Instalments -

Looking around the US economy right now. Homes have been foreclosed, bankruptcy looms on private debts and the retirement 401ks have taken a serious hit. Life as we knew it has been turned upside down without anything in place to catch us as we fell. So how did we get into this mess? The economists tell us we have been living beyond our means. Credit was cheap and, with banks and credit card companies raising their borrowing limits, there seemed to be nothing we could not afford. There was no need for savings. Everything could be charged. If the limit was reached, the housing equity could be released as cash. Over a period of about twenty years, we switched from a country that saves to a country that spends on credit. In the period just after World War II, we had “prudence”. People mostly paid cash for what they wanted and, if they did not have enough, they saved. It was a revolution when, suddenly, everything could be paid for in affordable monthly instalments. In one sense, this is the easiest way to get into serious debt without noticing. When you only pay a few hundred dollars every month, it hardly registers the total debt is tens of thousands.

Insurance companies were the last of the hold-outs. For years, they insisted everyone should pay them a lump sum once a year. Then, slowly, there was a cave. First it slipped to every six months, then quarterly. Now almost every company across the nation accepts monthly. What’s the problem for the insurance companies? Well, they estimate the likely total cost of the claims they will have to pay over the next twelve months and divide that amount between all the policy holders as the premium. If the company has done its sums properly and everyone pays once a year, the company always has the cash in the bank to pay out on all the claims. If people pay monthly, they can easily change to another insurer. They can miss one month’s payment when the family budget is under pressure. That means the insurer may not have enough money to pay the claims. So, to encourage all you people with some savings (or some slack on your credit cards), they offer discounts if you agree to pay every six or twelve months. It gives them more security and saves you some money. Paying monthly costs you the most.

That said, paying monthly gives you flexibility. You can use the online search engines to find auto insurance quotes at the lowest price. Then for just one month’s premium, you can be driving. In effect, this becomes a monthly policy. You can keep shopping around for new premium offers from different insurers. If you find a better monthly rate, you can transfer at the end of the month. But if you pay once or twice a year, the insurer will hit you with high cancellation charges to lock you in. Whatever you might save disappears. Worse, if you change the make and model of your vehicle during the longer policy term, it can be too expensive to move the policy to a cheaper company. You end up paying the higher premium until the six or twelve months end. So make a wise decision. Auto insurance is never cheap. Avoid making it too expensive.

One of the things we value in our life is certainty and predictability. It would be good if everything stayed the same so that, once we have put everything in place, we could just lie back and let life pass us by. Unfortunately, life has a nasty habit of waking us up. If we are lucky, the plans we laid cover the emergency. If not, it’s a case of picking up the pieces, working through the problems and putting new plans in place for the next time. But then there are the problems that creep up on us without any fanfares to announce their arrival. One morning we wake up and, when we look around, we find things are not the same. Welcome to the phenomenon of inflation.

This is where the prices of goods and services slowly rise over time. The purchasing power of our weekly or monthly paycheck drops. With some persuasion, our employers reluctantly increase the pay and make up the difference. The result is a steady erosion in the value of the dollar. What was a good sum twenty years ago becomes a pittance today. This represents a subtle threat. Unless you actually think about the adequacy of your insurance coverage, you just drift on paying the instalments. If the worst happens, your dependents then find out there is enough to cover the cost of the funeral and pay the family outgoings only for a month or so.

In a recent survey of financial preparedness, the answers show that about 60% of all adult Americans have coverage representing less than three times their net annual income. In many cases, this amount would not be enough to clear off the outstanding mortgage on the family home let alone provide a lump sum to tide people over until the loss of income can be recovered. But the detail of financial planning is about more than a simple formula. Some industry professionals recommend coverage representing not less than six or seven times the net annual income. But it’s always better to start with the estimated level of debts. We start with the mortgage and any other loans secured on the family home.

Although these amounts should slowly fall during your lifetime, many people actually maintain or increase the amount borrowed. This may be to trade up in the quality of the home or to release some of the housing equity as cash. The first priority should be to ensure that the family’s occupation of the home will not be threatened. Now add in the unsecured debts in overdrafts and on credit and store cards. Then what are the longer term plans to pay for your children’s college education? The number of dependents and their needs change during your life so keeping the amount of coverage the same is always an option. But, in most cases, inflation-proofing is the better choice, particularly if the policy has a cash value. This gives you more personal security later in life.

Life insurance planning is all about monitoring the needs of your dependents and assessing how much will be required to replace your earning power. When you are starting off, always get the maximum number of life insurance quotes. It’s also a good idea to take independent professional advice on the strategies to apply over your lifetime to get the most value out of the policy you buy.

During the boom years, all you had to worry about was the color to paint your home. Everything else was just great as house values kept on going up, releasing ever more housing equity as collateral for your loans. Now we have a recession and a wave of foreclosures has been sweeping across the land. Friends and neighbors have suddenly disappeared and their empty homes now stand out like bad teeth along streets that have forgotten how to smile. Needless to say, all these empty homes have no buyers and the resale value of all property has been falling over the last eighteen months. To complete the picture of the perfect economic storm, unemployment has pushed up above 10% in some areas. With this number of people out of work, there’s little chance of any significant pick up in the housing market over the next months. Indeed, you may be feeling the pressure of keeping your own head above the water. Too often people are discovering that the loans they acquired in the good years have terms raising the interest rates now. At a time when money is tight, this is unwelcome news.

The answer is negotiating a loan modification. This should be easy. You call up the loan company, explain your problems, show how much you can afford, agree to extend the term of the loan, and reduce the monthly instalments. Except you suddenly discover you no longer know who owns the mortgage. All these clever banks and finance companies sliced and diced all the loans into securitized bonds. The debts were all sold on and funding out who the owners are now can a real problem. But let’s assume you are lucky. That the original lender still owns the debt or you can find someone to talk to who works for the new owner. What exactly do you want? There are two options. The first changes the interest rates applied. Many people have been caught out by variable rates that have increased. To survive, you need to replace this balloon rate with a low fixed rate. The second option is hopefully added on to the first. You need to add years to the term of the mortgage. If you repay the same amount over twenty years instead of ten, your instalments are suddenly affordable again. Yes, you will pay slightly more interest over the additional ten years. But this will be a small price to pay to save your home.

At this point you discover that the person listening is not that sympathetic and sees no reason why the owner of the mortgage should now make less profit. Telling this person about family emergencies and health issues cuts no ice. You also discover the much-publicized Home Affordable Modification Program introduced by the Obama Administration is actually not that helpful. So what does work? The answer is either you are persistent or you get a specialist to help you. But be warned. There are a small army of crooks and con artists out there pretending to be home loan modification specialists. Never employ someone to help unless you have proof they offer real services. Always remember one truth. In the end, the lender makes more money if you stay in your home and pay something. If there is a foreclosure, everyone loses.

Insurance is a program that lets you pay instalments now against the risk of expenses in the future. With something like fire insurance, you get a quote for rebuilding your home or business premises from the ground up. That represents the maximum amount necessary to put you back into the position before the fire struck. No matter how optimistic or pessimistic you are, you and the insurance company can put a price on the potential loss. Unfortunately that does not work so well when it comes to medical costs. The young and optimistic have perfect health and prefer not to think about the risk of accidents or illness. These are things that happen to other people. But, sooner or later, there is greater realism. As the years roll by, most recognize the probability of illness is increasing and put some level of protection in place. But the basic question of optimism and pessimism never goes away. Do we assume the injury or disease will come and go quickly? Will there only be a few tests, no major interventions and no continuing costs? Or will the problem prove more serious, require major surgery and long-term care? Until the recession hit, we could all afford to be reasonably laid back. Those more inclined to provide against the darker possibilities would add a few dollars a month to the premium instalments and sleep well at night. But with every family budget coming under pressure as the economy tanks and unemployment stalks the land, the question becomes more difficult to resolve. Those few extra dollars a month have to be justified.

Why think about it now? Well, let’s take the worst case scenario. Suppose you or one of your family are struck down. Suddenly, you are looking at big bills and worried about the extent of the cover available under the policy. This is not the best time to open negotiations with the insurer. You are emotionally weak. Worse, the reality of large losses will color the reaction of your insurer. The best time for these negotiations is when you are calm and all the losses for the insurer are in the future. This allows everyone to deal with hypotheticals and not get alarmed when big numbers are mentioned. So why do insurers start talking about big numbers? The national statistics show claims for long-term care almost always fall into the range of three to five years. That’s a big bill when you add in all the different services potentially required, whether in your own home or a nursing facility.

So what happens to people without long-term health insurance? The worst happens to those who have built up assets. Instead of providing for their families, they find all their assets sold to cover the apparently endless series of bills. Of course, some families have one or two who can be persuaded to act as carers. They sacrifice their earning capacity to provide home nursing. This, of course, is the worst case, where the losses just keep mounting up as families cope with the emotional and financial costs of the care. Health insurance provides protection for retirement savings and the assets readied for the children to inherit. Long-term policies cannot remove the emotional burden of living with an injured or dying loved one, but it can make the time less financially stressful.