Learned The Hard Way

The advent of internet marketing and “instant online car insurance quotes” was most definitely a turning point in how car insurance was compared, marketed and purchased. The first player to the game was Progressive Insurance.  I remember it well [major digression coming….]  Since 1991, I have been fascinated by the internet as we knew it today, but years earlier a dear friend named Paul- who went to U.C. Berkeley introduced me to dial-up message boards. This was back in 1986 if I remember correctly. We would place our push button phone’s receiver into a special cradle connected to the computer. We would then dial into the board and download the messages. Our replies would be posted similarly and before we knew it- we were hooked.

Anyhow, my earliest recollections of shopping for car insurance online involved visiting Progressive’s site where I requested an online rate. This was way before the decision to tie credit ratings into the purchase of car insurance and the process was pretty smooth. Then along came a few others like Electric Insurance, 21st Century and a few others. The buggy interfaces soon gave way to improved versions and better features. Then Geico came onto the scene and somwhere inbetween aggregators like Insweb.com, Netquote.com, 4freequotes.com, 4insurance.com to name a few. The line became a bit blurry between the aggregator sites - which worked with both agents and carriers - and the actual insurance carrier web sites. Most have thrived, weathering the bubble burst of 1999-2000, but one of them-{begin rant} Insweb.com has fared so poorly in such a tremendous marketplace, that one has to wonder how they went public in the first place. How do you spend 100 million plus over 8 years and not figure out how to turn a profit? This eludes me. If only someone had invested $100 million in my ideas, the game would be over… {end rant} :o)

Since those days in 1994, the market has matured considerably and you can now make changes online, purchase insurance online using a credit card, even get a loan online, purchase a car right there, then insure it a few minutes later. Simply amazing in terms of the amount of legwork that has been removed from the average consumer’s search. It’s getting late.. will continue this line of thinking tomorrow.

How many times have you heard a person or accountant say “don’t pay off your house, you need the writeoff”? Too many if you ask me. Here’s what I figured out and my accountant shook his head in disbelief when confronted with it.

Let’s use the following parameters:

• 100,000 annual income
• 27% effective tax bracket
•  $16,000 in annual interest income.

By paying $16,000 in mortgage interest, you receive a $16,000 deduction. Simple enough. By taking this deduction, you actually save 27% of the $16k or $4320.

• Pay $16,000 in interest
• Take $16,000 deduction
• Save $4320 in taxes

Now let’s get this straight: Why the hell would anyone pay $16,000 to save $4320? You have lost $11680 just to get a $4320 deduction. Who perpetrated this fraud? It has to be the bankers. The same people who used to work until 3pm while you and I couldn’t leave our desks until 5pm when the bell rang. The one caveat here is that a $16,000 deduction could move you down a bracket, but even at that, you cannot break even unless you drop your effective tax rate 12% with a $16,000 deduction… I don’t believe this is possible unless you have a total of 71,000 in deductions on your $100,000 income.

If you have the ability to pay off your mortgage or not take one to begin with, why would you take a loss just to have a deduction???

Updated 5-29-07: Another scenario…

Let’s say you have $200,000 in mortgage at 6% and inherit $200,000 from your late uncle. Should you pay off the mortgage or put the cash in the bank?

Facts on the mortgage:

• The mortgage payment on a 30 year, $200,000 note at 6% is $1199.10 monthly (14389.20 annually).
• This provides a $14389.20 deduction your tax return for mortgage interest. The net savings is 27% of this number or $3885.08. Thus, the true cost of the money is $10,504.17.

Facts on the cash:

• $200,000 in a taxable CD earning 5% annually will earn you $10,000 annually in interest.
• The tax on this interest is 27% of the $10,000 or $2700, netting you $7300.
• HOWEVER, if you leave the cash to compound and pay the taxes out of pocket, this number will compound earning you a bit more each year.

Let’s consider the after-tax outcome of the above scenario:

$10,504.17 paid in mortgage interest
$7200 earned in interest on the $200,000.

Net cost to hold onto $200,000 in cash: $3304.17 or just about $275 per month.

What does all this mean? Your net mortgage cost is $275 per month, plus you have $200,000 in the bank! So when friends ask what your mortgage is monthly- the answer of course is $1199, but the reality is you have $200,000 in cash and make a net payment of $275 per month after realizing the interest on your money. Not too shabby. This is why the rich get richer.