Reader Mailbag: Sources of Information

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. Buying the next house
2. Starting over from scratch
3. Loan disqualification
4. Starting a business
5. Taking care of Mom
6. Building credit with business cards
7. Stocking my HSA
8. New side business and taxes
9. Diverting retirement to mortgage
10. Interest calculations

One thing that deeply frustrates me about personal finance and, frankly, most of modern life is that many people seem to be completely unable to distinguish between sources of information. They seem to think that all sources of information are equal or that sources of information that claim to espouse their values are more trustworthy than those who do not.

Here’s the truth, people. Never stop investigating the things you hold true in your life. Look at sources you agree with and sources you do not. When you’re about to make a life decision based on information, research it thoroughly before you make that move. Don’t just trust everything to one voice – mine or anyone else’s. The more diverse opinions and information sources you have, the better.

Q1: Buying the next house
My fiance and I own a modest town house in an up-and-and coming neighborhood very close to Seattle. Home prices are bloated like crazy here compared to other areas, but the education is great and it’s very safe. While we love our home and have spent almost two great years here, we’re going to need an upgrade very soon. Our home is 1500 sq feet with 2 bedrooms and 2.5 bathrooms. We originally planned on spending ten years here and dealing with the small space, but as time passes we’re less sure about that. A new development has started up the street from us, and they’re making gorgeous homes that range from 2,000-3,000 sq ft. We’ve taken a tour of a few of the demos and the craftsmanship is superb. We’re absolutely in love. The neighborhood isn’t going to be finished for another 3-5 years (possibly longer), but the houses are going up for sale as they complete them.

They’re the perfect size for us, and the perfect life style for us. They were also in our budget for what we wanted to spend on our next house. However, the problem is that we weren’t planning to spend that money for another ten years (not five). A house in that area is an even better investment than our own house, and would no doubt make more money (even in this economy). My fiance and I are thinking about buying one of the middle sized ones (around 2,500 sq ft) 3-4 years from now (after our wedding). We’re just not sure if we could handle the debt, and don’t want to over burden ourselves. The houses mostly feature finished “basements” with exterior entry that could double as apartments, and we would plan to rent that out (since we’re waiting on having children for awhile).

They cost around $625,000-$660,000. While I do not have a credit score yet (I never took on a credit card and I’ve never had debt), my fiance’s credit score is over 750. We’ve never made a late payment. He makes around $85,000 a year, while I am currently out of a job (I got laid off because of the recession and nobody has hired me yet. I had to work full time out of high school school so college was not an option for me. Which, I don’t mind, as I study on my own and read textbooks at the library). I’m 20, and when I do get a job again it will probably be around $17,000-$20,000 a year. My fiance (24) is working up the ranks as a software engineer and has a very secure job. Even without my job, we’re relatively comfortable. We don’t save much money, but we never go over budget and we’ve been able to afford nice things. To save money we’d clearly have to cut back (get rid of cable tv, start cutting coupons and stop eating out). We’re also possibly going to rent out a room for $400 a month.

I really do not know who else to turn to, Trent. My family has never been very good when it came to financial advice since money was never a problem with us (I grew up with a very wealthy family where everything was provided. My parents never thought to explain to me how much work managing that money was). Is it possible to save enough money for a 15-20% down payment within the next five years, or are we going to have to wait longer? Is there any advice you can give us regarding saving that money?
– Erica

I think there are two real rules of thumb you should follow before you take out a mortgage. If you can’t fulfill these two statements, you’re begging for something bad to happen in your life and to have your house be subsequently foreclosed on.

First, you should have a 20% down payment before you start shopping. If you’re looking at a $600,000 house, you should have $120,000 in the bank before you even start looking. Without that, you’re going to have a mortgage with a higher interest rate or with worse terms for you.

Second, you shouldn’t get a mortgage that exceeds twice your household annual income. In your case, that would be a mortgage of $210,000 or so. If you have a mortgage larger than that, you have little or no room for failure. A job loss or even a salary cut would be absolutely devastating if you’re in that kind of debt situation.

At this point, you’re far short on both counts. If you want to make it to that point, you’re going to have to make that your sole focus for the next few years. Your husband is going to have to dominate in his career path and you’re probably going to have to get a career going, too. While you’re at it, you’re going to have to buckle down and start doing some very intense saving.

Q2: Starting over from scratch
I was a widow at age 45. My husband died of prostate cancer. Everything I had went into his care and then some. I have since remarried and am trying to rebuild my financial future – at age 51. I have no clue how to effectively invest what little I can invest. I have seen others in a similar situation – illness and death sucks their financial security into a black hole. Have you already addressed this in a similar way? If you can I am interested in how you would deal with this

– Dori

The biggest thing is that you can’t spend your time worrying about what could have or might have been. You’re 51. You have very little saved for the future. What are you going to do from here?

I don’t have the details of your specific situation, but I can almost assure you that a big key to your plan is to start earning as much as you possibly can. Do you have a skill set that will help you find work that will earn significant money? Can you build on what skills you have (with additional education or training) to earn significant money?

Your concern here isn’t finding the perfect place to invest your money for retirement, but making sure that you are actually accumulating money to save at a significant rate. You must have that in place first before worrying at all about where to invest it.

Whatever you do have should probably go into a Roth IRA (assuming the amount is less than $5,000). Open one with your investment house of choice (I use Vanguard) and put it into something fairly conservative.

Q3: Loan disqualification
Despite never missing a single payment on any bill (something I’m quite proud of), I recently got a letter from PNC bank, the holders of my federal student loans. Apparently I have been disqualified from their interest rate reduction program (2% on one loan, .5% on another loan) because I was paying them TOO EARLY each month. Note that I was still within the payment time frame for the month, but they apparently disqualify you if you don’t pay within the 5-10 days prior to the due date. If you pay 11 days beforehand, you’re disqualified. They claim that they sent me a notice of this in August, except in August I moved to Philadelphia and lost some mail because of my change of address taking awhile. I never get any other billings from them because I do everything online. The biggest problem is that this is the second time I’ve been disqualified; the first time was because my parents, despite being sick, try to send a 5-10$ payment into the loan company when they’re able. Because during a payment period they received that payment first before my larger payment that covered the full monthly amount, they claimed that the first payment wasn’t the correct amount and disqualified me “because the payment can’t be split over numerous payments in a payment period.” My parents’ effort to help shot me in the foot.

It feels like they’re fishing to disqualify me for any reason they possibly can. The bank is refusing to talk to me without the federal government acting as an intermediary, and they’re stating they doubt they’ll help because its the second time I’ve had an exception. I don’t know what else to do. 2% interest is a lot of money potentially. I feel like I’m being punished for paying them back whats owed. I’m considering opening an issue with the Better Business Bureau but I really don’t know what good it will do. Do you have any suggestions?
– Sean

Likely, they are trying to disqualify you. Why wouldn’t they? There’s an agreement between you and them that reduces your interest rate and thus reduces the income they earn. Why would they not want to end that agreement if you didn’t follow the terms of it?

Companies are not out there to act in your best interest. Even the best customer service is almost entirely self-serving for the company. They provide it because it enhances their reputation and becomes a part of the package they’re selling to you, a la Land’s End.

If your agreement was worded that way and you violated the agreement, it’s completely within the company’s rights to adjust your interest rate.

Q4: Starting a business
I recently picked up the hobby of homebrewing. The thing is, I really enjoy it – to the point where I’m becoming a bit obsessive about it. I’ve had a secret dream my whole life to open a restaurant, specifically a quiet sort of bar with good food. I want to open a brewpub. However with over $100,000 in debt still staring me in the face I know there’s no place on earth that will give me a business loan to get started. If I stick 100% to my guns I should be out of debt entirely in about 6-7 years based on my current earnings. I’m following the avalanche method to get out. Is there any way you can think of in the meantime that I can prepare for the venture? I know you made the transition from engineering into a rather different field. I’m an engineer myself (don’t ask how you make the jump from psych to engineering, its a long story :) ) and would just like to see what advice you have.

– Matthew

I would suggest filling your spare time in those years with as much learning about brewing as you possibly can.

Making your own beer is just the start. You should be talking to other microbreweries. You should be touring breweries. You should check out every book on industrial brewing you can from the library and reading them thoroughly.

Through this process, you’ll figure out whether this is really something you want to be doing with your life. If you don’t, it’s no big deal – you still learned many things along the way. If you do, you’ll be as prepared as possible to make the leap.

Q5: Taking care of Mom
My parents divorced when I was quite young, and I am an only child raised by my mom with no support from my dad. The only family I know is her and a few of her elderly relatives. Despite a traumatic marriage, coming from a poor family, and no education, my mom was good with money and managed to provide for me fairly well, for which I am grateful.

I am in my late 20s and just finished grad school. I have a job in my field, but it doesn’t pay well, so I live at home and want to search for a better position in a city where I have more friends. I used savings to help pay for school, so I am trying to rebuild my savings and retirement. I also have $50k in student loans. I am serious about gaining financial independence so I can focus on more meaningful work.

My mom was laid off 2 years ago and has not looked for a new job. I have tried everything to help, from offering to make a resume, encouraging her to get a degree and making a list of job postings for her to apply to. Her reaction is always defensive and angry, regardless of whether I take a kind approach or use tough love.

She used to cover bills with her unemployment, but now uses savings. She’s started cost-cutting in a negative way – buying poor quality food/household items, getting rid of health insurance. There are also many things in the house in disrepair, that I don’t have the skills or funds to fix. Because of her outlook and loss of job skills, I have little confidence she will work again, and she is too young to retire. She seems to think things are fine, but I have a huge weight on my shoulders.

I want to move away and progress my life and career, but feel the need to stay at home and save money now to bail her out later, especially having no able family. I am even considering a second job. I want to help, but giving her money enables her to avoid her problems and hinders my goals. I can’t financially support both of us, and I don’t feel I should take care of someone being irresponsible, despite her being smart enough to know better. I am tired of the anxiety and unhappiness – how can I help this situation without giving up the things that are important to me?
– Roger

At some point, you have to recognize that people have to choose to help themselves. You can lead a horse to water, but you cannot make them drink.

If I were you, I’d give this some distance. Step back and let her hit her rock bottom, whatever that is, then be ready to help her pick herself up (at your discretion, of course).

Do not let your mother’s choices bring you down. She will find her own path through this. It will probably be different than the path you would have taken, but that’s fine.

Q6: Building credit with business cards
I’m 27 years old with 10k in student loans and I’ve never owned a personal credit card. On the advice of a co-worker, I have made large purchases on my corporate American Express card in order to build credit. I’m not too certain of the limits around this– at what point does this become detrimental and I should apply for my own personal rewards-card? I want to optimize my spending and build credit.

– Chris

The first thing you need to do is make sure this card is actually appearing on your credit report. I’d head over to the FTC’s website at annualcreditreport and find out what your credit report actually looks like.

The biggest thing that purchases on your card has shown is that you have a history of making your payments on time. The size of the purchase really doesn’t matter too much – what’s important is that you’re showing yourself to be reliable, which has a positive impact on your credit.

It probably wouldn’t hurt you to have a card of your own, especially if your business card isn’t appearing on your credit report. If it is (and you’ve been making your payments), you’ve probably already got a solid credit score.

Q7: Stocking my HSA
My question involves how much money should I be putting in my Health Savings Account. I am 26, relatively healthy, single, and maxing out my Roth. My employer provides me with a high deductible ($1450) insurance plan and an HSA, to which my employer and I both contribute $50 per month. $1800 is in the account as of today. Should I keep adding to it at my current rate or are there any benefits to maxing out my contribution for the year? My HSA allows me to invest with Charles Schwab now that my balance exceeds $1000, should I do this?

– Michelle

Since you have more than a deductible’s worth saved in the account, I think it would be okay to reduce your contributions. How much depends on whether your employer continues to contribute without you. If you reduced your contribution to $0, would your employer still keep putting in $50?

I would adjust my contribution so that $50 a month is going into the account in total, then redirect the remainder into something else you need in your life.

I probably would not invest with Schwab, at least not in anything with risk. The downside to that risk is far worse than the upside of a little bit of growth within an HSA.

Q8: New side business and taxes
My wife and I both have full time jobs, but my wife does some event/portrait photography in her spare time. She would eventually like to do this full time once she builds up a good reputation/client base in the area. In the past year she’s earned about ~$5,000 max from the 10 or so photo shoots she’s done. We keep all of our personal finances separate and she mainly just keeps the cash from her “business” in a envelope in our home fireproof safe. We have not formed any sort of LLC or anything, so no “company” exists yet. My immediate questions are relating to taxes. Do we need to report that money as income on our taxes? The amount of time she spends shooting/editing/etc. doesn’t come close to equally $5,000 even at a minimum wage. Not to mention she’s spent at least $3,000 on camera equipment. So, she’s undoubtedly operated in 2010 at a loss.

– Sam

Your wife is running a business as a sole proprietorship. She should report all income to the IRS, as well as deduct the expenses she incurred for this.

I would highly recommend using TurboTax or some other form of tax software for this. You don’t want to mess this up and the small investment in such a software package will alleviate some serious pain later on.

Typically, it’s not an issue registering a sole proprietorship at a small loss for a year or two, but continual losses often looks like a tax dodge and can garner IRS attention. Just be honest and you can’t really go wrong.

Q9: Diverting retirement to mortgage
We are way underwater on our home. Our outstanding mortgage is $134,260.99 and our estimated home value is now around $85,000, so there’s no way we qualify for the MHA program as things stand now. I know you are really big on saving for retirement, but I still wonder if in our situation it wouldn’t be better to use about $30,000 from our IRAs to pay down some of the home so that we will qualify. This won’t be the entirety of our retirement savings but it’ll put a big dent in it. We’re both looking at retirement in about ten years. We’ll both have Social Security and my husband has been a union carpenter all his life so he’ll also have a pension. At the rate we’re going, the home won’t be paid off for another 15-20 years. What do you think?

Another thing we’ve been considering is simply buying a rental property outright with money from our IRAs and using the income from that to help with living costs. Our IRAs and 401k sure haven’t been making any money over the years (in fact, they’ve pretty much just rebounded from the most recent value dive) and at least a rental property would provide a regular and substantial inflow of cash. The real estate market took a huge hit here in San Bernardino County, CA, so it’s not unrealistic to find a property for $30,000.
– Lydia

There are several problems with treating an IRA as a savings account.

First, it takes money straight away from your retirement. What happens if your husband passes on and there is no pension, or your husband and you split for some reason? The IRA money will be your key to survival.

Second, you’re going to get hit with a big tax burden if you start withdrawing IRA money prior to retirement. It will be treated as regular income that year, which means that you’ll have to pay income taxes on it, plus you’ll also have to pay an early withdrawal penalty on top of that. Remember that this income will be on top of your normal income, so you’ll be likely handing 40-50% of it right to the federal and state governments.

It’s almost never worth it to withdraw an IRA early. You lose a large chunk of the value of it right off the bat while also increasing your retirement risk.

Q10: Interest calculations
I have two bank accounts, one that earns 1.50% interest that is compounded monthly and another that earns 1.00% interest but is compounded daily. Which one would earn me the most interest?

– Evan

I would take the 1.50% interest account, without question.

The differences between compounding do make a difference, but it’s a small one. If the rates were the same, I’d vastly prefer the daily compounding.

What actually happens is that the quoted rate is sliced up over each of the periods and paid out at the end of the period. So, your monthly compounded account pays out 0.125% interest on your balance each month, with that amount usually going right back into the account. The other account pays 0.00274% interest each day.

Let’s just look at a single thirty day month. You start with $1,000 in each account. At the end of the month, the first account will pay out $1.25 and add it to your balance, giving you $1,001.25. The second account will pay out a little bit shy of three cents a day. At the end of the month, that account will have $1,000.85, according to my envelope math. Now, that’s better than what you’d have with monthly compounding, which would be about $1,000.83, but it doesn’t make up for the huge difference in rates.

Go with the 1.50% account.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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