Category: Maximum Potential

Is It Better to Rent A Home Or Buy?

In this article, I am going to tell you something you already know, or sort of.  To make sure I need you to answer a question;  Is it better to rent a home or buy?  The overwhelming response to that question is it better to purchase a house instead of renting one.

Although you answered the question that it is better to purchase a home, I am going to use Truth Concepts calculators to prove it to you.  Don’t stop reading because you think you know it all.  Stick with me and I am sure you will like the results. Plus there is a bonus idea at the end if you read it all.

Using a Maximum Potential calculator I am going to illustrate your rent costs over a 30 year time period.  I am assuming your initial rent is $1,000 a month and there is 4% inflation in rent in your area.  As you see below the total amount of rent checks you will write over that time is $673,019.

If you were to purchase the exact same house let’s say the purchase price would be $360,000.  In the current economic environment, we could get a 4%, with a 20% down payment ($60,000), 30-year mortgage.  Using the Loan Analysis calculator we see the following:

The most glaring thing you will notice is that the monthly payment is initially about 40% more expensive, $1,432.25 versus the $1,000 a month rent.  Looks like to me if we limit our vision of the problem to the initial monthly cost then renting is cheaper.  But then you notice that the total amount of mortgage checks for purchasing the house is $515,609.  Oops, looks like purchasing is cheaper.

Wait a minute are we really comparing apples to apples?  No, of course not, when you are renting and the toilet springs a leak what do you do?  Call the landlord and they come and fix that leak.  A similar process happens with every other problem with the house.  In some cases, the landlord takes care of the landscaping including mowing the lawn.  So we need to think about repair costs as well as other maintenance fees.  Oh and don’t forget the property insurance and property tax.

Using the same Maximum Potential calculator we can calculate how much you will spend on these items.  Please note in the annual income (really a cost in our story) I put the total monthly cost of the property tax, insurance, and repair, i.e. $375.  I then multiply that by 12 to get the $4,500.  The following is the result:

So in addition to the mortgage, we have an additional cost of $252,382 for purchasing a house, bringing the total to $767,991.  We also have to consider the down payment.  Like I assumed you decided to avoid private mortgage insurance so you came with 20% or the purchase price or $60,000.  At this point, it looks a bit more expensive to purchase a house than to rent.  (Purchase is $827,991 versus renting $673,010.)

With a lot of variables and issues, it might seem hard to actually know which is the best. Luckily at Truth Concepts, we have a calculator to help us out.  (Really do we need to KNOW if it is cheaper to buy a house versus renting?  We already know it is better to buy.  We know because everyone knows that.)

The Real Estate Analysis calculator is useful in our current situation – evaluating the purchase of a personal residence.  When you enter the numbers from above and click on the “personal residence” button right above the ROR box, you get the following:

Are you surprised by the result the calculator helps us to arrive at?  Like I said, I am going to tell you something you already know.  It is better to purchase a house than to rent it, from a financial point of view.

Let now consider some other reasons people feel that buying is better such as:

1)  Appreciation of the asset over time, that we enjoy as the owner.

2)  Tax advantages that we have not discussed, but the calculator allows us to account for them.

3)  Equity build-up that we get back when we sell the house.

4)  There is an emotional sense of pride from ownership.

5)  Control of the asset.  In other words, you can make changes to the house as you see fit.  You can put up a new wall or take one down, paint, nail etc.

6) You can borrow against your equity!

You should be asking yourself, why is this article even written?  Everyone knows that purchasing a home is better than renting.

Here is the heart of this article:  Purchasing life insurance is better than renting it.  (Whole life versus UL or term.)  Why is whole life better?  For all the reasons this article has pointed out and then some.

Now for the bonus, I promised: Can you see a new way to use our awesome software to help your clients see the WHOLE truth about financial decisions?

 

-Jason Henderson for Truth Concepts

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The Myth of Zero Percent Financing for Cars (John & Jane Jones Pt. 2 of 9)

Both Jane and John Jones were smiling as they walked into my office for the second meeting with them.  The first meeting had gone well and I was excited to meet with them.

After a few minutes of catching up and pleasantries, I asked John, “If you were talking to a good friend and they asked what our office was doing for you, what would you tell them?”

John was contemplative for a moment and then started to speak. “Well the first thing I would tell them is that you have completely changed my thinking about whole life insurance and its value.  You did not just convince me, but you helped me by using your special calculators, see the whole truth about how money works.  In fact, I would probably tell them that your office has not tried to tell me what to think, but has rather helped me to learn how to think.”

“That is quite a compliment, thank you.  I hope you have opportunities to say exactly that to people you care about,” I replied.  “But I want to make sure you understand one critical thing: I never want you to assume my opinion to be correct.  I want you to question everything I tell you. I want you to make your decision on your own – always.  With that as a starting point, I want to approach an issue that I think is rather important.  Are you ready to get into the serious side of our discussion today?”

Jane answered, “We definitely are!  And, just so you know, my parents are so happy you helped us to see the wisdom in their decision to purchase that whole life policy for me when I was a year old. They send their thanks.”

I couldn’t help but smile.  “Why thank you, Jane. That is very kind of you to report.”  Getting a down to business, I told them about a recent study done by Lexis-Nexis.  “Do you realize that 43% of American families own no life insurance?  And of the 57% that do own it, 30% of those believe they have inadequate amounts of life insurance.  Why do you think such a large portion of Americans are either under-insured or uninsured?”

“But I thought we were going to talk about purchasing a car – that is what we told you we wanted to talk about,” John said.

“Yes, I want to talk about that,”  I replied, but humor me a little as I help you to see a very important financial truth. So why are so many people uninsured or underinsured?”

“Well, I guess it is because people have never met someone like you?” Jane said, almost questioning.

“Or maybe it is because they do not understand the value of life insurance,”  John added.

“You are both on the right track.”  I complimented them.  “Have you noticed there is a disturbing trend in America that people do not understand the value of work?”

“Yes!” was their unified answer.  “It seems that many of my peers do not know how to work or even value the fact that they have a job,” John added.  “They just figure they can get another one if they don’t like what they’re doing or if something goes wrong with their employment.”

“It is a bit alarming, isn’t it?”  I responded.  “But an issue I believe is even more fundamental, is the confusion most people have about which of their assets is most important. What do you think most people would say is their most important asset?”

 

Once again both Jane and John answered together, “Their house.”

“You’re absolutely right – most people consider their home to be their biggest, most important asset. And it’s pretty safe to say that almost everyone has their house insured. But I disagree with that view. In fact, I think that perspective causes a serious lapse in financial judgment. A home – although definitely an important thing to have – is not the MOST important asset. The most valuable asset almost everyone has is the ability to earn their other assets. I believe – and tell me if you agree – that a person’s most valuable asset is their ability to work and make money. And yet very few have that asset protected sufficiently.”

John spoke up and said, “There you go again, helping us to see the bigger picture.  When you put it that way, I can’t help but agree with you.  I was surprised by the statistics you gave us, but knowing that information, it is even more surprising.  Everyone should insure their best asset.”

“So then, how much insurance should they have on their most valuable asset?”  I asked.

“As much as they can, of course.  At least, that is what everyone does with their house,” John answered.

“I am so glad you said that John. Let me show you why. I want to show you another calculator called the Maximum Potential Calculator.  I am going to use numbers for you both individually as you both are making about $45,000 a year.  I am going to illustrate this until age 65.  Let us assume that you will have a cost of living increase of about 4% each year.”  Pointing to my computer screen I asked, “How much money will each of you potentially earn in those 41 years?”

“Wow that is a big number,” was Jane’s first comment.  “Really?  We are both on track to make nearly 4.5 million dollars by the time we’re 65?” Jane asked.

“Yes, that is the amount of money that will come into your life in the form of payment for your ability to work.  Pretty valuable isn’t it?”  I said.  “There’s another important number to notice on this chart – what is projected to be your salary during the last year when you are 65?”

“$216,046.  Wait, is that for real? It would be great to earn that kind of money.”  John sounded a bit excited.

“Well John, let me ask you a question: will that $216,000 purchase more when you are 65 than your $45,000 salary purchases for you today?”  I asked.

“Of course it will.”  John blurted.

“Actually, the truth is this calculator shows the $216,000 salary you’d earn 41 years from now, is the equivalent of a $45,000 salary today.”  I continued, “In fact you most likely will be able to purchase even less because of taxation.”

“That is depressing.  But knowing that now can help me in the future.  But what does all this have to do with our most valuable asset?”  John inquired.

“The whole goal of home insurance is to replace your home if there is a complete loss. The same is true of life insurance.  What is being replaced is your ability to work and earn money.  In order to know how much life insurance you need, you need to estimate how much you will earn over time.  Let me put this another way –  what amount of money would you need in today’s dollars compounding at the same 4%, to be able to replace your ability to work and earn money?  But we are getting ahead of ourselves.  First, we need to look at another calculator, this one is called the cash flow calculator.  Again using the same 41-year time frame we are going to use your net income ($29,250) instead of your gross income ($45,000) because the government will always get their share.”  Pointing to the screen I asked, “what is the compounded value of your total net income?”

Looking for the red circle, John answered, “$7,367,704.”

“Great, but that is in dollars of 41 years from now.  What we need is to know the present value of that amount in today’s dollars.”  I quickly brought up a present value calculator and input the numbers. “What amount of money do we need today to make sure your ability to work and earn money can be replaced?”

“About a million dollars,” John said.  After thinking a moment, John looked at Jane and said, “It looks like we each need an insurance policy for $1,000,000.”

“Yes, we do. We better do as we are learning and do the most important things first,”  Jane said.  Turning to me, she said, “We need to get going on protecting our family’s most valuable asset.”

“I am glad that issue is out of the way.  I wanted to cover that with you before we got to your questions about purchasing a car.  Like John said, we like to help our clients discover, learn and understand the whole truth about their financial environment.  When you understand the whole truth, it becomes easy to know what decisions need to be made first.  You two are great students and have a bright future ahead of you,”  I said.  “Now on to another important concept, purchasing a car….”

“Did you get the proposal we sent to you?”  John asked.  “You know that 0% interest loan seems like a no-brainer to me.  But Jane really wanted to get your perspective before we made that purchase.”  John added.

“I am so glad you did because there are a few nuggets of truth you need to understand.  To start off, answer this question for me, ‘How does a car company make money?'”  I asked John

With a puzzled look on his face, John answered, “By selling cars.”

With a little chuckle, I said, “You are right. But think further; why do all the major car manufacturers offer to finance your car for you?  Is it possible they make money financing cars for people?  In fact, the car companies make more money financing the purchase of cars than selling their cars.”  I explained.  “But then there is the interesting offer of 0% financing.  If the financing is the major way they make money, why would they give that up?”

 

“I am not sure why they would, but isn’t that what they are doing with the 0% financing?”  John answered and asked at the same time.

“How much does the car you are considering cost if you financed it with the manufacturer?”  I asked.

“$35,000.”  Jane volunteered.  “Which will give us a monthly payment of $729.17.”

“Great.  How much will it cost if you pay cash or finance it through an outside source?”  I asked.

John beat Jane to answer, “$32,500.”

“So the car company will give you a rebate of $2,500 if you pay cash and drive off with the car.  Let me show you what the car company is actually doing by using my rate calculator. “I input the numbers, using the rebate cost of the car with the SAME car payment.  I then asked, “What interest rate are they charging?”

“3.68%?”  Jane asked, confused.

“Yes, that is correct.  By just raising the price they can call it 0% financing.”  So here is the next question: should you purchase the car from the manufacturer, using your policy as collateral or should you finance it at the credit union?” I smiled as I asked them.

Thinking out loud, John said.  “Well, at the manufacturer’s dealership our payment will be the same as at our credit union if they charge us 3.68%.  But they have offered us a rate of 2.99%.  So the better interest rate is at the credit union.  I know using our policy is a great way to minimize opportunity costs.”  Looking at me he then asked, “How much does it cost to get a loan from the insurance company?”

I wanted to jump up with excitement.  At our first meeting, this 24-year man wanted to get rid of his wife’s policy, but now he wanted to use that policy to finance a car.  “John,”  I started “you are beginning to understand the real value of a whole life policy.  But as I have said, a number of times, the whole truth is important.  If you use your policy as collateral for a loan from the insurance company, the interest rate will be 5%.”  I then waited to see what they would say next.

Again thinking out loud, but also looking at Jane, John said, “It seems to me that the credit union is the best way to go, unless I am not understanding something.”

“You are right.  You have to remember that just because you have cash values doesn’t mean you have to finance everything possible using those cash values.  You only use them when it is to YOUR advantage.  This time, it appears the credit union is the best way to go,”  I said like a proud teacher.

“Ok then, it is settled.  This has been a great meeting.  We will fill out an application for a $1,000,000 term policy for each of us right now.  We will buy the car using the credit union as the financing tool and set up a time for our next meeting.  Sound good?”

“Sounds great,” I said.

 

-Jason Henderson for Truth Concepts 

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Steps for the First Truth Concepts Meeting with a Client

Bold italics are the client’s answers

I’m glad we get some time together today.  We are going to be using software to numerically prove the truth about how money works as it grows and to discover the most efficient way to get your money to work as hard as it can.  Before we begin I have a few questions.

If we were meeting here 3 years from today, what has to have happened for you to feel pleased with your progress?

I’d like to have my money working harder for me, feel like I have financial options

Ok, what is the biggest danger for you now?

The loss of my 401k value, don’t know where to invest

I understand, what is your best opportunity right now?

My business is decent, and  I enjoy my work,

That is great and something to be grateful about for sure!  Are you conceptual or analytical?

Both actually…I know that’s an  unusual combo but its helpful

So, what do you think builds more wealth, increasing the rate of return

or decreasing the costs to build that wealth?

increasing the rate of return …that’s what I’ve always been told by the media and my other financial advisors

Response: well let’s take a look, I’ll pull up a Maximum Potential Calculator and we’ll figure it out.  This is from a suite of calculators known as Truth Concepts.  It enables us to be very transparent in our work with you by showing the gains as well as the costs.  You can actually buy the software yourself if you so choose at www.truthconcepts.com .

We use it to analyze all sorts of things about your finances as you can see here on this list of calculators, but for now lets look at the issue of returns versus costs.

MAXIMUM POTENTIAL CALCULATOR:

We’ll look at a Period of 35 years and you said your Income as $100,000.  It should Increase at least 4% a year if not more and for starters we’ll set an after tax Earnings rate of 5%.  You can see on the right hand side that if you didn’t have to eat or pay taxes or spend money in any way, your Maximum Potential would be 16 million.

Now, watch what happens as we add Truth to the situation.  Right here in the middle we have Total Taxes at 40%, that’s everything, fed/state/sale tax/property tax you name it.  Notice how 2.9 million of taxes dropped the savings down to 9.8 million.  That is opportunity cost in action which we’ll talk about in a few minutes.  For now lets stay focused on this issue of increasing returns or decreasing costs being the better way to build wealth.

So, we’ll set Debt Service at 34% as statistics show the average American family spends about 34% of their income in debt service.  Now were down to 4.2 million.  And we’ll set Life Style at 23%.  Ouch, now we’re down to 494,000.  Lets change Other to Gifts at just 1% and here in the middle we have what most people are doing, which is saving 2% of their income.  Now I see you are saving more like 10 or 15% and I commend you for that! But if this picture were true, there would be 329,000 and you can see that is not even one years worth of income  (which is 379,000)  So, on the right we’ll stay focused on that 329,000 figure.

Again, lets stay focused on our question here:  Can we build wealth more effectively by changing the 5% net annual earnings rate on the left or by decreasing costs in the middle?

Again, right now I’m not including inflation to keep this simple.  On the left hand side, lets try changing our 5% to say 10%.  I know it might mean increasing risk, but lets try it.  Before I do, you watch the 329,000 on the far right.  Going from 5 to 10% did what?

Brought it up to only 885,000. That’s horrible! At least it’s two years of income, but that won’t cut it.

 You are right, so lets go back to 5%.  What if we reduced costs.  Now when I say that, are you thinking I’m going to ask you to eat out less?

YES!   

Well, lets see if we can find ways to reduce costs that don’t reduce lifestyle.  What if we shifted our assets around a bit and were able to reduce taxes to 35%?  What did that do?

It changed 329 to 1.1!

And what if we reduced debt down to 24%? 

IT MORE THAN DOUBLED! 

Yes and look how much we are saving? 17%.  So reducing costs which allowed us to save more, enabled us to build wealth much more effectively than increasing returns.

This is a good example of that first Prosperity Principle we spoke of last meeting.  We called it THINK and reminded you that prosperity thinking is often opposite of what most people do in the economic world.  Here most people think chasing high returns is the way to wealth.  Now you know that reducing costs is the way.  And you are clear that  its not lifestyle costs we are wanting to reduce, but taxes and debt costs.  Reducing taxes and debt costs which enables us to increase savings will build wealth more effectively.

Next question for you:  Do you remember the third Prosperity Principle of MEASURE as it is related to opportunity costs?

Ahh, NO

 That’s not surprising, again, its because most people (including the media and most financial advisors) never take opportunity costs into consideration when making economic decisions.  Lets take a look at how people buy cars.  We’ll pull up this Automobile Calculator that shows the true cost of paying cash.  What do you think of the statement that you finance everything you buy?

I’m not sure I understand it.

I didn’t used to either.  So let’s figure out if it’s true.  If you finance everything you buy, then you either pay someone else interest or you give up interest you could have earned.

A good friend of mine says you pay up or you pass up.   Let’s take a look

AUTOMOBILE PURCHASES…THE TRUE COST OF PAYING CASH.

I’m going to say you had an account with $200,000 in it that you designated your “car buying account” and it was earning a net 5%.  We’ll look at a 20 year time frame and say you bought a car every 4 years for $30,000.  No increases or sales tax yet, we’ll keep it simple.  Over on the right, your account of $200,000 would have grown to $530,000 if you hadn’t bought any cars.  And we know that 5 cars at $30,000 each would be $150,000.  Yet you can see on the right the account is not $530,000, its $250,910.  That is a $279,750 difference.  Why did $150,000 worth of cars cost you $279,750?

I’m not sure

Ok, lets work through it.  Going back to the statement “you pay up or you pass up interest”  in this case, didn’t you pass up interest, the 5% that the account was earning, on the $150,000 you took out of it to buy the cars.  Over that 20 year period of time, that $150,000 could have turned into $279,000.  That is opportunity cost.  We must measure it so we know what we are dealing with and then we can do something about it.

NEXT

Q. So now, tell me what is your least favorite money spot right now? Your 401k,  your mortgage, your life insurance, your stock account, anything?  Lets take a look at what is really going on there.   What is working about that investment? What is not working about that investment?

OR
Q. So now, tell me, is there an economic decision you are getting ready to make?  Let’s take it through a calculator so you have the whole truth about the matter.

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How do I figure out if I can get ahead by earning 6% if I have an 8% cost?

How do I figure out if I can get ahead by earning 6% if I have an 8% loan?

At first glance, the answer is obvious, you don’t get ahead.  However, sometimes we get confused and think that since an account (say at 6%) has an increasing balance while a loan (say at 8%) has a decreasing balance, we might be able to get ahead.  Let’s look at it to see the whole truth of the matter.

Take a $100,000 account earning 6% over 20 years.  Future Value: $320,714.

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We know it earned $220,714 worth of interest.  This is calculated by taking the  $320,714 total and subtracting the $100,000 initial investment.

Now let’s look at a loan for $100,000 at 8%.

We can see that our loan payment is $9430.76 and if we multiply that by 20 years, we get $188,615.20, so we know that we paid $88,615.20 in interest.  So an incorrect deduction would be that it would make financial sense to have 6% earnings while we are carrying 8% debt, but this is only because all of the facts are not presented.  Let’s take a closer look.  The only way to make valid financial conclusions is to have exactly the same cash flows and time periods in each of the comparisons we are trying to make.

Under those guidelines, if we take the $100,000 and pay off the loan at 8%, then take the payments of $9430.76 that we no longer have to make loan payments of and pay them instead to the 6% account, in 20 years, we have $367,731, instead of $320,714 in the earlier example.

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So while it is true that we pay less interest ($88,615.20) than we earn ($220,714), that is only part of the truth.  The whole truth is that cost of money does matter and in the above example, our costs are greater than our gains.  This is the whole truth, even though we earned more interest than we paid out in interest.  There is a $47,017 improvement by paying off the 8% loan with the 6% account and redirecting the freed up payments to the investment.

One critical issue left over is liquidity.  Obviously $100,000 in an account leaves us in a more liquid position initially than $9430.76 being contributed to an account every year.  But eventually the investment account with $9430.76 being added annually will over take the account with $100,000 being contributed up front and will exceed it by $47,017 in the 20th year.

So if initial liquidity is a concern, then it may be worth giving up some of the $47,017 gain to be in a more liquid position.  However, it is not true that there is a mathematical advantage in having a higher rate of interest on your debt than on your earnings.

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