May 2008 Archives

Financial Building Blocks

There are nine elements or building blocks that create your financial identity.  Consider each element to determine your current financial status and use it as a tool to plan your future.

Your Goals Goals are usually specific items you wish to achieve within a time frame.  Initially, you may not be skilled at setting goals.  You might simply wish to improve your money management skills. SMART goals are Specific, Measureable, Attainable, Realistic and Time Bound. So instead of a goal of “I want to know how much in credit debt I owe” “I will develop a list of credit accounts I owe on by the end of this month”.

Your Records Have you developed a list of what you own and what you owe (a net worth statement)? Do you have a system of where and how long to keep cancelled checks, bank statements, birth certificates and other documents? Developing a methodical financial record keeping system can save you time and money. Consider your family a business and act accordingly.

Emergency Fund Each day brings unexpected challenges, sometimes with financial consequences. To prevent these emergencies from upsetting your spending plan having access to money in an emergency fund is useful.

Spending Plan A spending plan (budget) is a guideline you develop to plan how and where you want your money spent. By monitoring where you are spending your money you can make better decisions on what is important to you and changes you need to make in your spending to achieve your financial goals.

Bank Accounts Many people are familiar with savings and checking accounts offered by banks.  What other services do banks provide? What businesses in your community provide bank-like services? Do you know the pros and cons of each?

Personal Credit Do you have access to credit in your own name? Having access and building a positive credit history is key not only to getting credit with low interest rates, but also impacts your ability to rent an apartment, get a job, as well as insurance rates on your home and your car.

Insurance This product allows you to protect yourself and family against unexpected catastrophes such as illness, accidents, death or medical care. Managing the risks you may face daily is accomplished by carrying adequate levels and types of insurance.

Estate Plan Everyone has worldly possessions. The purpose of an estate plan is to look at all aspects of your financial picture and use it to prepare for future events such as divorce, marriage, incapacitation or death.  If you don’t take steps to prepare a will and other estate planning documents, Pennsylvania has a plan in place known as intestacy laws, that probably won’t handle your estate as you would wish.

Retirement Fund Many people seem to have difficulty surviving on their weekly paychecks. What will happen to them in retirement when there are no weekly paycheck and they took no steps to save for retirement?  Social Security will provide some retirement income…about 1/3 of the money most people will need to pay for their “golden years”.

Unless you are a circus performer, being upside down is not a comfortable position to be in. Financially speaking, being upside down is a term that means you owe more on an item you purchased than the item is worth. Generally, it is used when talking about car ownership, but the recent housing crunch means that while housing values have declined, their mortgage amounts haven’t.  Let’s start with the car example. You decide to purchase a brand new $20,000 car with a $20,000 bank loan. At the time of purchase the value of the car equals the value of the loan. You drive the car home feeling pretty good about being the proud owner of a shiny car that has the new car smell. While it may still smell like a new car, it is no longer considered new and immediately the value drops – this is called depreciation. In our example, let’s say the value of the car has dropped from $20,000 to $18,000. At this point, you owe $20,000 on a car worth only $18,000. Unless you carry gap insurance, if you are in an accident and total the car, your insurance will reimburse you the value of the car (less your deductible), NOT the value of the loan! Assuming a $500 deduction, you will receive a check for $17,500 from your insurance company and still owe the finance company $2,500! Purchasing gap insurance will cover this difference, but adds to your purchase costs.

Another situation where being upside down happens is when you are unable to meet your loan obligations and default. The finance company will repossess the car and sell it, generally for thousands less than it is worth, usually at a car auction. Continuing with our example, a few months after you purchase your car, you lose your job and can’t make the payments. You now owe $19,000 on your original $20,000 loan. At auction, the finance company receives $10,000 for the value of your car. You are still responsible for the $9,000 difference between the loan amount and what the car sold for – this is called the deficiency amount.

Being upside down in a loan is generally not a problem as long as all goes well and you pay your bills on time. Being upside down in a mortgage is a problem when you need to sell the house or can’t make the payments. When you bought the house, an appraiser made a good faith estimate of the value of the home taking into account numerous factors. The bank lent you money based on this appraisal. An old rule of thumb was that banks would lend you 80% of the value of the home while you paid the 20% down payment. This was the bank’s way of managing the risk that the property value might drop. If it dropped up to 20%, they still retained the 80% equity stake in the property. Recently a wide variety of bank products were introduced that allowed more people to participate in the American Dream of homeownership. Bank products such as 0% down payments, subprime mortgages and adjustable rate mortgages are finding more families waking up to the nightmare of losing their homes to foreclosure because their home values have plummeted below what they still owe and they cannot meet their payment obligations.

What can you do to avoid feeling like a circus performer? To avoid finding yourself upside down in a loan, try to make the biggest down payment you can, minimizing the amount you need to finance. If you find yourself in difficulty, first speak to your lender. They may be able to alter or restructure the terms of your loan such as accepting interest only payments. Most lenders would prefer to work with customers than to embark on a repossession or foreclosure. Your lender may also refer you to government sponsored programs that you might be eligible for.

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