April 2011 Nine Year Mortgage Newsletter

Possible home and auto insurance savings….

If you can free up $33/month, you can usually take one or two months off your debt plan—this is found money!
If you have not taken the time recently to make a comparison of the cost of your insurance premiums with other companies, you are probably paying too much for your car and home insurance.  Let me tell you why.   About two and half years ago I went in to see my insurance agent with a quote from another company.

Immediately my insurance agent proposed a move to another company so we could beat the quote I had brought in.  It was amazing how quickly that happened upon me walking into his office. Just two weeks ago I got on the internet and asked for another broker to give me insurance comparisons from several companies.  After answering a few questions and visiting with Crystal on the phone I ended up saving over $100 on my home insurance per year and $300 on my two cars each year.   That gave me $33.00 extra per month to put into my emergency fund, or apply to my debt plan to eliminate all my debts faster than ever.  Your insurance score that the insurance companies receive from the credit bureaus is constantly changing, and in many cases it will allow you to get a lower premium on your insurance than you think is possible.

What is the difference between a credit score and an insurance score?   A credit risk score is a number, produced by evaluating information in your credit file at a credit reporting agency, which evaluates the likelihood that you’ll pay your bills on time. FICO® scores, the scores that most lenders use, are based on mathematical models built by FICO and are available from any of the major credit reporting agencies (Equifax, Experian, and TransUnion).

These are used by financial institutions and retail credit grantors for all kinds of decisions: whether or not you get a credit card, or what kind of an interest rate you qualify for on a mortgage loan, for example. A different kind of a score is used by most insurers to help evaluate the risk of insurance applicants and policyholders. This score, generically called a credit-based insurance score indicates whether you are more or less likely to have claims in the near future that will result in a loss for the insurer.

There are obvious similarities between your credit risk score and your insurance score: There are, however, important distinctions. The credit risk models are built to predict the likelihood of delinquency or non-payment of a credit obligation. The insurance risk models, by contrast, are built to predict the likely “loss ratio relativity” of any particular individual.  Loss ratio is the amount paid out by the insurance company in claims divided by the amount they collected in premiums. Loss ratio relativity measures whether the cost of your insurance claims is expected to be higher or lower than average. Insurance scores are not the only factor used to set pricing, nor can they be used to deny coverage to any consumer.  This score is most often just one factor of many in an insurer’s underwriting evaluation.  Because of my experience with Crystal I would recommend going to her website which is www.expressinsurance.net  or give her a call at 801-655-1823 for help.

A profile of the average American financial situation…

Americans have grown up with the saying “Keeping up with the Jones” and they have come to accept it. Americans want to have everything that their neighbors have, and if they don’t have the money to buy it, they put it on credit. They believe that they need to live the same type of lifestyle as those around them but that lifestyle can quickly spiral out of control. Americans and the government fail to live within their means. Instead of cutting back on expenses and saving some money for the future or even retirement, many live in the moment. And unfortunately, that’s difficult to come back from.

The combined amount of personal debt in the US is $2 trillion which is about the GDP of England. That means Americans are in debt more than a country earns in a year.  And that $2 trillion debt boils down to $117,951 per household.  The statistics don’t get much better from there. Even though Americans are a hard-working and industrious people they undertake too much debt and save too little. In the 1960s the average American saved 11 percent of their paycheck and in the 1990s it had decreased to 5 percent and then in 2003 it fell to 2.3 percent. However, because of the shaky economy, savings among Americans have recently risen and now comprise up to 5 percent of their disposable income.

But despite the savings, many are failing to save for retirement Medicare and Social Security are going bankrupt, so individuals can’t rely on those programs or the government when they retire or can no longer work. They need to save up their money and prepare for their future. Currently, only 18 percent of Americans are confident about having enough money for retirement. And only 60 percent of Americans are saving for their retirement. So what about all those that aren’t saving? Hopefully they have some children that will take care of them in their old age or some backup plan.

Finances are tricky especially in today’s world, but it’s important to cut costs where you can and get a savings plan. As prices continue to rise and incomes (well don’t) it’s important to keep debt to a minimum and look out for yourselves and your family.

Remember, you don’t have to have everything brand new and it takes time to accumulate things. When people get married today they think they need a house and everything in it.

In the past newly married couples would start out with furnishings they got from a family member, at a yard sale, or just do without. But today the expectations Americans have can sometimes get out of control.

Beware the Debt Monster!  Look at compound interest …

Look at how compound interest can work against you.  Credit card and mortgage companies understand this.  You must get out from under their grasp. Be afraid, be very afraid of your debt. It is growing this very moment without you charging another thing. “Why?” you ask… because of compounding interest!

In terms of debt, the simplest way to think of compounding interest is to think of paying interest on interest.  Each month, interest is added to the principal so that every month thereafter, you are charged interest on the interest that has accumulated up to that point, as well as the principal, until paid.  This may be contrasted to simple interest, where interest is not added to the principal.  Simple interest is rarely used and monthly compounded interest is standard on most loans and credit cards or lines of credit.

Example: Suppose you borrow $1,000 at a simple annual interest rate of 20%.  At the end of each year you would owe $200 in interest, plus the $1,000 in principal until paid.  Therefore, at the end of five years you will owe $2,000 ($1,000 in principal and $1,000 in interest) as follows:

Year    Principal    Interest    Balance
1    $1,000    $200    $1,200
2    $1,000    $200    $1,400
3    $1,000    $200    $1,600
4    $1,000    $200    $1,800
5    $1,000    $200    $2,000

However, if you borrow $1,000 at an interest rate of 20% compounded annually, then, assuming no payments, at the end of five years you will owe $2,488 (the original principal amount of $1,000 + $1,488 in total interest), a full $488 more:

Year    Principal    Interest    Balance
1    $1,000    $200    $1,200
2    $1,200    $240    $1,440
3    $1,440    $288    $1,728
4    $1,728    $346    $2,074
5    $2,074    $415    $2,488

Using the same examples over 10 years, at high interest rates, the amount owing can grow quite quickly.  At the end of ten years the compounded interest loan has grown to double that of the simple interest loan.  As credit cards are normally compounded on a monthly basis, interest can often be more than the original principal amount when only minimum payments are made.

What is the danger of making minimum credit card payments…

Let’s say you have $1,000 outstanding on a card at 20%.  Assuming no new purchases,
if you have a minimum payment of $25, what is your balance next month?

Well, the $1,000 accrues interest of $16.67, so if you pay $25, you reduced your principal by $8.33, and the new balance is $991.67.

In a year the math goes like this:  You pay $300, the credit card accrues interest of just about $200, and at the end of the year, you have reduced the balance by $100.

How good an investment is this?  You pay in $300 and you get credit for $100?
The answer is that it depends on which side of the equation you’re on.  The credit card company loves it.  You are hating life.

This is why the old saying is true:  “He who understands interest collects it, and he who does not understand interest, pays it”.

How can you beat this rap?  The only way is to pay a little bit extra.  If you could find $5/week to pay as extra principal on this debt, you’d have $20 new each month.  That would take your payment up to $45/month.

Now let’s re-do the math for a year.  This time you pay in $540, and the credit card accrues interest of about $200.  (Actually, it accrues less, because the principal balance is going down—the exact figure is just over $140).

So, in this example, you actually reduced your principal by $400!
Bottom line–you paid in $540 over the year, and you got credit for $400.  Things are looking a lot better, aren’t they?

And how hard was it to come up with $5/week?
That’s skipping one lunch out each week.  It’s skipping two coffees a week.  It’s skipping one soda each day.  It can be done.  Where there’s a will, there’s a way.

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