Cash Flow is King

Whether it is your personal finances or your investment plans, cash flow is the single most important element in all of your financial planning. Sure you want to make a profit, however if you cannot carry the cash flow which includes the investment installment payments, you risk losing your investment or worse having to sell it at a loss. As part of your financial planning and assessment of any investment, always take into account the monthly installment payments to ensure that you have the cash flow to meet these payments.

Investment Business Case

Next to cash flow and installment payments, the business case for your investment is obviously important. There are a number of areas that you will need to assess to determine if the risk of your investment is worth the potential return you expect.

Most business case assessments deal with the income you can expect and the cost of the investment. Costs can be operating costs, interest on loans, and other license fees or permits that you may need. If the revenue / capital gain will not cover the costs and give you a reasonable profit then it may not be a good business deal to get into.

Investment Variables.

There are many variables to investments. Obviously once you have paid for a particular investment you have a fixed cost. From that point forward many things can change. Operating costs can vary from estimates. The value of the property or investment can change in a positive or negative direction.

The cost of the investment loan can also vary depending on the type of loan that you have. Interest rates change , so if you have a variable interest rate investment loan, the monthly installment payments can change a lot. Basically with a variable investment loan, you need to pay the interest that becomes due each month as a minimum.

The terms of your loan will dictate just what the minimum payment must be, however you must recognize that these payments can and will change, which impacts your investment installment payments each month.

How Much Money Can You Borrow?

Investment loans are usually handled much differently than personal loans. They have all of the same attributes, however obtaining an investment loan is usually much more difficult. The banks are understandably nervous about investments and your ability to repay the loan.

The banks will assess the risk of the investment that you are looking at to determine what the probability is that they will get their money back. They may also look at your reputation as a business person and your track record in terms of repaying loans through regular installments. Finally they may assess your personal credit rating, since ultimately they are expecting you to repay the loan even if the investment goes south and you cannot recover your original investment.

This is an important point that many people may not understand. The banks are loaning money every day with the expectation that they too will make money from loaning money to you. The only way they can do this is if you meet all of your loan installment payments until the loan is repaid or you repay the loan with a lump sum payment.

If your investment does not pass their criteria, they might refuse the loan application, or they may still loan you the money as a personal loan. You may have to pay a higher interest rate as well if they feel that the investment is high risk or if they feel you are high risk. Both of these factors have the impact of increasing your overall cost and your  regular monthly installment payments. Evaluate your cash flow under these circumstances to make sure that you are not jeopardizing your investment as well as your personal credit rating.

Tax Statements

In most countries the cost of your investment can be deducted from the revenue you make before you calculate your total income tax due. Loan interest is a cost of doing business as are other fees and operating expenses that may also be involved.

Keep accurate records of your costs, monthly installment payments, as well as revenue. Your accountant will be able to separate the interest paid from the principal repaid from your monthly installment payments. Note that is only the interest that you pay for the loan that can be deducted and not the principal that you have repaid.

Increase interest charges will decrease your profit, however they also decrease the amount of tax that you ultimately pay. Your net profit is based on the revenue you took in, less your costs that you paid out less the taxes that you had to pay on the net profit.

Summary

Remember that cash flow is king and must be managed carefully so you do not default on your loans. The business case must show how you will make a profit and also show what risk there is and how it will be handled. The financial institution that will loan you money will want to know how it will get its money back either from the sale of your investment or from monthly installment payments you will make. In the latter case you must be able to demonstrate how you are able to repay the loan either on a monthly installment basis or a lump sum from the sale of your investment.

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Over the past year we have seen the real estate melt down in the US with millions of people losing their homes when they could not continue to meet their monthly payments or in some case just chose not to continue making payments. Many consumers just concluded that even though they could make the payments, there was no sense in continuing when the value of their homes had lost so much money. Others lost their jobs and suddenly found themselves in dire straights when they could not meet their monthly installment payments on mortgages and loans that they may have had.

Principal, Interest Rates and Term

These are the three factors that are used to calculate your monthly payments. When you negotiate a mortgage, consumers need to pay attention to these factors and several others which we will get into a little later in this post. Your initial monthly payments will be determined by these three factors and it might mean the difference between affording your home and not.

Reducing the amount of money you need to borrow will lower your monthly payments. Obviously you want to get this as low as possible, however at the same time if you are planning some renovations to your new home, you may want to consider borrowing enough to fund these renovations.

The interest rate has a big impact on your payments. Consumers should work hard to get this as low as possible for as long as possible. Any time the interest rate changes on your mortgage, you run the risk of your monthly installment payments increasing and your home becoming unaffordable.

The term is another factor that influences monthly payments. Longer terms will lower your payments. Some people will take a short term mortgage of 15 or 20 years, while the most common is 25 years. There are also mortgage terms of as long as 35 years, however we think these are not the norm. The term is the time that it will take you to pay of the mortgage in full.

Read the Fine Print

Although you have a term of 25 years on your mortgage, your interest rate can change more often. Many banks will offer a 5 year commitment to the interest rate they are giving you on the mortgage. This means that the interest rate will not change for 5 years. At the end of five years , your monthly installment payments on your mortgage will change based on new calculations of the remaining principle, the remaining term and the new interest rate that is available at that time.

If the prevailing interest rate has increased, then your monthly payments are going to go up and conversely if the interest rates have gone down, then your payments will also go down. This is the normal type of arrangement that many banks offer and consumers have come to expect.

Unfortunately we have learned that many banks in the US were offering mortgages that did not follow these guidelines.  the fine print might refer to a change in interest rates partway through the initial 5 years. There were subsidies to the interest rates for a few years that allowed many people to purchase their own homes who normally would not have qualified for a mortgage. When the subsidy ended they were in trouble and could not meet the required monthly payments!

Always take the time to read the fine print and understand the impacts. If you do not understand what is being included, ask questions and get a 3rd party to explain it to you. At the end of the day, it is your home, your credit and your families lifestyle that you are putting at risk, so be fearless in taking the time to make sure that you can always afford to continue to make your monthly installment payments.

Taxes and Mortgage Payments

Some banks want to make sure that home owners will pay their property taxes and will not fall behind in this area. As a result they will ask you to make a monthly installment payment on your taxes. The bank will collect one twelfth of the estimated property taxes that are due on the home each month in addition to your regular monthly mortgage installment payment.

The money collected for your taxes goes into a special account they have set up for you. When the taxes become due the bank will make the payment on your behalf and ensure that your tax account is paid and always up to date. This is an excellent way to pay your property taxes. It smooths out your tax payment into 12 equal payments and gets you into the habit of making these payments on a regular basis.

Failing to pay your property taxes can be as bad as not paying your mortgage payments. The city will place a lien on the property if there are taxes owing  which means you cannot sell the home until you have paid this overdue tax bill in full. Always pay your monthly mortgage installment payment and your monthly tax payments on time every month to avoid any difficulty in this area.

Taxes and Interest

In Canada, we cannot claim the interest we pay on mortgages and loans against our income to reduce the amount of income taxes we pay. The only exception to this is if we borrow money to make investments which earn income.

In the United States, consumers can claim the interest they pay on mortgages to reduce their total amount to income tax they will pay. Consumers need to consider very carefully their monthly payments and ensure that they can always meet the payments and keep their credit rating intact.

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With so many jurisdictions across Canada and the United States we are not going to try and describe all of the different types of student loans. Safe to say that they fall into several categories. One category will be interest free until graduation or perhaps as long as 6 months after graduation. Other types of student loans that are available will have interest charged immediately just as you would with any regular loan. Some students will have a combination of  both types of loans prior to graduation and once they graduate, a blended interest rate and loan will be set up with corresponding installment payments.

In a few cases student loans will be forgiven, however you should not really count on this. The best approach by far is to excel in high school and at college and university to qualify for scholar ship funding which usually does not have to be repaid unless you violate the conditions of the scholarship. Treat the chase for scholarships as a job and a way to earn money while going to school. Of course you need to make sure you do not jeopardize your studies, so you need to find the right  balance.

Sticking to a Budget

Many students who are attending school for the first time away from their parents do not really have any idea what things cost and do not know how to set up a budget. As a result before they know it they have used up the proceeds of their scholarship or student loan and need more money. This of course has longer term consequences. The most obvious being that when they graduate they will owe more money and their monthly installment payments will be that much larger.

The best approach by far is to set up a budget that is withing the limits of your loan and stick to it. You may have to cut back a lot, however you will thank yourself when you graduate and find that you have a smaller monthly installment payment to worry about.

Why Do we Care  About the Size of the Installment Payment

When we graduate from college or university, and have a student loan, this loan will impact our credit score and our ability to borrow money. If you fail to make a payment on your student loan you will negatively impact your credit score and it will be even more difficult to get a loan. Many students when they graduate, want to buy a car, purchase furniture, clothes etc and all of this takes money that they do not have.

It means credit cards or more loans. Before you know it your student loan installment payments and your other loan installment payments are more than you can handle. With credit card interest rates at plus 20%, installment payments can quickly get out of control.

Going back to student loans and installment payments, one big advantage of student loans is that they are often interest free while you are still in school. The minute you graduate or quit, the loan becomes due and interest is charged on your student loan. Quitting school before you graduate, regardless of the reason causes the loan to become due and payable. You need to examine the terms before you sign to see just what the requirements are should you be forced to quit school due to poor marks etc.

Discuss the Terms with the Bank

The best time to negotiate the terms of your student loan is before you sign on the dotted line. Once you have signed the documents, there is little chance to negotiate your terms. Interest rates, the term of the loan and when the installment payments will begin are negotiable before hand and not after. Get all of these items clear ahead of time so that you fully understand this before you sign.

Knowing when installment payments will begin and when interest will be charged at what rate will help you understand what your obligations are and allow you to budget accordingly once you graduate. Knowing all of these details will avoid any surprises down the road.

Co-Signing on Student Loans

Since most students do not have any assets and do not have any credit history, their parents are often asked to co-sign the loan with the student. While this is a wonderful thing to do to help your son or daughter, the parent should really understand what they are signing and what the obligations are should the student be unable to repay the loan for any reason.

In the worst case the parents can be stuck paying the loan and their credit rating may also suffer if payments were missed as well. It pays to pay attention to the details and also that your son or daughter is fully committed to doing well at school so that they can find a job when they graduate and repay the student loan with regular installment payments.

Any failure on the students part will reflect directly on the parent if you co-sign the loan. Credit ratings, ability to borrow, remortgage your home or car are all areas that might come under scrutiny should there be a default on student loan installment payments.

Most parents do not really understand what they are getting into until it is too late. Figure it out now and discuss this with your bank manager and your student children prior to co-signing any student loan.

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As long as you always meet your monthly installment payments on your mortgage, your mortgage will be considered in good standing and your credit rating will be unchanged. Should you miss a payment or are late making your payments, the bank may get nervous and call the mortgage and / or file a comment on your credit rating which would make it more difficult to borrow money in the future.

Home Loan Installment Payments

Many consumers will also arrange for a home loan that uses their home as collateral that is in addition to any mortgage that they may have on their home. The installment payments on this home loan will be based on a term of whatever you negotiate, and amortization of the same term. This means that your home loan installment payments may be proportionally higher than the monthly installment payments on your mortgage.

Home loans are attractive especially when they are registered as a loan against your home. The interest rate is lower than a standard personal loan, because the bank perceives less risk associated with the loan. They can always sell your home to collect the principle remaining on the loan. Of course they will stand behind the mortgage holder in terms of who gets paid first.

Some consumers prefer this approach vs. increasing their mortgage because they can pay the loan off separately from their mortgage. The installment payments each month are different of course and will end once the loan is paid off.

In summary the major of a registered home loan is a better interest rate than what you might be able to negotiate on a straight personal loan. So you pay less interest and your installment payments each month are lower as well.

Why Would You Want a Home Loan

Home loans can be used for a multitude of purposes. Many home owners will take out a small home loan to cover renovations they plan to make on their home. Window replacement, a new roof , perhaps some new furniture are just a couple of examples. Typically they are larger than what your credit card can handle and they want to avoid the high interest rates of a credit card balance. Credit card balances will be charged an interest rate of 18% to as much as 28% depending on the store or credit card that you use. Compared to taking out a home loan at prevailing interest rates of around 5% at the beginning of 2010, this is a much better deal.

The installment payments on a home loan vs the installment payments on a credit card will be a lot lower and much more attractive.

Consolidating Loans into One Home Loan

Home loans might also be taken out to consolidate other loans into one manageable loan. Depending on the size of the loans, the maturity dates and the interest rates that are being charged on these loans you may or may not have a lower monthly installment payment. Talk to your local banker to see what your options are and how much your consolidated loan installment payments would be. Once yo have this information, you can make an informed decision about consolidating your individual loans.

In addition to comparing the interest rate and the monthly installment payment you should also ask the banker to tell you what the total cost of the home loan will be. This cost will be the total amount of interest you will be expected to pay and any fees that may or may not be charged to register the loan.

It is important to compare these numbers in addition to your monthly installment payment and interest rate. You could be paying more interest that you thought plus fees just to consolidate your existing loans.

Banks are There to Make Money

All of the banks are in business to make money and with the number of banks offering banking services, they are also pretty competitive. The point to remember that like all financial advisers they do not make money unless they sell something to you. Consumers need to do their home work regardless of what type of loan they are looking at.

If you are thinking of taking out a new loan to consolidate your existing loans and registering your loan against your home to obtain a better interest rate, always examine the details. What is the interest rate? What is the term of the loan? What are the installment payments? What fee’s if any will be applied to register the home loan? and What fee’s if any are there to discharge the home loan?

Always compare the answers to these questions against your current situation. There is no single answer as to what to do since every situation is different and people have different criteria. Some folks are totally focused on finding a home loan with the lowest monthly installment payment, while others will focus on the total cost of the home loan e.g. fee’s plus interest.

Once you have completed your assessment make the best decision for you that fits your situation and needs. You may not obtain exactly what you are looking for in terms of the best deal, but at least you have done the analysis and know what you are getting into. Good luck and we appreciate comments on our posts.

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Store credit cards typically charge interest on the balance on the credit card somewhere in the range of 18% to 28% depending on the store.  When you compare to 5 year term loans or mortgage interest rates, these store credit card rates are extremely high. The installment payments are also very high and most consumers will find it difficult to make their monthly installment payments with these high rates.

Solutions to High Credit Card Installment Payments

There are solutions to this problem, however it depends on your financial situation as well as whether you have the discipline to manage your credit cards once you have paid them down. Many people, once their credit card balances are transferred to a loan or mortgage with a lower interest rate and a much lower installment payment, just load up on the credit card all over again. They end up with a problem that is now much worse. They have installment payments again on the credit card and a large installment payment on their loan or mortgage. My suggestion: Cut up the store credit card if you are worried that you will not have the discipline to manage your credit card balances.

Arrange a Personal Loan at your Local Bank

Many people are finding it difficult to borrow money right now in 2010 due to the recent financial crisis, however for those of you that have the income and the credit rating, this may be an option. Paying an installment payment on a loan based on an interest rate in the range of 5% to 8% is so much better than making installment payments when the interest rate is 28%.

Increase your Mortgage Principle

Again, this option may not be available to everyone due to the recent financial crisis during 2009. Many homeowners found that the value of their homes actually declined, in some cases to less than the value of the existing mortgage. However if you have a small mortgage relative to the value of your home, you may be able to persuade the bank to increase the amount of your mortgage so that you can pay down your credit cards and eliminate the corresponding installment payment. Not only will the interest rate be a lot lower, the term of the mortgage is longer than 5 years ( in some cases it can be 25 or 35 years) which has the effect of making the installment payment increment quite low.  This option will give you the lowest installment payments overall, however we emphasize that cutting up your credit cards should be given serious consideration.

Transfer Credit Card Balance to a Competitive Credit Card

We have all received these offers in the mail. Apply for a new credit card, transfer your existing credit card balances to the new credit card and they will guarantee you a low introductory rate for some period of time. On the surface these credit card offers sound pretty good, however there are a few pitfalls to them which we would like to point out, which can effect your monthly installment payment significantly.

Often the introductory is quite attractive and will significantly decrease your installment payments. There are three issues that consumers need to be aware of. First the introductory rate only lasts for a defined amount of time. Once that time limit is up, the interest rate returns to the usual high credit card rate with the corresponding impact on your monthly installment payment. If you can, pay off the principle before you reach the end of this time limit.

Secondly, the next catch is that if you miss a payment, even by one day, the credit card company has the right to increase the interest rate to the normal rate that they charge. How many times have we scheduled an electronic payment, only to have keyed in the wrong date, or the wrong amount. That is all it takes so make sure this amount is correct.

Third, if you should exceed the credit limit they have offered to you, which includes the transferred balance as well as any new charges, they have the right to increase the interest rate.  Easy to do and with significant consequences.

The writer recently received an offer just like this one. If you missed a payment or exceeded the credit limit, the interest rate went from 1.99% for the first 10 billing cycles to 19.99%! A significant increase to your monthly installment payments!

Installment Payments

Installment payments are based on the term which is usually 5 years for credit cards, the interest rate and the balance. As we indicated earlier the interest rate can vary from 18% to 28% depending on the card and the institution you are dealing with. Your balance is a bit trickier.

If you pay the balance on your credit card each month prior to the due date, then no interest is calculated and you do not have installment payments. If you not pay the balance off or just pay a portion of the balance prior to the due date, then interest will be charged on the remaining balance from the end of the grace period to the billing date. If you take cash advances on your credit card, interest is charge immediately and is calculated as part of your installment payment. Consumers can easily find a large interest charge on their invoices due to cash advances and unpaid balances!

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