Exjackly

Being in a reasonable financial position, I want everybody around me to also do well.  I know where I am and where I want to go.  Unfortunately, some friends of mine are in the opposite boat.  They do not have their financial lives together and do not know where they are are or where they are going.

Deep down, I want them to make the right choices and come on a similar journey to the one I am making.  I also know that they are not going to, and usually the worst thing I could do for our friendship would be to give them money to turn things around.

... usually the worst thing I could do for our friends would be to give them money to turn things around.

Friends usually get into financial trouble over a period of time.  It does not come up unexpectedly.  The signs are usually there for anybody who is watching: deferred maintenance on vehicles, problems cropping up around the house do not get fixed quickly, or you notice their spending habits changing for the worse.  A quick and easy fix of more money is not going to fix what caused the problem initially.  If the underlying financial activity that got them into trouble in the first place is not changed all more money will do is delay the final meltdown.

Even if the extra cash is enough to get them out of trouble, the loan can cause worse problems.

In My Heels knows this. She puts it well saying:

“It’s age old advice for a reason.  The problem with lending money to loved ones is this:  If you lend serious cash to someone you care about, you still expect it back right?  Sometimes the people we care about expect the relationship you have with them to excuse or “forgive” loans that you have no intention of forgetting about… especially if you can’t afford to.  Tempers flare, words fly like knives, and those knives sever relationships.  Sometimes those wounds heal, and sometimes the damage is permanent.

So, what should you do?  For starters, say NO.  Be nice about it.  Explain that financially you cannot support the loan without putting yourself into a bad position.  You can offer to help them non-monetarily.  Perhaps offer to go over their budget with them or help them look at their financial big picture to offer suggestions.  Maybe offer to make a gift of a visit with a financial planner who will do the same but with more authority than you have.

If You Decide to Say Yes Anyways

Should this not be enough deterrent, and you want to say yes, ask yourself the following questions:

1. Can I afford to not get this money beack, ever?
2. Am I willing to forgive this loan to save the friendship?
3. Will they sign a promissory note for the full amount?
4. If it is for an asset, will they accept a lien for the loan amount?

If you cannot answer Yes unreservedly to all of these questions, you should not make the loan.  End of story.

If you can answer Yes to all of these questions, proceed with caution.  You must ensure that both parties see this as an ordinary business transaction.  Otherwise, if your friends get into financial trouble later, you will be the first obligation that they ignore.  They will trust in your kindness to overlook them not paying you back.  It usually will not be malicious.  But they will expect you to understand and to be fine with it.

That will be where the friendship begins to unravel.  Let it go on long enough, they will forget about the loan completely and you will feel misused and abused.  The friendship will be poisoned with a slowly burning drug.  You will begin to see slights and insults where there were none before.  They may begin avoiding you out of guilt.  Eventually, you will drift apart if the friendship does not simply implode.

That is why it is better to not loan the money yourself.  It can work out great.  It can strengthen your friendship or family ties.  More easily, it can straing and destroy those same ties, and much faster.

If You Need to Borrow

If the situation is reversed, do everything you can to avoid borrowing from friends or family.  If the situation requires that you do borrow, follow these rules:

1. Treat it as a business arrangement - because it is
2. Review your own financial situation to ensure you can repay the new obligation - be honest
3. Behind food, shelter, and clothing make this obligation your top priority
4. Pay it off as early as possible.
5. Sign a promissory note and allow a lien to be placed to secure your friend's position.

Offer these things without asking.  Money is worth less than friends and family.  Do everything you can to prevent money from getting in the way.

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I was Stumbling today and came across an interesting post on Millionaire Money Habits. It is the post titled 'The Money Spectrum'. This article and its accompanying graphic are useful as they are. However, I think it may be even more useful if it is brought over to a more personal level.

Working from the bottom up, we can look at the mindset of somebody at the various Stages of Wealth and see how things change as somebody amasses wealth. You will notice that there are no dollar amounts associated with the graphic. That is because - with the exception of the highest levels of wealth - anybody at any income level can be at any level. It is possible to make a 7 figure income each year and still be out of control. Likewise, it is difficult but not impossible to make $10,000 or so a year and still have your money working for you.

Admittedly, the more you make from any source, the easier it is to get higher on the scale.

Ignorance/Out of Control

A person at this stage probably has a negative net worth. Any money that comes in goes right out. If they are asked how much wealth they have they cannot answer because they do not know. They probably sense that it is not good, but there is not enough concern to find out. If they have credit, this person will generally be using most or all of it.

In the worst case, everything is so far out of control that they know things are bad. Notices from creditors and landlords get trashed or left unopened. The door and phone will not be answered in a last ditch effort to avoid the problem. The financial situation simply exceeds this person's ability to deal with it. Even if they get out of this situation with help, it is very likely that they will return to this state.

To move to the next state, ignorance needs to be removed, the problem identified, and the financial bleeding stopped.

Treading Water

Somebody in this state is still in debt, likely with a negative net worth. However, this person knows where they are financially. Being in debt, there is still a fight against the tide of economic forces. However, this person is no longer drowning. They have found a way to stay in place. Things are not getting worse, but they are not getting any better.

This individual is living paycheck to paycheck. As soon as money comes in, it is spent in some combination of needs and debt service. It is likely that some weeks progress is made and in other weeks gains are given up.

Climbing Out

This is the first of the truly positive wealth stages. Not only is the person not getting further into debt, they are actually decreasing their debt load. It is even possible that during this process a positive net worth is attained. Life is not easy, but there is some breathing room. The primary financial goal is to reduce debt.

Credit card debt, car loans, and home equity loans are still a part of the life during this stage of wealth. Using a debt snowball or other process, these debts are being eliminated over time. Depending how deep the hole was to begin with, this process can take a few months to a few years. When the short term, high interest debt has been eliminated it is on to the next Stage of Wealth.

Building The Foundation

This is the place to take a deep breath and celebrate. Somebody that has reached this point is ahead of a large portion of the population. With no short term debt there is a lot more flexibility with income and cash flow. Most people here have a positive net worth. In here the thought processes however will begin to differ.

Some individuals will continue with the debt snowball and work on long term debt like low interest student loans and home loans. Others will want to prioritize retirement saving. Still others will begin saving large emergency funds (6-12 months or more) or begin planning for large scale life changes.

The key point of this stage is that it is a transitional stage. The actions taken here are done to setup what is going to happen next. Usually, the actions involve continuing to pay down debt to some extent and increasing savings and investment rates. Once the foundation is complete, we move on.

Working For Yourself

This is where somebody is personally debt free. It does not always mean that there is no debt. Instead, any debt that is held on to is associated with an asset that generates the cash necessary to pay for that debt. For example, a rental property may have been financed, but the annual rents cover the mortgage and maintenance on it. There are other possibilities that work the same way (business loans, etc.).

What differentiates this stage is that while you still have to work, it is just to meet the daily, ongoing needs. Any money that is earned is yours. All income beyond the necessities can be spent as desired. Epicureans can spend it on food. Extreme savers can continue hoarding. Hobbyists can save up and add tools and other items to their collections.

By this stage, most people are continuing to save and invest with their sights on the next stage.

Money Working For You

This is where everybody wants to be. Between all of the assets that have been accumulated, there is enough free cash flow to live off of. Yes -full retirement is now possible. This is the level that most of us strive for because it is when we are truly free to do what we want. The only work that is needed is just to ensure that savings, investments, and other assets are maintained to keep the income for life going.

For anybody that wants to continue beyond this stage, their focus is going to be on continuing to grow their assets.

Money Working For The Future

Here, is is no longer about the here and now. All of the needs for a lifetime have been addressed and there is more money available beyond that. The concern at this stage is about leaving a legacy of some sort. It may be for the next generation - or several. It may be for a charity or a new foundation with specific goals. Whatever the desire is (and the range is infinite) it is beyond the individual.

Some people amass so much wealth and continue to be focused on more wealth acquisition that they fall into the last category:

Its Not Money...

Bill Gates. Warren Buffett. Steve Jobs. Larry Ellison. Among others. These individuals worked to build fortunes that far exceeded anything they could spend. All of them are continuing to work and build their wealth. It is a part of who they are. They are driven to succeed and control. They have visions and ideas about how the world should work. They are putting their efforts towards making those visions reality.

These individuals are very competitive. We hear about it too - one person gets a 200 foot yacht, the next gets a 250 foot one. A $20 million dollar house becomes a $30 million home. And it continues upwards. All of this is because of a never-ending drive to be the best and to be recognized as being the best.

The money eventually just becomes a way to keep score. There is not always a way to directly compare one person's achievements against another person's. So wealth and income become a proxy for measuring how people stack up.

Those are the stages of wealth. How far do you want to go? What are your goals? Where are you at now?

My desired destination is at the 'Money Working For the Future'. Currently, I am in the 'Climbing Out' stage but am shooting to be into the 'Building the Foundation' stage by the end of this year.

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The sub-prime meltdown has led to a lot of financial problems.  These cover the gamut from individuals, investors, financial institutions, builders, contractors, even governments.  The expected fix has been proposed - that of letting the government bail people out who have gotten into trouble.

This gives me serious heartburn.  I am among a significant - probably majority - of the country who believes that people should pay a price for their mistakes.  Why should people who were irresponsible - and I include lenders and other guilty parties as well as the borrowers - essentially get rewarded for bad behavior?

At the same time, with no intervention, there is going to be a lot of pain to be shared around.  And it will not be felt only by the irresponsible.  Those of us who find ourselves needing to sell our homes in the next couple of years are going to take a hit.  Depending on what bail-out programs are put into place the pain may be felt for five to ten years.

So what kind of compromise is available?  What mitigates the problems while still demanding sacrifice on the part of those responsible?  What can be done that will leave enough of sting to teach a lesson while not having serious repercussions that have worse unintended consequences?

A Hard Lesson

I think what needs to be done here is to teach a hard lesson to as many parties involved as possible.  This means that it will have to be a multi-pronged approach.  One part will have to penalize irresponsible lenders.  Another will have to soften the blow to the borrowers, without eliminating it.  The final part will be to penalize the supporting cast of players who made it all possible.

This is my proposal:

Congress shall create a limited life federally chartered corporation who will purchase troubled loans from financial institutions - the Federal Housing Preservation Corporation (FHPC).  These loans will be purchased at the face NPV (net present value).  The institutions selling the loans will in turn offer financing at 0% interest for 80% of the NPV to FHPC.

FHPC will modify the terms of the loans it purchases to limit the annual increases in mortgage payments to the 3-5% range to help borrowers stay in their homes.  All profit from this arrangement will return to the federal government to be used for reduction of the National Debt.

FHPC will have a set lifetime of 30 years, can acquire new assets for only the first 5 years of its life, and will sell off any remaining assets at public auction at the end of its federally mandated lifetime.

The third prong of the approach is to ask that Congress create another limited time organization to investigate the brokers, lenders, appraisers, and real estate professionals who contributed to the creation of this mess.  This commission will have the power to subpeona people and documents and to refer cases to federal or state jurisdictions as appropriate for any criminal activities discovered.  To limit the power of this commission, it should only be empowered to investigate residential real-estate transactions for the past 5 years.

The Results

This should have the desired results.   Financial institutions in trouble because of the number of bad loans have a way out that will give them cash to meet immediate obligations.  They may even lose less money than expected from the bad loans.  However, they will not be able to make any additional profit off loans that are 'saved'.  They stay solvent but make less profit than expected when they created the risky loans.

Borrowers will have an easier time staying in their homes, although the worst cases will still be brought into foreclosure.  At the same time, they will still face increasing payments and potentially higher overall outlays than if they had bought what they could afford.

The government, though involved with setting up a bailout program and putting money up front, has the possibility to break even or even profit from having to become involved.  With any proceeds aimed at debt reduction and limited life for the corporation managing this program, this is everything that can be done to minimize the impact (in terms of taxes or increases in national debt) on the rest of us.

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In my local newspaper, there was an article by Dave Ramsey recently talking about leasing a car.  In the article, it had some generalities and ultimately came down against leases completely, suggesting instead that the reader buy a two year old car because the most depreciation happens the first two years of ownership.

Now, I cannot argue against 'downgrading' to a two year old car from a new car.  Financially, it makes a lot more sense and is a lot easier to work into a budget.  For those of us that can control the desire to continually be driving something new and shiny, purchasing is almost always the better option.

I respect Dave Ramsey and do not wish to argue against his stance for personal financial responsibility.  Making our choices, living with them, and making an extra effort to do the right thing is important as an individual and as a society.  Despite this trust, I cannot take an article at strict face value.  I want to know why somebody says something.

In the article, Dave says, "The only one who comes out to the good in an auto lease is the dealership" and "...or as we call if 'fleecing' a car..." Such a blanket statements deserve to be looked at.  Dave does reference articles by Consumer Reports, Consumer Federation of America, and Smart Money Magazine.  That makes me expect his recommendation will be born out by looking at an example.

Buying

For the example, I will be looking at a $30,000 car.  To simplify the comparison, I will assume that insurance, maintenance, DMV fees and parking fees are the same over the 4 year comparison period.

This makes our comparison essentially the cost of the lease versus the depreciation on the car.

Since Dave provided the figure that the average car loses 60% of its value in the first 4 years, we get the following for buying the car:

• Purchase price: $30,000
• Depreciation:   $18,000
• Residual Value: $12,000

Thus, the loss/cost of the new car - ignoring the opportunity cost of spending $30,000 up front - is $18,000.

Leasing

Checking the same assumption at Ford, using a 2008 Mustang in their lease calculator (Sales price $30,000, No down payment or trade-in, 60000 mile limit) we get an estimated cost of $933 due at lease signing and $458 a month payment.  This gives us:

• Due at signing: $933
• Monthly Payments: $21,984
• Total Cost: $22,917

Conclusion

Using this example, it initially looks like Dave Ramsey is being accurate.  Essentially, it costs $4,917 extra to lease the car over buying it - a 27% premium.  Over 4 years, that is a good return for the dealership.  Especially since the people they choose to lease to have better than average credit and are generally unlikely to default on the payments.

However, I do like to try to be thorough.  Since we made the assumption that you can buy the car for cash to simplify the comparison, what if we assume that you have the $30,000 in cash when leasing too. How much do you have to make on the money to come out even if you invest the money you do not spend up front in the lease?

In other words, to make $4,917 over 4 years in interest on the decreasing $30,000 balance, what interest rate (compounded monthly) will it take?

Crunching the numbers in my spreadsheet, I get that it would take a 6.662% after tax investment return for you to break even in the lease vs buy comparison.  If you are in the 35% tax bracket, that translates to a 10.25% pretax rate of return.

Reference

Bankrate Car Lease Calculator

Suze Orman - Buy vs Lease

Edmunds Compares the Cost I want to highlight this article.  This one adds some information on buying a used car as well, which really helps to drive home the point that buying or leasing a new car is not the best way to minimize your long term cost of ownership.

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