... Engineered Consent

This video has been sent to us by one of our readers. It deals with the exactly the kind of subjects that made us start this blog. A lot of things that we do in our daily lives, a lot of thoughts and ideas that we might be having we designed and placed upon us by someone else. It is important to recognize that and attempt to live a bit more “examined life”. The title of the video “Century of Self” does not do justice to this four-hour program. One of its subtitle “Engineered Consent” makes much more sense. So, set a side a weekend afternoon and prepare to be shocked.

... short term mortgages

This post came to be as a response to the recent discussion on Get Rich Slowly of benefits of either 15 or 30 years mortgage. Obviously, the prevailing wisdom is not to have mortgage at all, and if one is required pay it off as quickly as possible making a strong case for a shorter mortgage.

First of all, do you really need a mortgage? Before jumping into a house purchase one should seriously weigh all factors of rent vs. buy decision, but that’s a perfect topic for another time.

Before we get to the topic at hand, it is important to articulate two important concepts that are intertwined within a mortgage – they are long and short term liabilities. The definition of short and long is usually pretty arbitrary, so here, we’ll choose a threshold of three years. In other words, any payments you’d need to make in the next three years is a short term liability; and any payments from there on – is a long term liability.

Keeping that in mind, the decision about mortgage’s length is more of a balance shift between long and short term, or so it may appear at first. Let’s say, your intent is to pay off the mortgage as soon as possible, and you are not planning of sitting out the entire 30 or even 15 year term. Great! This means that your decision will have no bearing on the long term side of the equation – at the end of the day, your long term liability will always be the principal (house purchase price less downpayment) plus whatever the interest has accumulated. On the short term side, things change quite dramatically. Let’s take a look at the following example:

On a $500,000 house with a 5% mortgage and monthly repayment plan a 15 year mortgage will translate into $3,954 payment, whereas a 30 year only $2,684. What that means is that every month you will need to come up with $1,270 or 32% less under 30 year plan.

And that is exactly what I mean by short term liabilities. Having this extra $1,200 every month will provide a significant cushion for your financial situation. If we were to expand the discussion, I would recommend an all-interest mortgage altogether. Even though, the days of zero-depreciation mortgages are mostly over, under that scenario you’d be looking at $2,083 required payment, further improving your financial situation.

Before you proclaim me crazy, let me address some of the more obvious and likely concerns:

• Why in the world, would you need a half-million house? Great point, you should only buy as much of a house you need and can afford. Half a million in this case is just an example.
• Sometimes interest rates vary based on the term. True – get the rate/term combination that results in the lowest required payment
• More frequent than monthly payments allow you to pay off your mortgage faster. Not true! You are just making the same payment in smaller steps.
• If my payment is lower, I can afford a bigger house. Technically true, but this post is about trying to save you money not inflate your lifestyle.
• I don’t plan on sitting the mortgage out for 30 years. Then don’t – very few mortgages see their full term, most of them are closed due to sale or refinance, so few folks ever sit them out
• Finally, what do I do with all this extra cash, should I spend it? Unfortunately, this is the trickiest part of all…

…You definitely should not be spending this money! Instead you should place it in one of the safer long term investments available to you. If you are planning to pay off the mortgage in 10 or 15 years – check out some government bonds, either directly or by means of a mutual fund. Stay away from equity or corporate bonds, this money is earmarked to ensure your security, do not gamble with it. Bank CDs or GICs are another viable alternative. Keep putting this money away until you are ready to move, refinance, renew, or have enough money to get out altogether. Every once in a while, when you are feeling particularly brave, you can throw in an additional payment or two.

Some things to be aware of under this plan is the bank penalties. Banks may not like early pre-payment, so you’d need to figure out the best balance between penalties and benefits of early debt-free living.

Hope this was helpful. In terms of disclosure, this is a method that we have personally used, so I welcome any kind of questions or comments. I would leave you with one final thought: when choosing among financial products, always ask yourself a question, who benefits from either choice most. Funny enough, banks win with shorter term mortgages and hate pre-payments. Short term mortgages provide them with less credit exposure, faster equity appreciation (in case they’d need to repossess the property), and less interest rate risk (they are less likely to be stuck with too low a rate for a long time).

… exchanging currency abroad

If you ever travelled abroad you have undoubtedly faced the very unfair exchange rates at the local exchange bureaus – some rates can be as high as 10% off from the wholesale currency market. Fortunately, there is an existing alternative to this injustice.

There are some people who are seriously averse to using credit cards, but they could be quite a convenient solution in this particular case. First of all, credit cards are accepted virtually everywhere and there are cash machines all over the world to easily obtain foreign currency. Secondly, it is much safer and more convenient to carry cards than wads of domestic and foreign cash when you travel. Finally, the rate you get is much closer to the wholesale rate than you get by any other means.

The biggest concern with using credit cards is cost. Most credit cards charge foreign transaction fees when foreign currency is being used. They range anywhere between 0 and 3%. There are opportunities to find the lowest fee card possible (you need to check the fine print of your credit card agreement).

If you plan to withdraw foreign cash from an ATM, keep in mind that some ATMs do charge a hefty commission for the transaction. These fees are usually posted at the machine itself. At the same time, most banks in Europe do not charge any fees on getting cash from your credit card. However, this transaction will be considered a cash transaction by your credit card with all related complications. Most cards charge fees to obtain cash regardless of the currency, which could be as high as 5% and may have a fixed minimum like $5. Credit cards also start charging interest as soon as transaction is processed. To manage these issues, you should find the card with the lowest fees and cash advance interest charges. Also, prior to the trip you should pay off the entire balance (and may be some extra), and pay the new balance off immediately at your arrival back home. This will help you to keep average balance at the minimum and avoid interest charges altogether.

Finally, not all cards are accepted everywhere. Visa, just as they claim, is the most widely accepted, closely followed by MasterCard. American Express is slightly less popular. Such cards as Discover, Diners Club and JCB are virtually unheard of in most countries outside of major hotels and airlines. There are other acceptability issues as well. For example, credit cards issued by American banks (Citi, Amex, Capital One) are not accepted in Cuba due to embargo. Some other countries are also suspicious of foreign cards, especially when used for online purchases.

So, you need a card that is accepted at your destination and carries the lowest combined fee for foreign transactions and cash advances, if you plan to withdraw cash, or just foreign transactions fore regular purchases. At the end of the day, even with all the fees, it could be much cheaper and safer to use your card abroad instead of carrying cash or travellers cheques (with their own fees and acceptance issues).

Domestic Amount = (1 + Cash Advance Fee %) x (1 + Foreign Transaction %) x (1 + ATM fee %) x Foreign Amount
Or (Min Cash Advance Fee) + (1 + Foreign Transaction %) x (1 + ATM fee %) x Foreign Amount