Any financial guys on here?

shack

Mazeroth wrote: »

Your math is way off. This is a quick and dirty calculation. The first year of the loan they will pay over $1500 in finance charges. With 30k in the bank and 2.5% interest they will make $750 in interest. However, they will also pay taxes on that interest so we'll say $600. Year two they will pay around $1250 in interest. Their $30600 will make them $765, or about $615 in interest (keeping things simple).

So, after 2 years they're $2750 in the hole with taking out the loan or they have $1215 they've made in interest from a bank at 2.5%. Now, if the bank was paying out 5% then it would be roughly a wash. Another thing you need to understand is the 30k they started with in the bank is no longer 30k as the payments are reducing that money, which I didn't calculate.

Laptop battery about to die. Goodnight!

Lets use real numbers to see if jakelm is right. Here are the assumptions

72 month car loan, $30,000 at 5.5%. P&I payments only.

Monthly car payment = $490.13
Total payments = $35,289.36
Interest paid = $5,289.36

Let's use real world savings rates. Instead of keeping the money in a MM account let's put it in a CD for 72 months paying 4% compounded monthly.

Certificate of deposit = $30,000
Value at maturity = $38,122.26
Interest earned = $8,122.26

In real life most of us will pay taxes so to be fair we must take the nominal tax rate into consideration. Since the vast majority of people fall into the lowest tax bracket we will use 15%.

Interest earned = $8,122.26
Tax = $1,214.44
Net interest earned = $6.907.82
Total savings $36,907.82

In this example jakelm is clearly right. At the end of 6 years the car is paid for and money in the bank. You are $1.618.46 better off ($6.907.82 net interest earned - $5,289.36 interest paid).

But whoa you say...what about the $490.13 he's paying each month in car payments? What if he paid the car in full and had the will power to invest that each month.

OK - for sake of argument we need to use a SAFE rate of return (no mutual funds due to the risk we are seeing now) so we will use what could be earned in a money market account. 2.5% is better than market rate now and is what jake alluded to so lets assume one invests $490.12 a month for 72 months with interest compounding monthly at 2.5%.

Amount deposited = $35,289.36 (hmmm - looks suprisingly like the total car loan)
Interest earned = $2,708.87
Total savings = 37,988.23

Lets not for get that TAX thing...

Interest earned = $2,708.87
Taxes paid = 404
Net interest earned = $2,304.87
Total savings = $37,594.23

On an after tax basis THIS is clearly the best alternative. Chances are over the next 6 years rates may actually be higher. If the rate just increased .5% to an average of 3% his after tax amount at the end of 6 years would be $38,044 and if it averaged 4% the amount would be $39,013.

So the bottom line is IF one has the discipline to put the amount of the car payment in the bank each month JUST AS THOUGH THEY WERE MAKING A CAR PAYMENT...they would be much better off at the end of 6 years.

The reality is...THAT ISN'T GOING TO HAPPEN for 99% of the people.

So jakelm's logic isn't that far off....

jakelm

shack wrote: »

Lets use real numbers to see if jakelm is right. Here are the assumptions

72 month car loan, $30,000 at 5.5%. P&I payments only.

Monthly car payment = $490.13
Total payments = $35,289.36
Interest paid = $5,289.36

Let's use real world savings rates. Instead of keeping the money in a MM account let's put it in a CD for 72 months paying 4% compounded monthly.

Certificate of deposit = $30,000
Value at maturity = $38,122.26
Interest earned = $8,122.26

In real life most of us will pay taxes so to be fair we must take the nominal tax rate into consideration. Since the vast majority of people fall into the lowest tax bracket we will use 15%.

Interest earned = $8,122.26
Tax = $1,214.44
Net interest earned = $6.907.82
Total savings $36,907.82

In this example jakelm is clearly right. At the end of 6 years the car is paid for and money in the bank. You are $1.618.46 better off ($6.907.82 net interest earned - $5,289.36 interest paid).

But whoa you say...what about the $490.13 he's paying each month in car payments? What if he paid the car in full and had the will power to invest that each month.

OK - for sake of argument we need to use a SAFE rate of return (no mutual funds due to the risk we are seeing now) so we will use what could be earned in a money market account. 2.5% is better than market rate now and is what jake alluded to so lets assume one invests $490.12 a month for 72 months with interest compounding monthly at 2.5%.

Amount deposited = $35,289.36 (hmmm - looks suprisingly like the total car loan)
Interest earned = $2,708.87
Total savings = 37,988.23

Lets not for get that TAX thing...

Interest earned = $2,708.87
Taxes paid = 404
Net interest earned = $2,304.87
Total savings = $37,594.23

On an after tax basis THIS is clearly the best alternative. Chances are over the next 6 years rates may actually be higher. If the rate just increased .5% to an average of 3% his after tax amount at the end of 6 years would be $38,044 and if it averaged 4% the amount would be $39,013.

So the bottom line is IF one has the discipline to put the amount of the car payment in the bank each month JUST AS THOUGH THEY WERE MAKING A CAR PAYMENT...they would be much better off at the end of 6 years.

The reality is...THAT ISN'T GOING TO HAPPEN for 99% of the people.

So jakelm's logic isn't that far off....

That sums it up, pretty good. Thanks Shack for going through the time to put it on paper.

Both of you are correct, however, the vehicle can be paid in full at any time, with minimal to no penalties. I beleive (I might be wrong here) that there is a much higher penalty for pulling money out of retirement. If Anything in life should happen, just yank the cash and pay the loan off. But untill then leave it and, at least, give it a chance to earn more.

I would rather pay $450 a month and still have my $30k in the bank for hard times, then a vehicle thats worth half of what I paid.. and no money.

madmax

jakelm wrote: »

I beleive (I might be wrong here) that there is a much higher penalty for pulling money out of retirement.

On the paperwork I received it said there was a 10% penalty and they would hold 20% for taxes. (I'm being forced to think about this stuff because of quitting a part time job where I had stock and a pension)

shack

madmax wrote: »

On the paperwork I received it said there was a 10% penalty and they would hold 20% for taxes.

Chuck, 20% is just an estimate. The entire amount you withdraw will be considered ordinary income on top of your regular paychecks, etc. That tax amount could be more if that bumps you up to a higher tax bracket or it causes the Aternative Minimum Tax calculation to kick in.

candyliquor35m

Buy a 4 cyl, 5 speed saturn for $15k and pay cash for it.

See I just saved you $20k

madmax

candyliquor35m wrote: »

Buy a 4 cyl, 5 speed saturn for $15k and pay cash for it.

See I just saved you $20k

Buy a Japanese 4 cyl, 5 speed for $15K.

See, I just saved you another $5K in repair costs.


Shack, understood on the taxes. They just withhold 20% to go towards that cost.

candyliquor35m

madmax wrote: »

Buy a Japanese 4 cyl, 5 speed for $15K.

See, I just saved you another $5K in repair costs.


Shack, understood on the taxes. They just withhold 20% to go towards that cost.

I've probably bought and sold about 100 saturns in the past 7 years and I like the saturns almost as much as nissans but nissans are usually out of my price range

madmax

One guy told me I should consider taking advantage of the loan I'm getting. Pretty much I'm putting down easily 3 times more than is required. He suggested I should use that money for something else like buying a piece of property, maybe a house to rent out or just investments in general. I'm a one thing at a time sorta person so that puts me out of my comfort zone. Any thoughts?

shack

madmax wrote: »

One guy told me I should consider taking advantage of the loan I'm getting. Pretty much I'm putting down easily 3 times more than is required. He suggested I should use that money for something else like buying a piece of property, maybe a house to rent out or just investments in general. I'm a one thing at a time sorta person so that puts me out of my comfort zone. Any thoughts?

Do you really want to be a landlord? Legal stuff, maintenence, checking credit, chasing rent payments, fixing stuff, etc.. Rental R/E can be a good investment but it is not for everybody. If you are going to do though...now is probably a good time...some property is depressed and demand for rental units should increase as more people don't qualify for loans.

It is probably a good time to invest as well. Put some in a decent mutual fund and some in a good safe investment that is relatively liquid, like CDs or Treasury bills/bonds. Again there are still risks out there. We really don't know if the economy has bottomed, whether inflation will continue to rise because of food and fuel, what industries may experience problems, etc...

madmax

I always thought it would be cool to own a place within seeing distance of your main house and rent it out. It seems like there might be easier ways to make money though.

shack

The other thing to consider...would you prefer the equity in your home...or in the investments you mentioned. I assume you are putting in the equity from the home you sold. A way to determine you willingness to leverage and your risk tolerance is the following:

If you had the equity in an existing home that is equal to the amount over and above the required downpayment (that the other guy is suggesting you invest)....would you take out an equity loan to make the investments. If the answer is yes...then put down less and invest the balance. If the answer is no...put it all into the house and move on.

candyliquor35m

The problem with the loan employee you're talking with is that his job is to sell you financing at the highest interest rate that he can sell you even if it's telling you flat out lies and yes when it comes to business and money, that is the norm these days. They may not be doing it intentionally but this is what they've been told to do by their boss or the owner of the company.

TroyD

What shack says is right on the money. You have honestly assess your own individual situation as there isn't a 'right' answer for anyone. You have to be an educated consumer......

BDT

madmax

TroyD wrote: »

You have to be an educated consumer......

BDT

Awe crap, I hate it when that is a requirement...

jakelm

candyliquor35m wrote: »

The problem with the loan employee you're talking with is that his job is to sell you financing at the highest interest rate that he can sell you even if it's telling you flat out lies and yes when it comes to business and money, that is the norm these days. They may not be doing it intentionally but this is what they've been told to do by their boss or the owner of the company.

You couldnt be anymore wrong. If "loan" employees did this, they would have no return accounts and have to live off of new accounts, which would lead to starvation.

Being in the loan buisness, most of my accounts are return accounts, why would I lie and risk loosing my bread and butter? If it works out that the customer is better off paying cash (in which his/her rate is very high or the amount is not worth financing) I always recommend the best route. I want/need then to come back to me.

I want them saying 1,2,3 years down the road. "That loan emplyee did me right the last time, I'm going back"

madmax

jakelm wrote: »

You couldnt be anymore wrong. If "loan" employees did this, they would have no return accounts and have to live off of new accounts, which would lead to starvation.

I agree this is probably correct. I recently met a fellow audiophile who was also in this business. After a couple of hours of listening we got to discussing many things and I could tell he got a kick out of setting people up with good strategies of investments. And no, he didn't try to sell me on anything...
madmax

edbert

You can possibly take a loan from your retirement account. That way with the market downturn, your account takes less of a hit, all the money you pay in principal and interest is paid directly back into your account and not the company, there is no credit check and generally you can take a principal residence loan for 10 years instead of the regular 5 years. Now, you still have to take into account the fact that you will not have the same earning potential as if you just left the money in there, but it is another possibility. Good luck and let me know if you have any more questions.

polktiger

edbert wrote: »

You can possibly take a loan from your retirement account. That way with the market downturn, your account takes less of a hit, all the money you pay in principal and interest is paid directly back into your account and not the company, there is no credit check and generally you can take a principal residence loan for 10 years instead of the regular 5 years. Now, you still have to take into account the fact that you will not have the same earning potential as if you just left the money in there, but it is another possibility. Good luck and let me know if you have any more questions.

What a great way to pay tax on the earnings twice - once when it is earned as loan payments are made after tax, and 2 when you pull the money out at retirement. Also, If you leave your employment with a loan in place, you will likely be treated as defaulted on the unpaid principle balance. I forgot, are we talking 401(k) or IRA? I don't think you can take loans from an IRA only a 401(k) IF you 401(k) permits them. Actually, if you plan permits them, taking a loan is required before taking a hardship unless the hardship is specifically excepted in the Code.

shack

IMO borrowing from one's own 401k is the absolute "next to last" option....with the only worse option being cashing it in early.

edbert

polktiger wrote: »

What a great way to pay tax on the earnings twice - once when it is earned as loan payments are made after tax, and 2 when you pull the money out at retirement. Also, If you leave your employment with a loan in place, you will likely be treated as defaulted on the unpaid principle balance. I forgot, are we talking 401(k) or IRA? I don't think you can take loans from an IRA only a 401(k) IF you 401(k) permits them. Actually, if you plan permits them, taking a loan is required before taking a hardship unless the hardship is specifically excepted in the Code.

shack wrote: »

IMO borrowing from one's own 401k is the absolute "next to last" option....with the only worse option being cashing it in early.

You are both right, I just thought that I would provide a slightly better alternative than just altogether cashing it in. Polktiger is right about the double taxation, but at least the money goes back on your account as tax paid dollars!

madmax

Alternatives are nice to know. Thanks for the info! I sent back the paperwork and will receive a check. I have 60 days to roll it over into my 401K plan at work. They hold 20% anyway so I will put the 20% in from my own funds. Oh yea, I upped my downpayment significantly on the house too. I know I could invest it elsewhere but thats not my style. One thing at a time. On the work 401K I'm upping it to 20% to lower my taxible income this year. So, now I'm broke so I can't waste too much money. Last time I had money laying around I bought speakers, this time I've learned not to keep too much laying around.

shack

madmax wrote:

Alternatives are nice to know. Thanks for the info! I sent back the paperwork and will receive a check. I have 60 days to roll it over into my 401K plan at work. They hold 20% anyway so I will put the 20% in from my own funds. Oh yea, I upped my downpayment significantly on the house too. I know I could invest it elsewhere but thats not my style. One thing at a time. On the work 401K I'm upping it to 20% to lower my taxible income this year. So, now I'm broke so I can't waste too much money. Last time I had money laying around I bought speakers, this time I've learned not to keep too much laying around.

Now THIS is the conservative madmax we all know.