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Financial Story Problem

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rupert
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Financial Story Problem  Reply with quote  

Story problem:
A 74 year old widow consults you for financial advise. Her annual income is $28,000. She still has a mortgage payment, $640, of which $150 is taxes & insurance. The loan is a 15 yr balloon at 6%, payoff is $73,000; this is her 5th year. Home appraises at about $100,000. She has an IRA worth $10,800 and has some vacant property worth about $30,000 which she's willing to sell. She has no debts besides the mortgage and her credit is excellent. In the short term, she needs some cash, say $3000, for home improvement, car repairs, etc. In the long term she'd like to save more of her monthly income. She's not a big spender, but it bothers her greatly not to be saving any money.

Thoughts?
Post Sat Nov 22, 2014 2:48 pm
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oldguy
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She definitely needs fix that balloon loan (it was inappropriate for someone to push that on her). It's 5 yrs old, she is going to need about $70,000 cash to pay the balloon 10 yrs from now.

I would put a 30 year, fixed rate $80,000 loan on the house. That gets rid of the balloon, gives her a small cash-out, and lowers the loan payment to $382/m (from the current $490/m).

She must be cashing out an RMD from the IRA - she could step that up a bit if she needs to supplement the $28,000/yr income.

The $30,000 vacant land could be sold and invested in mutual fund - then it would be available to her 'in small pieces' - ie, she could sell some whenever she needed some money.
Post Sat Nov 22, 2014 3:18 pm
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rupert
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Oldguy, thanks for your reply.

So far I've gotten almost universal agreement that the balloon is bad news, and that it was naughty that it was every suggested to her in the first place. She's about to officially apply for a refinance, she's cleared credit. They're offering 30yrs fixed at 4.1%. But she's 74, and I talked to one bank offering a 15/1 ARM with a 3% initial, and I'm wondering if that's worth looking into.

As for her property, it is in a tourism heavy county, where if you have a small cottage/cabin, they stay booked through the winter, and there's room for 2-3 cottages on the property. If we were thinking long term only, I'd say find the money to build 3 of them in sequence, then have a moneymaking business. To that end I've considering buying the land from her myself and doing this...

As for investing the money from the land if it is sold, I am terrible with investments....how secure would a mutual fund be? What is the buy in?

The bank working on her refi has suggested that she take that money and let them invest it, but the buyin is 5.5%, it'd take a year to make that back I think...
Post Sat Nov 22, 2014 4:05 pm
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oldguy
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quote:
The bank working on her refi has suggested that she take that money and let them invest it, but the buyin is 5.5%, it'd take a year to make that back I think...


Well, as you are finding out - banks are good at banking, checking & savings. And poor at investing. The 5.5% buy-iin is an added fee for advising you what to buy, plus an annual commission is added. Instead, go to a no-load fund provider - the big 3 are Vanguard, Fidelity, TR Price. Put the $30k into an SP500 Index Fund where it can grow and offset inflation.

Keep in mind that "risk and return are directly proportional". If you want no risk, you must use savings accounts, CDs, etc - things that return less than 1% (you are buying safety). But she doesn't need to buy that much safety, she can stand a little risk with the $30k (money that she isn't using for her livelihood).
Disclosure - I'm older than she is and I am over 50% invested in the SP500.)
Post Sat Nov 22, 2014 4:44 pm
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Wino
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I would suggest she instead go with a fixed-rate 15 year mortgage on the $80K refi, and bite the bullet on the income. Sell the property (no brainer, there), and invest the money as oldguy suggested, doling it out as necessary.

We are due for a pull-back soon, but the market is showing no signs of this happening. The energy sector is down due to oil prices, but just about everything else will be up because of the same oil prices. She needs to be aware that the S&P500 fund is not completely safe, but as oldguy said, you only get returns if you accept that risk.

With $2000 per month income, the $600 is not killing her, even if it is slightly higher than I would want for myself. The idea for her to develop the property is close to insane at her age. With good credit, she should be able to find a loan in the 3.25% range at 15 years.

The ARM is insane. Interest rates are only going to go up if they move, so you're guaranteeing her future problems with that.
Post Sat Nov 22, 2014 6:31 pm
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rupert
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A 15 yr fixed would increase her monthly payment to $720 taxes and insurance included, assuming the rate I've been quoted around here, 3.75. Even at 3.25 it'd be around $700. Her goals are to reduce expenses in her life time, not increase.

I agree that if she herself were to invest and manage the development of her property, it'd be insane. I would be paying for the development (I'm her son).

What's insane about a 15/1 ARM for a 74 year old woman? Sure, more details are needed re: the formula, but you have to understand, when we say long term in reference to a 74 year old, we mean from now until the day they die. I'd rather her be happy in her life time and inherit less.
Post Sat Nov 22, 2014 6:50 pm
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oldguy
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quote:
a 15/1 ARM for a 74 year old woman?


Don't get caught up in the 'rate' marketing, timing of the 'rates' market, there really isn't much difference between 3.5% and 4% - but people sometimes make bad decisions cuz 3.5% sounds so good. Over the years there have been many 'designer' loans - ARM, balloon, FHA235, Interest Only, wraps, yada.

I use borrowed money for investment capital - I have learned that I must make my money supply risk-free (30 year fixed rate fully amortized) - and concentrate my risk on my investments. (I won't risk having an investment crash and being hit with a balloon payment or a rate change or a forced-refi at the same time).

You mother is doing essentially what I do - she is keeping her own money invested (the $30K) and borrowing it against a house, rather than paying off the house.

My goal with mortgages is NOT to pay the least amount of interest - it is to make the most amount of profit. $30k cash for 30 yrs invested in the longterm SP500 at 11%/yr = $687,000. Ie, the time-value-of-money trumps paying a few thousand less in interest. Furthermore, when something happens to her, that $30k investment can continue, the house will be sold and the loan will be paid out of proceeds - but the $687,000 need not be disturbed. (I've told my adult children to sell the houses but let they can let the investments ride.)
Post Sat Nov 22, 2014 9:33 pm
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