Thursday, August 23, 2007

Home Economics

Every day it seems that there's a new story about how home foreclosures are increasing, resulting in widespread implosions of real estate "bubbles" and threatening the overall health of the American economy. Earlier this year, there were Congressional Hearings on the business practices of "payday loan" and credit card companies.

It starts to sound like the downfall of the American economy will ultimately come about simply because the majority of Americans are bad at math.

Before I start down that path, let me just say that, in my opinion, most credit card companies are sharks and many of their "business practices" are nothing more than heinous usury. (And the payday loan companies are at least ten times worse.) I also know that many home mortgage refinancing companies are doing some pretty shady things. Agents will promise certain terms over the phone, but then at closing, the paperwork will show a different interest rate or hide a boatload of closing costs that are being rolled into the loan, and desperate people will go ahead and sign on the dotted line.

Maybe these things should be illegal, but ultimately, I believe that educating consumers about their tricks and traps is probably a better solution than passing more federal regulations. If people would recognize how they're getting ripped off and start talking about it, then these companies would gain or lose business based on their reputations. Right now, no one is willing to step up and announce that, "My credit card payment was due on a Sunday. I mailed it on a Tuesday, it arrived on Friday or Saturday, but the credit card company didn't apply the payment until Monday. They charged me a $39 late fee and raised my interest rate by 5% just because they don't process payments on weekends." Or "Company A pulled a bait-and-switch on my refinance deal, and I wound up paying $5000 in closing costs."

The bigger problem is that most people don't even know it's happening. They don't understand how to calculate compound interest, and they're too intimidated to ask questions about the paperwork at closings. As my friend Tracie says, "Life's hard[er] for stupid people." She used to work in the mortgage industry, so she knows exactly how people get ripped off by hidden closing costs and the sky-high interest rates that are charged for having bad credit.

Exhibit A: When my brother-in-law got divorced, he agreed to buy a house in certain neighborhood so that his son could go to that school system. My ex-sister-in-law couldn't figure out why he couldn't afford to buy a house worth more than $125,000, because she thought that house payments were basically just the value of the house divided by the number of payments, plus maybe a hundred dollars to cover the taxes and 6% [simple] interest.

She's never learned anything about mortgages because her parents actually bought her a huge house and put into a trust fund for her. The problem is that she and her brother are eventually going to inherit a multi-million-dollar company from their parents. When they inevitably run it into the ground, dozens of their employees will lose their jobs, and the economy will bleed from one more small cut.

Most college students wind up buying a new car within a year or two of graduating. But I wonder how many of them actually understand what it means to be "upside down" on a car loan? Every year, credit card companies send dozens of pre-approved applications to every college freshman. Their goal is to make sure that they all walk of of school with $5,000 - $10,000 of credit card debt. Students might be somewhat troubled by the fact that they're so far in debt when they're not earning anything, but the credit card companies hope they they'll build up a tolerance to it until they reach the point where they're comfortable carrying $20,000, $30,000, or $40,000 worth of debt for decades. They might look around and see that all their friends have roughly the same income and debts, so they think they're doing OK, but actually they're just all broke together.

Exhibit B: I had a credit card in college, and initially I paid it off every month, but in grad school, my rent was actually more than my income. (No one told me that I would be taxed on the total value of my research grant. The majority of stipend wound up being withheld in order to cover the taxes from my tuition reimbursement. That's not meant to be an excuse-- It's just an example of a lesson learned the hard way.) So I wound up charging my groceries and living expenses on my credit card, and when I graduated, I had $5,000 in credit card debt on top of my $20k in student loans. I wasn't terribly worried about paying it off, because I was making more money than most of my friends from college. After I bought my house, I slid much further into credit card debt, and I started to lay awake at night, wondering how I would ever pay it all off. I didn't get out of credit card debt until I had been out of school for 5 years. (I'm still working on the student loans, but the end is in sight!)

My parents never talked to me much about budgets, credit cards, or mortgages. I remember my mom briefly listing all of our monthly expenses once, when my sister was complaining about why she couldn't buy all of the stuff that her friends had. When I graduated from college, my dad put $1,000 into an IRA for me, and he walked me through the calculations on how much it could grow by the time I wanted to retire. When I started working, he encouraged me to put 6% of my salary into my 401k, because he knew the company was doing a 75% match. But my dad learned a lot about investing from his dad, and I suspect that most parents never take the time to explain these things to their kids.

Maybe parents don't teach their kids about budgeting and investing because they feel like they're not practicing what they preach, or maybe it's because they simply don't understand the principles well enough to explain it.

Kids (and adults) can't see the value of Algebra or Geometry, let alone a reason to learn exponentials or compound interest. But no one can truly avoid learning about "the most powerful force in the Universe." If kids don't learn how to do the math while they're young, they wind up figuring it out in the school of hard knocks.

I tell the little girls that I tutor, "It's really, really important to be good at math, because otherwise, for your entire life, people will cheat you and take advantage of you. And you won't even know that they're doing it. You'll just know that you're always broke and you always will be."

I think it's time to start requiring a home economics class as a requirement for graduating high school. Obviously, it shouldn't be the traditional Home Ec of sewing, cooking, and all that antiquated stuff. Instead it should cover things like:

  • Monthly Budgets - How much do utilities cost? How much does a typical car cost, including the loan payment, insurance, and repairs? How much do people pay for childcare? What about groceries and eating out at restaurants?

  • Credit Cards - Suppose you buy a computer for $1000, and you start making payments of $100 each month. For a given interest rate, how long will it take before it's paid off? What will happen if you're late? How much will you wind up paying for the computer? Repeat the same calculations for rent-to-own furniture.

  • Mortgages - If you buy a house for $200,000, how much will it wind up costing every month? How much will you pay over 30 years? What happens if you make an extra payment every year?

  • Investments - The company you work has a 50% match, and the average rate of return is 7%. If your salary is $50,000, and you invest 5% of your income, how much will you wind up with when you retire?

  • Taxes - Given a W-2 form and a couple of 1099's, fill out a 1040-EZ tax return. (This skill is important so that people don't fall prey to tax refund loan companies, which are just as bad as the payday loan companies, IMHO.)

So here's my final thought for today:

What do you think?

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