12 Tips To Help New Parents Avoid Money Mistakes

12 Tips To Help New Parents Avoid Money Mistakes

“Don’t raise kids to have more than you had. Raise them to be more than you were.”

Anonymous

 

Having a newborn baby is a time to rejoice. However, the reality of raising a child can be daunting. The costs are often underestimated. Even those with the best money habits may get carried away for a new family member. We justify our spending more easily as we seek safety, comfort and fulfillment. Costs will mount if we don’t put some brakes in place in advance.

New parents must put a financial plan in place to fit their new responsibilities. To avoid financial blunders, parents should increase their efforts to save and invest, spend within our means, take a fresh look at workplace benefits and utilize tax credits.

Here are 12 tips to help you dodge potential financial mistakes:

 

1. Be Financially Ready With An Emergency Fund

Every household should have an emergency fund with 6 months of savings set aside for unforeseen events. It is no different when we are expanding our family. Arguably, we need this money cushion even more so.

Raising a child in the first year costs $13,186 on average.. These costs are before hospital costs which may be covered by health insurance. A LendEdu survey found that parents budgeted $9,371 for that first year, saving roughly that amount. However, this falls short of the actual amount. Diapers costs, among other items, are miscalculated.

Why Do We Underestimate?

It is so easy to be blindsided when we lack experience, especially when we are raising our newborns. Ask any new homeowner and they will share major home costs that were a surprise. That’s what an emergency fund is for.

I recall being surprised by the many purchases we had to make in a rush for our baby. We learned that the delivery date for our son was moved up about 2 weeks unexpectedly. Comparison shopping was just not an option. We were older parents but felt like helpless newbies. Excited at our upcoming birth, we acted like children in a candy store.

My Bad

One of my worst purchases (ever!) was handmade Egyptian cotton linens for the crib for $1,000. I was suckered into it by a salesperson at the now-defunct Bellini’s. How ridiculous a thing to buy for a newborn baby!

We were fortunate to have ample savings having worked for several years. But I always wonder, what if we were younger or didn’t have a cushion to spend.

2. Don’t Overspend For Your Newborn’s Needs

We want the best for our children always. However, we need spending limits or go broke before they go to college. Be judicious about spending early and learn to budget. We need good financial habits when planning for our new child. Not everything has to be the best, the newest or the most expensive. Emphasize safety above all else. Plan out what is important to get initially, borrow from family or friends for some items and consider thrift shops.

Find Acceptable Price Ranges For Needed Items

Initially, you do need diapers, a place to sleep (crib or bassinet) and a car seat. There are some great sites to find average costs and price  ranges for bassinets, cribs and mattresses, diapers (cloth is cheaper versus disposable) and a diaper bags, changing tables, baby monitors (audio or video), car seats, glide rocking chairs and ottomans, baby swings, and bath tubs.

You probably don’t need Louis Vuitton monogram mini Lin Diaper Bag, the world’s most expensive diaper bag at $2,200 or the other most expensive newborn items on this list.

What You May Need

Luxury is not a necessity. Some of your costs are one-time like baby proofing your home. Other costs will vary significantly by where you live. For example, if you are both working and want to hire a nanny the average fees can range from $400-$1000+ per week. Additionally, you may need a babysitter and their rates go from $10-$25 per hour.

The US National average for day care is $611 per month, however, in major cities like Boston or New York, it will be well over $1,000 per month. Well baby doctor visits without health insurance average $95 per visit according WebMD. Visits may be significantly higher in New York and other urban areas.

You can bulk up on baby food and diapers, however, your baby may reject some brands or tastes.

3. Avoid Lifestyle Inflation

As your child gets older and makes friends, you may feel pressed to shop for more stylish clothing and sporting a luxury stroller. Remember, young kids will size out of these things fairly quickly. Avoid throwing lavish birthday parties even though you want celebrate each year. Their friends will have fun no matter where you have the party. Of course, we do it to impress the other parents but we don’t need to.

Speaking of lavish waste, we once received a beautiful box delivered to our doorman. It was from a friend of our son’s with an invitation to a 5th birthday party that read like a wedding invitation. My jaw nearly dropped and I worried about what kind of party my son would want. The funny thing is I recall that Tyler did not have a good time at this birthday party.

It may start with birthday parties but we soon may think about bigger homes and nicer cars. Keep your spending in check. 

4. Saving Early For College

Set up a 529 savings account as soon as you have a social security number for your child. Start saving early for college to benefit from tax advantages and compounding growth. You are not limited to the plan offered in your home state. There are many investment choices to suit anyone. Don’t get so overwhelmed at the choices that you end up not activating the account.

To read more about 529 Savings Plans and alternative savings devices  for college, see our recent post here. Start with any feasible amount and continue to add to this account. Tell your child’s aunts, uncles and grandparents that you would prefer a cash present over another toy or outfit. Make them aware of your savings account.

There are several ways to save early besides the 529 Plan although that is preferable. Below, we discuss life insurance for babies and infants that have a savings component that may appeal to you.

5. Keep Up Your Retirement Savings

While saving for your child’s tuition is important, do not sacrifice  your own retirement savings. Many parents do that but it is not a good idea. As much you may hate your child borrowing for college tuition, taking a loan our for retirement is a worse outcome. It is better to reduce your spending on unnecessary items to save more than face withdrawal of your retirement funds or borrowing against it.

6. How To Talk To Your Children About Money

Our children take their cues from us in a number of different ways. Start to teach your kids early about money at an age-appropriate time. They may be better able soak in how to treat and respect money values.

We should be good role models in helping them learn how to save money. Teach them to know the difference between wants versus needs. Don’t give in to impulsive purchases when they get upset. Instead delay gratification on purchases. Set a good example on investing now for future growth.

Both parents should be on the same page in this regard. My husband and I often argue from on opposite sides.  He can’t seem to say no to the kids so I play the heavy parent. However, my kids just ask me less for things and go around me and get what they want from Dad. I think I just admitted that my kids manipulate us. (They do!).

 7. Your Employee Benefits Need A Fresh Look

Once you have a child, it is a good time to take a fresh look at your employee benefits package. What may not have jumped out at you when you first started working there, may be more important now for your growing family.

According to Harvard Business Review, when making a decision between a higher paying job or lower paying job but better benefits, health insurance (88%), more flexible hours (88%) and work-from-home options (80%) scored the highest in their survey.

Childcare Are Among Our Largest Expenses

The cost of child care is high for those who are working and need support. According to Care.com’s 2015 Cost of Care Survey, 28% of families pay more $20,000 annually for this. Childcare is the largest expense for many families and may even surpass college tuition and housing costs for some families.

Among the employee benefits that can lift some of working parents’ burden are dependent care assistance, child care financial support by way of tuition assistance and scholarships, long term care resources and referral. Back up child care is also key when the nanny is ill. Onsite child care centers are often offered by companies that have large campuses.

8. Flexible Spending Account (FSA)

If you have a health plan through your job, you can use a flexible spending account to pay for co-payments, deductibles, some prescription and non-prescription drugs and other out-of-pocket health care costs. The FSA is a savings account with tax advantages.

This account allows employees to contribute a portion of their pre-tax earnings to pay for qualified expenses.  Employees have limits of $2,650 per year per employer. If your spouse has an FSA at their employer, you can put in an additional $2,650 per year. It is a “use it or lose” plan. Your FSA does not earn interest.

Another type of FSA is a dependent-care flexible spending account which is used for childcare expenses for children age 12 or under. The maximum dependent care FSA contribution is $5,000 per household.

Making use of these accounts may provide you with beneficial cost savings.

9. Health Savings Account (HSA)

The HSA is similar to an FSA as it provides tax advantages. HSAs are associated with high deductible health insurance plans which are often used by the self-employed. Like the FSA, you can contribute your pretax earnings, making your contributions tax-free. Here, the contribution limit in 2018 was $3,450 for an individual or $6,900 for family coverage.

Unlike the the “use it or lose it” feature of FSA, you may rollover the unused contribution to the next year for the HSA. Your account earns interest and if you leave the job you may take the account with you.

10. Life Insurance Is Essential For Growing Families

To protect your growing family, you need to have life insurance coverage. You may have a starter plan from your employer but generally the amount is insufficient, especially with young children. In the event of the passing of the main earner of the family, your life insurance should cover your fixed living costs as college tuition and other child care needs depending on their ages.

There other types of insurance families need to consider including disability insurance. We cover several insurance types here.

Should You Have Coverage For Your Newborn Or Infant?

Generally, you don’t need to buy life insurance for your baby. Hopefully, they are healthy and they don’t have earnings streams to protect.

Among life insurance providers, Gerber Life Grow-Up Plan has some attractive features:

1. Parents, grandparents or permanent guardians may purchase this plan. It is whole life insurance of $5,000-$50,000 of coverage. They may apply for their newborns or infants when they are 14 days to 14 years.

2. As a whole life insurance policy, there a cash value portion that accumulates as premiums are paid. According to Gerber’s plan, coverage doubles during the child’s 18th year at no extra cost. Additional coverage may be bought as needed.

3. It guarantees insurability and locks in an affordable premium for a child at a young age. For families with high risk of medical issues, this may be an important benefit.

4. With a whole life insurance policy, it provides death benefits plus you are building cash value in a tax-deferred manner. This savings component can be used for college tuition. The policy may be surrendered for its cash value.

True, the death benefits is a bit macabre and hopefully not needed for children.

The Criticisms:

I don’t believe life insurance for babies is needed. I have read some criticism of Gerber’s plan. Despite having a longstanding good brand name for baby foods, review the details carefully.  Look into the fee structure for additional insurance coverage, its tough cancellation policy, and how slow the cash surrender value actually builds.

Although this plan has some appeal, I prefer 529 Savings plan for college tuition and it is debatable if life insurance is needed for babies.

11. Several Tax Benefits For Your Children

Our children may be helpful when it comes time to pay taxes.There are a number of different tax credits  that you can use if you have a child. Check with your tax professional for possible changes associated with the 2017 Tax Law.

Child Tax Credit

You may be able to reduce your tax bill up to $2,000 for each of your qualifying dependent children under age 17. The credit is intended to offset the cost of raising children. Parents may get the maximum amount with qualifying incomes (married couples who make under $400,000 or single persons under $200,000).

There is a $500 non-refundable credit for qualifying dependents (eg. an incapacitated parent) other than children.

As a tax credit, it reduces your taxes dollar-for-dollar. If you do not benefit from the full amount of the Child Tax Credit (because the credit is greater than the amount of income taxes you owe for the year), you may be eligible up to $1,400 for a refundable amount.

Child And Dependent Care Tax Credit

Paying for childcare and dependent care can be quite expensive. The Child and Dependent Care credit can be worth from 20% to 35% of up to $3,000 of child care (or $6,000 of expenses for two or more dependents) related to some or all of the dependent expenses you paid. The higher 35% is for incomes below $15,000.

This tax credit may help you defray childcare costs for dependent children 12 years or under. For dependents, other than children, the IRS requires that they must have lived in your home more than half the year.

Adoption Tax Credit

There is a federal adoption tax credit up to $14,080 per child for finalized adoptions in 2019. This is not refundable so you can only use it if you have federal tax liability.

This credit may be used for qualifying expenses you paid to adopt a child. These expenses include adoption fees, attorney fees, court costs, traveling expenses (including lodging and meals while away from home), and other expenses directly related to the adoption. You would need to have supporting documents that you received If you claim this credit.

American Opportunity Credit

Tax credits are for qualified education expenses for an eligible student for the first four years of higher education. The maximum amount you can claim is $2,500 per eligible student per year. The amount of credit is 100% of the first $2,000 of qualified education expenses you paid for that student. However, if the credit pays down your taxes to zero, you can have 40% of the remaining credit (up to $1,000) refunded to you.

There are income limits to claim full credit with modified adjusted gross income pegged at $160,000 or less for married couple filing jointly (or $80,000 for a single filer). The American Opportunity Credit is preferable, however, if you don’t qualify, you can try for the Lifetime Learning Credit.

Student Loan Interest Tax Deduction

You may be able to claim the Student Loan Interest Deduction for interest paid on a qualified student loan, even if you choose to claim a student tax credit. If you decide to claim the deduction, you could reduce your taxable income by up to $2,500 of the student loan interest you have paid for your dependent child. You don’t need to itemize your deductions to claim this deduction.

To qualify for this deduction, see respective modified adjusted gross income limits.

12. Estate Planning

The best time to think about your plan is when you don’t have a compelling reason to do so. When you are raising children, it is a great time to be  thinking of your family’s best interests.

Set Up Your Designated Beneficiaries

By creating your estate plan, you will have control over your asset distribution during your lifetime to your loved ones. A significant portion of your assets can be easily transferred to your intended heirs. This will help you to avoid often painful and lengthy probate court procedures.

When setting up your beneficiaries, think carefully whether to identify for your children as there may be complications for you to be aware of and we discuss here.

Creating a will, possibly a trust, and advance directive documents will help you with the rest of the way. Read  our guide to basic estate planning in 6 steps.

Make sure to consider your digital assets as part of your estate. We have addressed why you need to make an inventory of digital assets here.  

Final Words

Planning for a newborn is essential. It is an exciting time in your life and it is easy to get overwhelmed. We have all been there and made mistakes, especially financial ones. Hopefully, this will help you can avoid some of the more obvious errors by organizing well ahead of time.

Hearty congratulations to you and your expanding family. What steps have you taken to prepare for your child’s experiences? What mistakes did you encounter that you may want to share with us? We look forward to hearing from you!

 

12 Ways To Make College More Affordable (Or Even Free)

12 Ways To Make College More Affordable (Or Even Free)

Affording a college degree is difficult with costs rising for decades. Yet, having a college education remains an important way to reach success. We will point to ways to make college more affordable and even free. Planning early as parents and with your students, to save, actively budget, research college costs and seek financial aid are beneficial steps.

The Price Of A College Education

According to Trends in College Pricing 2018 (2019 should be out in about a month) College Board average annual tuition, fees, room and board charges published prices for 2018-2019 are:

$48,510 for private nonprofit four year colleges, and $35,830 before room and board costs;

$21,370 for public four year in-state colleges, and $10,230 before room and board costs, and

$37,430 for public four year out-of-state colleges, and $26,290 without room and board charges.

College prices and accompanying costs have outpaced inflation since the 1980s and have jumped nearly 8 times faster than wage growth. This is a concern for me as a mom of teens and as a college professor. I am a first generation American and the first in my family to go to college. Like many, I was raised on the belief that a college education is essential for advancement. It is still true today despite many paths to success.

In Sallie Mae’s 2019 National Study of college students, about 77% of families said they considered financial cost slightly more important than academics (73%) when choosing their college.

The share of the cost of college in 2018-2019 was relatively similar to the prior year:

  • 30% was covered by parent income and savings.
  • 10% from parent borrowing.
  • 13% was contributed by student income and savings.
  • 14% from student borrowing.
  • 31% was covered by scholarships and grants.
  • 2% from friends and family.

 

The Need For Family Planning For College

Planning helps families get ready for the college decision. More families planned early in their children’s lives for their college future in 2018 than the previous year according to the Sallie Mae survey. The top three ways families planned to pay for college were: 1) save for college (64%), 2) researched college costs and financial aid (40%) and 3) actively budgeted (36%).

Getting prepared for higher education also include activities for students such as taking Advanced Placement courses, enrolling in community college and learning more skills or practicing their talent.

Benefits of Preparation

By getting ready, families had access to resources to understand their purchase options and they often borrowed less, received slightly more financial aid by way of grants and scholarships than non-planners.

For these reasons, we believe that being prepared as early as possible may help you and your student afford the best college possible.

12 Ways To Make College More Affordable (Or Even Free):

 

Early Funding of your Child’s Education:

Saving early is a first step for your child. The different plans below are not mutually exclusive. As always, check with your tax professional as to the respective tax implications.

1. 529 College Savings Plans

Your children’s financial future may begin as early as their birth. Establish an account once you have a social security number for your child in their name or initially in the parent’s name. You can change the beneficiaries later on.

The more you begin saving early, the more you may benefit from compound growth using tax-deferred dollars. As a result of saving well before your child’s needs, the less you will need to borrow later on. There are imposed federal student loan limits, the more affordable borrowing source, as compared to private loans. Your best bet, if your child’s education is a priority as I am sure it is or will be, is to adopt a saving strategy.

A 529 plan is a college savings plan that offers tax-free earnings growth and tax-free withdrawals as long as these funds are used for qualified expenses. Just about every state has their own 529 plan. You may open an account across state borders. Each state’s plan varies so check which works for you.

529 Plans Post Tax Changes

Originally begun to save for college only, these plans may now be used for tuition at primary and secondary private or parochial  schools or qualified expenses at public schools. They retain their benefits. The Tax Reform Act in 2017 expanded 529’s ability up to $10,000 per year.

Under the Act, the $10,000 withdrawals per year are federally tax-free. State tax treatment of these withdrawals differs from state-to-state but are tax-free if used for qualified educational expenses. This is not allowed in several states like New York at this time.

So check with your state’s taxing authority or state 529 plan administrator. For example, Connecticut’s 529 plan allows you to withdraw tax-free for up to $10,000 per child to be used for private school tuition. There are no maximum caps as to how much money can be invested per year.

Investment Choices

Parents can typically choose among a range of investment portfolio options. They may include Vanguard mutual funds, exchange-traded funds (ETFs), static or fixed allocation fund portfolios and age-based portfolios sometimes called target-date portfolios. Which fund you choose depends on your appetite for control and risk. You can make changes between the funds based on your children’s age or the target date portfolios which shift from more aggressive growth rates to more conservative rates as your child ages.

The amounts can be used for any eligible higher education, not just four year colleges or universities, including vocational and trade schools; community colleges and graduate schools.

529 plans typically do not have income or age limits. An older person can use it for school later on.

2. Coverdell Education Savings Account (ESAs)

These accounts are similar to 529 plans offering tax-free investment growth and tax free withdrawals when funds are spent on qualified education expenses. Like 529 plans the invested amounts are not limited to college and can be used not only for K-12 tuition but also expenses, including books. At one time Coverdell ESAs were the sole tax-advantaged way.

Unlike 529 plans, contributions made to Coverdell ESAs are limited  to $2000 annually per beneficiary similar to limits set for IRAs .This means grandparents can each set up their own account for the same beneficiary with a $2,000 limit for each beneficiary account.

A Coverdell investment option is self-directed. It is not pigeon-holed into the state’s specific options like 529 investment track options.

Limits For ESAs

Coverdell ESAs have age and income limits. A beneficiary must use the funds by age 30 unless the beneficiary is a special needs person.  If your adjusted gross income is between $190,000-$220,000 as a married couple or $95,000-$110,000 as a single taxpayer, you cannot contribute any longer.

While Coverdell ESAs give you greater investment flexibility than 529 plans, the imposition of limits have caused some to consider rolling  their Coverdell ESAs into 529 plans.

3. Custodial accounts: Uniform Gifts to Minors Act (UGMA) or Uniform Transfers Minor Act (UTMA)

Custodial accounts can be set up for each child if they are under the age of 14 years and managed by the parent until the child turns the age of majority, typically age 18 years unless stated otherwise. Investments in these accounts are not limited.

For children below 18, the first $1,050 of unearned income from the investment is tax-free to the child, after which the next $1,050 is taxed at the child’s tax rate, then income above the $2,100 is taxed at the parents’ (usually higher) tax rate. Once your child turns 18, this money belongs to them. They will be paying taxes at their own rate.

Couples filing jointly can contribute up to $26,000 annually for each child, or $13,000 if an individual is setting up an account. Anyone can set up a custodial account, including grandparents, aunts and uncles.

Once the child has access to the account based on their age of majority, it is their asset. The invested money may be used for anything that child wants, including frivolous things which unfortunately the parents have little power in reclaiming that asset.

These type of accounts are typically for supplemental spending for college, and not likely to go to tuition.

4. Traditional IRAs And Roth IRAs

Traditional IRAs are typically used for tax-deferred retirement savings. Normally, you would incur a 10% penalty for withdrawals before 59.5 years. You also would have to pay income taxes on the amount withdrawn.

There is an exception if an individual wanted to use this account for qualified college expenses for themselves, child or grandchild. They would not be penalized for early withdrawals. You would have to pay income taxes.

You don’t have the same 10% penalty for withdrawal from the Roth IRA. You have more freedom with the Roth IRA in this regard.

Tap Retirement Savings As Last Resort

Frankly, retirement accounts should never be tapped for college tuition unless you set up these retirements accounts for your young children. Since you cannot borrow for retirement, but you can for college, parents or a child would be better off to take out a loan for college. I provide it as an option but I would consider other ways first.

5. Invest in discount bonds

You can save for college costs by investing in deep discount corporate, US government (Treasury) or municipal deep discount bonds. These bonds are often referred to zero coupon bonds because its owners are not collecting coupons twice a year.

These bonds come in maturities of one year-40 years and do not pay semi-annual dividends like regular bonds. Furthermore, the IRS requires that you pay tax on the interest portion annually.

Tax Implications Vary

Check with your tax professional about the possible tax implications for respective securities. Federal and state tax treatments of zero coupon municipal bonds are different. Munis are known for federal tax-exemption and sometimes state and local taxes as well.

On the other hand, there is no tax-exemption for holders of corporate bonds.  Treasury bonds are usually tax exempt by state and local authorities.

If safety is a priority, Treasury bonds have triple AAA ratings so they are virtually risk-free while ratings of municipal bonds and corporate bonds vary.

You can redeem the bonds at full face value upon their maturity. The proceeds of these bonds can be used for college costs.

Deep discount bonds are not just used to save for college tuition but their long term nature are suitable for planning for your children’s non-tuition college needs as all.

6. Series EE Savings Bonds

Savings bonds are sold by the federal government for half their value or $5,000 for maturity denominations of up to $10,000.

Like treasury bonds, they are safe based on their triple A rating.

Usually savings bonds are taxed at the federal level and tax-exempt on state and local levels but if you are using these savings bonds for college tuition expenses than they are typically tax-exempt at the federal level as well.

 

7. Earn College Credit In High School

Want to earn some college credits early at little cost? The Advanced Placement program offers college level courses and exams that you can take in high school. The exam is $94 which may allow to save up to $3,000 for a three credit course .It is a great way to save time and money in college if you are able to earn credits depending on the score you get.

There are 38 AP courses in a variety of disciplines. Having AP credits with a good score on your high school transcript is a huge plus for colleges considering your application.

Check Your School Policies On AP Credits

Be aware that some colleges and universities may a require a score of 4 or 5. The maximum score on an AP is a 5. The exams are given in May. Among the top colleges, 86% restrict the use of AP credits. Paul Weinstein, director of Johns Hopkins University’s graduate program assessed policies of the top 153 colleges and universities in a 2016 study.  A few colleges do not accept AP credits.

You should review your school policies on acceptance of your credits. If you choice school doesn’t accept your credits, you still got a bird’s eye view of what college exams look like.

8. Grants and Scholarships

If you are borrowing money for college, federal loans are far more attractive but have loan limits by year with the freshman year maximum loan the lowest at $5,500 rising to $12,500. Interest rates on federal loans have dropped for the first time in three years based on May’s 10 year treasury yields. 

To obtain a federal loan, grants or scholarships, you need to fill out the Free Application for Federal Student Aid or  FAFSA  for each academic year. The new 2020-2021 FAFSA form is about to be made available here. Make sure you file it on time, if not early as some states’ awards are on a “first come, first served” basis. Check your state’s practice as they differ.

Fill Out FAFSA Please

FAFSA determines whether you are eligible for need-based federal financial aid for college. It also may help you with getting scholarships, grants and work study programs for your student. See our family guide on how to save for college.

It is always a pain to fill out applications. However, since FAFSA will help you to get more affordable federal loans to supplement your income and savings contribution, go for it. It takes time to fill out the papers and get the supporting documents together but it is worth it if you get some financial help. Be super organized ahead of time!

Federal Gift Aid

Federal Grant and scholarship programs account for funding 31% of the needs of the average family in 2018- 2019. This is above the 28% of college costs last year. This is “gift aid” money for college and does not have to be paid back. Almost all of federal grant programs are needed based. See the list of grants here.

The federal scholarship programs are merit-based, received from school, outside organizations, or businesses. Information as to how to apply can be found here. Sallie Mae’s survey of 2018-2019, showed higher dollar contributions of $8,580 for those families making more than $100,000. Another place to look for scholarship opportunities is fastweb.

Federal Work Study

In addition to the “free aid” you can get through the federal government, there are federal work study programs which pay at least the federal minimum wage and are on-off campus. These programs are need-based so check out their website here.

State Gift Aid Programs

You can look at state programs for additional loans, grants, and scholarship opportunities which can potentially supplement what you are getting through the federal programs.

Take a look at the different programs by state for possible loan/grant/scholarship opportunities here. You can look for merit-based scholarships by college, if your college is on this list. Some colleges have supportive loan programs for those families that are need-based as the 25 colleges on this list, including Harvard, do

Doug Hewitt, co-author of Free College Resource Book has said that there are more scholarships available for you within your home state than nationally.

9. Student Education Tax Credits

There are two major tax credits available to offset the costs of higher education. The American Opportunity Tax Credit is the most valuable of the two (the other is Life Learning Credit with a $2,000). It only applies to first four years of post secondary education (university, college, vocational, non-profit or profit).

You may claim up to $2,500 per eligible student per year under the American Opportunity Tax Credit. Credits cover 100% of the first $2,500 of qualified tuition.  If the credit brings the amount of tax you owe to zero, you can have up to 40% of remaining amount (that is, $1,000) refunded to you. There are credits for qualified education expenses of 100% up to the first $2,000 for each students and 25% of the next $2,000.

10. Colleges With Free Tuition

There are a number of colleges that offer free tuition though you will likely have to pay room, board and living expenses. Some of these colleges may require work on campus or service after graduation as a means of earning the free tuition.

Accredited colleges with free tuition has been growing, and include:

Alice Lloyd College (KY)

Barclay College (KS)

Berea College (KY)

College of the Ozarks (MO)

Deep Springs College (CA)

St. Louis Christian College (MO)

Webb Institute (NY)

William E. Macaulay Honors College At CUNY (NY)

Williamson Free School of Mechanical Trades (PA)

US Military Academies

This colleges are a way of giving service back to your country:

US Coast Guard Academy (New London, CT)

US Military Academy (West Point, NY)

US Naval Academy (Annapolis, Md)

US Merchant Marine Academy (Kings Point, NY)

Some colleges have made their courses available online for free but may include a relatively small fee:

iTunes (Stanford University)

Open Educational Resources (OER) Commons

Open Yale University (Yale)

School of Public Health (Johns Hopkins University)

11. Go To Community College Or Public Four Year In-State College

There are many reasons to go to community college. Affordability is high on the list for that reason. Tuition and fees for two year in-state colleges were $3,660 in 2018-2019. A full-time student will likely receive more than enough grant aid and federal tax benefits to cover these tuition and fees. If a student chooses to live on campus, those expenses will be out of pocket.

Most of my students live at home and plan to go away from home for the latter 60 credits of college. I teach diverse community college  students with business majors. They are often immigrant or first generation students at community college. Many finish their four year degrees while working full-time and some have children.

The pros of going to community college tend to outweigh the cons for many students. Please see our extensive article on the benefits of going to community college here.

There are some wonderful public four year in-state colleges that are considered great value (See Value School listings in US News & World report). They combine strong academics with lower tuition costs than private colleges.

True Story About My Hiring Preferences

I went to public colleges (CUNY) for both my BA and MBA. When I was Managing Director at my investment bank, I was able to hire “the best and the brightest.” When my human resources employees came with  stacks of resumes, all the Ivy Schools were on top. My preferences were always public colleges given my background.

I always reminded HR to give me the CUNY resumes first, then the rest could be public colleges across the country. The early days of most investment banking firms on Wall Street were filled with public college graduates, if they even went to college. I am referring to Lehman Brothers, Goldman Sachs, Salomon Brothers, and others.

Here is our conversation:

HR: “I got the resumes you wanted. We think these are stellar candidates.”

Linda: “Great, thank you. Did you any from Baruch College (a CUNY Business School)?

HR: “We think this a better group. Most are Harvard, some Yale and Princeton and other top schools. I didn’t look for Baruch. Why do want students from there?

Linda: My MBA came from there. It is a great business school. Many international students. I also like paying back to students who want investment banking or equity research. Give the Ivys to some of the other analysts. OK?”

HR: “But, then you won’t get the best! They told me they only wanted to hire from top schools. You better talk to my boss.”

The funny thing was that at that time all three of my management, including my head of Equity, came from public schools.  I finally did get my way!

12. Certain Majors Are In Demand By Employers

There are certain majors that are in such strong demand that employers may consider picking up some of your tuition in return for your promise to work at their firms or entities for a certain period of time. While there may be a shift in desirable majors, there appears to be a strong call for those students in math, science, nursing, teaching and social work.

If you go to college while working full-time, many employers pay up to 100% of tuition as a major perk to attract those with evidence of strong work ethic. A bit of advice: don’t pick your major solely on the basis of your employer picking up the tab. That said, if you have an interest in that course of study, go for it!

Final Words

Financing a college education is difficult and most students have to borrow some money. Repayment of student loans can be an albatross for many years. If have taken loans for school, the monthly costs for college grads delay them from making their plans for life. Many postpone getting their own place to live, getting married, having children, buying a car and home because of their ongoing loans.

Planning early may help you (parents/students) avoid getting overburdened with debt. Strategize how to get savings ahead of time or while in school.

Once in college, students tend to budget better than after they get their first job. Be creative about saving money even in college when you are living on a limited amount of money. My college students often inspire me with tips they share in class and so I sometimes collect this information as we do here.

 If you graduate with student loans, read our piece on paying back your student loans faster. It may involve some sacrifice when you are young to better financially position you and your family in the future.

Are you applying to college this fall or next year? What steps have you already taken to help you in seeking your college? We would like to hear from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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How The Fed Rate Cut May Affect Your Loan Rates

How The Fed Rate Cut May Affect Your Loan Rates

“I think we do need to try to not just rely on the central bank to, in its wisdom, adjust interest rates, but allow for people to avoid being exposed to inflation risk.”

Robert J. Schiller

 

The Fed has recently cut its benchmark fed funds by one quarter percentage for the second time in two months. This is  the first time this has happened since the Great Recession of 2008-09.  After keeping this rate at historically low levels, the Fed raised rates nine times beginning late 2015 through end of 2018 to 2.25-2.50%.

Leaving aside whether it was a good move (I believe it was, by the way), what does a lower fed fund rate (reduced 0.50% to now 1.75%-2.00%), mean for consumers in terms of borrowing, saving and investing?

Yes, The Fed Cut Is Beneficial For Consumers

A short answer is that a reduced fed funds rate means lower loan and savings rates. The fed funds rate is the lending rate for banks and other financial institutions. Declines will likely be relatively small unless we see future Fed cuts. If you have a lot of debt outstanding, you may feel more relief.

However, the best result in lowering monthly payments is to improve your credit score. You will see greater incremental benefits.

While we can’t borrow at the fed funds rate, it directly and quickly influences the prime rate, the loan rate charged to the best creditworthy customers. Prime rate was  just lowered to 5.0% from 5.25%.  Other consumer borrowing rates are often pegged to the prime rate, London Interbank Rate (LIBOR) or Treasury yields.

However, There Are Two Factors That Determine Your APR

The major consumer financial products are mortgage loans, home equity lines of credit (HELOCs), car loans, credit cards and student loans. Two factors are important lenders use to determine your loan’s annual percentage rate (APR). They are:

  1. Federal Reserve action to modify the federal funds rate, which is out of our control and
  2. Your credit score which you can take steps to raise for lower borrowing rates.

 

What About Savings And Investments?

The savings account rates at banks will likely decline quickly by 25 basis points (or one quarter of a percentage point) matching the fed’s lending rate for intra-bank loans overnight.

Our investments in financial securities, notably short and long term debt and equity securities tend to move in the opposite direction of interest rates.Therefore, the cut, which was anticipated by markets, usually improves performance upon widespread speculation. This cut may fuel beliefs of future cuts by the fed.

Lower borrowing rates often mean higher consumer and business spending and therefore stronger economic growth.

Before we take a look at how a Fed cut may influence consumer financial products, a little background on the Fed may be helpful.

A Short Primer On The Fed

The Fed (formally known as The Federal Reserve System) is the central bank of the US. They regulate commercial banks and have the responsibility for conducting monetary policy. Its dual goals are full or maximum employment and stable prices, meaning  low inflation.

Through its monetary policy, the Fed uses its tools, notably the fed funds rate to influence money, credit, interest rates and  the US economy overall. The fed funds is the rate at which banks and other financial institutions can lend to each other overnight to meet mandated reserve levels set by the Fed.

The Federal Open Market Committee (FOMC) votes on whether to raise, lower or keep the fed funds rate unchanged. FOMC members meet is at predetermined dates about eight times a year. It is made up of the seven Board of Governors of the Fed, notably Chairman Jerome Powell, plus the Presidents of five fed district banks (including the New York Fed).

For more on why you need to understand the Fed, read more here.

The Fed affects every aspect of our financial lives.

You should have a working knowledge of what does, particularly if you are interested in all aspects of money and investing.

The Fed, through its monetary policy, influences our economy, our borrowing and saving rates, as well as our investments. They have a powerful role in controlling money supply based on economic and inflation indicators, factors that affect our economy as well as global markets.

The Fed’s role is multifold:

  • as the bank of last resort when other banks are unwilling to lend.
  • assess risk in our economy based on numerous variables.
  • a fiscal agent to the US Treasury supporting its securities auctions.
  • model for other central banks globally.
  • communicate publicly to explain their reasoning for their actions.

 

Mortgages: Fixed Rate or Adjustable Rates

The fed funds is a short-term rate but fixed rate mortgages are long term. When you borrow money to pay for your home purchase, you will likely choose between the conventional fixed rate mortgages or an adjustable rate mortgage (ARM).

If you are considering a home purchase, consider the seven steps to buying a home. Many potentials buyers are looking at the merits of renting instead.

Fixed Mortgages

Fixed rate mortgages are preferable for many home buyers. Your monthly payments are predictable for the length of your loan. Knowing your monthly amounts provides certainty and helps families to budget of one of the biggest costs.

Generally, 30 year mortgage rates are higher than the 15 year terms because of the longer time frame. Your rates will be highly influenced by your credit scores. Excellent scores of 750+ provide buyers with the lowest rates. I would encourage you to go for the shorter 15 year term as your total interest paid added to the home price is far lower.

Assuming you were applying for a 30 year loan, the average recent rate was 3.97% based on a range of 3.00%-7.84%. This range reflects best credit quality to fair (or riskier) borrowers. The 15 year average mortgage rate is 3.53% (on a range of 2.50%-8.75%).

Potential For Loan Refinancing

Those with the fixed rate mortgages will not be impacted by the Fed lowering the fed funds rate. However, if the Fed makes more rate cuts in the future, you may want to consider refinancing your mortgage if it makes financial sense for you. Refinancing costs additional fees. For potential buyers who have been on the fence in search for a new home, this cut could be an incentive.

Adjustable Rate Mortgages Will Benefit From Fed Rate Cut

Rates on adjustable rate mortgages (ARMs) change at different periods from annually, every 3,5, 7 or 10 years. They are reset based on either Treasury securities, inflation index or LIBOR. First time buyers often are attracted to ARMs as their initial rates are lower than the fixed mortgages.

A common ARM is 5/1, a hybrid mortgage, which is a 5 year fixed rate with annual rate changes after 5 years. A recent current average 5/1 ARM is 3.78% based on a range of 2.38-8.25% This may be attractive for someone expecting to sell their home or refinance to a fixed mortgage within 5 years. ARMs may fluctuate more quickly for those applying now, reflecting the Fed cut.

I have concerns with ARMs or any variable rate loans. They lack predictability and borrowers often don’t understand the terms of their agreements. Borrowers need to know when rates change and how they are impacted by rising interest rates. It is often difficult to budget their mortgage costs.

HELOCs Rates Will Decline If A Variable Loan

Most HELOCs are variable rate loans. This means that your month-to-month may fluctuate depending on the market interest rate. The benchmark is usually the prime rate. Some banks may offer a fixed rate option for customers who desire predictability and budget their costs. The typical fixed terms are 10 years and may range from 5-15 years.

Your HELOC loan is a credit line secured by the equity in your home and your creditworthiness. As your home serves as collateral like your mortgage, rates tend to be lower than credit cards. Once again, your credit score matters, along with Fed rate, which will determine your monthly payments.

How HELOCs Work

You may obtain an available line of credit of $100,000 but only draw $25,000 of the funds to pay your contractor. You will only pay interest on the $25,000. This provides  benefits for your credit score based on your utilization rate which you can read about here.

Recent average 5 year fixed HELOC rates are 5.09% according to Value Penguin based on a wide range of 2.75%-11.00% to reflect excellent to fair credit ratings. Variable rate is 5.51% (with a range of 3.50%-13.25%). The latter are higher rates and may indicate greater risk.

Generally, you may obtain your HELOC with the lender you already have your mortgage loan with. It is a convenient way to tap the equity in your home to get available credit to borrow money for remodelling your kitchen. A small reduction in your variable HELOC may help you incrementally.

Car Loans Rate Will Change Based On Fed Rate Cut

Most car loan rates are based on fixed terms pegged to Treasury yields. The average loan rate on a 60 month for new cars according to the latest Federal Reserve Consumer Credit report.  You are not likely to see any improvement on your existing loan rate or monthly payments. However, if you can refinance your car, you may recognize a difference in your monthly payments. On the other hand, your loan rate may vary based on three criteria.

1. New or Used Car

You will pay slightly more for a new car loan ( 4.30%) versus a loan for a used car (4.20%) or refinancing an existing loan (2.89%).

 2. Credit Quality

As with all loans, your credit score matters. Your loan rate may range from excellent or 750+ (4.30%), good or 650-699 (7.65%) or fair to poor on 450-649 (13.23%). Monthly payments may skyrocket with fair or poor credit.

Assume the average price of a car of $36,000 and a 20% down payment of $7,200 on a 5 year loan. Using a car loan calculator, your monthly interest payment will jump from $$534 per month with excellent credit to $$659 per month with a poor credit rating.

Total interest paid over the life of this loan will be $3,258 with excellent credit or $10,721 in total interest paid. Your car price with excellent credit amounts to $39,258 versus $46,721 when your credit is poor. Interest costs are the second biggest part of your total car price and may account for 25% or more of your car cost).

3. Loan Term

Term length varies from 36 months to 96 months with the longer time frame requiring the borrow to pay the highest rate. You should get to a shorter term auto loan so you are not shelling out a lot of money on interest. Take the shortest loan term on cars that you can afford. That is a good strategy for any loans you apply for.

The length of the loans have been getting longer and longer. Edmunds says the most common term is for 72 months, with an 84 month loan next in line. I am seeing ads for loans for as much as 96 months. That is an increase from 10 years ago when 60 months were the most common.A longer time frame means you are paying more in total interest cost on your loan.

What You Can Do About Lower Monthly Payments (Or No Payments At All)

Future car buyers may get reduced rates based on the latest Fed cut. However, your best path to a lower auto loan is to improve your credit score. Better yet, buy a used car outright without a loan. After years of car loans and leases (watch for hidden fees!), we are finally biting the bullet and buying older cars with more mileage for cash. Getting rid of these monthly payments are a longer term relief.

 

Credit Cards Rates Are Likely To Decline

Credit cards carry the highest borrowing rates of most consumer loan products. Their rates are linked to the prime rate which is quickly  influenced by the Fed’s benchmark rate. Interest rates will likely go down as a result of the lower prime rate. Of course, those high rates may not be a problem at all if you pay your card balances in full every month.

Unfortunately, the average credit card debt was $8,398 in June 2019. While the recent Fed reduction may trim some basis points off your APR, lenders are not required to lower rates when the Fed does so. However, there is a lot of competition for borrowers. If credit card issuers do, it will be marginal on on new cards. Lenders are far more willing to increase APRs when the Fed raises the fed funds rate.

Once again, issuers mostly look to your credit score for assessing your risk as a borrower. At the end of 2018, the average credit card rate for new offers were 19.24% and 14.14% for existing offers. The range for those with excellent scores were 14.41% to fair scores at 22.57%.  The national average rate did drop to 17.61% recently after factoring in the 50 basis point decline in the fed funds rate in 2019.

Good News For Student Loans

There is some good news on federal loans for undergraduate and graduate students and their parents for the 2019-2020 school year. This is the first time that these rates have dropped in three years. The rates for these loans were tied to the May 2019 Treasury auction for 10 year notes. Student loans have been a front page burning issue, likely to ramp up alongside the upcoming Presidential election debates.

Federal loans are fixed only with 10 year loans for school years as follows:

Type                                                       2019-2020                       2018-2019

Direct Subsidized (student)                        4.53%                              5.05%

Direct Unsubsidized (student)                    4.53%                              5.05%

Direct Parent Plus                                      7.08%                              7.60%

Graduates Unsubsidized                            6.08%                              6.60%

There is a cap on the amount you may borrow from the federal government for student loans. Undergrads may borrow up to $12,500 annually and $57,500 in total for student loans from federal sources. Graduates are capped at $20,500 yearly and $138,500 in total.

You need to consult the Federal Student Aid guide as the amount you may borrow depends on what year you are going into at school and your dependency status. These loans are not dependent on your credit score. For more on how to pay for college, see our family guide.

Due to federal loans being capped, most students will turn to private lenders where the credit scores of the students and parents matter. Loans may be fixed and potentially go for terms of 10-20 years or are variable. It is a good idea to pay back your student loans faster if at all possible.

The variable rates are influenced by changes in the prime or LIBOR plus the fixed margin tied to your credit score for your total rate. LIBOR rates tend to increase less slowly than the prime rate.

Banks may require a minimum credit score of 600-650 or better. So it is best to work on improving your credit report before borrowing. 24% of families in 2019 borrowed money from federal loans, private student loans, credit cards and other loans. 7% of students and parents each used their credit cards, loans from retirement accounts or other sources. 

Savings And Investing

Savings accounts at banks, including online banks, are likely immediately vulnerable to reduced rates after the latest cut in the fed funds rate. These rates have been low for years and not much of a source of interest income for savers as they have been in the past. However, these accounts did perk up after the rate increases in late 2018 enough to merit ads with “high yield savings rates.”

September 2019 rates have dropped in mid September after the August rate cut but likely not fully reflected. Average savings rates range from 2.00%-2.50%, with many banks requiring minimum amounts of $100-$10,000. Please read the fine print as there may be fees.

Savings accounts are great for accessibility to liquid funds such as your emergency money. Money market funds may offer slightly higher rates than saving accounts. They are great alternatives for safety and liquidity purposes. If the Fed continues to reduce rates, expect more trimming ahead. I don’t wish for high inflation but there was a time (1980-1982) that these accounts provided double digit returns with virtually no risk.

The Bull Case For Investing When Interest Rates Go Lower

Generally, when interest rates go lower, consumers and corporate borrowing increases. The lower interest rates may help some segments of our economy, like industrial companies. They have not participated in higher growth as much. Lower rates often results in strong economic growth. With low savings rates at 2.5% or lower, consumers have less incentive to leave money in the bank earning low returns.

Households may spend more by borrowing for a home or car. The reduction we saw in August and in September may be a small incentive for more buying of consumer assets.

Remember we have had a low interest rate environment with already low mortgages and HELOC rates. The housing and car markets have been strong in recent years because of lower borrowing rates. Those who may have wanted a house or car may already have done so. Can another 25 basis point encourage more buyers to look for new buyers? Maybe. Consumer spending has remained fairly strong particularly in the retail markets.

 

Better Long Term Returns From Stock Investing

I avidly participate in the stock market which are at or close to all-time highs. When the Fed reduces the fed funds rates, financial securities usually respond favorably or even upon speculation of an upcoming cut. Expectations of a stronger economy tend to push stocks higher. There are always risks that the market rotates from one issue to the next or one sector of stocks or another. To reduce risk, make sure to diversify your portfolio.

For example, US-China trade talks (on or off). There are some pockets of weakness being experienced in different sectors such as industrial companies such as Caterpillar, Fedex, and companies more dependent on strong global markets.

Households may seek higher returns from stocks which grow 8% annually over the longer term. Alternatively, they may seek higher yielding stocks such as ATT, Verizon or BP than they can earn in their savings banks.

Better yet, I would recommend those interested in stocks, to buy a low cost index fund. Vanguard funds are known for their low cost and choices in funds that focus on growth, value, blend or want something to mirror the market like S& P 500. Investors can also look at target rate funds.

 Final Words

The rate cut from the Fed was a welcomed event though it will likely have only marginal benefits for the average consumer. With lower interest rates it is cheaper to borrow than save. This usually leads to increases in spending. That is good for economic growth.

Still, households would realize even better financial health by improving their credit scores, reducing debt and spending within their means. This should be a priority so that you can invest more. Savings are great for liquidity but careful investing could provide better returns.

Have you noticed any reductions in your loan rates? Have the lower rates increased your consideration for house or car hunting? We would like to hear from you about your thoughts and experiences!

 

 

 

 

 

 

 

 

 

A Guide To Owning or Renting Your Home

A Guide To Owning or Renting Your Home

Owning versus renting your home is a longstanding and often passionate debate. The reasons for owning or renting are tied to financial calculations along with your personal preferences.

Questions To Consider

If you are seeking to own a home, do you prefer stability, building equity, control over home and its responsibilities and tax benefits? Will you enjoy a sense of pride of ownership? On the other hand, does flexibility and freedom appeal to you, not having to deal with the home’s repair and maintenance, freeing you to use savings to make investments, and not have to worry about declining home values?

I understand the allure of owning your home as I have had with our primary home. We continue to own a second home which we may one day make our primary spot. I grew up in the Bronx in an apartment building that was intended as affordable middle class housing. As a result, my family paid a relatively low stabilized rent. Owning our home as inspired by the American Dream was out of the question for my family at that time.

My husband, Craig, is a real estate attorney dealing with residential and commercial transactions. When I went to law school, I was fascinated by the real estate field and became an investor for a time.

Before we review the advantages and disadvantages of owning and renting your home, let’s address key factors to consider in making this important decision.

Housing Market Trends

When it is the right time for you to buy or rent, it may be worthwhile to be aware of the overall housing market, that is, home prices, interest rates, and mortgage rates in particular. US home ownership has grown from 45.6% in 1920 to 66.2% in 2000. Home ownership rates peaked in 2004 at 69.2% (in both April and October of that year) then retreating to 64.1% in June 2019.

Generational Gap In Buying Homes

Part of that decline may be explained by the age of the typical home buyer being older now at 44 years versus 25-34 years in 1981. Only 37% of people aged 25-34 owned a home at the end of 2015.

Despite lower mortgage rates, Millennials, born between 1981 and 1997, have been slow to purchase their homes, as they grapple with high student debt and slower wage growth since the Great Recession. They own a smaller percentage of homes at 32% as compared to Gen X (60%) and Baby Boomers(75%).

A major consideration in timing a purchase is the level of mortgage rates. Generally, mortgage rates rise during periods of strong economic growth and decline during weak or recessionary periods. Mortgage rates have been low for a longer period of time than normal as the Federal Reserve has kept overall interest rates low based on its monetary policy.

By pursuing a home purchase, make sure your finances are in order. That means being debt-free and establishing or expanding your emergency fund. When we review the financial costs, you’ll better understand the need to have a strong financial condition.

Substantial Financial Differences Between Home Buying And Renting

Financial costs differ between purchasing a home and renting. Home buyers face substantial costs.These expenses can be divided into one time payments upfront and at the closing. Purchasers are usually dumbfounded by the number of one-time upfront and closing costs that are required in addition to the ongoing or recurring expenses.

The process of buying a home through closing may be overwhelming but each step is well defined.

Upfront And Closing Costs

Home buyers are usually surprised by the number of payments that are required to those professionals (home inspector, bank attorney, title closer, appraiser, broker, attorney) who are assisting in their purchase. There are also other costs that are made in the process of securing the mortgage and protecting the lenders as they will effectively own 80% of your home. You will pay mortgage application fees, points and origination.

Upfront Costs

 

Earnest Money

This can range from 1%-3% up to 10% of the price of the home depending on the locale. This money is consideration for the mutual acceptance of a deal with the seller. It is credited toward the purchase price at the closing. If you default before the closing the earnest money can be the measure of liquidated damages to the seller.

Home Inspection

It is important for an inspection of  the home to be done by a qualified inspector. An inspection is done when you have decided on a house to buy but before you put money down. The fee amounts vary based on type of home, square footage and the locale. This is an essential cost as you may find structural damage or disclose other issues that can be used to reduce the price you are willing to pay.

Appraisal fees

These fees are paid to an independent certified appraiser. It is required by the bank to protect their exposure for their collateral. The fees vary. They are paid directly to the bank after inspection but before the closing and in conjunction with the mortgage loan agreement.

Escrow Accounts

There are different purposes for each escrow account. One is for the benefit of the bank and related issues and the other is for the attorney to hold until the closing.

The attorney escrow account holds your down payment for the house. The bank’s escrow covers prepayments for property taxes on homeowner’s behalf up to six months. Additionally, the buyer will be paying a full year’s homeowners insurance premiums upfront and one-twelfth of the premium into escrow. Some borrowers,  if applicable, pay private mortgage insurance (PMI) premiums. PMI is required if the buyer is making a down payment less than the 20% of the home price preferred by the lender.

Closing Costs

The final part of your purchase involves a number of closing costs associated with formalizing the processing of the mortgage and concluding the transaction between buyer and seller. They include costs for the loan application, processing and  underwriting. The latter may amount to about 1% of the loan. So if you are borrowing $300,000, you will pay $3,000.

You will be paying for a title search and other title-related costs in order to ensure you are purchasing a home with “good title” free of fraud and any liens for unpaid taxes, etc. The title company collects a premium and receives recording fees.

In most states, you will also be paying an attorney for closing your deal and representing you as the buyer. The attorney’s fee ranges from $750-$3,000 depending on the deal’s complexity and your locale.

Recurring or Ongoing Costs

Your monthly ongoing costs of buying a home are your mortgage payments, utilities, garbage, property taxes and homeowner insurance. These are predictable or fixed costs.

If you are buying a house (rather than an apartment), maintenance, repair, painting and appliances may vary depending on the condition and age of the house. This is often difficult to estimate and may depend on your DIY abilities. You will also have other costs for lawn care and snow removal which differ based on your geographic location.

Costs of Renting Your Home

Upfront costs are far less. Landlords usually require 1-2 months for a security deposit  at the time of the lease signing. Some landlords will increase additional security or fees for any pets you have for potential damage to their property.

There may be an application fee required by the landlord for administrative costs as well as a possible broker fee unless the landlord pays this. There may be a move-in fee depending on the type of of home you are renting.

Recurring Rental Costs

Tenants are responsible for monthly rent, all utilities and renters insurance. While the homeowner has homeowners insurance, that doesn’t cover your personal property including your furniture, clothing, electronics, computers, jewelry and anything of value to you or liability insurance. The landlord will require you to purchase renters insurance.

Landlords are required to provide you with at least 30 day notice in most states with any increase in rent unless it is stated as part of a multi-year lease.

What Is Your Financial Situation?

Before going house-hunting if you are planning to make a purchase, it is a good idea to check your credit report for any errors or issues you need to correct and be aware of. You should know your credit score and what amount of mortgage you can afford. There are steps you can take to raise your credit score.

By the way, your credit report matters to your landlord also. A poor credit report could be a thumbs down on your ability to rent. If your credit score is fair, it may mean providing your landlord with more security. However, a poor credit score has far more of a negative impact on your ability to borrow.

MyFICO’s loan calculator is very useful for estimating your APR, monthly loan payment and total interest paid. For example, using a $300,000 loan your payments for 30 year and 15 year mortgages as of September 13, 2019 based upon your FICO score will be:

30 Year Mortgage

Credit Score                APR             Monthly Payment        Total Interest Paid

760-850                      3.355%                  $1,323                    $176,269

700-759                      3.577%                  $1,360                    $189,622

680-699                      3.754%                  $1,390                    $200,410

660-679                      3.968%                  $1,427                    $213,618

640-659                      4.398%                  $1,502                    $240,694

620-639                      4.944%                  $1,600                    $276,077

 

15 Year Mortgage

Credit Score                APR             Monthly Payment        Total Interest Paid

760-850                      2.897%                  $2,057                    $70,245

700-759                      3.119%                  $2,089                    $76,012

680-699                      3.296%                  $2,115                    $80,650

660-679                      3.51%                  $2,146                    $86,302

640-659                      3.94%                  $2,210                    $97,810

620-639                      4.486%                  $2,293                    $112,710

 

A Few Observations

Irrespective of your FICO Score, the lower the credit score, the higher your APR, monthly mortgage payment  and total interest paid will be.

Financial Implications For 30 Year versus 15 Year Mortgage

When comparing the different loan maturities on a $300,000 loan:

  • The APR will be higher for the 30 year mortgage than 15 year year, all else being the same.
  • The monthly mortgage payments will be significantly higher for the 15 year mortgage given the shorter period. If you can afford to pay the higher monthly amount, you are better off with the 15 year mortgage because you are paying less in total interest.
  •  Assuming you have a 720 credit score, the total home price, inclusive of total interest paid and down payment will be lower with a 15 year mortgage loan.
  • The 30 year mortgage is much higher because you are paying interest on your loan longer, so  total home price or principal is $375,000 plus $189,622 equalling $564,620.
  • If you opt for a 15 year mortgage, your total home price or principal  is $375,000 ($300,000 loan + $75,000 down payment of 20%) + $76,012 in total interest equals $451,012 for principal and interest.

Advantages Of Buying Your Home

 

1. Building Equity

Paying your mortgage over time will result in building some equity in your home. You should be aware that your initial payments are predominantly for interest on your loan, especially if you have a 30 year mortgage, and equity builds relatively slowly.

On the other hand, you will certainly be owning your home much more quickly with a 15 year mortgage. A mortgage amortization calculator is helpful to compare the principal and interest portions for the 15 and 30 year mortgages. Assume your loan begins September 2019.

The comparison reveals that more than half of your first monthly payment goes to principal than interest with the 15 year mortgage. However, only about a third of your payment goes to principal with the 30 year. The amount between principal and interest does reach parity until the year 2031 and equity rises slowly thereafter until year 2049 when you satisfy the 30 year loan.

2. Your Home As An Appreciable Asset

Depending on your time frame, US new home median prices reflect appreciable growth. Median new home prices have risen from $17,200 in 1963 to $212,300 in 2011 according to the US Census of Housing. That is a 5.38% compounded annual growth rate. However adjusted for inflation, the growth rate is 1.8%. On the other hand, inflation adjusted monthly rent grew from $568 in 1960 to $934 in 2010 according Apartment List Rentonomics. This 68% hike in rent is well ahead of the 18% rise in household income during the same period.

Your investment in your primary home largely keeps pace with inflation rather than generating strong investment returns. When calculating returns you need to factor in the interest costs to total price. That said, you are living in your home and hopefully enjoying a high quality of living which can be priceless for many.

There have broader differences in select markets across the US that exhibit stronger appreciation due to higher population growth, demand and other factors.

Housing Bubble

The US housing bubble was particularly troubling for homeowners in the mid 2000s. Housing prices peaked in early 2006, then leveled off until record drops of 18% were reported by the S& P Case-Shiller index in October 2008.

While this drop was exceptional, it still provides a warning sign for those interested in purchasing their homes as loss in home values is real. However on a positive note, some markets have recovered from the Great Recession and recent housing price trends seem more favorable.

3. HELOC As A Source of Funding

Once you have built some amount of equity and have paid your mortgage on time, you may be able to set up a home equity line of credit or HELOC. Often you are able to get a loan more quickly and at lower rates because you are using your home equity as collateral. Part of these funds could go to building a new kitchen or expanding the house.

The HELOC, if not maxed out, can positively help your credit score. This is because the HELOC has increased the available amount of credit, lowering your utilization rate and improving your financial situation. Credit utilization accounts for 30% of your credit score. HELOC is added debt so make sure you pay this loan on time and in full. To avoid a hit to your credit score don’t close the HELOC, unless you are too tempted to use the money or about to close on the house, as it will then lower the available credit.

4. Possibility of Rental Income

When you are living in your primary residence, you don’t often think about renting out your property. However, you or your spouse may need to relocate for your firm for a couple of years, or your kids are moving out and you want to travel more. You may decide to rent out your home or list it with Airbnb.

5. Stability In Owning Your Home

It is wonderful to raise your kids in one home, become part of the neighborhood and community. There is a certain calm feeling of not having to search for a place to live and pack and unpack boxes. (Having just moved to new home, I can share that I will be immensely happy when our family is finally settled in our home and the last box is gone.)

6. Tax Benefits After The Tax Law Changes

The 2017 tax law did impact some of the tax deductions enjoyed by homeowners. If you itemize your deductions on a joint filing, you still claim mortgage interest payments up to a $750,000 face value loan. Qualified loans, include your mortgage, home equity loans and HELOCs. This is a reduction from $1,000,000 prior to the recent tax law change. You can no longer deduct interest associated with home equity debt unless it is to buy or improve your home.

Deductions for state and local taxes (known as the SALT deduction) along with property taxes are capped at $10,000. This  is okay in some parts of the country like Ohio but not in high tax states like New York or California. This is a reduction from unrestricted amounts previously deducted. You are still able to deduct the proportionate interest associated with your apartment building’s mortgage if it is  a co-operative.

Homestead Exemption

Certain states, like Florida, offer exemptions if you meet certain requirements. This exemption may protect a surviving spouse when the homestead spouse dies. A homestead exemption is a law that protects the value of a home from property taxes and creditors. Depending on the state, a property tax can get an exemption in the range of $25,000-$75,000 of a home’s assessed value from property taxes.

7. You Have Freedom To Do What You Want

Are you creative? Your home can be a good option for you. There may be some conformity required but design and remodelling is limited by your wallet. You can do gardening and grow vegetables. Owning your pets is easier in your home is easier. Your childrent can listen to loud music with less rules of noise after hours. Peace of mind can be very valuable for you and your family.

8. Sense of Pride In Ownership

For those who have rented for a long time. owning your home feels like an accomplishment. Land is a natural resource and there is a good feeling of knowing you own the land you walk and live on.

Ask any refugee that has had their home taken away from them what a home meant to them. My mom was a refugee when she came to the US having lost her family. Her home was taken away illegally and violently. While owning a home eluded her, she always considered owning a home a way to wealth.

Disadvantages of Owning A Home

 

1. High Costs To Own

We addressed the one time and recurring costs a homeowner has to realize but it bears repeating. In particular, there are unforeseen events that require homeowners to do planning ahead of the purchase. Having an ample emergency fund is really essential for all but homeowners need to expand that fund to avoid borrowing unnecessarily.

The age of the home and its condition must be considered when factoring in maintenance and repairs. Are you handy? We are not and so we rely on a plethora of plumbers, electricians, and those who can help us around the house with showers breaking and leaky pipes. I keep wanting to spent time watching YouTube so I can pick up some tips but I am always afraid of starting a fire.

Our teens are more handy but not always available given their schoolwork, friends, sports, video games, and sleeping in.

It may be worthwhile to watch the 1986 movie The Money Pit with Tom Hanks and Shelley Long. It left an indelible memory on what not to do with your house.

2. Lack of Flexibility

If you are adventurous, you may feel stuck in the same house and environment especially as your friends may be picking up and leaving to try life in another place or country. You may want to sell your home and retire to another locale but the local economy is weak.

We had next door neighbors who experienced that predicament. They lived in Connecticut and had bought a house in Florida. The market had been terrible for the better part of a decade. They had to stay put in the colder climate they planned to avoid in their later years. They finally sold last year.

3. Your Home Has An Opportunity Cost

A home is usually the largest asset you own. The mortgage, the maintenance, repairs and property taxes require a lot of capital that may be better invested in a diverse investment portfolio. Many people believe that when they sell their house the money will be used for retirement. That is true but there is no guarantee that you will be able to sell your property quickly or not be facing declining values.

Too much concentration in one asset is very risky. You need to have investments in other assets but saving to invest in other vehicles is difficult when so much capital is to tied to real estate.

One way to avoid this difficulty is don’t buy a house too big for you. The amount of  space homeowners have been buying has greatly increased since 1973. Specifically, median size homes have recently expanded to 2,467 square feet, up 1,000 square feet. During that same time, the average living space per person in the household has nearly doubled to 971 from 505. This is partly due to small household sizes averaging 2.54 persons, down from 3.01 in 1973.

Do we need all that space, and then have to furnish it too?

Advantages of Renting

 

1. Rental Costs Are Less

The lease agreement with the landlord provides your financial responsiblities which are essentially predictable: monthly rent payments, utilities, lawn care, garbage disposal and snow removal if applicable. There are a minimum of upfront fees. Finding an apartment may be harder in certain markets and more expensive based on demand.

2. Benefits of Ownership Without The Property Taxes

You may be able to be fortunate to get the best of what property taxes are used for without having to pay these costs when you rent. Families are always willing to pay more money for a house to be located in a nice place with a great school district. Higher home prices and property taxes may put buying a home out of your range.

Our Recent Move To A Rental House

By renting, you have access to the beauty of the town, its infrastructure like transportation, town pool and its schools. This is a big reason why we made a move to a small town (from a big city)  to a house rental (from an owned apartment) and switched our kids from a private school to one of the best public schools in the state, if not the country.

Our son joined the football team and our daughter is considering other sports not readily available at her previous school. It was a difficult decision, especially for me having grown up in the city. Although it is early it feels promising.

Renting may also help you get familiar with the area before purchasing and allow you to get your financials in order.

3. Free Of Maintenance And Repairs

Your landlord has primary responsibility for the care of the property. It is up to you to inform your landlord of the need for maintenance and care. For those not handy or not wanting to spend the money to fix things, renting can be ideal.  Usually the landlord wants to use their own folks (eg. painters, electricians) for respective issues in the home.

4. Flexibility To Leave

At the end of the lease, you can leave the premises. Many people decide to move around and explore different areas or look for different jobs. You aren’t tied down and as long as your payments through the end of lease are made, you are good to go. It is very difficult to leave your own home as quickly as a tenant can.

Disadvantages of Renting

 

1. Higher Rent Or Sells Property

Your landlord can raise your rent with proper notice or sell the property. Renting has increased faster than household income has since 1960. Apartment List Rentonomics points out that inflation adjusted rent rose 64% from $568 per month in 1960 to $934 in 2010 while household income grew only 18%.

Many homeowners turn to renting if they are unable to sell their property due to a poor market. Once the market turns, they may ultimately sell the home you are renting.

Markets vary but in certain markets, there are fewer homes to rent.

2. No Equity Buildup or Tax Benefits

It is common for people to say that renting is throwing money away. Of course, this is not true as you are paying for the living space for a period of time. You have the freedom to find the best affordable apartment you can to live in an area you prefer.

You are not getting equity or tax benefits from your rent but you are getting a number of advantages. You can divert your savings into other assets.

3. A Bad Landlord

It would be a drag if you rent an apartment from a bad landlord but the good news it is not permanent. Before you rent, check out Yelp to see if there any red flags to know about your landlord. People are always willing to share their bad stories.

I recall some horrifying stories that painted their landlord as a reincarnation of Jack Torrance played by Jack Nicholson in The Shining. Torrance was the caretaker at an isolated hotel.

If you are having trouble with your  landlord who is not providing services promised in the lease there are courses of legal action to take.

4. No Upside From A Strong Housing Market

As a renter you do not get the benefit of an improving house values. This may feel bad when your friends are experiencing some growth in their home value while you may be getting a notice from your landlord that they are getting ready to sell or raise rent.

 

Final Words

Hopefully, this guide provided you with good information to make a decision between choosing to buy or rent your home. Frankly, you can look at the calculations related to mortgage costs, building equity, home prices, square footage but in the end, the choice is a personal one for you and your family.

If there is one point I would like to make, it is to consider how your preferences line up with your long term financial goals. Make sure that if you find your dream house, it is doesn’t break the bank. You don’t want to be too overladen with debt.  Remain disciplined in your spending and make saving a priority.

 

If you rent or own your home, would you kindly share your experiences with us. We always like to hear how you made your decision which shed light for others about to go looking for a home.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Personal Finance Lessons From The Richest Man In Babylon

Personal Finance Lessons From The Richest Man In Babylon

A Timeless Classic On The Basics of Money

Personal finance lessons are all around us in our everyday lives. We handle money all the time. However, we  may not grasp our own financial mistakes. Learn better financial habits from The Richest Man in Babylon by George S. Clason, among my all time favorites. This book can help anyone avoid financial blunders, create wealth and build a financially secure future. I recommend this easy-to-absorb book to my business students and my own children.

Richest Man lays out the major tenets of good money management through ancient Babylonian parables told by charming characters, notably Arkad, the richest man in Babylon himself. It has been read  by millions of readers. Clason gave it out initially as separate pamphlets to banks and insurance companies for their customers. Then it was published in 1926 before the Great Depression and has remained an inspirational classic.

Creation of wealth and growth are reiterated through “Cures” and  “Laws”  utilizing various tales in Babylon is considered among the oldest  civilizations. The Babylonians were known for their resourcefulness, wisdom, enterprise and justice. Clason points out that the Babylonians were clever financiers and traders who invented money as a means of exchange.

Women Did Not Make Money Decisions In Babylon

All of the major characters are men. That is appropriate as women didn’t manage money then. In fact, women were not able to apply for credit cards in their own name until the Equal Credit Opportunity Act in 1974!  Clason wrote at a time when women had finally etched out a win with women’s right to vote was finally approved in 1920. Fortunately, we are now seeing women gain financial independence.

The Babylonians were enlightened in many areas but it is doubtful that gender equality was one of them. That said, don’t let the gender bias hold you back from this good read. Just recast it into contemporary times when women are often better with money!

10 Money Lessons From Ancient Times For Today:

 

1. Pay Yourself First By Saving 10% of Your Annual Earnings

 

Start thy purse by fattening

Clason is believed to have coined the term “pay yourself first.”  That means you should put away 10% of every paycheck into savings.  These savings can be allocated to an emergency fund amounting to at least 6 months coverage for basic essential expenses.  Unforeseen events are unpredictable and undesirable but need to be planned for.

Once this fund is established, use some of your savings stash to invest for retirement and taxable investment accounts . Putting away some money may be difficult at first depending on your spending habits.

2. Spend Within Your Means

 

Control thy expenditures.”

To set aside money for saving and investing, you may need to cut some costs. To control your expenses, assess what is your necessary living needs. These are predictable monthly fixed costs such as mortgage payments or rent, property taxes, utilities, car loans, typical grocery bills, credit card payments and any costs you pay monthly. Remember these costs are for our needs, rather than for our wants and desires.

As our income grows, we often increase our so-called “essential costs” leading to lifestyle inflation. While we are allowed the occasional latte and extravagant dinners, we need to keep our spending in check. You shouldn’t deprive yourself of everything. However, fulfilling every desire is no longer a special treat.

Don’t fall into the trap of spending your raise soon after you have received it. I have often been tempted to buy something special upon getting a raise and bonus after a year of working hard. You soon realize your pay hike is pretax and shrinks on an after-tax basis. If you do need some things, make a list of what you believe are important if you had some extra cash.

Be reasonable about satisfying your every want. For example, that 10% raise on your $80,000 salary may not significantly help you to buy that luxury car (or chariot in ancient times) you have been eyeing. A rise in earnings may not fully accommodate every gratification we seek.

3. Make Your Investments Work For You Long Term To Accumulate Wealth

 

“Make thy gold multiply.”

Saving and investing your money as early as possible enables you to benefit from compound interest through the years. This is often referred to as a magical way of earning interest on the principal invested and the cumulative effect of earning interest on that interest. Compounding works to your advantage when it is your invested money.

On the other hand, compounding works against you when you are borrowing long term like for your home.

Arkad explained how this magic works: “As they labored for, so their children also labored and their children’s children until great was the income from their combined efforts.

4. Pitfalls of Investment Is Overconfidence

 

Guard thy treasures from loss.”

Investments are often fraught with dangers, especially for beginners. Not every investment bears fruit. Learn about the risks of investing, whether in the stock market or investing in a new business. Consult those with more experience and trained in that field. Arkad tells of his folly when he entrusted a bricklayer to buy jewels for him and returned with glass.

While you can’t prevent every loss or mistake, there are ways to minimize your risks. When investing, you should diversify your portfolio and implement asset allocation depending of your age and life cycle. As your wealth increases, consult a financial adviser who may enhance your abilities to address and confront many financial, tax and legal issues.

5. Owning Your Primary Home Is A Good Investment

 

Make of thy dwelling a profitable investment.

Buying your own home versus renting is a very common debate. Clason via Arkad advocates in favor of owning your home. From the 1920s and well past the post World War II period, buying your home was an essential part of the American Dream.

Is it still part of the American Dream today?  US home ownership rose from 45.6% in 1920 to 66.2% in 2000. Ownership of your home has since retreated to 64.1% in June 2019 despite low mortgage rates. North Dakota is the state with the highest ownership ever recorded at 80% and that was in 1900!

Lower Homeownership Rates For Millennials

Home ownership rates in recent years have been impacted by higher property taxes, reduced tax benefits and more difficult conditions to qualify for mortgage loans since the Great Recession. That, combined with crippling student debt, have kept many on the sidelines. Millennials between ages of 25 and 34 made up a smaller percentage (37%) of the home buying market in 2015 than previous generations (about 45%) at the same ages.

Having said that, there are many benefits to owning your home over paying rent in particular parts of the country.  You should weigh the costs of owning your home (downpayment, monthly loan, insurance, taxes and maintenance), against rising rents, lack of control over your home and renter’s insurance.

Housing Appreciation Rates

If you are renting, consider the benefit of having some savings for investments or retirement rather than its use as a down payment. This  could be a major plus. In the best years for the housing market (1976-2005), real price appreciation averaged 2.2% annually. This compares to long term stock appreciation of 8% annually if you were to put your savings into the stock market.

Of course, there are many reasons to buy a primary home such as gardening, more space and decorating rather than as a good investment.   However, investment returns may be a major factor if you are on the fence between buying or renting your home.

 

6. Retirement Savings And Insurance

 

“..it behooves a man to make preparation for a suitable income in the days to come, when he is no longer young, and to make preparations for his family should he be no longer with them to comfort and support them.

Although the American Express Company started offering private pensions in 1875, it wasn’t until 1920s that private pensions were offered by a variety of American industries. State governments established pensions for employees in 1911 followed by federal pension plans. Social Security income did not yet exist at the time Clason’s book was published.

Today, fewer people (4%) can count on the traditional defined benefit pension plans if they work in the private sector. Participation through pensions are down significantly from 60% in the 1980s.  The responsibility of saving for retirement falls on us. About half of Americans 55 or older have not put away any retirement savings. Roughly 22% have less than $5,000 in savings earmarked for retirement.

Don’t make this mistake. Saving for retirement is really investing with deferred tax benefits The earlier you save, the more you will benefit from compound growth. Make sure to participate in your employer’s 401K plan, if offered especially if they offer a matching contribution.  This is free money from your company. Don’t throw it away.

The IRS sets caps on the maximum annual amount you may contribute to your 401K plan. Your contribution is made on a pretax basis. Payment of taxes are deferred until you withdraw money. You will be able to direct these funds into an investment vehicle of your choice.

How 401K Matching Works

Many companies offer their employees access to 401K plans. Most  employers provide a contribution match (partial or dollar-for-dollar) based on the employee’s contribution.

A common example is a partial match provided by employers. This means they will contribute 50% of what you put in, up to 6% of your salary. Some companies will provide the more desirable dollar-for-dollar matches where your employers will put in what you do.

An Example

Let’s say you make $80,000 per year and you contribute $4,800 annually based on 6% cap in your plan. If your employer provides  dollar-for-dollar matching, they would be contributing another $4,800. This is essentially a gift from your company. Why wouldn’t you make your contribution in order to earn your company’s match?

Check your plan at work as to what your employer offers. You want to get the maximum amount from your company so make sure to meet the cap of 6% or whatever the percentage is that they will contribute up to.   That is free money for those employees that participation.

Roth IRAs

Separately, you should also fund a tax-advantaged Roth IRA on your own. You can direct your money into a number of different mutual funds. Contribution is made with your after-tax income up to the maximum amount.  Roth IRAs work differently that traditional IRAs as you are contributing after-tax dollars. The benefits of the Roth IRA is that you have already paid the taxes. You will not be paying taxes when withdrawing and can do so without penalties.

As Arkad insists, you need to provide for a suitable income in older age to continue to enjoy your life.

“…no man can afford not to insure a treasure for his old age and the protection of his family, no matter how prosperous his business and his investments may be.”

Insurance Is Needed Protect Your Family, Income And Your Assets

 

We cannot afford to be without adequate protection.

Insurance planning is one way to protect your family in the event of your passing. Life insurance  is often a benefit that is provided by your company benefit package. However, it is usually a smaller amount than you need. You should make sure to have enough coverage for essential living payments and future costs like college tuition.

Besides  life insurance, there are other insurance types you need to protect your assets, income and family. There are 8 types of insurance to consider: car, home, renters, health, disability, long term care and an umbrella policy.

7. Invest In Yourself

 

“Increase thy ability to earn”

After you earn your college degree, real learning has just begun. To increase your earnings abilities, leverage any skill-building or training opportunities offered to you at your workplace.

I remember being at an employee orientation with others shortly after I graduated college. The head of human resources at the investment bank provided us with a list of investment workshops (in different kinds of financial securities) she recommended we take over the next 6-12 months.

Being a bit of a learning nerd, I was excited by the opportunity to educate myself about certain areas I was unfamiliar with. Someone behind me kept groaning as each workshop was described, finally saying: “I didn’t take this job to go back to school!” Needless to say, the groaner didn’t stay long and not by his choice.

Use Every Opportunity Offered To Gain More Skills

Increased skills at your job are justly rewarded. “The more wisdom we know, the more we may earn.” Alternatively, you don’t want to be doing the same thing in your 50s what you are doing in your 20s. Seek more skills to make yourself a more valuable employee, in order  to get a better job or start your own company. Learning should be a life long goal.

8. Invest In What You Know Or Seek Smart Advice

 

“Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep.”

Arkad tells a Babylonian tradition that sons of wealthy parents must earn the right to inherit the estate of the parents. Arkad gave his son two things he himself had been denied by his parents. First, he gave his son a bag of gold and in then, a clay tablet which had been carved with the five laws of gold. He told his son to come back in 10 years and give his father an account of how he did. If worthy, he would inherit the estate.

Ten years later, his son came back to tell his father he handled the gold poorly and lost it all. He had gotten involved with horse racing and wagering with deceitful men. His son admitted he knew nothing of horses, a business he was unfamiliar with. He was essentially defrauded.

The son sought employment but had no worthwhile training. He then turned to the clay tablets which contained financial wisdom and provided him a road to wealth.

Lost The Gold, Gained The Wisdom

Essentially, his son followed Arkad’s wisdom which provided greater value than that of the bag of gold.  As a result, he multiplied his earnings through putting 10% of earnings into savings, spending less than he earned.

He also learned how to make savvy investments from  knowledgeable financial advisors, avoiding the scams he had experienced before.

Arkad was impressed with the multiple of bags of gold returned to him and he provided his son with the inheritance upon Arkad’s passing.

9. A Lesson In Borrowing and Lending From The Gold Lender

Mathon, the  gold lender is approached by Rodan, the spearmaker, who has been paid a fortune of fifty gold pieces. Rodan’s sister wants him to lend his money to her husband because he cannot seem to make enough earnings on his own. Mathon provides counsel to Rodan based on his largely successful  lending experience.

Can the loan be well made if the borrower cannot pay?

Mathon shares the ways he makes loans if the borrower can demonstrate:

  • possessions like property or jewels with greater value than the loan that can be collateral;
  • they are a wise trader or purpose of money is wise;
  • the capacity to earn enough to pay back the debt, and
  • there is a guarantor to pay back the loan if the borrower is unable.

Mathon will not make a loan to a borrower who is:

  • indiscreet with investments;
  • will take shortcuts to make money; or
  • poor (or lazy) workers.

In the end, Rodan made his decision to not lend money to his sister’s husband. He believes his brother-in-law to be not only envious but also lazy. Rodan knows from experience that his sister’s husband is a spendthrift and will use the money on unnecessary things and will not repay him.

Ill fortune pursues every man who thinks more of borrowing than of repaying.”

 

10. Budget Rule:  10/70/20

The clay tablets of Babylon provided a budgeting plan of 10/70/20 with earnings allocated as follows:

  • 10% goes for savings for future investments.
  • 70%  should go for necessary expenses, notably to provide for home, clothes, and food.
  •  20% for paying off debt.

The above percentages provided by Clason differ from Elizabeth Warren’s popular budget rule of 50/20/30 or spending 50% for your needs, 30% for your wants and 20% allocated to savings.

While the Babylonian budget rule may seem to be antiquated, budgeting of any kind that works for you is the best way to control your spending. Overspending leads to having to borrow and carrying too much debt. Whatever plan can you choose and stick to is good so long as you spend within your means and don’t overly burden yourself with debt too difficult to pay off.

A Final Note

Arkad, as the richest man in Babylon passes on his financial knowledge to generations of readers, which wisdom remains worthy advice to those wanting to create and grow wealth to this day. His stories and that of others in the book are classic, easy to grasp and implement. The rules may differ but remain quite relevant today. Whatever way it is easiest to learn personal finance, take those first steps through tales of old or contemporary means.

If you like classics like The Richest Man in Babylon, check out the personal finance lessons from these classic gems.

Have you a favorite personal finance book or story you would like to share? There are many good ways to learn better financial habits. What works for you can work for others. We would appreciate any thoughts you want to share!

 

 

 

 

 

 

 

 

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