Chapter 4 - Spending

By Richard Valentine Reily, author of Gregory's Hero.


Identifying your spending is the first step to controlling it. You basically have two forms of spending, discretionary and fixed.

Interest expense to a great degree is fixed spending, especially where related to car loans and mortgages though interest on credit card debt is much more in your control. Even so, small changes in your interest payments can have large impacts on spending since interest tends to be a big expense as a portion of your fixed spending.

Let’s take interest spending and look at the major debts that incur interest and ways to reduce that spending.

Mortgage debt, and consequently mortgage interest, is not necessarily a bad thing. You have invested some portion of the purchase price of your home and borrowed the balance from a lender. In return you pay the lender interest on the loan.

The amount you owe is fixed even as the value of the investment itself, your home, can change. If you put $10,000 down on your $200,000 house, you invested 5% of the purchase price. As the house appreciates you realize 100% of the appreciation even though you invested only 5%, because you promised to pay the lender a fixed interest rate for the use of their money.

If you sell the house for $300,000 you have realized a $100,000 gain on a $10,000 investment. Not bad! Even when you consider the interest you paid to the lender for the use of their money. And for some icing on the cake of housing, in almost all cases the cost of the interest on the mortgage is deductible from your federal income tax which reduces your cost even further in spending that would have gone as additional tax. Mortgage debt and interest can work in your favor.

Car loans are a different story. I had a friend who was a car salesman. This guy looked and acted the part. Well, he didn’t have a checkered or plaid jacket, he dressed sharp actually, but if you can tell a horse is an animal, you can tell this guy is a car salesman. Let’s just leave it at that.

Anyhow, one evening he’s telling me about being on the floor at the dealership. You’ve seen them; standing around the perimeter like vultures awaiting you descending from your car so they can swoop in and empty your wallet. Even wonder why you feel that way whenever you arrive at a car dealership? Because your feeling is right; that is exactly what they are poised and planning to do.

You are involved in a car transaction once in a blue moon. They do it all day long every day. You can’t win. Oh, I promised you a story; my friend who is a car salesman.

He’s telling me over a beer how this vulture thing works. Whoever is nearest to the landing quarry gets him. He tells of being on his way in a direct line to meet someone getting out of their car when another salesman pops up from between two used cars nearby and cuts him off in route.

My friend is smart though. He waits, and watches and lets the others chase off and fight over the everyday up; the guy in the four year old minivan with a wife and two kids who fall out of the back screaming before they hit the pavement.

What is he waiting and watching for? The real clunker (that’s a not very nice car); it’s blowing smoke and he can hear it coming down the street two blocks away. When it is finally silenced in the parking lot and the smoke has dissipated enough to get close without getting gassed he greets the poor – that’s right not too much money – guy struggling out a squeaking door followed by his overweight wife falling out the other side. A quick appraisal of the car reveals that it is of reasonable age and not a bad model in its day but now a worthless clunker because it has been overused and under maintained.

This is my friend’s favorite customer. This is the guy who is going to drive away from that dealership in a well marked up used car, perhaps of questionable quality, but of high perceived value. He is going to have his old car paid off by the dealer. The upside down amount is going to be rolled into the new purchase. He is going to buy an extended warranty, an on-going prepaid service agreement, credit life insurance, and his first year of liability auto insurance and pay the highest interest rate available on not just the car but also on all the service and insurance products.

He is going to drive away from that dealership with a payment higher than a brand new car of far greater value and be instantly buried in the new car far worse than he was in the loud smoking clunker he rolled into the dealership in. My friend is a happy camper because he gets a commission of each part of the rolled up deal. He sold a car, insurance on the financing, insurance on the car, an extended warranty and financing on all of the above at a high interest rate.

The deal sounds good. Service and repairs are prepaid. Insurance is paid for the whole year. The car is paid off on death. Everything handled in one place. What a deal! That’s for sure. What a deal for the dealer.

Here is how the deal should work.

There are three deals going on here. You are buying a car. You are selling a car. You are financing a car. You are best served and get highest value for lowest cost when the deals are handled separately.

Sell your existing car to someone else. If you think it is difficult, let the dealer put a value on your car, then simply ask around those people you know. Someone is bound to give you more than that amount because the car will be worth it. If you insist on trading it in, go to the dealership armed with a reasonable value for the car and stick to it. Know that you can always go away and sell it yourself.

Now credit life insurance on the car is an interesting concept. You pay premiums for insurance that pays off the care on your death. Who benefits? The bank that lent the money; let them pay the premium!

Go to a lender before you go to a dealer. Get a pre-approval that you qualify for an auto loan. The lender will tell you how much they are willing to lend based on your credit qualifications. Maybe you want more, but the lender is in the business and knows the odds of you being able to pay the money back. Listen to them and limit yourself to a car transaction that fits with their pre-approval.

Leave the bank with a sight draft in your hand. A sight draft is a check from the bank with a limited maximum value. It is a check for your purposes. When you buy a car, the dealer includes a title with the check and it is processed like a check to pay the dealer. With a pre-approval you are less likely to fall into the financing traps set by the dealer to make you spend more of your money.

Know what car you want before you arrive at the dealer. With the advent of the Internet there are almost unlimited resources to determine who has the car you want and what the real value of that car is. A dealer has one prime objective – take your money from you. Do your homework and arrive an informed buyer ready to take your business elsewhere if the deal is not right. Never forget: you are the customer and the dealer must earn your business. You do not have to give it away.

Now you turn into my friend’s worst nightmare. Here you come in the old clunker with check in hand ready to pay exactly one number for that car right over there. The salesman is now an order taker and you are in charge of the transaction.

I can all but guarantee that you will not leave there having purchased any useless warranty or insurance, not over paying for the new car, having received fair value for your trade in and not been signed up for a usurious, but perfectly legal, interest rate. Chances are you will not be upside down in your car when you drive off the lot.

That all said interest on a car loan is controllable at only one point. At the beginning; once you sign the note you are locked in until the note is retired by paying it off or selling or trading the car. Once the deal is done you are locked in and your car loan interest spending is then fixed. This is a four to six year commitment. Do your homework first and keep your money in your pocket.

Credit card interest is another story altogether. One rule here; don’t. That’s it. Don’t.

Don’t what you ask? Don’t pay credit card interest. That is the one and only rule. There is nothing good to gain from paying credit card insurance. You might just as well flush your money down the toilet. You will get just the same value for your spending. If that seems harsh, think about it. What are you getting for your money?

With a mortgage you get a place to live and perhaps appreciation on your investment. Even with a car you buy the ability to get around, most importantly to work. But, credit card interest gets you nothing. It’s a tax on stupid.

You bought stuff you didn’t need and without planning how you would pay for it. Now you have credit card debt and interest that never seems to go down no matter how hard you try. That’s the plan. The credit card issuers plan; keeping the cash flowing from your pocket to theirs.

It’s a great plan and you and I would do it if we could; people send money every month and we don’t have to do anything. Works for me!

Remember the one rule here. Don’t. That’s it. Don’t.

Oh, I see. You already have credit card debt. lots of it. And, I’ll bet it never goes away no matter how much you pay. I knew it!

What are you going to do about that? I highly recommend paying it off. That’s right, pay it off. Actually it’s easier done than said, but since most of you won’t believe that statement I’ll go ahead and say it, but later on. Later in the book I’ll tell you how to do this without incurring further spending.

For now let’s stay focused on how spending happens and later on how it can be controlled.

Most interest is fixed, and some is discretionary.

Fixed spending is spending you have to do to survive. It’s easy to determine. Food, clothing and shelter; that’s it! Okay, go ahead, start your rationalization.

Even within that required fixed spending there are opportunities for discretion. You can live in a less expensive place. I know it’s tough to think about scaling down, but it is really good for the budget. Within your living expense, where do you not have to spend? Do you really need new furniture or can the old serve you well for a bit longer? Do you really need to run the air conditioning at sixty eight degrees all day while you are out trying to earn the money to pay for it? Do you really need that third bedroom that no one uses; could you live in a less expensive two bedroom or rent out the third room for additional income? I presume you get the point.

How about food? Do you need to pay Kraft to process you food? Some of the best foods for you are the least expensive (which is an entire separate subject). Do you really need to eat out three, four, five times each week?

And, clothing; I have to figure that mink wrap was a bit extravagant. Sure you need clothes, but along the way of building wealth do with less, items, brand awareness and fads. Keep the money.

All other spending is discretionary. That’s right, you choose to spend on those things you don’t really need them. That is the spending we will reduce.