Figuring Out The True APR

For many years now, lenders have been required to disclose not only the rate and fees, but also estimate the APR – Annual Percent Rate, which is supposed to accurately represent the borrowing cost and account for expenses associated with the loan.

If you haven’t taken a mortgage before, here’s a crash course on long term lending:
- loan rate refers to the monthly rate x 12 (or daily rate x 365)
- points refer to optional fees the consumer may pay to lower the interest rate
- origination fees are simply bank charges

It always puzzled me how a person with good credit can get a $60,000 credit card with a single signature and no fees (sometimes even a bonus), but a mortgage of $60,000 secured by collateral takes days to create, costs hundreds in fees, and in many states requires the involvement of real estate attorneys. Must be the tradition, I guess.

For example, let’s review 30-year mortgages listed at http://www.bankrate.com/. As of October 2011, a well-qualified borrower in Portland, Oregon can count on a 30-year, $60,000 mortgage with a 4% rate, zero points, $950 in fees and a stated 4.133% APR. The extra 0.133% comes from the $950 in fees spread across the 30-year life of the loan.

But what if you decide to refinance in five years? With a little spreadsheet magic, I came up with 4.45% APR when accounted for a 5-year term – a whopping 11% increase over the base rate! At that point a no-cost 4.5% loan starts to look like a bargain.

Bottom line – the stated APR can be way off for long term loans, because with a future refinance any upfront costs amortize over a much shorter period, hiking up the rate.

Paying Taxes Early? Are You Mad?

November is when Florida homeowners receive their property tax bills.

Unlike citizens of some other countries like Peru (no real estate tax) or Monaco (free housing provided by the prince), most homeowners in the United States pay annual taxes on the housing they’ve already purchased, with rates ranging between 1% and 2% of the property’s assessed value. So before you accept that 5 million dollar mansion as a gift, consider how you will pay the $70,000 annual tax (which is, mercifully, deductible from your federal taxes).

Back to the tax bill: the November invoice is actually for taxes due in April of next year, with the following twist – for each month the bill is settled early, the county will knock 1% off the amount. That’s 12% APR, a pretty spectacular rate these days.

The conventional tax strategy is to accelerate deductions and delay payments. Florida property tax may be one of those rare instances where it’s beneficial to pay tax early, even if you pay it with borrowed money (borrowed at less than 12% APR, naturally).

Someone paying this tax in November rather than in April is paying 5% less, and also deducting it from federal tax a year sooner. For a $6,000 property tax, that’s $300 saved, and a tax liability reduced by $1500, assuming the 25% federal tax bracket.

What is Your Time Worth?

It happens to most of us:
Your friend is moving into a new apartment, and needs an extra pair of hands. Or your dear aunt asks you to take her to the airport. Or your in-laws have trouble with the computer again and need your help. None of these favors are difficult, but they can be time consuming.

Helping others builds “karma points” and general goodwill, but sometimes makes you wonder – what’s your time worth? If it were a stranger, what would you accept as an equitable compensation for your time?

I asked my (salaried) friends this question over lunch, an no one had an immediate answer. Eventually, however, most answers clustered around 50% of their hourly rates at their places of employment. This is different from the “market rate” for labor, which is dictated by laws of supply and demand for a given skill.

Here’s what others said about valuing your own time:
http://lifehack.org/articles/productivity/what-is-your-time-worth.html
http://thesimpledollar.com/2007/05/20/figuring-out-exactly-how-much-your-time-is-worth/
http://blogs.wsj.com/juggle/2011/06/15/whats-your-time-worth/
http://www.inboundsales.net/blog/bid/22818/What-is-your-time-worth

Does your perception of your own time value match the 50% rule? I’m curious to find out.

Borrowing from Credit Cards

If you have a credit card, you have likely received “convenience checks” allowing you to borrow against your credit line for a certain period of time. Does such borrowing make sense?

It depends on the terms, how you will use the borrowed funds and your confidence on being able to repay it on time. For example, borrowing $50,000 for six months interest-free and paying $50 advance fee is equivalent to Annual Percentage Rate (APR) of about 0.2%. That was an actual deal offered by Bank of America and others a few years back, from 2002 to 2005. Not even US federal government can borrow money on these terms!

But if the funds were paid back only a month late, they would incur one month of interest to the tune of 18% APR. At that point, your average borrowing cost just jumped from 0.2% to  2.7% APR after the first month, 4.6% APR after two months and 6.1% after 3 months.

Since 2005, banks wised up to savvy consumers and now charge 3-4% fee upfront on such convenience checks, driving APR on a 6-month “interest-free” loan to about 6-8%, and more if you pay off the balance early. For borrowers with good credit, rates better than 5% are available elsewhere.

In October 2011, Bank of America offers 0% loan for 11 months, with 4% fee at sign-up. This corresponds to about 4.5% APR, close to current mortgage rate if you borrow for exactly 11 months. Pay two months early, and the APR is 5.3%. Pay two months late, and the APR is 5.1% – no longer a bargain.

How to figure the APR for short term loans: add up all borrowing costs (upfront fees, calculated interest), length of the loan in months and your average balance for the duration of the loan, then use this formula: (Costs*1200%) / (AverageBalance*Months).

For example, for a 2-week payday loan:
Costs: $50
Loan length: 0.5 (2 weeks – about half a month)
AverageBalance: $300

APR = ($50*1200%) / ($300*0.5) = 60000%/150 = 4000%

4,000% APR? Now you know why they call them loan sharks!

Welcome to Cash Economy!

Welcome to the Cash Economy blog!

This blog is written and published by real people at MechCAD Software, the maker of AceMoney and AceStock: personal finance management software. Our goal is to keep things simple for our customers, and be helpful when our customers need assistance with tech support, or general product discussion in an online forum.

The topic of the blog is personal and small business finance. Whenever a particular AceMoney feature or a product from another vendor adds to the topic, we’ll mention it.

With this disclosure out of the way, let’s begin…