significant estate taxes (numerous states have far lower limits). Estate planning can help minimize the portion of your estate subject to such taxation. One simple but powerful estate-planning strategy is to give money to your desired heirs to reduce your taxable estate. (If your relatives are in the fortunate position of having great wealth, they may give, free of tax, up to $15,000 yearly under current tax law to as many recipients as they want. If they give you $15,000, you can use this money toward your home’s down payment.)
Wills, living trusts, and estate planning are nothing more than forms of insurance. Remember that it takes both time and money to generate these documents, and the benefits may be a long time off, so don’t get carried away with doing too many of these things before you’re older and have significant assets. Read the latest edition of Personal Finance After 50 For Dummies (Wiley), which Eric coauthored with Bob Carlson, to find out more about estate planning. Eric also enthusiastically recommends Ray’s excellent book, Winning the Endgame: A Guide to Aging Wisely and Dying Well.
Along with buying insurance to cover the replacement costs for loss of or damage to your valuable assets, you should purchase adequate liability insurance for those assets. Both homeowners insurance and auto insurance come with liability protection. Make sure that you carry liability coverage for at least twice the value of your net worth (assets minus liabilities).
In addition to the liability protection that comes with auto and homeowners insurance, you may purchase a supplemental liability insurance policy known as an umbrella or excess liability policy. Purchased in increments of $1,000,000, this coverage can protect people with larger net worth. Note that this coverage doesn’t protect against lawsuits arising from your work.
Invest in Yourself
Last but not least, in your zest to build your financial empire and buy ever bigger and more expensive homes, don’t forget your best investment: you. Don’t run your life and body into the ground by working horrendous hours just to afford what you consider your dream home.
In addition to investing in your health, your family, and your friends, invest in educating yourself and taking charge of your finances. If you need more help with assessing your current financial health; reducing your spending, your taxes, and your debts; and mapping out an overall financial plan (including dealing with your investments and insurance), be smart and pick up a copy of the latest edition of Eric’s Personal Finance For Dummies (Wiley).
Chapter 3
What Can You Afford to Buy?
IN THIS CHAPTER
When you’re in the market for a car, the auto salesperson will eventually ask, “What is your budget?” or “How much can you afford to spend on a car?” Of course, they hope that a large number rolls off your tongue. If you’re like many car buyers, you may be likely to say something along the lines of, “I’m not really sure.”
Many car buyers today finance the purchase — so they allow a banker or other lender to determine how much car they can afford. Such determinations are based on a buyer’s income and other debt obligations.
But here’s where most people get confused. When a lender says you qualify to borrow, say, $30,000 for a car purchase, this doesn’t mean you can afford to spend that much on a car. What the lender is effectively saying to you is, “Based on what little I know about your situation and the fact that I can’t control your future behavior, this is the maximum amount that I think is a prudent risk for my organization to lend to you.”
The lending organization normally requires a certain down payment to protect itself against the possibility that you may default on the loan. Should you default on an auto loan, for example, the lender has to send the repo man out to take away and sell your car. This process takes time and money, and the lender will surely get less for the car than the amount that you paid for it.
Much of the same logic applies to a home purchase with one important difference — over time, your home should hopefully appreciate in value whereas a car most definitely will not.
In this chapter, we help you determine what you can comfortably afford to spend on a home as well as how to calculate how much a particular home is likely to cost you.
Lenders Can’t Tell You What You Can Afford
Falling behind in saving for retirement
Wanting to save money for other important financial goals, such as starting or buying your own small business
Parenting a small army of kids (or facing steep private-schooling costs)
Lacking proper personal insurance protection
And therein lies the problem of making your decision about how much home (or car) you can afford to buy on the basis of how much money a lender is willing to lend you. That’s what Walter and Susan did. They set out to purchase a home when Walter’s business was booming. They were making in excess of $200,000 per year.
Walter and Susan really wanted to buy the biggest and best house that they could afford. When they met with their friendly neighborhood banker, he was more than willing to show them how they could borrow $900,000 by getting an adjustable-rate mortgage. (You can read all about these mortgages in Chapter 6. We’ll simply tell you here that because some adjustable mortgages start out at an artificially low “teaser” interest rate, they enable you to qualify to borrow a good deal more than would be the case with a traditional, fixed-rate mortgage.)
Walter and Susan bought their dream home with an adjustable-rate $900,000 mortgage. Within a few years, Walter and Susan’s dream home turned into the Nightmare on Oak Street. Their mortgage became a financial noose around their necks.
When
