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Category Archives: financial advising

Useful Behavioral Finance Information for CFPs®

Mid adult couple smiling while looking at female financial advisor at desk in office

 

The concepts of behavioral finance are applied increasingly in our world. Governments are using decision-making psychology to encourage behaviors like saving more for retirement. This type of psychology is also used by a wide range of businesses to help maximize their profits. Although plenty of behavioral interventions do work, others fall short of expectations or even backfire. Understanding what creates these differences is essential for CFPs® who want to provide the assistance clients need to make the right financial decisions:

 

The Role of Emotional Triggers

 

Both governments and businesses that use behavioral finance strategies have to overcome the challenge of getting people’s attention in a world that’s full of distractions. To cut through the noise technology is being developed using systems that trigger emotional responses.

 

One example of these types of triggers has been developed from the concept of loss aversion. The theory of loss aversion states that people react more strongly to the threat of a loss than the possibility of a gain.  Using this concept, app developers have found that  the average person doesn’t want to use something that solely tracks their failings without any positive reinforcement.

 

Another example arises from the realization that nudges become less effective over time. It’s standard practice for app developers to do extensive testing to figure out exactly what works best with users. But as many technologists have discovered, what’s fully optimized now may not be nearly as effective in a few years. Dealing with this issue is why more resources than ever are being put towards creating and delivering experiences that are highly personalized.

 

Using Behavioral Finance on a Big Scale

 

While behavioral finance is something that has a lot of appeal to smaller technology companies looking for a big opportunity, it’s on the radar of larger financial institutions as well. Designing more effective savings products, small-dollar loans, and automobile loans with lower rates are all things that established financial companies have enlisted help with from behavioral finance experts.

 

One interesting aspect of all the attention on this topic is the realization that this attention will eventually reduce the effectiveness of behavioral finance. While these practices currently have the ability to improve outcomes by ten to thirty percent, experts have stated that consumer suspicion is something that may eventually make it more difficult to achieve these results.

 

By taking the time to test out some of the apps and other types of technology being developed in the area of behavioral finance, CFPs® can gain some hands-on insights that they can pass along to clients.

 

Reverse Mortgage: Rip Off or Blessing?

Reverse mortgage on blackboard

 

A reverse mortgage is a useful tool for helping senior citizens remain in their homes and maintain their lifestyle.

 

A reverse mortgage is a ripoff, a scam. Don’t fall for it or you might lose your house!

 

So which is it, a blessing or a trap? As with most financial products, the answer is, “It depends.” For some clients, it is just the opportunity they need for financial stability, but for others, it can be a danger. No one solution is right for everyone, as we all know.

 

Most of us in the financial planning field are familiar with the basics of a reverse mortgage. It is a means by which older homeowners (62 or over) can make use of the equity in their home without having to make payments on a loan. The amount a person can access depends on the value of the home, the age of the homeowner and interest rates. The money can be taken as a lump sum, monthly payments, or a line of credit. Nothing needs to be paid back until the home ceases to be the primary residence, either due to death or to the homeowner moving, perhaps to a nursing home.

 

Along with the age restriction, there are a few other conditions. Besides a single family home, a 2-4 unit building also qualifies, as long as the owner occupies one of the units. The home generally must be owned free and clear, although if there is a low mortgage balance it can be paid off with proceeds from the reverse mortgage. A financial assessment should be done to assure that the homeowner will have the means to keep paying property taxes, insurance, and maintenance.

 

Most current reverse mortgages are FHA-insured Home Equity Conversion Mortgages (HECM). There is a maximum amount a person can borrow under this program, currently $625,500. The owner of a higher-valued home might consider a proprietary reverse mortgage through a private lender. These are not subject to the HECM loan limits.

 

Under certain circumstances, a reverse mortgage can be the perfect instrument to address a senior’s needs. A lump sum can be used to make necessary home repairs or adaptations for an elder. A monthly stream of income might be the difference between an active or restricted lifestyle. Perhaps a line of credit can be tapped for a special vacation or a new vehicle.

 

A reverse mortgage is not the solution for everyone, however. In some cases, the homeowner might be better off downsizing, or moving to an assisted living facility. Some people might take a lump sum, only to squander it and be left with no equity and no cash. Unexpected expenses may deplete resources needed to pay property taxes, insurance, etc. And there may be no value left for heirs. If the heirs don’t have the means to pay back the mortgage themselves, they will have to sell the home. Fortunately, there is usually a “non-recourse” clause in the agreement so that if the value of the home is less than what is owed, the heirs don’t have to make up the difference.

 

Reverse mortgages come with significant fees and closing costs, so it’s worthwhile to shop around. However, the client must beware of salespeople who try to pressure them into a hurried agreement or sell them other products to invest the proceeds. There are always shady operators out there, and the best course of action for a client is to consult with a financial planner and consider all options before making a decision.

 

Important Details to Understand About FHA and VA Mortgages

Approved mortgage application

A conventional mortgage is usually a fixed mortgage, which means the interest rate and amount of each monthly payment are fixed. Conventional mortgages are traditionally not insured or guaranteed by any agency, although now private mortgage insurance is available to insure losses in the event of a default.

 

The Basics of FHA and VA Mortgages

 

An FHA mortgage is a loan given by an approved lending institution, and the loan is insured by the Federal Housing Administration. The borrower pays a fee for the FHA loan insurance, but this fee can be amortized over the life of the loan. In the event of default, the FHA will pay the lender for any losses.

 

VA mortgages are guaranteed by the Veterans Administration. Only honorably discharged Veterans of the U.S. armed forces are eligible for these loans. The VA, like the FHA, sets the interest rates, qualification standards, and down payments required for their mortgage loans. While interest rates for VA and FHA loans are set by these agencies, rates for conventional loans are set by the lending institutions and depend upon money market supply and demand.

 

More Details About FHA and VA Mortgages

 

FHA and VA mortgages may be assumable, which means a buyer can take over the existing mortgage and make the monthly mortgage payments to the lending institution without qualifying for a new mortgage. The lender also cannot increase the interest rate or require refinancing of these loans. Most other mortgages contain due-on-sale clauses which require payment of the mortgage balance upon the sale of the property. These clauses force refinancing of the mortgage loan whenever a property is sold.

 

Are There Advantages to An Assumable Mortgage?

 

An assumable mortgage can be advantageous to the buyer because the buyer is relieved of qualifying for the mortgage, and the interest rate on the existing mortgage may be below the current market rate. In addition, the buyer can avoid paying several costs that are associated with obtaining a mortgage loan. For example, to obtain most mortgage loans, a borrower must pay an origination fee to the lender for arranging the loan.

 

The borrower may also pay points, which are essentially a way to increase the lender’s return on the loan in the first year while offering the borrower a slightly lower interest rate. A point is one percent of the mortgage loan amount. On a $100,000 mortgage, one point is $1,000. A borrower must also pay closing costs, which may include title insurance, attorney’s fees, recording fees, survey and appraisal fees, credit reports, and insurance and tax reserves.

In addition to avoiding payment of the origination fee and points, an individual assuming a mortgage can avoid some of the other closing costs associated with purchasing real estate. Note that the assumption of an existing mortgage may not make sense where the interest rate on the existing mortgage is above current market rates or where the existing mortgage balance is relatively small.

Two Pieces of the Health Care Puzzle

Health puzzle

 

A relative newcomer to the health insurance field, the High Deductible Health Plan (HDHP) first came on the scene in the early 2000s. Sometimes referred to as a Consumer Driven Health Plan (CDHP), this option was meant to make consumers more cost-conscious and careful about their health care choices. For instance, perhaps it would encourage people to use the Emergency Room only for true emergencies and seek less costly care for routine matters such as the flu or a sore throat. Because consumers are obliged to bear more of the financial burden, these plans have lower premiums and have steadily gained popularity with employers who offer health care coverage.

 

Fortunately, another piece of the puzzle is the Health Savings Account (HSA), a tax-advantaged vehicle for accumulating funds to cover these increased healthcare expenses. A person who is covered only by an HDHP meeting certain criteria is eligible to open an HSA.  For 2016, the HDHP has to have at least a $1,300 deductible for individual coverage or $2,600 for a family, and an out-of-pocket limit of no more than $6,550 for one person or $13,000 per family.

 

Contributions to the HSA are tax-deductible (above the line) and withdrawals are income tax free if used for qualified medical expenses. If the money is taken out for any other purpose a 20% penalty applies, along with income tax. For an individual 65 or older there is no penalty, but taxes must be paid if funds are used for non-qualified spending.

 

Unlike other medical savings accounts, such as a Flexible Spending Account, the money in the HSA does not have to be spent by the end of the year; it can be left to accumulate until it is needed. Also, although many HSAs are sponsored by employers, and the employer might make a contribution each year, the account belongs to the employee and goes with the person if he or she changes jobs.

 

Given this favorable treatment, an HSA can be an excellent way to save for retirement, similar to an IRA.  The maximum annual contribution for an individual is less than for an IRA, $3,350 in 2016, including employer contributions, but is increased by $1000 for those 55 and over. If the HDHP covers a family, the 2016 contribution limit is $6,750, also with the $1,000 catch-up provision for age 55 and above.

 

The money in the HSA can be invested in money market, stocks, bonds or other such products. If the funds are then used for eligible medical expenses, the HSA is better than a Roth IRA, having deductible contributions but no tax on withdrawals. Once a participant reaches age 65, the account functions like an IRA for non-medical expenses, with income tax due on withdrawals but there is no penalty. The other side of the coin is that persons who are age 65 and older (enrolled in Medicare) are no longer eligible to make contributions to the HSA, although existing balances within the account can be maintained.

 

With health care expenses expected to be a much greater burden for retirees, a wise strategy in your younger years is to pay as much of your medical expense as possible from funds outside your HSA and try to build up the account as a cushion for the future.

 

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