No One Can Afford to be Poor

Hey Paul: What is the “ghetto tax”? I heard this mentioned on a blog about poverty in cities and how the poor are taxed more than others. Do we have a ghetto tax in Jessamine County?

The name “ghetto tax” is a bit misleading and it doesn’t necessarily apply to a “ghetto” and is definitely not a tax imposed by the government. The concept was popularized about a decade ago by a study conducted by the Brookings Institute. The study focused on the urban poor — “ghetto dwellers”.   The main idea is that the poor often pay more for things because of lack of access to the same deals as the middle-class or rich.

The study listed the following ghetto taxes that are better described as poverty premiums and a tally of what it may cost the typical poor person:

  1. Check Cashing: Using a check cashing service rather than a personal checking account costs 1% to 5% of the check’s value. Suppose you cash $1000 in checks each month with a 2% fee – this would a $240 annual ghetto tax.
  2. Pay-day Lenders: The fees can be upwards of 15%. The larger problem with this type of loans is that they are a temporary solution that creates a permanent problem as the loans are rolled over. Suppose you take out just one pay-day loan for $400 to pay your winter heating bill and fortunately a Christmas miracle pays it off when due paying fees of $60.
  3. Tax Refund Services: The advance payments of the tax refund could have implied interest rates of 70% to 1800%! Suppose you are due a $1000 refund but take $800 for immediate cash – you are down $200.
  4. Car Prices, Loans, & Insurance: For the exact same car and driving record the poor paid $50 to $500 more, an extra 2% on car financing and $50 to $1000 more for auto insurance! For a modest $5000 car suppose you get a good deal on the price but have to finance at 10% rather than a customer with good credit who would get an 8% auto loan. This will cost you about $70 each year over a five-year loan.
  5. Home mortgages & Insurance: The poor pay on average about 1% more on mortgage rates and about $300 more for home insurance. Suppose your 30-year mortgage on a $100,000 home is at a 5% rate rather than 4%. This is costing you an extra $700 each year in housing payments.
  6. Furniture, Appliances & Electronics: Renting-to-Own any of these is an expensive proposition. One example cited in the Brookings study was that a $200 TV ended up costing $700 once the interest charges were factored into the cost. Suppose you got a widescreen TV and the finance charges are $100 a year for five years.
  7. Grocery Prices: The lack of personal transportation forced some urban poor to shop at local grocery stores that tend to be smaller and with higher prices.  In Wilmore we’ve got the iconic Fitch’s IGA and in Nicholasville Walmart and Kroger’s each with competitive prices. So let’s suppose there is no ghetto tax on groceries.

The grand tally of the “ghetto tax” for this hypothetical poor Jessamine resident is $1370! Yes, it could be less if you do not “own” a home but it could easily be double or triple this amount if one finds himself in the throes of a pay-day-lender spiral or falls deeply into one of the other poverty premium traps.

So the answer to your question is yes, there is most definitely a ghetto tax that is subtly draining money off the local poor. Is there anything we can do to reduce or even completely avoid these financial dings? Yes, but it will require rethinking how we approach our finances.

A common theme through these poverty premiums is that the poor have to take on debt and then consequently pay higher rates due to weak credit scores or simply not shopping around for a better rate. My suggestion is plain and simple – if you do not have money to buy it with cash, then do not go into debt. This applies to cars, couches, appliances, electronics, clothes, and vacations. Buy used items or accept used furniture or appliances from Southland or one of many other local churches who pass along perfectly acceptable items.

A home is a bit different as very few will ever save up enough to pay cash; but if one can save enough to put down a 20% down payment and has no other debt then you may very well qualify for the best mortgage rates.

To save on tax processing you can do a few wise things. First, you should have no Federal or state taxes taken out of your pay check – it’s coming all back the following April if you are anywhere close to poor. In fact you can also be prepaid the Earned Income Tax Credit if you qualify. Second, do your own taxes using a free online software. If you can’t do this then bring your tax documents to the Jessamine public library early in the year for free tax filing sponsored by the AARP. You can file in early February and have your refund check within a week.

Finally open up a free or low cost ($5 a month) checking account. Talk to my friend Steve Smith at Town Square Bank or Jess Correll at First Southern National about an automatic savings strategy. Build up a $1000 emergency fund so you aren’t dragged under a pay-day-lender debt avalanche.

In summary by avoiding debt, not overpaying taxes, and using a bank for banking the poor and the rest of us can avoid the dreaded “ghetto tax”.

 

 

 

The Inside Scoop on the Local Schools

Hey Paul: We are looking into buying a home in Jessamine County and have three school age children. Where will they go to school? What are the best schools?

 I grew up here and the three schools I attended no longer exist at least in their original form. Wilmore Elementary, Jessamine Junior High, and Jessamine High school are now Providence High, the Early Learning Village and West Jessamine HS. As you likely know Jessamine is one of the fastest growing counties in the state and this has lead to the addition of schools and periodically rebalancing the schools by shifting the district boundaries.

The ELV enrolls all 900 Kindergartners in the county and then they are dispersed to one of the six Elementary schools based on where you live. A school district map can be seen at the Jessamine schools website http://goo.gl/vN8Ycm. Nicholasville, Rosenwald-Dunbar, and Wilmore Elementary students head on to West Middle and then West High. Brookside, Warner, and Red Oak Elementary students feed into East Middle and East High School. Middle school is grades six through eight.

If you look purely at the numbers such as students at proficiency level then there is a distinct advantage to Wilmore Elementary and Rosenwald-Dunbar Elementary that carries on to West Middle and West High. You can see all the statistics you want at the state school report card website, https://applications.education.ky.gov/src/.

But let me advise you to look beyond the aggregate numbers or better yet don’t look at them at all. Why do I say that? Well stats can be misleading in that they attach the success (or lack of there of) to a school rather than the student or the student’s family. Unfortunately this type of school report cards has sullied many good administrators and teachers when the blame lay somewhere else.

Laura Callisen on the Family Share blog describes the “hard capital” factors as forces largely outside of the family’s control whereas “soft capital” factors were harder to quantify but were to some degree choices a family could make to improve their child’s success rate. Your home purchase will largely dictate the quality of the schools and the neighborhood influences upon your children. But other factors such as the parent’s involvement in the child’s education, reading with your child, eating meals together and overall providing a stable family life trump the school influences. In other words if your kids turn out “bad” don’t put the entire blame on the schools.

Our local schools are across the board good schools with dedicated teachers who know their stuff. Okay probably with a few exceptions but that’s true at any school. Unlike many counties in Kentucky where the schools are subpar due to challenges such as finding quality teachers, we are fortunate not to have that problem in Jessamine County.

I would suggest focusing your house search on factors other than trying to place your children at the so-called best schools as they’ll be shaped more by the home than by where the house is located.

 

 

 

Refinancing is Worth a Look

Hey Paul: What do you think will happen to mortgage rates this summer? We have a 30-year mortgage that we have 22 years left paying on. Our mortgage rate is 4.75%. Should we refinance our home?

 The refinance question comes up a lot and there are certainly plenty of blogs and mortgage calculator apps out there to help you answer your question. But like always, who do you trust? Well hopefully you can at least think about trusting what I have to say as I don’t have a skin in the game.

Let’s start with a few mortgage myths.

Myth #1: Mortgages are “good debt”. No, there is no such thing as good debt just as there is no such thing as a good cancer or good divorce. Yes, it’s better than credit card debt as you have a home as collateral and the rate is reasonable but a mortgage is a liability not an asset.

Myth #2: Since mortgage interest is deductible the rate is quite a bit lower than the stated rate. The simplest example of this is a 4% mortgage rate for someone in the 25% tax bracket. If they have enough other deductions such as state income taxes, property taxes and charitable giving to surpass the standard deduction than this myth has some validity. However most middle-income households do not get the full deduction impact from their mortgage as they simply don’t have enough other deductions.

Myth #3: It is always better to have a 15-year rather than 30-year mortgage if you can afford the higher payments. This actually has some truth to it as you’ll get about a 1% lower rate and obviously be freed up from mortgage debt in half the time. The fact is that you if (and this is a big if ) you can earn the same rate on investments as your mortgage rate then at the end of three decades you will have exactly the same wealth no matter what term you choose for your mortgage.

Myth #4: If you refinance you have to restart over at 30 years or fit into one of the standard length terms like 15 or 20 years. Not so. In your case you could go with a 15-year mortgage but the payments may be more than you can comfortably handle. An alternative is to go with a 30-year mortgage but immediately pay down the balance to leave only 22 years remaining while keeping the monthly payment at the scheduled rate. Another method is to pay extra each month to pay down the balance faster. The lender can tell you this amount – or I’ll calculate it for you.

Is this the lowest rate we can expect or will they drop even lower in the next few months? My hunch (and keep in mind the track record of economists making predictions) is that right now is as good as it will get. I’m surprised rates have hung around this long at historic lows.

For your 4.75% mortgage you can expect to knock about a percentage point off your rate with a new 30-year mortgage. A 15-year mortgage rate is almost 2% points lower – if the finances (and wife) are alright with it consider chopping seven years off the housing debt schedule. Of course the best rates are for those with excellent credit and the income capacity. If your credit or earnings have taken a hit since your original mortgage then you may not be able to lower your rate with refinancing.

There are at least a couple local lenders who have very reasonable refinancing costs. Suppose your closing costs (e.g. appraisal, title work, etc.) are only $500. This probably means the bank is eating some of the costs. If you have a $150,000 mortgage balance then a 1% rate saving will roughly save you $1500 of interest expense in the first year. So in about four months you have recouped your refinancing costs and your mortgage will be about $90 less per month.

Any local bank can provide you with a good faith estimate of the costs. If you have any “special circumstances” then working with a local lender is usually beneficial. If you don’t mind dealing online then go through BankRate.com or Zillow.com to search for the best deals nationally. I wish the best in your mortgage journey.

Dr. Paul Hamilton is an Associate Professor of Economics at Asbury University and a CFP providing fee-only financial advice. He is available to provide free workshops to churches, local businesses and other groups.

 Contact him at Paul.Hamilton@Asbury.edu or www.USA-Economics.com

 

 

Who Needs a Financial Advisor?

Hey Paul: We are a middle-class family with three children the oldest headed off to college next fall. We are halfway through a 30-year mortgage but otherwise do not have any debt. All our retirement savings of about $300K is in our employers’ 401(k). Do we need a financial advisor? What would be the benefits as we plan towards retirement and other life goals?

It’s a great blessing to have people in your life that you can rely on for trusted advice and accountability. The trick is, of course, how to identify those people with the skill set and character to deliver advice at a reasonable price.

The truth is that almost anyone can call himself or herself a “financial advisor”. If they provide “investment advice” then generally they need to register with the state and undergo background checks and have achieved a certification such as being a Certified Financial Planner (CFP). But that fact that a person is not a criminal and has some book knowledge of money doesn’t necessarily make them a good financial advisor.

A recent commercial (http://goo.gl/bG0tB5) features a Chase Financial Advisor visiting various retirement parties where his clients profusely thank him for making this all possible. While I am all for being grateful for those who have helped us along life’s journey, it is preposterous to claim that it was the advisor rather than the client who put in 40 years of work that is owed the lion’s share of the credit.

Perhaps the small print of the commercial should include Vanguard founder, John Bogle’s take on financial advisors:

“Our hypothetical fund investor has earned $1,170,000, donated $700,000 to the mutual fund industry, and kept the remainder of $470,000. The financial system has consumed 60% of the return, the fund investor has achieved but 40% of his earnings potential. Yet it was the investor who provided 100% of the initial capital; the industry provided none. Confronted by the issue in this way, would an intelligent investor consider this split to represent a fair shake? “ In other words your advisor brought you a bottle of wine to celebrate your retirement and drove up in the Porsche that you bought him.

Now that I have thoroughly bad-mouthed my own (side) occupation, let me provide some brighter views and various alternatives to getting good financial advice. There are several opportunities to obtain solid financial advice. For those who work in a company with a Human Resources office, some basic but very important guidance can usually be gathered on selecting a health insurance plan, flexible spending accounts, and opportunities to contribute (often with a company match) to the employer retirement account.

A second resource is your tax preparer particularly if they are a CPA. A CPA’s forte is tax planning but some have developed expertise in financial planning. Since they would be familiar with much of your finances from your tax return, turning to financial advice is a natural compliment to their services. My mother-in-law has been relying on David Hudson, CPA for many years for both tax and financial advice.

To truly receive comprehensive financial planning one must typically turn to a “financial planner” which as I mentioned earlier can mean many different things. The Hatfield and McCoy feud in financial advising is between those who are fee-based versus those who are commission based. I won’t drag you into all the gory details but much of the challenge is that people are reluctant to pay for advice but will accept a “free” financial review that almost always concludes with a sales pitch for an annuity, permanent life insurance &/or long-term care insurance. These aren’t necessarily bad financial products but often are riddled with exorbitant fees.

The fee-based financial planner is not necessarily a viable option for middle-class households. A typical comprehensive plan will run you around $2000 and for those assets they manage for you there is around a 1% annual fee. [Shameless self-promotion warning] In my own practice I charge $1000 for the plan and show the client how to manage their assets using Betterment.

Let me ask you something. When you’ve been at a restaurant and got a so-so meal did you complain to the manager? No, probably not. Your ‘problem’ is that you are too nice. And when your supposedly trusted advisor puts the hard sell on you won’t be able to say no or ask the tough questions and expect full answers.

What would be some tough questions to ask your advisor? If I invested the funds in an index fund instead of buying this financial product, what is the probability that I’d come out ahead? [No advisor will answer this. Watch out for a mildly related fact such as ‘70% of seniors rely at some point on long-term care.’] How much is your compensation for selling this product? [Could easily be more in an afternoon than you make in a month.]

Fortunately an imminent ruling by the Department of Labor is going to impose a ‘fiduciary standard’ on all financial advisors. A fiduciary is required to put the client’s interest above their own – a modern version of Love Thy Neighbor as Thyself.   The DOL fiduciary ruling will dramatically change how financial planners provide advice and sell products.

Do you need a financial advisor? You know it sounds like you’ve got some enduring financial principals figured out on your own – living within your means, avoiding debt, and working hard. My first advice would be to self-educate by reading a general book on finances as well as religiously turning to my More-Than-Money column each week. A second piece of advice is to seek out a fee-based planner and pay an hourly fee to get specific advice such as financing your child’s college education.

Dr. Paul Hamilton is an Associate Professor of Economics at Asbury University and a CFP providing financial coaching to middle-class Americans. He is available to provide free workshops to churches, local businesses and other groups.

 Contact him at Paul.Hamilton@Asbury.edu or www.USA-Economics.com