Income for Life

Debt is a nasty four-letter word

As a real estate investor, I used to think that there was good debt and bad debt. Debt used to acquire assets that appreciated was acceptable. Today, I'm not as sure of that, as I have written before.

Before the real estate crash, it was assumed that the appreciation of your investment property would more than make up for the cost to acquire it -- your debt. Now that appreciation is much more questionable these days, it has made many investors re-examine at how leveraged they should be in their investment assets.

I still think real estate is a solid investment in that longer-term, properties will still appreciate. The problem is can properties purchased at the peak of the bubble cash flow enough for it to make sense to hold onto them long-term? Because of the kind of debt we investors took on to acquire properties when credit was easy, we are not enjoying the same kind of cash flow investors in today's, post-bubble market are enjoying.

Which brings us back to debt. It's not a good thing.

There was a recent study done by Scottrade -- the online investing firm -- that showed about 63 percent of people's retirement savings was affected by the debt they carried in 2009. The study showed that for 2010, even as lessons have been learned and a recovery is underway, 61 percent of people will have retirement savings be affected by their debt.

This perspective -- the impact of debt on your retirement -- provides a glaring example of how dangerous debt can be. Think about the retirements of the generations that went before us, for example.

Sure, when you retired, you stopped earning as much income. But, in general -- in our parents' or grandparents' time -- you also didn't NEED as much income. Your house was paid for. You paid off cars and kept driving them. You didn't have thousands of dollars of credit card payments to make.

But look at us now, the debt generation we have become. We took out exotic mortgages, or financed houses with little money down. We drive cars as expensive as the houses our grandparents lived in. We have student loans, credit card balances and home equity lines of credit.

Our grandparents didn't buy things without cash, so it might have seemed as though they had very little. We buy nothing with cash, and we have less cash. That's because buying on credit is way more expensive than buying with cash. Which means our retirements -- when, like our grandparents, our incomes will go down -- will be more challenging. Because of current debt:

1. We are not able to save as much for retirement now

2. We will need more money in retirement

In other words, debt costs our retirement savings now, AND will add to our income needs when we actually retire. So what to do about it?

Well, for years we investors have been concerned about our return on investments, our rates of return. But now our focus should turn on becoming debt-free, or as debt-free as possible. I know it's easier said than done, but if you take a minute to do some basic financial planning with the idea of attacking debt as your goal, you'll be amazed at what you can do. Instead of thinking "How can I earn the most money with my investments," ask "How can be free of debt?"

Think about it this way: If your'e taking 2 percent out of each paycheck toward retirement and putting it in a fund that earns 8 to 10 percent annually, how smart is it to carry a $7,394 credit card balance (the U.S. average per household) with an 18.8-percent interest rate (also the U.S. average)? Putting the money toward debt relief is the smarter investment.

So a good strategy might be to use the retirement money from your paycheck to pay the debt off, then take the extra money you'll have from not making payments on that debt and apply it to your retirement savings. Or once the credit card is paid off, you can take the extra money to pay off other debt with higher rates -- maybe a car loan, or a second mortgage.

The bottom line is that once you realize what a nasty four-letter word debt is, you can pursue financial independence from a debt-reduction standpoint, which, in this economy and in your retirement, will serve you well.

Could the mortgage interest deduction disappear?

For years, one of the benefits of owning a home in the United States has been the tax break that comes with it -- the income tax deduction for mortgage interest paid. This deduction has been in place since 1913, but it has come under some scrutiny lately.

In fact, arecently released paper published by researchers at the Tax Policy Center suggests it might be time to reform the tax policy as it pertains to this deduction.

In some ways that might make sense. Look overseas, and you will see a nation -- Greece -- that has all but collapsed economically because its government can't raise enough revenue to prop up all its expensive entitlement programs. The amount U.S. taxpayers will deduct for home interest in the tax year 2012 is expected to cost the U.S. government about $131 billion.

That's just a drop in the bucket of the national debt, but if you get the feeling that the U.S. government is going to have to one day "pay the piper" in regard to its spending, that $131 billion or so might seem like a good start to you.

It's also fair to ask whether the government should be subsidizing homeownership with tax policy, which, in effect, it does with the mortgage interest deduction. Even if promoting homeownership is something that's desirable -- I, for one, believe it is -- is the mortgage interest deduction an efficient way of doing it?

In Canada, mortgage interest is not deductible on a primary residence. Yet home ownership rates in Canada are largely the same as in the States. What's different is the amount of equity Canadians have in their homes -- about 70 percent on average compared to about 45 percent. So it's fair to ask if the MID promotes ownership of homes that could be too expensive for their owners.

The Tax Policy Center study mentioned above actually says that the deduction does not affect home ownership rates. In fact, many taxpayers don't use the deduction, even if they own a home. This is because most tax payers do not itemize deductions.

The paper also argues that the wealthy benefit much more than the lower class when it comes to the tax credit. More expensive homes mean larger mortgage interest deductions, and higher tax brackes mean the bigger dollar-for-dollar breaks for the better off. President Obama's budgets for 2010 and 2011 have included capping the MID at 28 percent, even for those in the 33 and 35-percent tax brackets. Congress has not enacted that cap, however.

The paper compares alternatives for reforming the tax policy as it pertains to mortgage interest. Making the tax break a credit rather than a deduction, for example, might help lower-income tax payers more than the current system, the paper finds. The study suggests that there policy could be reformed to either increase the U.S. tax revenue, or to promote home ownership more at the same dollar cost as the current MID.

Personally, I don't see this deduction disappearing any time soon.

For one, it would be political career suicide for any incumbent member of congress to start introducing any measures that would essentially amount to higher taxes during an election year. The fact that the home builders and real estate agents have some pretty powerful lobbying efforts in Washington would also make it difficult for radical changes to take place.

On top of that, real estate is an industry that's down right now, and for the federal government to kick it while it's down would deal a severe blow to the overall economic recovery in the U.S. Why would the feds prop the industry up with the tax credits that just expired, only to turn around and deal a blow that would knock the market back?

There's no question that the U.S. cannot keep spending money it doesn't have -- on social security, on proposed health care programs -- without somehow adjusting revenue to keep up. So you will probably continue to read about the mortgage interest deduction disappearing.

But don't bet on it any time soon.

A way to get back in the game

During the recent housing downturn in the United States, one of the constant challenges for investors has been the ability to continue to invest.

Unfortunately, when it was easy to get home loans, many investors did just that. Now that credit is much, much harder to come by, they are tapped out. What makes that situation more painful is the fact that NOW is when prices and interest rates are ridiculously low.

It's a terrible feeling to know you're missing out on deals because you can't get financing. Right now, those who have cash are cleaning up. Investors with good credit scores but cash shortages are sitting on the sidelines.

There might be some good news on the horizon for investors, however. Owner financing might be making a comeback. And not just in the U.S. With tougher lending criteria by banks in Canada looming, the conditions for owner financing might be stronger there, too. 

Owner financing helps investors in that you don't have to deal with a bank or other mortgage lender, possibly even avoiding an appraisor, too. If you've tried to invest in homes after 2007, you know that those parties can make it tough on a home deal.

If a seller is willing to finance the purchase themselves, though, you can avoid those headaches. The trouble is, of course, that there aren't a ton of sellers out there in position to finance the purchase themselves. I have noticed, though, that there seem to be more and more of these showing up in the multiple listing service lately.

That could be for several reasons, but the most likely is that because of the recent tax credits and low interest rates, more and more sellers came out of the woodwork. In fact, during the months leading to the expiration of the tax credits, even though there was a rush on homes and the volume of sales went up, inventory of homes on the market actually GREW. This is because sellers who were waiting decided that the expiration of the tax credit would give them an opportunity to sell their home.

The influx of more sellers is why we saw the volume of sales go up, but not home prices. There are still many homes on the market. For investors, this could be a good thing.

July and August are typically very busy home sales months. They will not be this year -- not with the buyers who jumped into the water trying to get closings before the end of June so that they could get the tax credit. The sellers who missed those buyers are going to be left holding the bag in July and August, and they are likely to be very motivated.

The guess here is that they will be very willing to negotiate and the fact that they were waiting to sell -- not forced to sell at a bad time -- makes it possible they will be in better equity positions and therefore will be better equipped to finance deals. Let's face it: Distressed sales can be good deals, but those sellers are not in a position to carry owner financing!

If you have been wanting to take advantage of some of the deals in today's market, but have not been able to qualify for a favorable loan, think about looking for owner-financing deals. All it takes is an MLS search, and you might have investment homes to pick from again. It might be your way to get back in the game.

BP shows us what NOT to do

The scope and seriousness of the oil rig disaster in the Gulf of Mexico are astonishing. Even more astonishing is the way BP has handled the mess after their oil rig exploded.

More precisely, it's astonishing that they have no way of handling it. It sure seems as though the company had no real plan for what to do in the event of such an oil leak, almost as if they believed it couldn't happen. If you are drilling 5,000 feet down into a resevoir of oil that can send 20 to 40 million gallons of oil into the ocean in six weeks, don't you have some kind of emergency plan in place?

If it were me, I'd have contingency plans for my contingency plans. BP doesn't seem to have any contingency plans, and that's a big lesson.

I am not a pessimist, but thinking like one on occasion can help you make plans for bad situations you might find yourself in at some point. I don't think you should plan ON the absolute worst thing happening to you, but you should plan FOR the worst that could happen.

If you own a business, put cash away when times are good. Plan ahead as if you know bad times are coming, and plan for them to last a while

If you're an investor, plan for the market to turn for the worse. Know where you will move your money BEFORE you lose it.

What is the worst thing that could happen to your household's financial situation? Plan for that. What will you do if you lose your job? What will you do if your spouse loses his or her job?

Look, life's "emergencies" happen all the time. Some things, like a sudden illness or a bad car accident, can't be foreseen. But other things, like loss of income, CAN be planned for. Your life's plan needs to have contingencies built into it.

Since the oil rig exploded, BP's share prices have plummeted. The company has lost $63 billion of its value, and it has also spent nearly a billion more dollars trying to control the leak. Of course, nothing so far has worked, and it might be months before a solution is in place. No one knows the ultimate impact the disaster will cause, but you can be sure it wouldn't have been as bad if BP had had some sort of preparedness plan spelled out ahead of time.

There is too much at risk to not be prepared for potential disasters. BP has certainly taught us that lesson.