PART 1 Lesson 7 The Problem

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Content: Page 17, Becoming Your Own Banker Fifth Edition

Several years ago, I did a study on the spending habits of American families. The results are depicted in the graph on page 17 of the book. Since that time, I have kept an eye on the proportions on income allocated to each category and I’m convinced that the situation has become worse — they are spending more on interest and saving less.

I build my scenarios around the “average person” because I don’t want anyone to think that you have to be rich to create a banking system that can handle all your needs for finance. This young man is 29 years old and is making $28,500 per year after taxes — that is all he can spend. What does he do with the after-tax income? 20% is spent on transportation — 30% on housing — 45% on “living” (clothes, groceries, contributions to charitable causes, boat payments, casualty insurance on cars, vacations, etc.). Many of these items are financed by credit cards or bank notes. The balance is financed by paying cash for them — and thus, giving up interest that could be earned, otherwise. He is saving less than 5% of his after-tax income! (At the time of this writing he is saving absolutely nothing!) It is the first time in the history of America that this has happened. This scenario has all the ingredients for an impending disaster!

To be as generous as possible, let’s assume he is saving 10% and spending 40% on living expenses. This is giving him every benefit of the doubt on the matter of savings. Just remember — the real situation is much worse than these assumptions.

The problem is that the cars, housing and much of the “living” items are financed by other banking organizations. The typical financing package for an automobile for this hypothetical person is $10,550 for 48 months with an interest rate of at least 8.5% and this produces a monthly payment of $260.00 per month. It is a fact that 95% of the cars that are traded in are not paid for. This means, at the end of 30 months, that 21% of every payment is interest – and this is a perpetual factor. It never seems to dawn on him that the volume of interest is the real issue, not the annual percentage rate.

What’s more, ask the sales manager of the high-priced cars, “What percentage of the cars that leave your agency are leased?” He will probably tell you 75% or more! That is even worse than having them financed!

Now, let’s move to the housing situation. This young man can qualify for a 30-year fixed-rate mortgage of about $93.000 at 7% APR with payments of $618.75 per month and closing costs of about $2,500.00. The problem is that within 5 years he will move to another city – maybe just move across town – or even refinance the mortgage. Something happens to a mortgage within 5 years. During the 60 months he has paid out $39,625, including closing costs but only $5,458 has gone to reduce the loan. This means that $34,167 has gone to interest and closing costs. Divide the amount paid out into the interest and closing costs and you find that 86% of every dollar paid out goes to the cost of financing! If he sells the house is less than 5 years, it is worse. This situation is also perpetual. He thinks he is buying a house, but all he is really doing is making the wheels of the banking business and the real estate business – in that order – turn. But, all the “financial experts”are advising him to indulge in this activity.

In the next segment of the spending pattern graph – the living expenses – you will find the interest on boat payments, credit cards, plus the cost of casualty insurance on cars, etc. will rival in volume the interest he is paying on the two cars in the family that we addressed earlier. Later on, in this course you will learn how to self-insure for comprehensive and collision insurance on cars.

Now, add up all the interest he is paying out and you find that 34.5% of every dollar paid out is interest. For the average All-American male this proportion never changes. Let’s assume that he is saving 10% of is disposable income (which he is not doing!). This would mean that we have a 3.45 to 1 ratio of interest paid out as compared to savings.

Now, get this young man together with his peers at a coffee break and have one of them suggest that they discuss financial matters. You can rest assured they will all talk about getting a high rate of return on the little dribble they are saving. Meanwhile, all the participants are doing the above! What a tragedy! But that is how they have been taught to conduct financial affairs.

We will continue this in lesson 8. See you then!