Finally, a PF post

It has been a while since I've blogged a real personal finance post, so I'm going to try this again.

Recently, I've finally put into place my free and no-risk interest income from debt.

Having read enough of these posts on other blogs, I know its going to start off looking like another convoluted get-rich quick scheme. It is not. This is neither quick nor easy.

1. First off, you need to have good to excellent credit.
   
2. Second, credit companies or banks must be willing to lend you money at no interest for anywhere between 6-12 months.
   
3. Third, you have to know a bank willing to give you a reasonable 3-5% interest rate.
   
4. Finally, you need to be able to handle a sizable debt load without any large debt needs in the near future.

This is how it works:

1. Credit card company X sends you a letter: "You can get $Y amount of money to pay off your other credit card bills for Z months for 0%"
2. Say you are given a $10,000 line of credit for 6 months at 0%.
3. You find a bank willing to give 4% APY.
   
4. You take credit card company X's loan and deposit into the bank for 6 months.
5. At the end of 6 months, you have collected $200 in interest.
6. You empty your bank account, pay back the $10,000, and keep the $200 for yourself.

Of course, you have to be sure to pay it all back before your 6 months is up, or you'll be hit by massive interest rates (probably 25% or more).

Ironically, as you take on more debt load, you'll get even more debt offers. These interest payments start small, but it is not unheard of for the debt load to go up to $100,000 to $200,000 at a time.

Given the same 4% APY for 12 months on $200K, that's $8,000 a year for free.

Now who can't use $8,000 a year more?

Can debt be good?

The classic answer to any finance question is always, "It depends."

Consider Chief Clancy Wiggum (PS - I love the Simpsons). Clancy probably makes about $55,000 a year, plus the fringe benefits of all-you-can-stuff donuts and coffee. He's faced with a tough decision: He wants to join a gym, but gym membership costs $200 / month, and he'll need to pay for 12-months up front.

He can: A) Save up $2,400 and pay it in cash, B) Put it on his credit card with a high-interest rate, or C) Find some mix of A and B.

If he goes with A, it can take quite a while before he gets that much money, and in the meantime, he may end up spending that money for other things.

If he goes with B, he runs the risk of maxing out his credit for what isn't necessarily essential, and paying high-interest rates.

If he goes with C, there is a lot of headache time, as he figures out what he can do. But, it gives him time to weigh (no pun intended) how much time he is willing to wait before getting the membership and how much the credit cards will charge.

But, Clancy may even have a plan D. Say Homer Simpson finally comes up with his killer invention that will make the family millions, but he needs a small loan to get it going. Homer goes to Clancy and says, "Hey, I'll pay you 20% APR for $2,400" If Clancy has a good credit rating, his credit card APR will probably be about 16-18%. Now Clancy can loan the money, go to the gym, and still make money off the 2-4% APR difference!

It's called making your money work for you. On a side note, I once interviewed with a wealth management division of a major bank. In our discussion, we talked about how much money it would take to before the bank will do business with you. Their lowest rank started at $100K cash.

I mention this because many of these rich folks have their money fully invested in the bank, and actually take out loans to pay for items such as cars and homes. Many times, these people are making 10% returns on their money. When they need money, the bank loans it to them for about 7%, so the customer is still making a 3% return on the money he spends (the difference between what he has invested and what he borrows)!

To answer my initial question: Debt can be both good and bad. Having a little is always good; having too much is always bad. Being debt-free is worry-free, but you're not putting your money to work.

Another Strike Against My Goal

As I get closer and closer to my first job, I've realized there a lot of expenses involved. Some of them are necessary, ie. suits, computer, etc. Others are just because I suddenly have more money that I've ever had before coming to me, ie. car.

Oh yea! But not just any car. Just like any 22 year-old, in the words of Ricky Bobby, "I wanna go fast."

I've got my eye on this beauty:
the new 2007 350Z.

MSRP with the options I want? $36,500. It's red cause its going to decrease the speed at which I reach my goal.

Now why I do tell you about it? Well for one, its a really cool car. But, more to the point of my blog, is to discuss the financial considerations that go into a car purchase.

When it comes down to it, cars are terrible investments. Few cars appreciate in value. But we have to have them. So what should go into the calculations in getting a car?

Things to Consider

1. Sticker Price of the car - the most obvious expense is the upfront cost of the car
2. Maintenance costs - regular oil changes, tune-ups, tire rotations, etc.
3. Gas - its expensive now, and there's no real end in sight. This can really add up.
4. Insurance - the faster, sportier, more luxurious it is, the more you'll pay
5. Other expenses - such as taxes, parking fees, car wash, etc
6. Resale value - the only real return. Most experts would say you lose 20% of the car's value just by driving it off the lot.
   

Once you add up 1-5, and then subtract 6, you'll find your real cost to own the car. But that's assuming you can pay for it all. If you need financing, you'll probably add at least another 5% to the total bill.

How Does Financing Work?
There are a few terms you should know before you get into any kind of financing:

• Loan Term - how long you have to pay back the loan, usually listed as number of months
• Interest rate - your annual rate to borrow is. This rate, divided by 12, is the interest rate you are charged every month.
• Principal - the amount you actually borrowed
• Down payment - how much you need to pay of for the car before the bank is willing to loan you the money

On loans in general, and car loans more specifically, a down payment is necessary to assure the bank that it can make some profit off the loan if you were to default, that is, be unable to pay off the loan.

A complex formula is used to determine your monthly payment. You can find a calculator here. Essentially, every month you are paying a portion of the principal as well as interest. Initially, you will be paying much more interest than principal. As you get closer to the end of the loan, more of your monthly payment will be devoted to principal.

A lot of people would suggest paying off loans as quickly as possible, to avoid the interest payments. However, I come from a school of thought that there is never a single right answer for all circumstances. Sometimes, a little debt is a good thing.

Are you unsure about when you should pay off debt? Feel free to leave a comment for me to address.