend each month?”. To which you reply, “around $450 to $500”.

Now that the salesperson has your “top end”, they begin showing you cars in the $27,000 and $28,000 range and will likely say something to the effect of, “look, you can $3,000 more worth of car for only $50 more per month? Is that really going to break your budget?”.

What they’ve done is shifted your focus away from the overall cost and toward the incremental change that it will have on the payment.

If you borrow $28,000 for 5-years at 4.5%, the monthly payment may only be around $50 more ($522 per month) but you’ll end up paying $3,320 in interest over the life of the loan.

Or just finance for longer

What can be even worse is if you stick to the monthly budgeted amount and the salesperson says, “You can always extend the term of the loan which gets you BELOW your target budget! In fact, you can borrow $29,500 for 6-years at 4.5% and the monthly payment will be around $468 which is right where you want to be at!”.

Quite the compelling story. But what the salesperson forgot to mention is that you’ll end up paying $33,716 over the life of the loan and $4,216 of which is interest. That’s $1,252 more in interest than if you would have stayed with your original amount.

Sadly, it seems like this scenario plays out often.

According to Experian, about 85% of new cars are bought with financing and the average loan term is 69.03 months. Research by R.L. Polk & Co. says that the average length of time drivers keep a new vehicle is 71.4 months — around 6 years.

So what happens at the end of the 6 years? Most people have become so used to having a car payment, they do it all over again!

The tradeoff

What are you really trading off when you continually borrow for a mode of transportation?

I would argue that you are missing out on years of compounding interest and eventually having enough money to spend your time as you please, for however long as that time lasts (AKA retirement).

For fun, let’s pretend that instead of spending $466 per month on a car payment for the next 30 years you contributed that to a Roth IRA. 30 years is the equivalent of owning six cars in your lifetime, which is the average.

Assuming a very conservative annual growth rate of 3%, at the end of 30 years you’ll have accumulated $272,234! Using a slightly higher growth rate of 6% and that amount jumps to $470,444!

Is that new car smell really worth almost half a million dollars?

When it comes to DIY repair jobs and other housework, I always calculate if it makes financial sense for me to actually do it myself or not.

Take for example this paint transfer on my car.

Determine the Cost.

I’ve done my fair share of routine maintenance to my car and figured doing it myself would be a cheaper alternative than taking it to an auto body shop.

It only took me a few minutes of searching on the internet to find exactly what I was looking for, a video tutorial on YouTube.

I began looking around the garage for the things I needed. Luckily, I already had most of the required materials but for illustrative purposes, let’s pretend I didn’t have any of it.

If I had to purchase all of the items for this job, I calculated that it would have cost around $70. The best part is that all of these products can be used over and over.

I predicted that the job would take around an hour. Using the average hourly rate of a personal financial advisor in Indiana, that would be $45 of labor.

After looking at the total estimated cost for me to do the job, which was $115 ($70 + $45), I decided it was worth my time to attempt the repair myself.

I followed the video’s instructions and, as predicted, a little while later I was scuff-free!

The Value of Time and Money.

So what does this have to do with finance? Well, a lot, actually.

Calculating the trade-off of doing a project on your own versus outsourcing the work plays a huge role in making everyday budgeting decisions. And the smarter decisions you make with your time and money, the happier you’ll end up being.

Money Isn’t Everything.

Of course, there are other, non-monetary, factors to consider before deciding to outsource a task or not.

It may not make a lot of economic sense to mow your own lawn, but many people find it therapeutic and enjoy doing it themselves.

Along those same lines, it may not have saved me a lot of money to remove the paint scuff from my car, but I appreciate the challenge of learning a new skill.

Using an employer-sponsored defined contribution plan — 401(k)s, 403(b)s, etc. — is one of the most effective ways to save for retirement. That’s because most employed Americans have access to one and a majority of plans offer a matching contribution in some form.

Yet many 401(k) participants could be losing out on hundreds of dollars, if not thousands, each year by not taking advantage of the matching contributions that their employer provides.

How Does 401(k) Match Work?

There are a few ways your employer could contribute to your 401(k) plan through an employer match. 

Dollar-for-dollar match: Your employer will match your contributions dollar-for-dollar up to a certain percentage of your total compensation.

Stretch match: In a “stretch” contribution set up, your employer matches a percentage of your contributions up to a certain percentage of your total compensation. For example, an employer might do a 100% match up on the first 3% of your contribution and then 50% on the next 2%, for a total contribution of 4% of your salary.

Non-elective match: In this arrangement, your employer will determine a set dollar amount to contribute to each employee, regardless of whether you are contributing to the plan or not.

Check out the table below to see how an employer’s matching contributions could look based on an individual with a $100,000 salary.

Determining the way your employer is contributing on your behalf will inform how much you need to contribute in order to receive the full amount.

Under the dollar-for-dollar example, if you contribute 5% of your salary to your 401(k), your employer will contribute the same amount as you. In this instance, you might want to contribute at least 6% to take full advantage of your employer’s match program and get the extra $1,000.

Think about it this way, if you aren’t contributing enough to unlock all of your employer’s match, you are essentially throwing away free money.

Here is a handy online calculator that can help you determine the optimal amount you need to contribute in order to maximize your employer’s match.

reaching the max

Typically, you’ll want to save between 10% and 20% of your gross salary toward retirement.

The maximum that you can defer into your 401(k) personally in 2020 is $19,500 with employer matches going above and beyond that. There is also a $6,500 catch-up contribution if you are over the age of 50.

While reaching the maximum contribution level may not be a realistic goal for the majority of people based on income levels alone, it is achievable for a lot of high-wage earners who are committed to saving for retirement.

If you are one of those savers who max out their 401(k)s, there are two issues that you need to be aware of:

1. If you hit the max early in the year, and
2. How your employer matches your contributions – on a plan year or pay period basis

You could be leaving money on the table, depending on how your company’s 401(k) plan is set up.

Per pay or plan year?

If your employer is simply putting in one lump-sum of matching contributions for you – typically at the beginning of the following year – then there’s nothing to worry about. You are getting the full match.

The issue arises when your employer is making the matching contributions on a per pay period basis and you are maxing out the contributions prior to the end of the year.

If you are no longer contributing to the plan because you’ve maxed it out for the year, then you are no longer making contributions per pay period, which means your employer won’t be making matching contributions!

The following illustration should help clarify the point:

In the above example, you would reach the $19,500 max contribution in October. That leaves two months where you’d not be getting an employer match. That’s $1,000 you’re missing out on! In order to fix this, you would need to reduce your contribution rate to 19.5%.

Something to keep in mind is that even if your employer uses a per pay match, the plan may have a “True-Up” feature, and, at the end of the year, you will receive a full match from any missed matches during the year.

You can reach out to your HR representative or review your plan’s Adoption Agreement to find out what type of match your 401(k) plan offers and if there is a True-Up feature included.

PRO TIP: If you are already maxing out your 401(k) plan contributions, you could save even more by opening a health savings account. These accounts are about more than paying healthcare expenses, and when properly utilized, they can supplement your retirement savings now and reduce your expenses in the future. 

The goal of contributing to your 401(k) is to achieve financial independence, but you want to make sure you are doing it in the best way possible.

Be aware of how your plan operates so that you can ensure you’re taking full advantage of your employer’s match.