Sunday, December 24, 2006
The second type of the 529 Plan is the College Savings Plan. This type of plan generally allows the college saver (the account holder) to establish an account for the student (the beneficiary) for the purpose of paying the beneficiary's eligible college expenses. There are several investment options to choose from. Investment options often include stock (or equity) mutual funds, bond funds, money market funds, and age-based portfolios that automatically shifts to more conservative investments as the beneficiary gets closer to college age (which is usually 18 years old). This plan can be used with any college or university. Remember, mutual funds are not guaranteed a rate of return and are not FDIC insured.
Let's take a look at the benefits of the 529 Plan
1) Tax benefit. Any qualified withdrawal from the plan are tax-free. Qualified withdrawals are withdrawals that are used to pay for college tuition, room and board, textbooks, mandatory fees, and maybe a computer (if it is required by the school that students need it). In most states, earnings are tax-deferred. In some states, you may be allowed to make tax-deductions.
2) You have complete control of the account's assets. Unlike other education plans such as Coverdell or custodial accounts where the child can use it at age 18 or 21, the beneficiary does not gain control of the account no matter what age he/she becomes.
3) There are no restrictions on who you can open the account for. It can be your child, a relative, a friend, the mail man, or even yourself.
4) Since there are no restrictions, anyone can contribute to the account
5) No income restriction. It doesn't matter how much money you make, you can contribute!
6) Gift-tax exclusion. You can contribute up to $11,000/year or $22,000/year if you are married. (*Please note that this amount may change. Check for other sources to how much you can contribute tax-free.)
7) In most states, there are no age limit or time limit on when the money has to be used. If the child does not want to go to college, you can roll it over to another child in the same family.
8) In 529 College Savings Plan, the child can use the money for any college or university and maybe some international schools.
9) If your child gets a scholarship, the remaining balance in the plan can be rollover into another sibling or relative or it can be cashed out and you will just pay income tax on it.
10) Various investment options. Many states work with well known investment companies. There are many investment options to choose, but once you choose an option, you can't change it. You can roll it over to another state's 529 plan without any penalties if you are not happy with your investment option. You can only do this once every 12 months. Many plans offer age-based investments. That means your investments are invested in aggressive growth funds in early years to moderately aggressive growth in pre-teen years and finally in conservative funds (such as bonds and money market) in teenager years.
Let's take a look at some of the drawbacks of the plan:
1) If your child has a 529 plan, this may impact his/her ability to get financial aid.
2) Money in 529 plan can't be used as a collateral for a loan.
3) Any non-qualifed withdrawals will result in income tax and a 10% penalty tax. If the child receives a scholarship, you can withdraw money up to the amount in the scholarship and only pay income tax on it.
4) You don't control the investments since they are professionally managed by a portfolio manager.
5) You can only make cash contributions (by check or money order or direct debit).
6) Only one 529 plan per child.
Now that we establish the benefits and the drawbacks, its all up to you on which 529 plan to choose. I'm going to list some hints here to help you out.
1) Look at your state's 529 plan.
2) Check the manager of the plan. Look at investment company record of success.
3) Look at the fees the plan charges and the expense ratio.
4) Look at the maximum and minimum contribution limit.
5) Check if the plan offers any other benefits such as disability, terminal illness, or death.
6) Most of your questions can be answered in the prospectus.
To see the 529 Plan in your state, go here: http://www.savingforcollege.com/
Common questions and answers:
Q1) What if my child doesn't want to go to college?
A1) You can let the account grow tax-deffered until he/she changes her mind. You can change the beneficiary to another child. You can withdraw the money, but you will pay income tax and a 10% penalty. People who usually don't go to college usually can't afford it. But I find out that most people who didn't go to college really wanted to go. Some people start college later in life. Even older people in their retirement has went to college. If money wasn't the issue, more people will be attending college.
Q2) There are so many 529 plans. Which one should I pick?
A2) Look at your state's 529 plan. Though, I personally like Colorado's Scholar Choice 529 Plan. Learn more about it here: https://www.scholars-choice.com Which one is best? Compare it with your state's 529 plan with the one I recommend.
Q3) Are contributions tax-deductible?
A3) Only some 529 plans allowed that and others say you have to live in that state in order to make tax deductions. So the answer is "only some of them."
To see other questions and answers, go to the Securities and Exchange commission website: http://www.sec.gov/investor/pubs/intro529.htm
Before we talk about education plans, you need to take a look at your retirement plan. Are you accumulating enough wealth to live on when you retire? If not, then setting up an education plan may not be the right move for you. However, its up to you on what you want to do with your money.
There are two types of plans that are designed specifically for higher education and offer tax benefits as well. They are 529 Plans and Coverdell Education Savings Accounts (formerly known as Education IRA), which will explained in the next couple of blogs.
Thursday, December 21, 2006
1) Single Employee Pension IRA (SEP IRA)
This is a Traditional IRA setup by an employer for a firm of employees. Self-employed individuals, partnerships, and sole proprietorships may setup one as well. Employers are allowed to make tax-deductible contributions to each of their employees. Employees do not pay taxes on these contributions, but will pay taxes when they withdraw money from it. Since SEP IRAs are Traditional IRAs, rules for Traditional IRAs are the same as SEP IRAs.
Employees cannot setup a SEP IRA. Instead, they must setup their own Traditional IRA in order to participate in the SEP IRA. When the employee setup a Traditional IRA, the employer will make contributions to employee's Traditional IRA. This is the definition of a SEP IRA. However, it is the employer's own discretion to contribute. So, don't expect the employer to contribute to your Traditional IRA every year. In order for the employee to participate in the plan, he/she must meet these eligibility requirements:
- Must be at least 21 years old
- Must earn at least $450/year
- Has worked with the employer 3 out of 5 previous years prior to the year which contributions are being made. That means, you must worked full-time for three of the 5 previous years.
There is a limit on how much an employer can contribute to the employees. An employer can contribute up to 25% of the eligible employee's compensation, providing the contribution does not exceed $45,000 (for 2007). If the employee is at least 50 years old, he/she can receive an additional $5000. Of course, this is all up to the employer on whether to contribute or not.
2) Savings Incentive Match Plan for Employees IRA (SIMPLE IRA)
In this IRA, employers can make contribution to their employee's retirement plan and their own retirement plan. In SIMPLE IRAs, employees may choose to make a salary reduction contribution and the employer makes matching or nonelective contributions. Since contributions by employees are not taxed, any withdrawals they make will be taxed. Employers may make tax-deductions when they contribute to the plan.
Not all employers can qualify for a SIMPLE IRA. Here are the eligibilty requirements for the plan:
- The employer employed 100 or fewer employees. All employees employed during at any time during the calendar year are counted for, regardless of whether they qualify to participate in the plan or not.
- Participating employees must earn at least $5000 in compensation during the preceding year.
- The employer maintains no other plans, including collective bargaining agreements (Union plans)
If the employer employs more than 100 employees in any calendar year, the employer has two years to fix the problem or they will no longer be eligible to maintain the plan.
There are two ways that an employer can contribute. One way is matching the employee's contribution dollar for dollar up to 3% of the employee's compensation. The employer must give 3% in 2 of the 5 years when the plan is maintained. That means, the employer can't be cheap and only give 1% every year. An employer can't give any matching contribution below 1%.
Here are some examples to explain that last paragraph. Cindy, Joe, and Mary worked for company XYZ in 2006. XYZ decides to take the matching contribution of 3% for that year.
Cindy earns $10,000 and puts away $2000 into the plan. XYZ matches the contribution, but can only contribute $300 (10,000 x 3%).
Joe earns $200,000 and puts away $8000 into the plan. XYZ can only contribute $6000.
Mary earns $20,000 and puts away nothing into the plan. XYZ can only contribute $0.
Second way is a 2% non-elective contribution to all eligible employees, whether or not the employees make contribution. If the employer chooses the 2% non-elective contribution, they can only do so up to a salary cap limit of $225,000 (for year 2007. This amount will be adjusted every year by the US government). This salary cap limit does not apply to matching contribution.
Either way, the employer is required to make contribution for each year the SIMPLE IRA is maintained.
For employees, their contribution limit is $10,000 for 2006, $10,500 in 2007, $11,000 in 2008. If you are age 50 and above, you can contribute an addition $2500.
3) Spouse IRA
Simply put, if you have a spouse that makes little or no money, you can setup a Traditional or a Roth IRA for him or her. If you recall the contribution limit on Traditional and Roth IRAs, you can now double that figure. For example, the contribution limit for any individual who has a Traditional or Roth IRA in 2007 is $4000. Since you have a spouse, you can contribute up to $8000. However, you can only contribute $4000 for yourself and $4000 for your spouse. You cannot put $8000 into your own IRA. If you or your spouse are over age of 50, you can contribute an additional $1000 to yourself and another $1000 to your spouse. Remember income limit applies for Roth IRA, which is currently $160,000 for married couples.
4) Rollover IRA or IRA rollover
This means you can move a qualified plan such as a 401(k) into an IRA without any penalties and taxes. It also means you can move assets from one IRA into another IRA. Currently you can only move your employer's qualified retirement plan into a Traditional IRA and rules for Traditional IRA applies. Here are the different ways to do a rollover:
1. You can move your 401(k) into a Rollover IRA and later move it into another employer's 401(k), 403(b), or 457 plans. That is, the new company you work for allows it. If you make contribution into the Rollover IRA, you cannot move it into another employer retirement plan.
2. You can move your employer's qualified retirement plan (401k, 403b, or 457) into your own IRA. There are two ways to do a rollover. One is called the "indirect rollover." This is where the company will hold 20% of your assets and give you only 80% for taxation purposes. You must make up the 20% balance or you will pay a penalty on the entire rollover. You will have 60 days to move the entire balance of your 401(k) into your IRA. When you do your taxes, you will get the 20% balance back. The other rollover is called a "direct rollover." This is where your entire 401(k) funds are transfered into your IRA.
3. You can withdraw money from your current IRA and move it into another IRA, as long as you deposit this money in the new IRA or the current IRA within 60 days. During the 60 day period, you can use the money for whatever purpose. Failure to meet the 60 day requirement will result in a 10% penalty and the entire proceed is fully taxable.
It is important to know that you can only do a rollover once every 12 months. If you do it more than once every 12 months, your entire IRA account is fully taxable and there will be a 10% penalty as well.
If you want to keep your IRA, but want to change companies, you can do that as many times as you want. This is called an IRA transfer.
5) Inherited IRA
An inherited IRA is either a Traditional or Roth IRA that is given to a designated beneficiary who is not a spouse (such as a family member). So, if you received an IRA asset of the deceased owner and you are not married to that person, you cannot roll it over to another IRA or make tax deductions. There are limited choices on how you wish to receive the proceeds. Only the spouse has the choice of taking ownership of the IRA, cashing in the proceeds, or rolling it over to his/her own IRA.
Wednesday, December 20, 2006
Let's say you invested $6000/year for 30 years at a 10% rate of return. Your annual income tax is 27%.
If you invested this money through a Traditional IRA, in 30 years you will have $685,500.
If you invested this money through a Roth IRA, in 30 years you will have $1,192,500.
That's a difference of $507,000!!
Why? In Traditional IRAs, your withdrawals maybe fully or partially taxable, depending on whether you treated them as tax-deductible when you do your taxes. In Roth IRAs, any withdrawals you make after age 59 1/2 are tax-free because none of your contributions are tax-deductible.
Here are some more differences between Traditional IRA and Roth IRA.
1) There is maximum contribution limit you can make in any given year. If you are age 50 or above, you can contribute an additional $1000 to your IRA.
2) 10% penalty on any NON-QUALIFYING withdrawals before age 59 1/2.
3) Rule 70 1/2 only applies to Traditional IRAs.
4) Initial 5 year holding period only applies to your first Roth IRA and all conversions.
5) In Traditional IRAs, your contributions are tax-deductible up to a certain limit.
6) In Roth IRAs, your contributions are not tax-deductible.
7) In Traditional IRAs, your withdrawals maybe fully or partially taxable.
8) In Roth IRAs, your withdrawals may be tax free after age 59 1/2.
9) In all IRAs, your investments grow tax-deferred
10) Many, if not all, financial companies charge an annual custodial fee on the IRA account. In most cases, this fee will be automatically be deducted from the IRA, unless you choose to pay it by writing a check
Monday, December 18, 2006
All investments grow tax-deferred. That means any capital gains, dividends, or interests you receive in any given year, you do not pay taxes on them because they are automatically reinvested to purchase more shares of a fund. There are many types of IRAs, but the common ones you may of heard about are Traditional IRA and Roth IRA. IRAs are a great way to save for retirement because there are many investment choices you can pick to fund your IRA. The IRS website (http://www.irs.gov/pub/irs-pdf/p590.pdf) has in-depth definitions of the different types of IRAs.
Wednesday, December 06, 2006
Here are some benefits of owning a mutual fund:
1) They are professionally managed. That means there are one or two portfolio managers who has many years of investing experience.
2) They are diversified. This means that a mutual fund invests in many companies, some of which you already know or heard of such as Disney or Microsoft.
3) You may receive dividend payments, though this is not guaranteed.
4) Any dividends you do receive can be automatically reinvested.
5) Mutual funds are regulated by the United States Securities and Exchange Commission (SEC). All funds must provide a prospectus, which describes the fund in great detail, to every investor.
6) Mutual funds will send you an annual statement showing your income and capital gains, if any for tax reporting purposes.
7) Your money is always available. Should you decide to sell your shares, your mutual fund will buy your shares at the current net asset value. By law, mutual funds must send you a check within 7 calendar days. Be careful if your mutual funds are in a retirement account. You may pay a 10% penalty if it is in an IRA.
8) Tracking your investments is easy. Most major newspapers have a daily listing of the fund's performance. Plus you'll receive fund statement whenever you make a transaction, as well as semi-annual or annual statements on your progress.
9) There are a variety of objectives. Every mutual fund has a specific investment objective, from aggressive growth to conservative growth to everything in between.
10) There is a potential for growth. Historically, mutual funds have far outperformed more conservative investments. There is some risk, but the returns in mutual funds offer a far better potential for growth than investments that are completely risk free.
Things you should do when choosing a mutual fund:
1) Obtain a prospectus, which is a small booklet that contains lots of information about that particular mutual fund you are looking at.
2) Check if this fund's objective is meeting your investment objective.
3) Check the past performance of this fund. While past performance cannot guarantee future results, it gives a good indicator on how well the fund has been managed.
4) Check its sales charge. Studies has shown that Class A shares or Class B shares has no distinct advantage over the other. Whether you pick Class A or Class B, its totally up to you. Class A shares mean you pay an upfront sales charge. Class B shares mean you don't pay any sales charge when you invest, but if you redeem the shares in the first 5-8 years, you will pay a sales charge on the shares you are selling. This sales charge decreases by 1% every year until it hits zero. Class B shares become Class A shares after 8 years.
6) This is the most important factor when choosing a mutual fund. Check its expense ratio, which is usually shown in the tables near the end of the prospectus. You want to pick funds with a low expense ratio since this will effect the rate of return of your porftolio over the long run.
7) Check its turnover ratio. A fund with a high turnover ratio (anything above 50%) is never good. The turnover ratio means how often a fund sells and buys shares of a stock. If the fund is constantly trading, it incur costs each time it buy and sell shares of a stock. Usually aggressive growth funds or high growth funds has a low turnover ratio and conservative funds and bonds have a high turnover ratio.
Things you should do when investing in mutual funds:
1) Ignore all headlines and news media since they don't provide any details or information about the mutual fund.
2) Depending on your income level, you maybe able to put your funds in a tax-deferred account such as a Roth IRA. If you have kids and want to start a college fund, invest in 529 Plans. Tax-deferred accounts always have a higher capital gain advantage over taxable accounts.
3) You should setup a systematic investing plan with your mutual fund(s). This means, you invest your money each month. When you setup a systematic investing plan, you give your bank account number to the fund and the fund will automatically take money out of your bank account on the same day each month. With most funds, the minimum to invest systematically is $25/month. Why systematic invest? On some months, price of a share maybe high, so you buy fewer shares of that fund. On other months, price of a share maybe low, so you buy more shares of the fund. This is known as dollar cost averaging, which lowers the cost per share.
4) Never pull out when stock market crashes. This is only a temporary phase. Instead of pulling out, you should continue to invest. Since prices are so low, you can buy lots of shares. While they don't worth much at that moment in time, the stock market will always rebound.
5) Over time, your investment objective will change. So, you need to make some changes in your portfolio as well.
6) Stick within the same fund family. For example, if you invest in Legg Mason Partners Fund (formerly known as Smith Barney), then pick mutual funds from this family. Don't mix your portfolio with so many different families. Investing in two fund families is good enough such as Legg Mason and Van Kampen. Though, its up to you on whether you want to invest with other fund families. The reason why I don't mix my portfolio with so many different families is because of the sales discount. If the value of all my mutual funds (including your spouse and children under age 21) in the same fund family meets a certain limit, which is $25,000, I get a sales charge discount. The lower the sales charge, the more of my money is being invested.
7) The earlier you invest, the less you need to save toward retirement. So, stop procastinating, stop saying "I don't have any money" because you can invest as little as $25/month and start saving!
Disclaimer: I am not an investment advisor. The information in this blog are only my opinions and are base on the information I am aware of. I am not responsible on how your portfolio performs. It is totally up to you on how you want to invest.
Sunday, November 12, 2006
Premiums: $100/month until age 100. Let's assume that $20 is used to pay the insurance and $80 goes toward cash value. In reality, cash value life insurance policies has hidden annual fees and surrender charges, so its not really $80. But to keep things simple, lets say that $80 does go toward cash value. Lets also assume that you get a 2% rate on the cash value, which is pretty realistic base on what I see from many policies I replaced. In all whole life policies, no cash value is accumulated during the first two years.
Cash value accumulated by age 60: $36,053.11
30 year Term:
Premiums: $20/month for 30 years
Cash value: N/A
Investing the difference...
Invest $80 @ 2%, by age 60 you will have $39,483.73. You can get 2% by saving it in a savings account or in money markets.
At 5%: By age 60, you will have $66,858.11. You can get 5% by saving it in the online savings accounts such as HSBC Direct or EmigrantDirect or in CDs.
At 8%: By age 60, you can potentially have $120,023.61. You can get 8% by investing in real estate or some conservative mutual funds.
At 12%: You can potentially have $282,393.10 in 30 years. You can get 12% by investing in large growth or aggressive growth mutual funds.
If you die during the term, your beneficiary will get death benefit plus all your investments. In whole life insurance, your beneficiary will only get the death benefit and all the cash value is kept by the insurance company. How sucky is that?
What if you outlive the term? Then you need to take a look at your financial needs. In 30 years, do you still need life insurance or as much coverage? If you invested the difference, you can potentially have anywhere from $120,000 to $280,000 in your portfolio. If your investments were in a Roth IRA, all your investments grow tax-deferred and you can withdraw your contributions at anytime without paying penalties. When you are 59 1/2 years old, you have tax-free withdrawals. (If you put it in a Traditional IRA, the only tax-free withdrawal you can take is the contributions you didn't make tax-deductible. All others will be subjected to income tax.)
Right now, you probably don't have much saved. You probably have kids, have a mortgage to pay, and some other debts. If you die tomorrow, your family will be emotionally and financially devastated. This is the time when you need most income protection and only term can provide that need for the lowest possible cost.
In the later years, your kids grow up, your mortgage is paid off, and hopefully you got your debts under control. You are nearing retirement, so you better have lots of money saved. If you have less financial obligations and have lots of money saved, do you still need life insurance or as much coverage?
You don't know what is going to happen in 30 years. If it turns out that you still need life insurance, there are several things you can do. Majority of term policies provide coverage up to age 100, but some cancel at the end of the term. You should carefully read the policy to see what would happen when the term ends. But in most term policies, you have several options you can take.
1) You may renew the term policy, but your premiums will go up each time you renew, but at least you don't have to provide proof of insurability. If you are going to renew, you should lower your coverage to the point to cover your funeral expenses.
2) You may exchange the 30 year term policy to a shorter term policy such as 20 years or 10 years. Here, you may be able to afford the current coverage amount. If not, you can always lower it.
3) You may convert it to a whole life policy. You will be fixed in the new premium for life and begin building cash value. But I wouldn't recommend it because they are complete ripoffs.
4) You may cancel the term policy by not paying your premiums. If you cancel the policy, then you should allocate more money toward your investments. If you have some debts, then apply some of the savings to the principal balance. Though, its only $20/month savings, there's really not much you can do to be productive with this extra $20.
But I wouldn't worry about what would happen in 30 years. Right now, your focus is getting the right amount of income protection and build wealth for the future.
To see a related story comparing whole life to term insurance, go here: http://www.smartmoney.com/insurance/life/index.cfm?story=lifeterm
Thursday, October 12, 2006
Folks, the chance of you dying from an accident is very very low. Every day, someone gets injured and its very rare that they die from it. If someone did die from accident, it must be concluded that no other medical factors contributed to that injury. For example, if you have weak bones or that you commonly have blood clots in your vessels, then you did not die from accident. It was your medical condition that lead to your death. In this case, your life insurance company will not pay the accidental death claim.
If you have this accidental death benefit, you are wasting your money. You are better off getting more coverage on your life insurance policy because life insurance will pay a death claim regardless on how you died. Accident death benefit only pays out if you died from bodily injury. With today's technologies, its almost impossible for someone to die by accident.
Monday, October 02, 2006
Good thing about having a fix rate mortgage is that if you bought a home when interest rates are low, you are lock into that rate for life of the loan. Bad thing is that if interest rate do fall, you can't change your interest rate unless you refinance, which will cost you more money.
Thursday, September 14, 2006
On all ARMS, there is cap limit on how much interest rate may increase or decrease. There are generally 2 types of cap limit. One is called "Adjustment Cap" and the other is called "Lifetime cap." Adjustment Cap sets the limit on how much the interest rate can increase or decrease. For example, if adjustment cap is set at 2% and your current interest rate is 6%, that means your new interest rate can not go above 8% or below 4%. For lifetime cap, it sets the maximum interest rate you can ever pay in any given year over your start rate. For example, a 6% lifetime cap means that your interest rate can go up 6% over your start rate. If your start rate was 6%, that means the lender can charge you 12% interest!
Anyway, interest rate on ARMS are base on how the securities market is doing. Mortgage interest rates are tied to current market conditions and a good measure of market conditions are yields on treasury securities. The index is normally the weekly average yield on a 1, 3 or 5 Year Treasury Security 30 or 45 days prior to your adjustment date. Keep in mind, a 1 Year Treasury yield is lower than a 5 Year Treasury yield.To this index, the lender will add a margin of X% determined solely by the lender. A lender could add a margin of 2.25%, 2.5% up to or greater than 3% to the index to determine your new rate. When shopping for an ARM you want to look for the lowest term treasury security index with the lowest margin.
The Caps, Margin and Index play an important deciding factor when shopping for an ARM. For example; you have been quoted the following rates and terms on a 3/1 ARM both with a 1 Year Treasury Security index:
Loan #1 - Rate 6.00%: Caps are 2% per adjustment, 6% lifetime with a Margin of
Loan #2 - Rate 6.125%: Caps are 2% per adjustment, 5% lifetime with a
Margin of 2.50%
On the surface, loan #1 looks like the better loan since the interest rate is .125% lower than loan #2 and that holds true if you plan on moving or refinancing your loan at the end of the three years. But if there is a chance you will keep the loan beyond 3 years, loan #2 is probably the better way to go because 1) when loan #2 adjusts, the rate will always be .25% below loan #1 (unless it adjusts the full 2%) and 2) the lifetime cap is a full 1% lower than loan #1.
Is ARM right for you? Well, how long do you plan to live in the home? Are you going to refinance before the interest rate adjustment? Are you able to afford the highest interest payment?
ARM are not for everyone. If you can't afford the highest interest payment and/or you need to refinance, then a 30 year fix rate loan is the way to go.
This type of mortgage is good for people who plan to sell the home before the term expires or they plan to refinance. Just remember, when you refinance, there are closing costs and other fees involved.
Friday, September 08, 2006
If homeowners only pay the interest, the balance of the loan remains unchanged. That's because none of your payment is going toward the principal. When the interest only term expires, your monthly payment will increase to include the principal. For example, for a $100,000 loan at 6.25%, the required monthly payment is $520.83 for the first 5 or 10 years. Without the interest only option, the required monthly payment will be $615.72.
Who buys interest-only mortgage? People who likes the flexibility of paying the principal. People who wants to buy a more expensive home. People who expect their income to rise over the next few years. People who need to invest the difference (Interest minus the principal) in hope that their investments' rate of return will be greater than the interest being charged on their mortgage. If you don't meet any of these reasons, this type of mortgage is definetly not for you.
Why am I against this type of mortgage? For one, you are not paying any principal into your home. Therefore, you are not building any equity into your home. Equity is included when determining the value of your home from year to year. In the long run, you may need to use the equity to fix up your home or for emergency uses. If you don't have any equity, you don't have this option. Second, when your interest-term expires, homeowners may experience a huge payment shock because their monthly payment just increased. Third, this is a high risk loan to the lender. Because of this high risk, the lender will charge more fees than a traditional loan that includes principal and interest in the payment.
To learn more about what the US Government has to say about Interest-only mortgage, go here: http://www.federalreserve.gov/pubs/mortgage_interestonly/
Friday, August 25, 2006
What does the monthly mortgage payment made up of?
1) Principal. This is the total money you are borrowing from the lender (after your down payment).
2) Interest. This is what the lender charges you for the loan, which is the percentage of the total amount of money you are borrowing.
3) Taxes. This is property taxes. Money you pay into the property tax are usually put into an escrow account, which is handled by a third party. A portion of your property tax is added to your mortgage payment and are held in an escrow account until it is time to pay the state the property tax (which is usually once a year).
4) Insurance. These are usually just hazard insurance to protect your home against fire, flood, wind, theft, etc. It may include a PMI (Private Mortgage Insurance) if you did not make a down payment of at least 20%. PMI protects lenders in case you default on your loan.
How do payments work? In the first several years, majority of your payments are paid toward the interest. As time goes on, more of your monthly payment will go toward the principal.
Before you go out and look to buy a home, you should first see if you qualify for a mortgage. There are two types of the qualification process. One is called "pre-approved" and the other is "pre-qualified." While these two words sound similar, the qualification process is different. When you are "pre-qualified," that means you given the lender your income level, your credit and debt information, and the lender ESTIMATES what you can afford. When you are "pre-approved" this means that the lender has done the extra work to put you CLOSER to the loan. Pre-approval process consists of: Credit report check, debt-to-income ratio check, and in depth analysis of your current financial situation.
In the next few blogs, I will talk about various types of mortgages. These are:
1) Interest Only
2) Balloon Mortgage
3) Adjustable Rate Mortgages (ARMs)
4) Fixed-rate mortgage
5) Government mortgages such as FHA or VA
Monday, August 07, 2006
There are two types of credit cards: fixed credit and revolving credit.
What is fixed credit? This means whatever you buy today, you must pay off the whole balance by the end of the month.
What is revolving credit? This means as long as you pay the minimum balance on your credit card, you can continue to use the credit card for next month. Any remaining balance on your credit card will be charge an interest. This is the most common used form of credit cards.
You might of heard or read the news that consumer debt is in the trillions. This does not include mortgages, which is too big of a number to say. My theory on how this happen is that Americans are spending freaks. We like nice things and we sometime go overboard that is well over our spending limit. If we max out one credit card, we can always apply for more. While spending is good for the economy, spending more than what you make is really bad for you because you are going to find yourself to be in debt for a very long time.
To avoid putting yourself in big debt, spend what only you can afford. Make a budget or put up a spending limit. To do this, figure out how much money you make each month. Then deduct bills you have to pay such as mortgage, utility bills, maintenance, etc. Then deduct how much money you want to save toward retirement. And from that, this is how much you should spend and divide that by 4 or 5 to see how much you can spend each week.
So here's a typical example on how a budget should look like (you can add more if you want to the list):
Let's say you make $42,000/year. Divide that by 12, that's $3500/month.
You have a mortgage bill of $950/month,
utility bills (phone, electric, water, heat oil/gas) of $400/month,
maintenance (such as your car, including gas) of $200/month,
and insurance (life, car, home, health) of $1000/month.
This leaves you with $950/month to spend. Let's say you want to save 10% of that ($95), so you now have $855/month to spend on food, clothing, supplies, and other things.
If you decide to buy an expensive item such as $2000 TV, then deduct your monthly spending by whatever percent you like (such as 20%) so that you can pay off this $2000 TV faster. If you finance the TV where you don't have to pay it for another year, then open a 12 month CD and then use it to pay off the TV.
The goal in life is to not be in debt for a long time and at the same time be able to save for retirement. I wish you all best of luck on creating a successful budget and on your goal on reaching financial independence when you retire.
Sunday, August 06, 2006
What is cash value life insurance? It is a term policy to age 100 that contains a savings vehicle in it. Cash value comes in many forms, such as whole life, universal life, variable life, or a mixture of those words together such as variable universal life or universal whole life, etc. The advantages of having cash value life insurance is that you are protected until age 100, you can use the cash value anytime for any use such as paying your premiums, and interest on your cash value is tax-deferred.
The disadvantages of having cash value life insurance is that you are paying lots of premiums for low amount of coverage, no cash value is accumulated during first two years of the policy, rate of return is very low, and if you use any of the cash value, you will owe monthly interest on it. This interest does not go back into the cash value, but rather kept by the insurance company because the money you taken out of the cash value is treated as a loan. In many policies, if you were to die, your beneficiary will receive the face amount and all cash value will be kept by the insurance company. Keep in mind, if you use any of the cash value and you did not pay it back, this amount will be deducted from face amount upon your death.
Another disadvantage of cash value life insurance is that they are riddle with insurance fees. The most noticeable fee is the surrender charge. This is clearly stated in the policy of how much cash value you will get if you surrender the policy. Then there are fees you don't see such as administrative fees, policy fees, maintenance fees, and all these other operating fees. If your cash value life insurance is a variable policy, that means your cash value is invested in the stock market. Investments too have their own operating fees. If you combine investments and life insurance together, now you have so many different fees that eats away the returns on your investments.
You are probably asking, why would anyone buy this kind of life insurance? First reason is that many people do not understand how this policy works. Second reason is that people don't buy life insurance, they are sold on it. The agent who sells cash value life insurance does not care about you or your family. All he/she cares about is how much commissions he/she is getting paid and they going to use whatever deceptive sales tactic to make you buy it.
So, what is term insurance? It is the type of insurance that provides a level death benefit for life. Just like car insurance, if you don't pay your premiums, you will lose coverage. Advantages of having term insurance are: premiums are very low during the term, you have more flexibility to invest your money in a savings vehicle (hence the phrase, "buy term and invest the difference"), and if you were to die during the term, your beneficiary will get the face amount and all your investments. Another advantage is that you can change the amount of coverage without affecting your savings and vice versa. (In cash value life policies, you are stuck with paying into both.)
The disadvantage of term that while premium remain fix for certain amount of period (10, 15, 20, 25, 30, or 35 years), the premium will go up when it is time to renew. Majority of term policies provide renewable term coverage up to age 100. But there are some term policies that stop coverage after the level term expires because the insurance company wants you to convert it to whole life or universal life.
Why would people buy term insurance? First, premiums are very low and remain fix during the term. In the early stages of your adult life, you probably have lots of debt to pay off such as your mortgage, you probably have kids to support, and you probably don't have much money saved for retirement. So you need lots of insurance coverage to protect the family. As you get older, your kids are all grown up, your mortgage is or almost paid off, and you better have lots of money saved for retirement. As you get older, you probably won't need life insurance or need as much coverage as you did 20 to 30 years ago.
What happens when the level term expires? When the level term expires, you enter the phase of the contract called "Annual Renewable Term." That means you have the right to renew the term without having to provide proof of insurability. The premiums will go up every year or so (check the policy on how often the premiums goes up after the level term). Depending on your policy, you are usually given several options when the level term expires.
(1) You may convert it to a permanent whole life policy (which I don't recommend).
(2) You may exchange it to another level term (I recommend that you significantly lower your coverage amount to a minimum of $20,000). You may need to provide proof of insurability.
(3) You may refuse to pay the premiums to cancel the policy (if you do this, I highly recommend that you allocate the money toward your retirement).
(4) You can change the death benefit to the amount you really need. In most cases, the amount of coverage you need is usually lower than what you needed years ago. In fact, you probably won't need life insurance as long as you enough money saved.
If you have cash value life insurance right now and are probably pissed off about having it, you should figure out what you want to do. Do you want to cancel it or should you replace it with term? It all depends on your current needs. If you have a problem with or questions about your life insurance policy, don't call the agent to get your answers because an agent's job is to sell life insurance, so they won't say the bad things about your life policy. Call the company's phone number that is listed in your life policy (which is usually on the cover page).
If you are going to replace it with term, don't cancel your current life policy yet. First, you want to see if you qualify for term insurance, which you probably will if your health is not that bad. When you get your term policy, then you want to cancel your old life policy. There's a couple things you can do with your cash value. First thing you can do is that you can surrender it. You may have to pay surrender charges on it and you will owe income taxes on it, but at least you have choices on where you want to put this money. The second thing you can do (and is probably the best way to do it) is do a 1035 exchange, which moves the cash value into an annuity product or another cash value life insurance without any tax implications.
I have always sold term insurance and help clients invest their money 100% of the time. That way they are protecting the family's income for a low cost and at the same, building wealth for the future. It does not make any sense to bundle life insurance and savings together. Life insurance's main purpose is to protect your family's income in the event of your death, not as a way to build tax-deferred savings. Since term insurance is so inexpensive, I show clients on how to effectively build wealth. One way is to open an IRA, either Traditional or Roth. Money in an IRA grows tax-deferred. If they max out their contributions to an IRA, then they should put more money toward their 401(k) or 403(b) or whatever retirement plan they have at work. If they don't have an employer's retirement plan, then a variable annuity would be the next choice, not a cash value life policy.
If you are going to meet with your agent to go over your life policy, you want to record everything he says. That way you can review it with your attorney or send it to your state's insurance department to find out if he is telling the truth. If he is lying, you can take lots of legal action against him and his company.
What is a dividend in an insurance policy? It means that you are over paying your premiums and the life insurance is returning (or refunding) it as a dividend. Keep in mind, this is not the same as receiving dividends on mutual funds. Dividends in mutual funds are only paid out if profits are recognized that year, so shareholders will get a share of that dividend.
Getting separate insurance policies will cost you lots of money in the long run. Each policy cost about $100 to maintain each year. If you have multiple policies on yourself, you should immediately change your life insurance agent and probably the company as well. There is no reason why you should have more than one policy on yourself. It is best to add "riders" to the policy such as spouse rider and child rider. That way the whole family is protected under one policy.
Some of you seen the word, "unit" on TV commercials. A unit represents one-$1000 worth of coverage. I seen commercials for retire people where one unit cost $8.75/month. In your mind, you are thinking thats very cheap. If you do the math, you will find out that's very expensive! If you wanted $100,000 coverage, thats 100 units. 100 time 8.75 = $875.00/month you need to pay for life insurance. I have a 30 year term of $500,000 coverage when I was 30 years old and I pay $475/year for it. Notice I wrote "$475/year" not $475/month.
All life insurance policies are term life policies. They all provide protection up to a certain age (usually age 100). Whole life insurance is a level term with a savings plan attached it. Let's hypothetically say you pay $100/month, $25 goes toward insurance and $75 goes toward cash value (supposedly, but all insurance policies has some sort of fees, so its not really $75).
Universal life is an increasing term with a savings plan. Continue with the hypothetical example, next year, $30 goes toward insurance and $70 goes toward the cash value. As years goes on, all your premiums goes toward the insurance and none goes toward the cash value and the premiums will continue to increase. That's why a universal life policy gives you two different payment option. You can either pay the minimum premium or pay the target premium.
Cummings, William H and Spears, J. Mac. The L.I.F.E. System. Indianapolis, IN: Pathfinder Corporation, 2003.
"ACLI Fact Book 2006." American Council of Life Insurers. 1 Jan 2006 http://www.acli.org/ACLI/Tools/Industry+Facts/Life+Insurers+Fact+Book/