Understanding what a mortgage actually is
A mortgage is a loan used for the purchase or refinancing of a home. Practically speaking, it is the amount of money given to you by a lender for the financing of a home.
The mortgage loan has many parameters including, but not limited to:
Mortgages are typically used when you do not have all of the money upfront for the sale of a home. If you do happen to have the entire upfront cost, you might still choose to mortgage the property if you do not want to give up such a large sum of money, all at once.
Is a mortgage the same as any other type of loan?
Yes and no.
A mortgage is specifically a loan given as financing for a home purchase, or refinancing. As collateral for such a large amount, the home is typically put up against the value of the home just in case you stop making payments to them. If payments should stop, the home could then be used as collateral for "repayment" of the loan. I use the term "repayment" very loosely because you lose more than just a home in this process. In the process of losing a home due to missed mortgage payments (essentially a foreclosure), your credit score will be ruined.
Keep in mind that this black mark (i.e. foreclosure) stays on your record for 10 years. Avoid this at all costs if you ever hope to receive any other loans or favorable terms on lines of credit.
Lenders typically get into business to lend money, not to own homes. They want your money, not the house. I have heard of many people getting away with up to a year's worth of missed payments prior to the lender foreclosing on the property. This is proof of concept that lenders really don't want to be homeowners.
What is a mortgage "pre-approval" or "pre-qualification"
The initial process of obtaining a mortgage is to receive a pre-approval or a pre-qualification. Be advised, these are not the same thing. These two terms are often used interchangeably, but they differ in some important ways.
A pre-qualification is solely based on information that you provide to the lender. This is simply a way to help you "ballpark" the amount of money you can hope to spend on a home. This is by no means a commitment nor is it a hard number to use when making home buying decisions.
A pre-approval is a much deeper dive into your history including, but not limited to:
The pre-approval is a much firmer commitment to lend you a given amount of money. Essentially, a pre-approval is a mortgage loan application without a specific property affixed to the loan application.
How does the rest of the mortgage process work?
After obtaining a pre-approval letter (highlighted above), the potential buyer includes this in an offer on a particular home. If the offer is accepted, the potential buyer typically has a period of less than 10 days to officially apply for a loan with a lender. This is the time where most people "shop" around for the best quotes before submitting a formalized application. Beware however, you really do not have a ton of time to do your shopping so move forward wisely.
Around the same time as you are gathering documents for your mortgage application, you will be arranging to have the property inspected (if you choose) and place "earnest money" in an account based on the terms of your contract.
As for the application process itself, the lender will now perform any final verification of employment, income, and assets. The lender will also attain details on the specific property for which you intend to purchase following the seller's acceptance of your offer. The lender will look to have the following done prior to fully approving your loan:
If everything checks out and terms are acceptable (interest rates, loan duration, loan type, etc.), you will move towards closing on your mortgage.
Closing on your mortgage involves meeting with the lender and your real estate agent (and any other necessary parties depending on your state's rules/regulations). This is where you will sign your mortgage papers. This is also typically when your down payment and closing costs are due, in full.
As always, this is not to be interpreted as financial advice. Check your local rules and regulations as some of the information will ultimately differ according to where you live or desire to live.
Above is a summary of the basic "moving parts" surrounding mortgages. It is important to understand the nuts and bolts of a mortgage since it will likely be the largest financial transaction of your life.
The creation of mortgages permits many to attain home-ownership where it would otherwise be impossible due to limited income and finances.
There are many more things to know about mortgages. Learn everything you can. Knowledge is power.
Best of luck.
Can Credit Cards Be Effective for F.I.?
The financial independence community often demonizes the use of credit cards. The words of advice that are commonplace in the personal finance realm suggests you pay for everything in cash. Guys like Dave Ramsey even go so far as to encourage that you cut up your credit card.
But wait, this cannot be the only way. We should not have to carry pockets full of cash around just to fit in with the financial freedom crowd. Why do I have such a problem with this "cutting up the card" advice? I will tell you why. Cutting up your credit card to avoid spending does not correct the actual behavior of overspending.
I agree, it adds friction to the process which many psychologists believe will interfere with the participation in an undesired behavior. In this illusion of self-control, you would add friction to your undesired habit as a means to decreasing the likelihood you will participate in said habit. A smoker would lock their cigarettes in a cabinet and hide the key down the block as a method for increasing friction between them and their undesired behavior. Cutting up the card is like hiding the cigarettes. It fails to address the poor habit head on.
Credit Card Rules To Abide By
Where credit cards shine
First up is credit card rewards. The fellas over at ChooseFI have a great section on their site about travel rewards and credit card rewards. Cash back, bonus points, airline miles, travel rewards and hotel credits are some of the many perks that certain cardholders can participate in with disciplined use. Without a credit card you cannot participate in these rewards. Remember however, these credit card rewards are not actually for your benefit (at least they are not supposed to be). These rewards exist to encourage spending behavior. Period. You are lying to yourself if you say that rewards will not encourage you to spend more. It will, unless you are hardcore about recognizing your spending habits and budgeting. This is why you have to "game-out" rewards and turn the tides in your favor so that you can benefit from something that was originally intended to cause you harm (in the form of overspending).
Next up, cards can help build your credit score. To do this, you need to pay particular attention to some important factors in order to build your score:
Why is building a credit score important?
The benefits of a high credit score (720+) include:
The final credit card benefit worth mentioning is the added safeguards of carrying a credit card vs. carrying cash all the time. If you think this doesn't apply to you, think again. Lost your wallet? Just immediately call and freeze your credit card. If there was cash in your wallet, likely forget you ever had it.
Pulling out your wallet or money clip and revealing some serious paper is asking for trouble. Remember, criminals are looking for targets. If they see you at the checkout shuffling through your $100 bills to pay for a light bulb you might have an expected encounter on your way out to your car in the parking lot.
Yes, you can be both frugal and have a credit card. Just manage it responsibly and it can be an asset instead of a hindrance. Spend wisely and continue to find ways to improve your saving habits and spending behavior.
Let me know your thoughts in the comments below.
Why panicking is the worst thing to do in a financial downturn
During a period of decline in the market, many individuals feel like they are losing their shirts (and possibly much more).
Remember, corrections happen often. Technically, so do recessions. We typically have a correction once every couple of years and a recession every 5 years or so. That said, the overall equity market still returns just under 10% over the last 200 plus years.
So what might one do amidst a significant financial downturn? Suggestion: hold on tight!
How often do these "market crashes" happen exactly?
According to USnews, corrections happen at least once every 2 years. Sometimes they happen annually. When corrections do occur, they typically only last a couple of months and drop less than 20%.
Bear markets (recessions) occur every 4-5 years. They typically drop 20% or greater and last for a duration of one year, give or take a few months.
The worst meltdowns or recessions in recent memory was "The Great Recession". That sucker lasted 18 months and was the worst meltdown since World War II. During that period, the S&P 500 lost approximately 50% of it's total value. Now that's scary stuff!
How long does it take to recover from a typical market dip?
The single most significant factor of a recovery whether or not you stayed invested throughout the entire downturn.
As history has shown repeatedly, if you choose to try and time the market and you get out while it's on the way down, you technically have to time the market correctly twice- once on the way down, and then once on the way back up when you "re-enter" the market. Market timing is a fool's errand.
There are professional money managers who spend their whole entire life's work trying to time the market and, guess what... 92% of actively managed funds fail to match the returns of the market (i.e. S&P 500 index) over a 15 year period.
That means if they cannot do it, why would you even try? You don't have the time to sit around and read financials all day like these guys do.
As for how long the typical recovery takes.
In a correction, you should be back to even within a couple of months. For recessions, you usually get back to square within 18 months, give or take. Regardless, the markets have always climbed back and resumed breaking records. This is no guarantee but it seems highly likely given that we have two centuries of market data to rely on.
What to do when things get scary
My personal philosophy, as well as the philosophy of many seasoned investors, is to sit tight. Selling when the market is falling is one way to guarantee a financial loss and give yourself a lasting bad experience with investing in the market.
For the bravest of the brave, you could take this one step further and actually invest during a downturn. This is what I personally do. I take advantage of funds going "on sale" and purchase shares of the index funds that I already usually invest in at a drastically lower price than I would have gotten if the market continued to climb. See my thoughts on low cost index funds if you are unsure what these are.
It was the infamous Warren Buffet who said when the sky is raining gold do not go outside with anything less than a washtub. This is the very basis of the saying "buy low".
If you happen to be an individual stock picker, and not a typical index fund investor, then I suggest you go elsewhere for information because this is not a game I like to play.
When you invest in index funds like the S&P 500, you are betting on the entire US economy. Realistically, in order to lose ALL of your money, the entire country would nearly have to "go out of business" and I just would not bet on that happening anytime soon. Beside, even if the U.S. economy completely tanked and all businesses closed up shop, there will be much bigger problems going on in society that will quickly overshadow your worries about how much money is in your account.
If you are invested in broad based, low-cost index funds, then I would plan to stay the course and avoid selling in a downturn. You lose money when you sell or when a company goes out of business. If you stay invested, particularly in these broad index funds, the likelihood of never returning to baseline is slim to none.
If you had a crystal ball and could see things coming, perhaps you could adjust your asset allocation (i.e. more bonds and less stocks) prior to or immediately after the beginning of a downturn. The problem is, nobody is able to time this. Most of the corrections and recessions have no consistent way to assess when another one is coming. The best you can do is decide whether you think major market fluctuations are ahead based on national news - think politics and pandemics.
For example, take the onset of the coronavirus (COVID-19). If you had first heard of the potential outbreak on the news January of 2020, perhaps you could have adjusted your allocation more towards less-volatile bonds to soften the blow. Nevertheless, things were able to return despite the fact it seemed the downward spiral would never end. If you are considering yourself a long-term investor (which I hope you are), perhaps ignoring these events altogether is your best bet. Ask your financial pro if you don't believe me and if he disagrees, find out why (it usually revolves around him or her making an extra commission to manage your funds).
In the end, no results are guaranteed. Past history does not indicate future returns. Besides, none of this is investment advice and I am not a financial professional. You have to take the good with the bad. The overall average returns of the market of just under 10% per year include years where the market dips greater than 50%-such as what happened in 2008. You truly do have to take the good with the bad when it comes to investing.
In closing, corrections happen all the time. Further, we are never that far away from a full recession. They are coming. They will continue to come. Be prepared. Be ready to see your accounts lose massive value. This are the harsh realities. If you cannot handle it, maybe you should go bury that money under the shed and let the worms get it.
Understanding life insurance policies
Insurance is often a very important component of a sound financial portfolio. However, the needs of each person is unique, especially when it comes to life insurance.
When deciding on life insurance policies, there are several important things to consider.
First, you need to consider your current debt to income ratio. If you are the high earner in the household, and carry a lot of debt, taking out a larger policy on yourself is probably justified. Even if you are a low earner, but carry a large amount of debt, considering a medium to large policy is definitely warranted.
It is also important to consider where you estimate you will be in the future regarding your financial situation. If you are a habitual saver, perhaps taking out a larger policy now and shifting to a smaller, more affordable policy later would be justified.
If you are already financially independent, saved 5 or more years worth of expenses, and carry no significant debt, life insurance may not be needed at all. It is definitely a conversation worth having with your financial professional.
What is Life Insurance?
Basically, it is a contract. The payer (insured) is in contract with the insurance company. The exchange is a monthly premium for a "potential" lump-sum payout. To remain under contract, the insured pays a monthly premium to remain eligible for a "death benefit", which is often the lump-sum payout.
If you ever wanted to discontinue your policy, you could just simply stop paying the premiums and your coverage would cease. I would check with your provider first however.
Common Types of Life Insurance
Basically, there are two types of life insurance. There are fixed term policies and there are lifetime policies.
Fixed term policies are often referred to as term policies, or term life insurance. This type of policy provides coverage for a fixed period of time, most often 25-30 years. Term insurance is the most popular type of insurance chosen by followers of the financial independence and financial freedom movements as it is typically the more cost effective form of life insurance.
Lifetime policies typically come in the form of whole and universal life insurance. These policies typically carry a much higher premium, however they are payable for the lifetime of the insured instead of expiring after a pre-determined period like a term insurance policy.
Essentially, for a higher monthly premium you stay eligible for a "death benefit" payout under a lifetime policy. In a term policy, if you are not deceased prior to the policy expiration date, there is no "death benefit".
Why I Chose Term Life Insurance
My thought process, like many F.I. followers, is that I chose the policy with the greatest amount of value.
Term insurance affords a much lower monthly premium than a lifetime policy. This allows me to instead invest the difference in cost between the two policies, month after month, compounded over time.
By investing the amount I am saving with a term policy, compared to a lifetime policy, I will take advantage of the effects of compound interest. While taking advantage of this investing strategy, I do not leave myself "exposed" to significant losses of income that my family would incur should I meet an untimely demise. This is because I still have a substantial "death benefit" payout with my term life insurance policy.
I chose to avoid a lifetime (universal or whole life insurance) policy because I anticipate reaching a significant amount of net worth and savings by the time my term life insurance expires.
In other words, if you anticipate saving and investing for the next 30 years, you will likely have a significant amount of money at the end of that term. The need for continued coverage beyond this point, like you would receive with a whole or universal life insurance policy, is unnecessary and very expensive.
Overall, everybody is different
Assess your needs on an individual basis. Consult with a financial professional.
Not everyone will benefit from a term policy over a lifetime policy. Your circumstance may be unique. Consider your overall picture (time horizon, investing strategies, savings rate, anticipated expenses, etc.) when determining what type of life insurance policy will best meet your needs.
In the end, whichever policy you choose, I do feel that life insurance in general is an excellent thing to consider for anyone with a spouse or dependents that will be deeply impacted by your loss of earnings upon the event of your death.
Getting "smarter" about money is a proven road to riches
I am not referring specifically to college education either. I am referring to "getting to know money".
You see, most wealthy people (people with a high net worth) seem to know money pretty well. They know where and how to save it. They certainly know how to make more of it. Perhaps most importantly, they know how to invest it. There are very few millionaires who do not have an excellent education on "how money works" as a medium of exchange.
There are some popular exceptions to this rule such as professional athletes, divorcees, trust-fund babies, and celebrities. Consider how many stories of celebrities and athletes going bankrupt or having significant amounts of debt that we are aware of. It seems that the only difference between those who have received a windfall due to celebrity status or otherwise, and those who remain millionaires for decades, is the level of education they have about their money.
Most of the wealthy got their status because of their desire to study riches. Take some of the wealthiest investors in America as an example:
What all these men have in common is they have dedicated their lives to learning about money!
Buffet is said to read some 500 pages of financial statements per day. This is taking learning about money to a new extreme. Any coincidence that his passion and desire for learning about money and value has led him to be one of the richest men in America? I think not.
Icahn is a ruthless investor and seeks undervalued assets to turn a profit. He has developed an incredible ability to remain patient and concentrate his bets and investments in definitive assets. He has consistently beaten the returns on Buffet by nearly 10% over the last 30 years. How could he possibly have developed these skills? He learned about money and value investing by educating himself on how to read and interpret financial statements.
For Dalio, it has long been said that he had an innate ability to find a way to learn from anyone who had something to teach. He is reported to have even listed to his barber or somebody that he caddied for to pick up valuable long-term investing tips. This should all come as no surprise that he made his money by learning about money.
These are some extreme examples of how learning about money typically leads to generation of assets and accumulation of net worth. However, it can be true for all of us as well.
How can "everyday folks" become wealthy?
Same answer as before: improving your education and understanding of money.
For example, try to predict whether learning about any of the following would increase or decrease your net worth"
My guess would be that your net worth would increase if you learned any, or all, of the above! What do you think?
Where You Can Start Learning About Money
Picking one of the items listed above and searching the library or the internet for reputable sources would be a great place to start. Your goal should be to learn slowly and consistently over time. This information and knowledge will not be an overnight success, but I think you will be surprised at how quickly you see measurable differences when you start teaching yourself about money management.
I have a resource page on this site that lists my favorite and most highly recommended books that I have read which have made profound improvements on my understanding of money management and contributed to substantial improvements in my net worth.
Over time, you will develop the skills necessary to be a dependable money manager which is the most reliable method to increasing your wealth.
Please comment below which area of money you plan to learn about first.
Increasing Your Net Worth Is Simpler Than You Think
How to Increase Overall Net Worth
These steps are for anyone interested in increasing net worth and savings.
Whether helping you get started with saving your first dollar, or guiding you to remain motivated as you cross another financial milestone, these 3 steps are the building blocks of increasing your overall net worth.
My advice: revisit these 3 step early and often.
Saving money does NOT have to be difficult
Saving money does not have to be a difficult endeavor. Yet for many of us, we find it nearly impossible. Most of us suffer from "too much month at the end of the money" which essentially means the average American is living paycheck-to-paycheck.
In the United States, it is a sad state of affairs when examining our average net worth by age.
The chart below highlights, by age, the average net worth inclusive vs. exclusive of the equity in their own home:
Summary of Average U.S. Household Net Worth by Age
Average Net Worth in the United States by Age:
Summary of Average U.S. Household Net Worth by Age less Home Equity
Average Net Worth in the United States by Age minus Personal Home Equity:
The Average U.S. Household Net Worth
As you can see, the average American under the age of 35 is only worth less than $7,000. You would hope that by the age of 50, that number would go up dramatically.
Well, guess what, it doesn't. According to the chart, by 50 years old, you can expect a net worth of less than $90,000. By the age of 65, Americans are only worth about $170,000.
That means that after 30 plus years, the average American only increases their net worth by $160,000.
Sound like a lot? It isn't! So how can we kick these savings into overdrive and take advantage of the power of compound interest?
Easy ways to increase your overall net worth
1. Learn about money
Seems simple right? This one seems straightforward but many readers ask why this is important.
Think about it this way: you would not perform heart surgery without going through undergraduate studies, med school, fellowships and residency training first. That's a lot of preparation.
So why would preparing to increase your net worth be any different. You need to learn about it. What is the primary driver of net worth... money!
Here is a list of the most meaningful books that I read when I first started my financial independence journey.
2. Track your money
I don't really care how you do this but it is unavoidable. You do not need a full blown budget but you do need to be aware of where your money is going. If you have no idea where an entire months worth of earnings or paychecks are going, you have very little chance of increasing your overall net worth.
If this intimidates you, take this on incrementally. For example, if last year you had an extra $200 every month in your checking account after expenses, and now you only have $50, investigate where that extra $150 went.
This is a great place to start. This is where you can identify extra savings very quickly.
Some ideas and quick tips for where to look for extra money each month:
3. 'Automate' or 'Normalize' your savings
I purposefully used BOTH automate and normalize for #3. Why? The fear factor associated with "automation".
Some of you are going to be scared off by the "automate" verbiage. You do not like the rules of needing to link accounts and automate savings in regular intervals directly to your 401k, 403(b), 457 (b), etc. I am certainly aware that this is very common advice in the common wisdom of pay yourself first.
The problem with automation is that it becomes another point of friction, or sticking point. Many of us do not like the rigidity of automatic deposits.
For others, automation is great advice. If your company gives you a "match" into your retirement account, you need to take advantage of this up to the maximum amount they will match. Otherwise, this is free money being left on the table each month.
To get started with automation, simply set up an automatic deposit on a weekly, bi-weekly, or monthly basis. Direct it to your 401k, 403(b), 457 (b), IRA, brokerage, etc.
I personally prefer sending it to a taxable brokerage account or IRA which gives me access to low cost index funds (although volatile, over a 210 year history they typically yield an 8% return, give or take). Please consider the fees of your retirement accounts. Make sure to ask for all types of fees. Be sure to ask about:
If you need a little extra motivation, consider that Tony Robbins - in his book Unshakeable - tells a story of what happens if the government imposes a tax on you.
To paraphrase Tony: if you had a tax imposed on you suddenly, you would initially complain and kick dirt, but you would still eventually pay it. Think of your automated savings like a self-imposed tax. You might complain about saving a pre-determined percentage of your pay initially, but eventually you would find a way to "pay it". Consider the added benefit, in this case, that this self-imposed tax is actually just you "paying" yourself.
If you still cannot get over the idea and rigidity behind automation, do not give up. I believe there is an alternative option.
It is something that I personally do. It typically is not as consistent and it does require some discipline.
I call it normalization of savings.
What I mean by normalization of savings is find a way to make savings a normal part of your life and money management.
How would you do this? With repetition and practice.
For example, if you never saved before and you anticipated finally starting to save, that first $100 deposit is going to seem monumental. While it certainly is monumental, it only is so because you have never done it before.
Over time, as you continue to deposit $100, month after month, year after year, each individual deposit will not have the same psychological impact as the very first $100.
This habituation effect is actually what we are looking for! It is the normalization of savings.
If a deposit into your accounts seems like a big deal, it is probably because you have never done it before (or at least not in that amount). This psychological "wow factor" adds yet another layer of friction which will prevent you from saving it in the first place.
Put your money where your mouth is.
Write these 3 steps on a whiteboard, paint them on the wall, whatever. I do not care how you do it, just remember to revisit these 3 steps no matter where you are on your path to financial independence.
They can serve as a great motivator for beginners or a "back to basics" course for those well seasoned pros already along the journey.
Be sure to leave us a comment below on how these strategies gave you a kick in the ass to get started or helped orient you somewhere down the road...