Tuesday, September 2, 2014

Playing the Percentages or Managing Your Money and Loans

I never had a student loan.  I've thought I had no advice to give someone who had student loans because I've never walked in their shoes.  Then I realized:  paying off a loan is the same for any loan, whether student loan, home mortgage or credit card.  In each case, there is an amount of money which was borrowed in order to pay for something.  It could have been a physical item like a computer or a house or an experience like a concert or an education.  One thing important to recognize with loans, you are borrowing money from your future to pay for something in your present.

It's such a dramatic concept, borrowing from your future.  Seems like it should come with a finger wagging that "you're bankrupting your future, young lady!"  But we Americans have drifted off the path in terms of debt.  Maybe by grounding the whole thing back into the underlying concepts, we can find our way again.

Borrowing money to pay for things sounds sensible to us for one of two possible reasons.  First, we can't pay the entire amount now and borrowing the money splits the total into bite sized payments.   Or second, we don't have the money right now, but we have an expectation we will have it in the future.  Like expecting a Christmas bonus.  For the privilege of paying on installment or delaying the bulk of the price until we have more money, we are giving the lender interest or a little bit more than the amount we are being loaned.

My father once tried to explain the concept of how prices work to me, but it wasn't easy.  He kept fuming that prices were determined by what the buyer would pay.  I kept telling him that might be true, but that I couldn't go to say, McDonald's, and tell them I will only give them 75 cents for their one dollar burger.  But really, he was right.  Just think about it.  Let's take a hardcover book.  Perhaps the very first Harry Potter.  The publisher suggests a price for the books.  In some cases even sets a price that can't be undersold.  Let's say $25.  Copies of the books are sold to big box stores, internet stores, or independent stores for varying prices (less than $25.)  The distributing businesses receive a price that is largely dependent on how many books they have the wherewithal to order.  In some cases, the big box stores receive a large enough discount where the independent stores can actually buy directly from them at the same price they would receive anyway.  In that scenario, the price for the very first Harry Potter is not a set thing.  It's a changeable thing dependent on where you are in the food chain.  In other words, it can't be a constant in order to allow for everyone in the book's path from idea to 3D item in your hands to make some money.  The end of the line is the person who buys the book on a credit card that carries a balance.  Let's say the credit card has an interest rate of 25%.  The big box stores would pay around $12 per book, the consumer $25 and the credit card consumer?  $31.25.  (Or thereabouts, the price plus that interest.)

There's nothing wrong with that.  I've had instances in my life where I have intentionally thrown six dollars extra at something because it felt like the right thing to do.  Maybe it bought me a bit more comfort, like having the headphones to listen to the movie on the airplane because the time would go by faster.  Maybe I overtipped a little because the waitress was that good and I was that happy.  Not buying things at the absolute cheapest price is not a sin.

Remember, money is a tool.  Tools work best when you understand what they do and how they work. It doesn't matter what you paid for something or what someone else paid for something, as long as you are: 1.  aware of the price you paid and 2. content with that price.  I'm convinced for many habitual credit card users, they have disconnected from their awareness that they are paying an added price.  So I would say that the first thing you need to do, before you take on any sort of debt due to borrowing money, is calculate what you will actually be paying.  While you are calculating the price, keep in mind how long it will take you to pay off the debt.  For instance, mortgages can be 15 to 30 years in duration.  Generally the longer the duration of the loan, the lower the interest rate.  The shorter the duration of the loan, the greater the interest rate.

Have you heard the notion about "compound interest?"  How you will earn exponentially more if you re-invest the interest paid into the capital (thus creating a higher base of capital to receive interest from.)  "Compound interest."  That is basically what you are giving your lender in reverse.  Compound debt.  You pay the minimum.  Let's say it's $25, just like that Harry Potter.   In fact, you could tell yourself, "Well essentially I bought the Harry Potter this month and VISA bought everything else.  For now.  Except your credit card balance is a mixture of the items you buy and the interest you owe.  Every time you pay the minimum, the balance grows and the amount the interest is applied to is compounded and larger.  Trying to pay a credit card off by paying the minimum each month is like reaching for a ball bearing on a slick table.  Always slipping just out of your grasp.


As I've said so many times, I'm lucky.  I didn't have a student loan.  I paid for my education with a little bit of money from my parents, a little bit of money from grants and scholarships, and a little bit of money from my job.  I worked my way through college.  I don't have kids, but the parents I've talked to, when I talk about what things were like back then, I witness the "you're hopelessly behind the times" eye roll.  I gather, like everything else, school tuition is a lot more expensive now.  In that case, it is especially important to know how much you are paying.  Calculate what you are borrowing by how much interest they are charging and guesstimate how long it will take you to pay off the debt.  Remember to consider the salary with which you will be paying it off.  Now, I absolutely believe that there is no price too large to pay to learn about something you will love.  Something you would find to be your "life's calling."  But the truth is, you may borrow more than your dream job can logically afford.  So calculate it.  Figure out how much you will be paying and whether it is worth it to you.  In the end, I don't think it matters if you paid a "lawyer's" worth of student loan for a pastry chef's worth of salary if it brought you happiness.

Keep in mind, though, if you wildly overpay for things you might later try to resell, you may not find someone who agrees with your inflated price and vision.  You know, in real estate you can over improve a house for its neighborhood.  Once again, I think if you can afford it and it will make you happy, forget the resale price.  Make it completely your own.  Just know what you paid for, how much it cost and don't expect to get reimbursed for it.  If you're buying for an investment, remember all investible items can be subject to price bubbles.  Nothing goes up without ever coming down.


Always remember the percentages.  Respect the percentages.  For instance, after your monthly bills, you have $400 left to aim at something in order to improve your situation.  Do you put it in savings?  Do you aim it towards your mortgage?  For years, I believed the answer was "put it in your savings" and the greatest financial minds in my life believed the same.  

Now I would ask you, "What are the percentages?"  Right now, if you have a savings account, it is likely to be earning just under 1% in interest.  I have paid off my mortgage, but while I had one it had an interest rate of 5.65%.  If you think simply in terms of money and not fear, you come to realize that sometimes, spending money towards a debt with a higher interest rate is more beneficial to you than holding onto that money and earning a tiny amount of interest.  You maximized your return on that money by aiming it where it was most useful.  That was part of how I paid off my mortgage.  Every time I got a little bit of extra money, I aimed it at the basis.  I think by the end I had cut something like three years off the length of my loan.  


Awhile back I listened to a friend talking about paying a large bill in cash.  It was a situation involving airplanes and travel and one that most of us would have thrown a credit card at.  He didn't have a credit card.  He saw them pretty much as "the devil's instrument" and the cause of everyone's debts and woes.  

Credit cards can be a good thing.  They can be your friend.  You can consolidate and track bills using one.  You can buy things you can't find locally over the internet.  If you can discipline yourself to never spending more than you can pay off each month, you can make use of some pretty awesome rewards from some of them.   It depends on you.  If you had 100 dollars in your pocket, you wouldn't be able to spend more than 100 dollars.  Know what you're buying and how much you're paying.  Don't buy more than you can afford to pay back.  You can do it.  After all, who is the boss of you?  You.  Just because you have a credit card in your wallet, you don't have to use it.  That credit card is a tool.  Know when and how to use it and hold yourself responsible to yourself.  I mean, if you can't depend on you .......

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