Lottery Syndrome
Posted on March 6, 2006 - Filed Under Philosophy |
Last week, California’s lottery hit above $250 million. Many people that I know bought tickets for that "chance at a dream". And with this large flux of greedy, ticket buying hopefuls came stories about people who had lost their lottery winnings or, more importantly, wrecked their lives.
Kiyosaki writes that these people fall into these traps because, while their income levels rise, their financial intelligence remains the same. They repeat the same habits that keep them poor. OK, so I admit that having your brother hire a hit-man to kill you doesn’t qualify as having anything to do with financial intelligence.
This last weekend, I had a chance to talk with my loan officer over coffee. One of the questions I asked her, as my barometer for the market, is exactly how busy is she. How many loans is she funding, how many refi’s, how quickly are houses moving . . .
Right now, her biggest workload deals with refi’s. Everyone is pulling out money from their house to pay off credit card debt. Why this big rush? It’s because this month, credit card statements started are going out with a tiny surprise. The minimum monthly payments have now doubled or even tripled. So these people with their already large monthly payments to credit cards are finding themselves unable to make these payments.
Why?
Two reasons. The first is that people don’t have a two or three thousand in credit card debt. We’re talking between $40,000 and $60,000 in credit card debt. Can you fathom that? I certainly can’t! At my worst, I had $15,000 in credit card debt and I was freaking out! But $60,000? So if you’re paying $1,000 per month in credit card debt, you’re now paying (at a minimum) $2,000 per month. Congratulations!
The second reason is that the credit card companies are raising interest rates, which they can do with only a 30 day notice. You didn’t know this? Yeah, it’s printed on one of those illegible tiny pieces of paper that you throw away along with the other 23 advertisements with your credit card bill.
You see, the credit card companies are a business just like any other. And for them, it’s better if you pay the minimum monthly payments because they’ll make more money that way. Now if, by federal law, your time to payoff has been reduced to 10 years versus 60, they’re going to lose money. So they raise their interest rates in an attempt to keep revenues coming in.
Some of the people my loan officer has seen more than once, with regards to this various issue. They show up once a year, refi their house, pull out money and pay off credit cards. And this is what people are doing. Because their home values have sky-rocketed, they’re treating the equity like free money. I agree with Nina that they are blowing it!
The moral of the story: These people are suffering from the lottery syndrome. In this case, these people stretched themselves thin to buy these homes when their value was $500,000 just 5 years ago. Now the home values have doubled and they have $500,000 in equity just staring at them. And they’re repeating the same habits. But for the equity burning folks, there will be a little harsher sting.
Unlike the lottery folks, the equity burning folks don’t pay taxes on the equity they pull out. Lottery people pay their taxes up front, when they receive their money. Equity people will pay their taxes when they sell their property. And this is when the real howling (and news stories) will begin to fly. People that have burned all their equity, sold their house, and now owe Uncle Sam 30% of the equity. For my example above, on $500,000 property value increase, that’s $150,000 in taxes. And Uncle Same will get his money, one way or the other.
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"Change your thoughts and you change your world.
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5 Responses to “Lottery Syndrome”
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Hey, Clifford… thanks for the Sitting Pretty shout out.
I know! I really feel for those that aren’t financially educated and blow every cent they get and refi to do it. If the CA markets bottom out, they’ll easily be upside-down in their properties and unable to sell if they absolutely must because they’ll be indebted to the IRS. Not even a bankruptcy would help them out of that predicament.
IRS Tax on Equity Loans? I know very little about finance: My father taught me that if I couldn’t afford it today I likely couldn’t afford to pay 10% more for it next month. I’m dating myself–I think credit cards cost more than that now. So I learned that much and don’t use credit cards. We did however, take out an equity line of credit to finance my husbands business. We recently found a peice of property that we had to have so we bought it–down payment come out of the line of credit. Bottom line: we now owe just over 1/2 of the value of our house (which has just gone on the market) in the form of a line of credit. We did not know that there could be IRS taxes on the sale of our residence. We live in Maine. I will call my accountant in the morning but you are freaking me out. Anyway, keep teaching cause I’m paying attention now! How will I know what to ask about when it comes time to finance our next home/ business on the new property?
Good Morning ELL!
No, the IRS doesn’t take taxes on equity loans. Well, not yet anyway.
What is happening is, let’s say the value of someone’s home goes up $200k. Therefore the Capital Gains on the home is $200k. These people are taking out money out, in the form of an equity loan. Like buy boats, cars, etc. When they sell the house, the government taxes them on the capital gains. In this example, that’s $200k. At 30%, that’s $60k. Since they’ve already burned up their equity, how do they pay? Most people don’t have $60k laying around.
And when people sell their homes, they have burned all the equity up and wind up having to pay the government out of their own pocket.
Of course you can avoid all this by doing a 1031 exchange.
That’s what I meant when I wrote that note. My apologies if it didn’t come across clearly.
The encouraging aspect of your message is that you’re not buying “stuff”. You’re buying property and investing money into your husband’s business. And that’s good!
Clifford
You also get a $250k-$500k (single/married) tax free gain on owner occupied property…