When it comes to the cost of cars, people pay a lot of attention to the price they pay, their financing costs and the trade-in value they get. But the cost of owning a car can be as much or more than the cost of buying it. Maintenance and repairs can add greatly--or not--to your car budget. Insurance is also another major expense. An important way to reduce the costs of owning a car is to drive gently.
The harder you push a car, the faster it wears out. Charging down city and suburban streets as if you were driving in the Grand Prix puts a lot of wear and tear on the brakes, tires, transmission, and suspension. Drive the car gently, and the same items may last a lot longer. Take brakes. If you push the car hard, the brakes may need repairs every 30,000 miles, or maybe less. Drive the car gently, and the brakes may go 50,000 or 60,000 miles, or more, before needing work. If you put 100,000 miles on the car before you trade it in, hard driving could mean the expense of three brake jobs. Gentle driving may require paying for only one.
Tires offer similar savings. Properly inflated and rotated high quality tires, driven gently, may last 50,000 or 60,000 miles or more. The same tires on a car that's put through the paces every time you go to the grocery store may last only 25,000 or 30,000 miles--especially if you don't keep them properly inflated. If you drive the car for 100,000 miles before trading it in, you may have to buy two or three sets of replacement tires, or just one, depending on how you drive.
Suspension systems are vastly improved over the shock absorbers in the classics from the 1950s and 1960s. The shocks of that era might need replacement every 15,000 miles. Today's cars, with McPherson struts up front and better shocks in back, last much longer. Vehicles with rugged suspensions, like pickup trucks and SUVs with offroad capability, may, if driven gently, go 100,000 miles without needing suspension work.
Gentle driving also reduces the chances of accidents and tickets for moving violations, because you're likely to be going slower. That means a better driving record, which translates into lower insurance premiums.
Exhaust systems also last much longer than those of 40 years ago. Back in the days of the General Lee, a car might need a new exhaust system every 15,000 to 20,000 miles. Today, exhaust systems can have much greater longevity. Perhaps counterintuitively, it's a good idea to drive a car at least once every few days to prevent buildup of water condensation in the exhaust system. That will reduce the potential for rust, and help the exhaust system to last.
As for routine maintenance, do what the manufacturer recommends. This is especially important if the car is under original or extended warranty (which will require compliance with the manufacturer's maintenance recommendations). The manufacturer's maintenance schedule can often be found in the owner's manual; or maintenance work will be indicated when necessary by codes or lights on the instrument panel. However, be skeptical of routine maintenance the dealer recommends. Dealers make much larger profits from their service departments than from sales. They will push service managers to foist all kinds of unnecessary routine maintenance on unsuspecting customers. For example, fluid flushes (e.g., power steering or brake fluid) are frequently recommended when not needed. The time to listen to the dealer is when you have a specific problem you've asked the dealer to diagnose (and even then, be on guard).
When it comes to buying a new car, going through dealers' Internet Departments can be a money saver. See http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.
Showing posts with label cars. Show all posts
Showing posts with label cars. Show all posts
Wednesday, September 7, 2011
Thursday, June 2, 2011
When the Future Looks Grim, Invest in the Future
With economic growth slowing, unemployment levels persistently high, earnings stagnant, the stock market falling, and the housing market falling harder, it's no wonder people think the future looks grim. That, however, offers no reason to turn away from the future. Investing in the future is crucial to success and prosperity later on. Take a page from Ford, the car company that didn't want a federal bailout. CNNMoney reports that Ford will build a 3-cylinder, 1.0 liter engine, with performance comparable to today's 4 cylinder, 1.6 liter engines, to be offered a couple of years from now. http://money.cnn.com/2011/06/02/autos/ford_three_cylinder_engine/index.htm. That's a major investment at a time when auto sales are slowing. But it makes sense to build a more fuel-efficient gasoline engine, since true national infrastructure for electric cars remains decades away.
People, too, can benefit from investing in the future. Here are some ways.
Higher Education. The earning ability of people with college degrees compared to those with just high school diplomas remains highly favorable to the better educated. Of course, there are exceptions, and for people who have the inclination and ability to go into a trade like plumbing or being an electrician, vocational training may be a better choice. But no education beyond high school is a bad idea. Lots of analysis is available today indicating that the earning potential between an internationally known Ivy League school and a less well-known state university may well not be worth the cost differential. Going to a less expensive state school, or two years of community college and then two years in a four-year college, may be financially more astute than taking on the mega debt required for an expensive private school. A lower profile school that offers a nice scholarship/grant package instead of the bigger name, bigger tuition Ivy or equivalent, may pave the way for you to accumulate a higher net worth by middle age. What doesn't make sense is not continuing with your education beyond high school. Continuing education may be a good idea throughout your life. Our advanced economy rewards those with current knowledge and specialized training.
Save More. As the returns on your investments start or continue to look shaky, the best response is to save more. Saving less may be tempting. Why save more only to lose the money when you could have a big blowout of a weekend instead? Because come Monday, you'll have a nasty hangover and the same problem of financing your retirement. Saving more strengthens the foundation for your retirement. Investment returns ebb and flow--after bad times come good times. If you don't persist in expanding your pool of savings, you'll get less in returns when the financial markets go positive.
Maintain What You Have. It's important to maintain your major property items, like cars and houses. Making big ticket items last can eventually save you a lot of money. Do the routine maintenance recommended by the manufacturer of your car (but not necessarily the maintenance recommended by dealers, which often involves a lot of unnecessary b.s. meant primarily to lighten your wallet). Maintain your house--change the filters on the HVAC and have the equipment cleaned regularly, repaint as needed, repair bad roofs and defective plumbing, do battle with the crab grass, and deal with potential homewreckers like mold, termites, etc. The expensive upgrade of the kitchen and bathrooms may look good, but won't do that much to enhance the value of the house. Not doing maintenance can detract from the value of the house and force you to sell below market when you move.
Remember, there will be a future. It may be good, or not so good. You'll either be part of the future, or face an alternative that's worse. If you're going to get the most out of the future, you should invest in it. Otherwise, you aren't likely to have much of a future.
People, too, can benefit from investing in the future. Here are some ways.
Higher Education. The earning ability of people with college degrees compared to those with just high school diplomas remains highly favorable to the better educated. Of course, there are exceptions, and for people who have the inclination and ability to go into a trade like plumbing or being an electrician, vocational training may be a better choice. But no education beyond high school is a bad idea. Lots of analysis is available today indicating that the earning potential between an internationally known Ivy League school and a less well-known state university may well not be worth the cost differential. Going to a less expensive state school, or two years of community college and then two years in a four-year college, may be financially more astute than taking on the mega debt required for an expensive private school. A lower profile school that offers a nice scholarship/grant package instead of the bigger name, bigger tuition Ivy or equivalent, may pave the way for you to accumulate a higher net worth by middle age. What doesn't make sense is not continuing with your education beyond high school. Continuing education may be a good idea throughout your life. Our advanced economy rewards those with current knowledge and specialized training.
Save More. As the returns on your investments start or continue to look shaky, the best response is to save more. Saving less may be tempting. Why save more only to lose the money when you could have a big blowout of a weekend instead? Because come Monday, you'll have a nasty hangover and the same problem of financing your retirement. Saving more strengthens the foundation for your retirement. Investment returns ebb and flow--after bad times come good times. If you don't persist in expanding your pool of savings, you'll get less in returns when the financial markets go positive.
Maintain What You Have. It's important to maintain your major property items, like cars and houses. Making big ticket items last can eventually save you a lot of money. Do the routine maintenance recommended by the manufacturer of your car (but not necessarily the maintenance recommended by dealers, which often involves a lot of unnecessary b.s. meant primarily to lighten your wallet). Maintain your house--change the filters on the HVAC and have the equipment cleaned regularly, repaint as needed, repair bad roofs and defective plumbing, do battle with the crab grass, and deal with potential homewreckers like mold, termites, etc. The expensive upgrade of the kitchen and bathrooms may look good, but won't do that much to enhance the value of the house. Not doing maintenance can detract from the value of the house and force you to sell below market when you move.
Remember, there will be a future. It may be good, or not so good. You'll either be part of the future, or face an alternative that's worse. If you're going to get the most out of the future, you should invest in it. Otherwise, you aren't likely to have much of a future.
Tuesday, November 10, 2009
Car Savings
If you're thinking of buying a car, don't just look at the price, mileage and cost of a loan. Some of the biggest expenses of car ownership come after you drive it off the lot, and they aren't well advertised. Here are some of the unpleasant surprises that await buyers of both new and used cars who don't carefully research their purchases.
Tires. Car manufacturers are increasingly using high performance tires to boost the driving experience of their products. The designs of high performance tires are taken from racing tires, and use softer rubber compounds to keep a grip on the road. This means the tires wear out faster and cost more to replace. Some high performance tires cost $500 each, meaning you have to spend $2,000 for 4 tires. This expense may come as soon as 20,000 miles and isn't covered by any warranty. Standard, black high wall tires, by contrast, cost around $100 to $150 each to replace, and can last 50,000 miles or more (depending on how you drive and how well you take care of the tires). You probably shouldn't replace high performance tires with standard tires, since each car's suspension is designed to be complemented by tires like the original equipment. So a car with high-performance tires can become a money pit.
Maintenance and repair costs. Many higher end cars, especially luxury nameplates like Mercedes Benz and BMW, are amazingly expensive to maintain and repair. Lexus and Volvo aren't cheap, either. Repairs on American cars that might cost hundreds can cost thousands for some high end cars. Part of the reason is that the parts are imported, and cost more because of the weak dollar. Also, the technology and design embodied in these cars can be more complex than in other cars. We also suspect that some of the cost is simply because the dealerships think they can get away with it because people expect high end cars to be expensive. Whatever the reasons, research maintenance and repair costs before buying.
Insurance. Insurance costs catch a lot of buyers by surprise. Small, inexpensive, fuel efficient cars like the Toyota Corolla, Honda Civic and so on can be more expensive to insure than a big old sedan like a Ford Crown Victoria or a mid-size SUV. A lot of the reason is smaller cars provide less protection in a collision. Also, because they are popular, they are stolen pretty often (for parts). Of course, your individual cost of insurance depends on your driving record, the state in which you live, the insurance company you use (shop around) and how large your deductibles are. But keep in mind the additional insurance expense of an "economy" model.
Depreciation. Models with established reputations for reliability and longevity depreciate more slowly than other cars. Toyotas and Hondas generally depreciate more slowly than Chryslers, Chevrolets and Fords. As American manufacturers improve quality, the depreciation rates on their models should improve. Research depreciation. It's a hidden cost that doesn't seem to matter while you own the car. But when you decide to trade it in, you'll find out that depreciation can be important.
Remember to use competition in your favor. When buying a new car, trying e-mailing the Internet departments of several dealerships for a price. You can easily get a quote lower than the showroom floor price. See http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.
Tires. Car manufacturers are increasingly using high performance tires to boost the driving experience of their products. The designs of high performance tires are taken from racing tires, and use softer rubber compounds to keep a grip on the road. This means the tires wear out faster and cost more to replace. Some high performance tires cost $500 each, meaning you have to spend $2,000 for 4 tires. This expense may come as soon as 20,000 miles and isn't covered by any warranty. Standard, black high wall tires, by contrast, cost around $100 to $150 each to replace, and can last 50,000 miles or more (depending on how you drive and how well you take care of the tires). You probably shouldn't replace high performance tires with standard tires, since each car's suspension is designed to be complemented by tires like the original equipment. So a car with high-performance tires can become a money pit.
Maintenance and repair costs. Many higher end cars, especially luxury nameplates like Mercedes Benz and BMW, are amazingly expensive to maintain and repair. Lexus and Volvo aren't cheap, either. Repairs on American cars that might cost hundreds can cost thousands for some high end cars. Part of the reason is that the parts are imported, and cost more because of the weak dollar. Also, the technology and design embodied in these cars can be more complex than in other cars. We also suspect that some of the cost is simply because the dealerships think they can get away with it because people expect high end cars to be expensive. Whatever the reasons, research maintenance and repair costs before buying.
Insurance. Insurance costs catch a lot of buyers by surprise. Small, inexpensive, fuel efficient cars like the Toyota Corolla, Honda Civic and so on can be more expensive to insure than a big old sedan like a Ford Crown Victoria or a mid-size SUV. A lot of the reason is smaller cars provide less protection in a collision. Also, because they are popular, they are stolen pretty often (for parts). Of course, your individual cost of insurance depends on your driving record, the state in which you live, the insurance company you use (shop around) and how large your deductibles are. But keep in mind the additional insurance expense of an "economy" model.
Depreciation. Models with established reputations for reliability and longevity depreciate more slowly than other cars. Toyotas and Hondas generally depreciate more slowly than Chryslers, Chevrolets and Fords. As American manufacturers improve quality, the depreciation rates on their models should improve. Research depreciation. It's a hidden cost that doesn't seem to matter while you own the car. But when you decide to trade it in, you'll find out that depreciation can be important.
Remember to use competition in your favor. When buying a new car, trying e-mailing the Internet departments of several dealerships for a price. You can easily get a quote lower than the showroom floor price. See http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.
Monday, May 28, 2007
Buy a New Car Without Haggling and Save
There’s a way to buy a new car without negotiating and get a price that might be better than what you could get from hours of old-fashioned haggling. Try purchasing your new car through the dealership’s Internet department.
Here’s the process. If you know what vehicle you want, contact the dealer by e-mail and describe what you’re interested in. If they have it in stock, they’ll get back to you. The prices they quote may be surprisingly low. Word has it that Internet departments are compensated based on the volume of vehicles they sell, rather than the markup on each sale. By contrast, the salesperson on the showroom floor is paid a commission, so the dealership will be less enthusiastic about discounting a vehicle you buy through the showroom floor.
If you want to try the Internet route, start by researching the makes and models you’re interested in. Consider features, capabilities, mileage, safety, insurance costs and resale value. Decide what you want, preferably in detail. Your chances of getting a good deal are better if you can specify the make, model, features, colors and even the frilly options. Okay, a DVD player for the second row seats isn’t a frill; it’s a necessity when you have hyperactive kids. But you know what we mean.
Then, research prices. Go to sites like Edmunds.com (free, with ads) or Consumer Reports (no ads, but you need to subscribe) to get an idea of the dealer’s costs and what other buyers have been paying for the same vehicle in your zip code. Be sure to research total costs of ownership as well as sales prices. (Total cost of ownership, sometimes called “true cost to own,” is a five-year tally of the major expenses of owning a car, like depreciation, financing costs, insurance premiums, maintenance and repair costs, taxes and fees, and fuel expenses.)
Next, go to the showroom. No, we’re not kidding. You should test drive all vehicles that you’re interested in. Another reason for going to the showroom floor is that you’ll be able to ask to any questions you have. You might even get an idea of the price the dealership would ask if you went the traditional haggling route.
Line up your financing before you start shopping. Trying to get financing through the dealer may not be the lowest cost option. If you arrange your financing in advance, you'll very possibly get a better deal. (Hint: try a credit union.)
Now, prioritize your choice of vehicles. Identify the dealers nearby that sell your top choice. Send them an e-mail describing in detail what you want. American manufacturers offer a large variety of options, so your description could get lengthy. Still, it’s better to be specific because you’ll be more likely to get what you want. Foreign manufacturers are more likely to offer a choice of styles with largely fixed options packages—although this is less flexible, it makes shopping by e-mail easier.
The dealers that have your preferred car in stock will get back to you quickly. You may be pleasantly surprised by the prices they quote. If you see a deal you want, call and let them know you’re coming.
Last September, we tried this. Not every dealer had our top choice in stock. The first dealer to respond offered a price that was 8% lower than the best price advertised in the local newspaper. The second dealer offered a price 10% lower than the best newspaper price. The second dealer made a sale about three hours later. When you consider that the average price of a new car is somewhere around $28,000, discounts like these can fund half your annual contribution to an IRA. (For more information about IRAs, read the discussion of retirement accounts in Uncle Leo's Den.)
Of course, the price advantage you might get would depend on supply and demand. If you want the hottest car in the market, the Internet department won’t be selling it. But if you want something that's in lower demand, perhaps at the end of the model year when the dealer hopes to clear out old inventory, you might pocket a fair amount of dinero. Can you haggle with the Internet department? It’s a free country and you can try. But if they’ve offered you a very good deal to begin with, they may not be able to do much more (or anything). Even so, you could still have a very good deal.
Not everything is improved when you buy through the Internet department. If you have a vehicle to trade in, you’ll end up dealing with the same old bluster, bluffing and snake oil nonsense that you wanted to avoid. But if you get a good price on the new car, this is more tolerable. Another annoyance is that if a dealer doesn’t have the make and model you want, they’ll probably try to interest you in something else they have in stock. But it’s up to you whether you follow up. Since you’re probably e-mailing from the comfort of your home, you’re only under the pressure you place on yourself. A third annoyance is that if you send an e-mail to a dealership, they’ll put you in their customer address book and e-mail you for months about every car you didn’t want to buy. Just remember that you control the delete button.
It’s harder to use the e-mail technique to buy a used car. One used car won’t be strictly comparable to another used car, and each needs to be individually researched and checked out. But if you’re in the market for a new car, think about buying through the Internet department.
Crime News: A caper with toilet paper. http://www.wtop.com/?nid=456&sid=1150769.
For more shopping ideas, visit the blog carnival of shopping: http://www.become.com/pocketchange/2007/06/carnival_of_shopping_16.html
Here’s the process. If you know what vehicle you want, contact the dealer by e-mail and describe what you’re interested in. If they have it in stock, they’ll get back to you. The prices they quote may be surprisingly low. Word has it that Internet departments are compensated based on the volume of vehicles they sell, rather than the markup on each sale. By contrast, the salesperson on the showroom floor is paid a commission, so the dealership will be less enthusiastic about discounting a vehicle you buy through the showroom floor.
If you want to try the Internet route, start by researching the makes and models you’re interested in. Consider features, capabilities, mileage, safety, insurance costs and resale value. Decide what you want, preferably in detail. Your chances of getting a good deal are better if you can specify the make, model, features, colors and even the frilly options. Okay, a DVD player for the second row seats isn’t a frill; it’s a necessity when you have hyperactive kids. But you know what we mean.
Then, research prices. Go to sites like Edmunds.com (free, with ads) or Consumer Reports (no ads, but you need to subscribe) to get an idea of the dealer’s costs and what other buyers have been paying for the same vehicle in your zip code. Be sure to research total costs of ownership as well as sales prices. (Total cost of ownership, sometimes called “true cost to own,” is a five-year tally of the major expenses of owning a car, like depreciation, financing costs, insurance premiums, maintenance and repair costs, taxes and fees, and fuel expenses.)
Next, go to the showroom. No, we’re not kidding. You should test drive all vehicles that you’re interested in. Another reason for going to the showroom floor is that you’ll be able to ask to any questions you have. You might even get an idea of the price the dealership would ask if you went the traditional haggling route.
Line up your financing before you start shopping. Trying to get financing through the dealer may not be the lowest cost option. If you arrange your financing in advance, you'll very possibly get a better deal. (Hint: try a credit union.)
Now, prioritize your choice of vehicles. Identify the dealers nearby that sell your top choice. Send them an e-mail describing in detail what you want. American manufacturers offer a large variety of options, so your description could get lengthy. Still, it’s better to be specific because you’ll be more likely to get what you want. Foreign manufacturers are more likely to offer a choice of styles with largely fixed options packages—although this is less flexible, it makes shopping by e-mail easier.
The dealers that have your preferred car in stock will get back to you quickly. You may be pleasantly surprised by the prices they quote. If you see a deal you want, call and let them know you’re coming.
Last September, we tried this. Not every dealer had our top choice in stock. The first dealer to respond offered a price that was 8% lower than the best price advertised in the local newspaper. The second dealer offered a price 10% lower than the best newspaper price. The second dealer made a sale about three hours later. When you consider that the average price of a new car is somewhere around $28,000, discounts like these can fund half your annual contribution to an IRA. (For more information about IRAs, read the discussion of retirement accounts in Uncle Leo's Den.)
Of course, the price advantage you might get would depend on supply and demand. If you want the hottest car in the market, the Internet department won’t be selling it. But if you want something that's in lower demand, perhaps at the end of the model year when the dealer hopes to clear out old inventory, you might pocket a fair amount of dinero. Can you haggle with the Internet department? It’s a free country and you can try. But if they’ve offered you a very good deal to begin with, they may not be able to do much more (or anything). Even so, you could still have a very good deal.
Not everything is improved when you buy through the Internet department. If you have a vehicle to trade in, you’ll end up dealing with the same old bluster, bluffing and snake oil nonsense that you wanted to avoid. But if you get a good price on the new car, this is more tolerable. Another annoyance is that if a dealer doesn’t have the make and model you want, they’ll probably try to interest you in something else they have in stock. But it’s up to you whether you follow up. Since you’re probably e-mailing from the comfort of your home, you’re only under the pressure you place on yourself. A third annoyance is that if you send an e-mail to a dealership, they’ll put you in their customer address book and e-mail you for months about every car you didn’t want to buy. Just remember that you control the delete button.
It’s harder to use the e-mail technique to buy a used car. One used car won’t be strictly comparable to another used car, and each needs to be individually researched and checked out. But if you’re in the market for a new car, think about buying through the Internet department.
Crime News: A caper with toilet paper. http://www.wtop.com/?nid=456&sid=1150769.
For more shopping ideas, visit the blog carnival of shopping: http://www.become.com/pocketchange/2007/06/carnival_of_shopping_16.html
Tuesday, May 22, 2007
The True Price of Affordable Loans
We all know it's a bad idea to let an eight-year old loose in a candy store. Temptation and self-restraint will be mismatched, and cavities, hyperactivity and weight gain will follow. Today's credit market is about the same.
The U.S. economy is awash in credit. Vast quantities of the stuff roam around in every direction, like the enormous herds of bison that swept across the prairies 150 years ago. The abundance of credit puffed up the real estate markets until they bubbled and popped. In the financial markets, the ready availability of credit has enabled hedge funds to accumulate vast investment portfolios funded by borrowed money, and more recently has financed a flurry of "private equity" deals, in which private investors and corporate managements buy up major public companies using credit that banks line up to provide. All this activity has pushed blue chip stocks to record levels. But are these prices sustainable? Only time will tell.
For consumers, there's no shortage of credit, either. Credit card offers in our daily mail kill entire forests. If you have any unused equity in your home, banks rush to offer home equity lines of credit to burn up that equity and convert it into debt payments for you. Car loans now have longer and longer terms in order to make them "affordable" (meaning small enough for you to pay each month). All of this comes at a price, and it isn't cheap.
Car loans illustrate the point. Back in the bad old days when grown men wore leisure suits, cars were usually sold with three-year loans. If you assume an interest rate of 6%, a three-year loan increases the dollar cost of the car by about 10%. For example, a $25,000 car ends up costing about $27,500.
Today, many car loans have terms of five to six years. A six year loan at 6.5% (rates on longer term loans are higher than rates on shorter term loans) will increase the total dollar cost of the car by about 20%. The same $25,000 car ends up costing in the range of $30,000. Of course, the monthly payment on the 6-year loan is much lower--maybe 40% lower (about $425 a month for the 6-year loan, versus approximately $750 a month for the 3-year loan). That's why people take out the longer loans. But they end up paying more for the same car.
A related problem comes up with real estate mortgages. Some mortgage lenders are now offering 40-year fixed rate mortgages as a way to qualify people to buy homes. Arithmetically speaking, a 40-year mortgage costs many more dollars than a 30-year mortgage (around 30% more; so if you're talking about a $200,000 mortgage, that's an extra $60,000 for the same house).
You don't plan to stay in the house for 40 years, so you ask why does it matter? Because the rate at which you build equity in the house is slower with a 40-year mortgage than with a shorter mortgage. The early payments in any mortgage are mostly used to pay interest charges. Only a small portion goes to reducing the principal balance of the loan. As you make more mortgage payments, the amount that goes to reducing the principal gradually increases and you begin to build equity in the house (equity being the value that is yours). A 40-year mortgage with an interest rate of 6% increases your equity in the house by about 8% of the amount of the mortgage loan after the first ten years (about $16,000 for a $200,000 mortgage). A 30-year mortgage with the same interest rate will increase your equity in the house by about 16% of the mortgage loan in the same time period (about $32,000 for a $200,000 mortgage). Given that housing prices are now flat or dropping in most areas, paying down the principal of the mortgage is pretty much your only way to build equity. The monthly payments on a 40-year mortgage might be about 8% or 9% lower than the monthly payments on the 30-year mortgage. But you pay a large price in terms of slower equity growth to get that reduction.
For more information about the risks of financing your home purchase with "affordable" mortgages, please read our May 10, 2007 blog, "How the Right Mortgage Loan Helps You Build Wealth" (http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Remember that you will get a finite amount of money in your lifetime--basically, what you earn, what you gain from investments, anything you inherit, and your lottery winnings (haha, just a joke for 99.9999% of us). The more of your finite lifetime income you spend on interest payments, the less you will have for steaks and champagne. This is a zero-sum game: either the banks get your money, or you get it.
The reason why banks crowd around throwing credit at you is because they stand to make big money lending to you. From your standpoint, the problem with that is the big money comes out of your pocket. Borrow if you must, and borrow for a good reason. Getting an education is a good reason. Buying a house is a good reason. Buying a car is a good reason. But not every loan is a good loan. Buy less house or less car if necessary to keep your borrowing under control. You can't borrow your way to a comfortable retirement. You can save your way to a comfortable retirement.
Celebrity News: Paula Abdul and the risks of owning a Chihuahua--http://www.nbc4.com/entertainment/13364020/detail.html.
The U.S. economy is awash in credit. Vast quantities of the stuff roam around in every direction, like the enormous herds of bison that swept across the prairies 150 years ago. The abundance of credit puffed up the real estate markets until they bubbled and popped. In the financial markets, the ready availability of credit has enabled hedge funds to accumulate vast investment portfolios funded by borrowed money, and more recently has financed a flurry of "private equity" deals, in which private investors and corporate managements buy up major public companies using credit that banks line up to provide. All this activity has pushed blue chip stocks to record levels. But are these prices sustainable? Only time will tell.
For consumers, there's no shortage of credit, either. Credit card offers in our daily mail kill entire forests. If you have any unused equity in your home, banks rush to offer home equity lines of credit to burn up that equity and convert it into debt payments for you. Car loans now have longer and longer terms in order to make them "affordable" (meaning small enough for you to pay each month). All of this comes at a price, and it isn't cheap.
Car loans illustrate the point. Back in the bad old days when grown men wore leisure suits, cars were usually sold with three-year loans. If you assume an interest rate of 6%, a three-year loan increases the dollar cost of the car by about 10%. For example, a $25,000 car ends up costing about $27,500.
Today, many car loans have terms of five to six years. A six year loan at 6.5% (rates on longer term loans are higher than rates on shorter term loans) will increase the total dollar cost of the car by about 20%. The same $25,000 car ends up costing in the range of $30,000. Of course, the monthly payment on the 6-year loan is much lower--maybe 40% lower (about $425 a month for the 6-year loan, versus approximately $750 a month for the 3-year loan). That's why people take out the longer loans. But they end up paying more for the same car.
A related problem comes up with real estate mortgages. Some mortgage lenders are now offering 40-year fixed rate mortgages as a way to qualify people to buy homes. Arithmetically speaking, a 40-year mortgage costs many more dollars than a 30-year mortgage (around 30% more; so if you're talking about a $200,000 mortgage, that's an extra $60,000 for the same house).
You don't plan to stay in the house for 40 years, so you ask why does it matter? Because the rate at which you build equity in the house is slower with a 40-year mortgage than with a shorter mortgage. The early payments in any mortgage are mostly used to pay interest charges. Only a small portion goes to reducing the principal balance of the loan. As you make more mortgage payments, the amount that goes to reducing the principal gradually increases and you begin to build equity in the house (equity being the value that is yours). A 40-year mortgage with an interest rate of 6% increases your equity in the house by about 8% of the amount of the mortgage loan after the first ten years (about $16,000 for a $200,000 mortgage). A 30-year mortgage with the same interest rate will increase your equity in the house by about 16% of the mortgage loan in the same time period (about $32,000 for a $200,000 mortgage). Given that housing prices are now flat or dropping in most areas, paying down the principal of the mortgage is pretty much your only way to build equity. The monthly payments on a 40-year mortgage might be about 8% or 9% lower than the monthly payments on the 30-year mortgage. But you pay a large price in terms of slower equity growth to get that reduction.
For more information about the risks of financing your home purchase with "affordable" mortgages, please read our May 10, 2007 blog, "How the Right Mortgage Loan Helps You Build Wealth" (http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Remember that you will get a finite amount of money in your lifetime--basically, what you earn, what you gain from investments, anything you inherit, and your lottery winnings (haha, just a joke for 99.9999% of us). The more of your finite lifetime income you spend on interest payments, the less you will have for steaks and champagne. This is a zero-sum game: either the banks get your money, or you get it.
The reason why banks crowd around throwing credit at you is because they stand to make big money lending to you. From your standpoint, the problem with that is the big money comes out of your pocket. Borrow if you must, and borrow for a good reason. Getting an education is a good reason. Buying a house is a good reason. Buying a car is a good reason. But not every loan is a good loan. Buy less house or less car if necessary to keep your borrowing under control. You can't borrow your way to a comfortable retirement. You can save your way to a comfortable retirement.
Celebrity News: Paula Abdul and the risks of owning a Chihuahua--http://www.nbc4.com/entertainment/13364020/detail.html.
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