Beating Broke

Obligations of the Buyer

November 12, 2010 By Shane Ede 4 Comments

With all the news lately about people “walking away” from their mortgages, increasing bankruptcies, and debt consolidation/repayment schemes, I got to thinking about what the obligations of the buyer are. And, also, the ways that we as a society have made it easy to sidestep those obligations.

Obligations

What are our obligations when we buy something? Does buying a pack of gum carry different obligations than buying a house? Naturally, we have obligations to ourselves as to the upkeep and use of that which we buy. If I buy a house, I have an obligation to myself to do what I can to make that house last as long as possible and remain structurally sound. If I buy a pack of gum, it’s a lesser commitment, but that obligation still exists as an obligation to not let my purchase go to waste and either chew the gum or give it to someone to chew.

What obligations to we have to the seller when we buy something? There are two ways to look at this. The first scenario involves paying cash for something. If the full purchase price that was negotiated is satisfied, I don’t believe you have any obligation to the seller. However, if the purchase involves debt of some sort, there are obligations that arise. If you purchase with a credit card, there is an obligation to pay that debt to the credit card company. The same is true for a mortgage, a car, and even a pack of gum. Not only do you have an obligation to pay the debt, but you also have another obligation to yourself to learn what that debt is going to cost you. This last obligation is the one that was most ignored during the fiasco that we like to call a housing bubble. Many ignored the facts of what their new houses were going to cost and bought them anyways.

Sidesteps

In the pursuit of a consumerist society, these obligations can sometimes get in the way. If I ignored the obligation to know the cost of debt and bought a house anyways, I likely entered into an agreement to pay a mortgage company a set amount each month. Recently, it’s become popularized to demonize the banks that lent the money to people as the sole problem and, as a result, it’s become no big deal to merely “walk away” (default, or stop paying) on a mortgage. The reasoning follows that it’s better to default on the mortgage than remain paying on a house that is worth less than what the purchase price was, or that has had payments adjusted higher.

In the same way, the obligation to pay credit card bills, auto loans, and most other consumer debt has been sidestepped. It’s no longer a social stigma to declare bankruptcy. Many, knowing they are about to file for bankruptcy, will go out and max out their credit lines in anticipation of the bankruptcy cleaning the slate.

As these sidesteps become more and more common, the social stigma will decrease even further. If everybody is doing it, it’s hard to demonize something. You might demonize your friend. Or relative.

Of course, this isn’t to say that defaulting on a mortgage should never happen. Or that bankruptcy should never be declared. It happens. It’s the rampant social acceptance of these situations that is troubling. What happens when it becomes commonplace for mortgage borrowers to default? The loans become more expensive. The banks have to cover their costs to repossess the house, the staff to service the loan, and associated costs with trying to resell the house. Where is that money going to come from? They aren’t going to just pay it out of the kindness of their hearts. They’ll pass it on to the customer. Suddenly, mortgages will become even more front loaded with fees and interest. When bankruptcies become more commonplace, credit availability is going to decrease. We’ve already seen that recently. People who could easily get a credit card before will be denied.

All of this is all the more reason to avoid debt whenever possible. If society isn’t going to do it, hold yourself to your obligations as a buyer. Obligate yourself to paying off your debt. Then, obligate yourself to paying in cash from then on.

photo credit: EJP Photo

Bye, Bye Pension; Your Opinion Needed

November 10, 2010 By Shane Ede 14 Comments

We were recently told that our defined benefits plan was being taken away. For those that are confused, a defined benefits plan is what is normally called a pension. For me, I haven’t been around long enough for it to really affect me. Some, who have been around for a very long time and are nearing retirement, it will mean a rather significant chunk of the money that they thought they would have for retirement will be gone. To their credit, our employer is doing it the right way.

Rather than just declaring the fund bankrupt, or letting it run until it was bankrupt, they’ve decided to shut it down gracefully. What that means is that those of us who are vested in the plan will receive a payout of the amount we have vested. And, as part of that, we need to decide what to do with that money. We have four options:

Buy an Annuity. Annuities basically work like this: You give them a lump sum of money, and they agree to pay you a monthly amount back. The total of the payments is equal to some amount greater than the amount that you gave them. It’s usually based on current interest rates.
Roll the money into the company 401(k). I’m already participating in the 401(k), so this would be a logical place to go with it.
Roll the money into an IRA. Also a logical way to use the money. Could be rolled over into a Roth IRA as well. Either way, I have far more control of the money than I would in my 401(k). Also, I don’t believe I’d have to worry about IRA Contribution Limits if I roll it over.
Take a cash payout. They’d just write me a check, minus the 10% early withdrawal penalty from the IRS.

I’ve ruled out option 1 as it doesn’t make any sense to do with the interest rates where they are. Most likely, I’ll be using option 2. But, I just can’t come to a concrete solution. If I take option 2, I add a significant amount of money to my 401(k). More is always better. But, I have no more control of that money than I do with the current money that’s in there. If I take option 3, I still retain the same amount of money in a retirement account, plus I have far more control of where the money is invested than I do in the 401(k). That’s also the con of this option though. I’m no investment expert. I could look to invest in a stocks and shares ISA but as a general rule, most of the investments I’ve made aren’t all that great. Which means it would have to be limited to EFTs and Mutuals which doesn’t afford that much more control than in the 401(k). The final option would be to take the money in a check. The big downside there is that the IRS takes 10% off the top as a penalty. Then, it’s counted as income which gets taxed as income. In our tax bracket, that could mean an extra 15% in tax liability. If it bumps us up into a new bracket, it could mean some of it could be 25% in tax liability. So, I’d pay an instant (or nearly so) 25-35% if I took a check. But, that still means I would receive a lump sum of several thousand dollars. That money could be used to pay off at least one credit card, if not two, and alleviate some of the monthly burden that our debt gives us.

I know that the safest (rightest) answer is to put it into one of the retirement accounts, but having the cash to dump some of our debt would also be very advantageous.

What would you do? If you were in my situation, would you play it safe and roll the money into your 401(k)? Would you take the cash and pay something off to reduce your monthly expenses? Tell me how you would handle this!

photo credit: House Committee on Education and Labor

Affluent Wants vs. Needs

November 8, 2010 By Shane Ede 4 Comments

We already know that a good portion of saving money (both saving in savings accounts and saving on spending) can be determining whether something that we think we need is really a need or not and whether we could really do without that need. The underlying problem there is that as we become more affluent, wants become needs. This isn’t a new problem.

What those wants are has changed, but the problem remains. In the days of the Roman empire, things like Oranges were considered a luxury. They didn’t have the ability to transport them as quickly as we can now. Because they were unable to get them somewhere quickly, they would spoil in all but a few cases. The elites of the time were affluent enough that they could afford to dedicate a whole team of chariots and riders to move the Oranges from the orchard to their homes as quickly as was possible in the times. Today, oranges are a bit more commonplace. And, as such, aren’t nearly the luxury that they were to ancient civilizations. The same is true for many different commodities.

And so, we can be said to be equivalent of a Roman elitist. But, even as we are equal in many ways when we compare our access to certain things, we are not equal in socio-economic standing. We aren’t elitists. We’re the modern day equivalent, in that way, of your average, everyday Roman. Just as the elite Romans had their scarce commodities, the elites of our society have theirs. Bentleys, Mansions, Lear Jets, and Caviar just to name a few.

One of the hazards of harnessing our personal finances is that we may begin to loosen our own self-made restrictions and some of our wants might become needs. Sure, a private jet would be nice. I want a private jet. I certainly don’t need one, though. But, what if my prowess with personal finance (stop laughing) causes me to become more wealthy than I could possibly imagine. As it becomes easier and easier for me to get that jet without breaking the bank, it also becomes easier and easier for that want to morph into a need.

A jet is a bit of an extreme example. But, apply the same concept to one of the things that you want now. Here’s a perfect example from my own financial adventures. About 7 years ago, shortly after my wife and I became engaged, we decided that we needed to move from the apartment we were in and into something that was a little bit more pet friendly. If you’ve ever tried to have a 100+ pound dog in a one bedroom apartment, you know what I’m talking about. Initially, we were talking about finding a house to rent that allowed pets. However, the more we looked at it, the more we discussed buying a house. We wanted to buy a house. But, as we looked at houses to rent, we convinced ourselves that we needed a house. And we bought one. Now, 7-ish years later, we want to move into a bigger house to make room for our two children and a dog. We certainly don’t need a bigger house. But we want one. As we get a better handle on our finances, it’s very possible that what we want now will become a need if we let it.

I won’t say whether that will be a bad thing or not. Some would argue that if we don’t truly need the bigger house, we shouldn’t buy it. Others will say that if we have saved up and can afford it, we should go for it. That’s not the point of this article though. What is the point?

Awareness. One of the most important factors in your personal finance journey will be how aware you are of your situation. Being aware enough to understand what you can and cannot afford as well as what is and isn’t a need will be a determining factor in where your finances end up when you are ready to retire. Moreover, being oblivious to your situation isn’t an excuse. Be responsible for your situation. Learn how to fix your mistakes. And become aware of your situation so that you can make educated choices for your financial welfare.

Image Credit: Without money by Toban Black, on Flickr