Getting Personal
Debt Archives
Too Much Debt
Question: I'm ashamed to say that I am one of those Americans who have used credit cards to make ends meet. Mostly they've been used for moving expenses due to health reasons, and financing school supplies. I'm now having trouble paying off these cards, and worried about calling those groups that advertize debt consolidation services on late night TV. Who do I contact to help me get the interest rates on these cards to a reasonable level and organized so I can make a single payment each month? Maureen
Answer: You have no reason to feel ashamed. At some point in our lives, most people take on too much debt. They end up with big credit bills for good reasons--medical bills, a move, a lost job, helping out a child--and not because they're living the champagne lifestyle on a beer salary.
The real question is: What lessons do we take away from the experience of carrying too much debt? In other words, will you leave your debt burdens behind and change your money habits? Or will you go on a roller coaster, zooming into too much debt, followed by a period of getting rid of it, only to take on more debt once your balance reaches zero?
Finally, you're so right to steer clear of the fly-by-night outfits that advertize on late night TV. Don't dial their 1-800 numbers.
I wish I could say that there's a magic wand to wave that will get you out of debt fast. There isn't. But here's a two-step formula:
First, get a copy of a book such as Gerri Detweiler's "The Ultimate Credit Handbook: How to Cut Your Debt and Have a Lifetime of Great Credit." It's in its third edition. Gerri is good at dealing with debt issues, and her book will give you a practical lay of the credit landscape. You could also check out Nolo, a leading financial self-help information organization. It's at www.nolo.com.
If you want to work with an organization--a good move for many people--I would contact the National Foundation for Credit Counseling (NFCC). It's the largest and oldest national nonprofit credit counseling service. You can find a branch near you at www.nfcc.org. If you like working online, by the way, I know that one branch--the Consumer Credit Counseling Service of San Francisco at www.cccssf.org--offers all the financial basics, plus an online debt counseling service and debt management plan.
Good luck.
College Choice
Question: My son, a high school senior, was accepted to one of Minnesota's private colleges. We have been fortunate in that we invested over the years and have saved enough for about 3 years of his education at this school. He also received scholarships to a different MN private college that would pay for about 66% of his costs for 4 years, leaving him with a substantial amount of $ at graduation. I have 2 questions. He wants to turn down the scholarship and go to the other school. There is a difference in the 2 schools, one has a very strong regional reputation and the other a national reputation. He wants to forgo the scholarship for the national reputation. From a long-term $ perspective, what advice would you give to him? Second, assuming that he forgoes the scholarship, I am considering keeping the $ we saved for him invested and taking out loans to cover the cost of the education and then paying off the bulk of the loans at graduation. Is that a solid strategy? The investment has averaged 10% over the long term. Thank you for your advice. John
Answer: This is one of those times when the outcome of a financial decision is positive no matter what, yet people strongly disagree about the answer. Some of my friends are adamant that it doesn't pay to attend the more expensive, nationally known school. They'd leap at the scholarship money. Over the course of a lifetime, the importance of that degree shrinks, and the dollars saved add up. Other friends believe the national reputation is worth it if the student expects to attend graduate school, move to another part of the country upon graduation, or enter certain professions, like investment banking. To them, the extra money you're paying is the price of an "option" on a particular career choice and geographic mobility.
So, where do I come down? What strikes me over the past 30 years is just how good college and universities have become, including small private liberal arts colleges. The gaps in performance and quality have really narrowed even if national rankings haven't kept up with the transition. But your son has also expressed a clear preference for the better known school. One way to make this decision is insist that your son "own" more of his education. If he goes to the regional school, he graduates debt free--and that is a genuine advantage these days. He'll be in a position to choose a job at graduation based on desire (and perhaps a low income) rather than face the pressure to take a less desirable job that pays more because he has student loan bills to meet.
If he still wants to go to the other school, then I would have him borrow at least some money to pay the difference in costs himself. He won't graduate debt free. Instead, along with his diploma he will get a student loan repayment booklet. I think making the decision this way is a good life lesson.
That said, I would limit how much he borrows so that he still has a choice at graduation. For one thing, you have the savings. For another, you don't want him too burdened by debt. By the way, it can be a good strategy to borrow, even if you have the money, if there is a reason to keep your options open. You can always help them pay off their student loans at that point.
01/31/08 by Chris Farrell
Too much Debt
Question: I'm 54, earn about $80,000/yr and plan to work for 10 more years. I have $100,000 invested with Edward Jones in growth funds and would like to use some of that to reduce my $140,000 home equity loan. I have another $500,000 in 401k & IRA savings. And I don't have any other debt -- no car loans or mortgage.
Currently I am in a loan plan with my bank where I only pay interest on the debt. That plan continues for 4 more years. The interest rate is ~6.7% or $850/month. I have not paid anything on the principal in the last year.
I know I earn a comfortable salary, but after enormous increases in property taxes and some unexpected house maintenance spending, it seems I live from pay check to pay check...even though I'm a pretty frugal person.
I contribute the maximum amount to my 401k--$17,000/yr. My friends say I put too much money into my retirement, but I plan on doing some spendy playing when I retire: ski, travel, hike the Sierra Mountains and Wine country etc.
How should I manage by debt and savings? I'd appreciate your advice. Sincerely, Mary
Answer: Mary, many people are in similar financial circumstances. Like you, they're carrying too much debt, but hardly living the champagne lifestyle. I wish there was a magic-wand-suggestion for eliminating debt. But there isn't. But there are trade'offs to consider. Here are some thoughts and suggestions.
You need a budget, but that's not the same thing as bookkeeping. Budgeting is really all about bringing goals, expectations, and money into accord. Ask yourself, where do you want to be a year from now, 5 years from now, 10 years from now? Then map out a way that will get you there. The real trick here--I can't emphasize this enough--is that you don't want to go through all this work to get rid of debt only to start building it up again.
Once you've gone through that process, and only then would I tap into your savings to pay down a chunk of your home equity loan. You can get rid of the rest of it over time with a budget. So, play with the numbers, and see how much you want to take out of savings (and pay capital gains tax on) and how long it would take you to get rid of the debt.
One other reaction: I'm with your friends. It's terrific that you're aggressively saving for retirement and that you have all these plans for what you want to do in your Golden Years. My fear is that you're denying yourself too much today to pay for your dreams tomorrow. Ease up a bit to shore up your finances now--and for tomorrow.
Co-signing a Loan
Question: I have a very good credit rating and am considering co-signing on a loan for a family member who has a very poor credit rating. Will her poor credit rating affect my credit rating in any way, if I co-sign the loan? Thank you, Bette, Richfield, MN
Answer: Her poor credit rating won't immediately affect you on co-signing--assuming that she then pays her bills on time. But if she defaults you're on the hook to make good on the debt. The lender will go after you for the money she owes. Your good credit rating could be ruined. It's understandable that you want to help out a family member, but co-signing a loan is very risky.
Mortgage Accelerator Programs?
Question: My husband & I are both retired. We have parent loans for our 3 children's college expenses. We have a $20,000 home equity loan but no other debt. Recently we were approached by a friend to look into u1stfinancial as a way of paying them off sooner and decreasing interest. Do you have any information or advice regarding this company? Carol, Pine City, NY
Answer: We've been getting a lot of questions about United First Financial and its Money Merge Account. Full disclosure: I'm not a fan of the product.
Here's how the company describes the money merge account on its website.
The Money Merge Account system is a powerful tool that enables homeowners to pay off a 30-year mortgage in as little as one-third of the time, without refinancing their existing mortgage or increasing minimum required monthly payments. The system incorporates the homeowners' checking and savings accounts with an advanced line of credit (ALOC), then helps to strategically and incrementally position their money where it provides much more financial benefit than "sitting stagnant" in a standard checking or savings account until it is otherwise needed. Complex financial details programmed into the Money Merge Account software help to better educate the homeowners and assist in some of the greatest time and interest savings possible.
Got that? There are a number of comparable products on the market. The bells and whistles may differ, but it looks like the basic idea is the same. You set up a special home equity line of credit off the value of your home (which is getting harder to do and more expensive these days, thanks to the credit crunch. As I understand it, you could use a personal line of credit or a credit card, but the latter at least sets off all kinds of alarm bells.) When you get your paycheck it goes into the line of credit, decreasing your mortgage balance and, after paying your bills from the account, the remaining money keeps your mortgage balance down. The software costs for $3500 for the Money Merge Account, and other programs also charge for their software.
Carol, as I mentioned above, I'm not a fan. In essence, I think these programs boil down to a complicated and expensive way to keep a household to a very tight budget. If that's what you want to do there are other, cheaper ways to map out and maintain a frugal lifestyle. Perhaps more important, I worry about homeowners pouring so much of their discretionary income into their home. It's nice to own your home free and clear, but it's also important to build up a well-diversified portfolio with a well-funded emergency cushion.
And if it makes sense for you to pay off your mortgage early, well, you can do it on your own without paying for special software. Just make extra payments to pay down principal. A classic approach is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal. Last, Carol, these mortgage loan accelerator programs seem to violate a time-honored financial motto: Keep It Simple.
Cash or Loan?
Question: Hi, I have to replace my roof (sooner then later). Should I pay cash from a money market savings account, or take out a loan? Thank you, please get back to me rather sooner then later :) Gabriele, St. Paul, MN.
Answer: This is really a money management question. The baseline answer is pay for the home improvement with cash from savings. This way, you don't take on any debt. Plus, the interest rate you're getting on your savings is probably a paltry sum anyway.
However, there may be some good financial reasons for you to hoard savings right now. If that's the case, then by all means take out a loan. The best loan is probably a home equity loan. It's ideal for a lump sum payment such as a new roof, and you're preserving the value of your home. The rate of interest is fixed, which makes it easy to plan. You could take out a home equity line of credit, but the interest rate is variable. It's a loan option best tapped for projects that are done in batches or over a long period of time.
Roth vs Pay Down Debt
Question: I'm 26 years old, and have no credit card debt, no car loans, no student loans. I max out my 401(k), and have a six-month emergency fund. Pretty good, right? But I also have a mortgage and a $40,000 second mortgage (which is structured as a home equity line of credit).
Over the past year, I've saved up about $5,000. My question is, should I put this money into paying off the home equity line of credit, or should I start a Roth IRA? I know the Roth IRA has higher returns over the long-term, but in my gut, I REALLY want to knock off that home equity line of credit. What should I do with the $5,000. Seattle, WA
Answer: First of all, I admire your financial acumen. I know that I was nowhere near as financially savvy as you are at your age. You're saving for retirement. You have a nice emergency stash. And no debt other than your mortgage and home equity line of credit. It's great.
If I were you, I would pay attention to your instincts: Go ahead and tackle that home equity line of credit. It's a smart move.
Credit Counseling? Bankruptcy?
Question: My husband and I have been offering budget counseling to friends and family for about 2 years now. It is rewarding to help people find their way back on track. Recently though, I'm afraid we've strayed out of our league and know it. We're trying to come up with a budget for a family with 40,000 in credit card debt that has eaten away at the monthly salary. Their mortgage is 50% their monthly income and they're a large family. I can't send them away empty-handed though, so what are some resources we could share with them and when (as homeowners) is it time to think about filing for bankruptcy? Thanks, Jacqueline, Sacramento, CA.
Answer: It's great that you help out family and friends with their money issues. It's also smart to know when someone needs more expert advice than you can offer.
That said, there are a lot of scams at worst and incompetence at best in the consumer credit counseling and debt management business. The organization that I like is the nonprofit National Foundation for Credit Counseling. NFCC has a search engine at its website for you to find an accredited Consumer Credit Counseling Service near you. (To be sure, the quality of the advice varies across the country with some offices better than others, but the service is legitimate.) I took a quick look and I didn't see a CCCS in Sacramento. I do know that the Consumer Credit Counseling Service of San Francisco (www.cccssf.org) offers credit and bankruptcy advice over the phone and the Internet.
If your friends would like to do some research on their own, one of the best consumer- friendly guides to bankruptcy and credit is offered at Nolo.com (www.nolo.com.) Their books are good. Your friends can profitably spend some time on their website gleaning information.
And they can always consult with a bankruptcy attorney to talk through their options.
06/02/08 by Chris Farrell
Heloc vs. Student Loans
Question: Is it better to use money remaining in our HELOC, money in our savings account or to take out student loans to pay for our daughter's college tuition ($49,000.00)? Linda, Los Angeles, CA.
Answer: We've been getting many more questions about equity loans recently. When it comes to paying for college my approach is a mix of student loans, work-study, and parental savings.
I am wary of parents taking out home equity loans for college. The reason is that for most of us one of the best financial moves we can make is to enter our retirement years without a mortgage (or at least a minimal mortgage). This way the home is a critical part of our financial safety net.
In sharp contrast, your daughter has a lifetime of earnings ahead of her. It makes more sense for her to borrow for her education, and for you to help her out along the way (perhaps even after she's graduated) so that she doesn't end up with too much debt.
06/03/08 by Chris FarrellHome Equity Loans?
Question: A) Love the show. B) In these uncertain economic times, am I better off getting a Home Equity Loan, or a Home Equity Line of Credit? Oh, and, what the sam-hell is the difference? Joel, Milwaukee, WI
Answer: I'm glad you love the show. Let's do the definitions first. A home equity loan (also called a second mortgage) is a lump sum of money. You pay it back on a regular basis over time, just like a mortgage. A home equity line of credit allows you to write a check (or use a special credit card) whenever you need to borrow against the equity in your home. The interest rate is typically fixed with a home equity loans, and the rate fluctuates (depending on the market environment) with a home equity line of credit. In both cases the equity in your home acts as collateral.
In general, a fixed-rate home equity loan is tailor-made for major remodeling projects, such as a new kitchen or bathroom. The variable-rate home equity line of credit is better for smaller projects that are accomplished over a longer period of time.
Now, I'm in the camp that says the money borrowed against the equity in your home should go toward improving the value of your home and the joy you get from living in it. This isn't money you tap for expensive vacations.
However, one additional advantage of a home equity line of credit is that it can be part of your emergency savings. In case of a financial emergency, say a major medical bill or a lost job, you can use the line of credit to help tide you over.
06/05/08 by Chris Farrell
Bankruptcy? Credit Counseling? Where to Turn?
Question: Hello Chris, I am a thirty year old male living in Asheville, NC. I currently have over 20,000 debt to a private student loan lender (Loan to Learn) which is a consolidation of a previous loan plus an additional amount from L.T.L. The school I attended did not participate in the Federal student loan program or I would certainly have opted for that instead. I have not been in school for the last year but have filled out the FAFSA for the 08-09 school year and am considering going back. I am in serious default of my private loan right now and in no financial state to 'catch up' in the manner they wish. They allowed me to apply for forebearance, then denied me due to being in default. I have been regularly ignoring their daily phone calls for some time now. I am wondering, if I return to school is it possible to transfer or consolidate my private loan over to a federal loan where I would have drastically better interest rates, lower payments and the possibility of forebearance? Are the re any other options to begin working this matter out? In addition I also have two small credit card debts. They are far more feasible for me to deal with right now and the cards have been destroyed. Should I consider bankruptcy?? I am engaged to be married soon and hope to start a small business with my brother in the next couple years. In other words, I am thirsty for any knowledge about how I can begin to relieve myself of this awful financial dilemma! Thank you for your time! I really hope to hear some feedback! Sincerely, Ryan, Asheville, NC
Answer: A few specific points: Declaring bankruptcy won't get rid of your student loans. You can't "discharge" student loans in either Chapter 7 or Chapter 13 personal bankruptcy. You never want to mix private student loans and federal student loans in a consolidation. The reason is that federal consolidation loans offer far better benefits than private ones, and you don't want to lose those by putting the two very different species of student loans together.
You could also visit with a credit counselor to get advice. In earlier posts, I've recommended the Consumer Credit Counseling Services with the National Foundation for Credit Counseling (www.nfcc.org). There is an office in Asheville, the Consumer Credit Counseling Service of Western North Carolina (www.cccsofwnc.org).
You have a lot going on: A big debt burden, a desire to head back to school, getting married, starting a business with your brother. My advice is to slow down. There is a season for everything, and it seems to me that you need to make some priorities. Right now, the big priority in your life is to sit down with your fiancé and go through all the financial options. The two of you should gather information together (such as both of you visiting with a credit counselor). The two of you need to come up with a mutually agreed upon plan for handling the debt and getting you to school.
529 Plans
Question: My husband and I had our first child in February. Our budget has us paying off our student loans and credit card debt in the next 16 months. We'd like to put the money we currently spend on our student loans ($500 a month) and place it in a 529 fund for our daughter once both debts are paid off. I've seen a lot references to 529s, but was wondering if you could recommend some sources that provided guidance on how we can review the various states' 529 plans and their pros and cons. By the way, we plan on spending the money we've budgeted monthly on paying off the credit card debt to restore our savings as I stayed home on unpaid FMLA to care for our daughter after utilizing all my paid sick leave from work. We were able to finance the unpaid leave from our savings, which also depleted it (but was well worth it). Jennifer, Spring, TX
Answer: What a good use of savings. You had the money to do something important for your family. Bravo. The reason I'm posting this question is that your approach toward debt-and-savings is one I highly recommend: Pay down the debt, and when it's extinguished keep on setting aside the same amount of money into savings. It's a sound strategy for replenishing and building up savings.
The best resource for learning more about 529 college savings plans is at www.savingforcollege.com. It offers a good overview section for free. You will have to pay a modest price to get access to the detailed information. Check it out.
06/09/08 by Chris FarrellCo-Signer Rights?
Question: I am trying to negotiate with Sallie Mae to settle the loan amount: to get some principal forgiveness and in return I will pay them off in full on the settled amount. My purpose in this is simply to reduce the loss I have to take on this.
My question to you is, what are my rights as a co-signer? What can I reasonably expect Sallie Mae to do for me. They are not very responsive, it is hard just to find someone who will return my call. So, I just would value your comments on what I should, and should not, expect from them in the way of help. Your response would be very much appreciated, thank you. Jeff. Irvine CA
Answer: You're now responsible for the debt as co-signer. Go ahead and try to negotiate with Sallie Mae. It can't hurt. But since you signed a legal document you're on the hook for the full amount. Maybe they'll cut you a break. But it is under no obligation to make a deal with you.
I know it's too late, but your experience is why everyone needs to think very carefully about the financial risks before co-signing a loan. There are other ways to help someone out with their student debts (or any other debt for that matter) without taking on the obligation imposed by co-signing.
Merging Finances, Including Debt?
Question: I am 37 and getting married in three months to a gal who is 10 years younger than me. Financially, we're at different places in our lives and I am wondering what I need to do as we merge our lives together to protect my modest wealth and assets in case of a financial disaster on her part.
I've had my hard financial knocks in life, but have gotten to the point where I have a good job, good credit, own a condo, own a car, have money in retirement accounts, and my credit card debts are very low and manageable (and could be paid off quickly if needed). My fiancée has huge student loan obligations ($100k+) and damaged credit because she declared bankruptcy three years ago. Her debt is almost entirely student loan debt, so that does simplify things.
How would you proceed into such a situation? Please do not use my name if you answer this question as I do not want friends/family to be able to identify us should they hear or see the question. Thank you! Washington D.C.
Answer: Ah, romance. Poets, philosophers, and songwriters have long struggled to capture the mysteries of love and marriage.
That key question is this: Are all the financial issues out on the table, discussed, and the approach toward dealing with debts bought into by both of you? Are you on the same page about handling her student loan debt? Your credit cards? How much is each of you going to set aside in retirement accounts? What you need to do is really gain an intimate understanding of each others desires and fears about managing money as you go into this marriage. The rest is financial technicalities.
This is where a prenuptial agreement can help. Now, most people don't like the idea of a prenup. It isn't romantic. It has an aura of preparing for failure in the marriage. But look at it this way: A prenup can be a critical part of your money discussion. The beauty of a prenuptial agreement is that it is a vehicle, an impetus for full financial disclosure. Many couples like to write their own wedding vows. A prenup allows a couple to write their own marriage contract. It should cover all assets, including property and difficult-to-value holdings like stock options, businesses and professional practices, and academic degrees. You should also cover all debts, potential inheritances, and spousal support.
A prenup is a binding legal contract. That means you'll need lawyers to help both of you understand the document and to make sure the prenup does not violate any laws. Another way to handle it is a more informal, do-it-yourself approach. It isn't a legal document and it won't hold up in court, but it's a written understanding between the two of you. It's a way of getting both of you on the same financial page. The value lies not in the contract, but in the process.
Two books that might help your financial relationship: For Richer, Not Poorer: The Money Book For Couples by Ruth Hayden (Health Communications), and Prenups for Lovers by Arlene Dubin (Villard Books).
What Debts to Pay Off
Question: My husband and I will receive about $50,000 inheritance. He wants to use the whole sum to pay down our mortgage. I argue that we should pay down the higher-interest credit cards and car loans (about 6k in the former, 28k in the later). He argues that the sooner we build more home equity, the better. I say that we're losing lots of money on these higher interest products. I'm right? He's right? Split the difference? We're in our 40's, both employed in education, and have (hopefully) good retirement accounts. Nancy, Columbus, OH
Answer: First of all, in this case neither of you is wrong--or right. You'll be better off financially whether you decide to pay down the mortgage, get rid of credit card debts and car loans, or compromise on a mix of the two strategies. The bottom line is that you're getting rid of debt and your household balance sheet will be healthier.
That said, I'm with you on this one: From a financial point of view the best use of the money is to get rid of the credit card debts and car loans. Both have a higher rate.
Now, you'll still have some inheritance money left over if you eliminate the short-term debt. You could put that toward principal on your home. Or, in light of the recession, you might want to consider setting it aside in a safe place just in case you need it. You can always invest it in your home once the economy looks better.
Social Security Do-Over?
Question: This morning, rushing my kids to get them ready for school and myself to work, I overheard someone talk about borrowing from his/her own social security account, interest free. Please, Is there such a thing? Is there a website? I don't have a crises, though I lived below Houston and to the west of Christie Street when 911 happened, but I never looked for any help related to that. I'm a person in lots of debt, credit card(divorce) and student loan, single mother with two kids trying to start a new career, possibly start a small non-for-profit cultural center - lounge in my neighborhood. A loan such as this could be the answer. Thank you, Malu. Brooklyn, NY
Answer: What you heard was a report by Bob Moon. He looked into what can be called the Social Security "do-over." But it doesn't involve borrowing from your Social Security account.
When people retire early, say, at age 62, they take a reduced monthly benefit. Well, it turns out that you can change your mind, reapply, and get the bigger payments that go to those who wait to collect benefits. The catch? You must send the government a check covering the benefits you've been paid (But that payment is without interest or adjusting for inflation. That's probably where you heard the word "interest".)
For others that are interested in the Social Security do-over, they can check out the website of Laurence J. Kotlikoff, economics professor at Boston University. He's also the head of the financial-planning software company ESPlanner. (It's at www.esplanner.com.)
For instance, he ran numbers for me a while back for a couple who retire at 62, have $300,000 in savings, and an additional $100,000 each in retirement assets. They want their money to last until they're 100. If they apply for benefits at 62, each gets $17,921 a year. Fast-forward eight years. Had they waited until age 70 to file, they would get $31,005 each, for a total of $62,010 a year. To get those higher payouts now, they'd each write a check for $118,957. That's a hefty sum. But the cost of getting that same payout by buying the cheapest commercial annuity would be 40% higher. When you include earnings from the couple's other assets and factor in their 30-year time horizon, Kotlikoff calculates that their annual aftertax spending can go from $58,765 to $70,420.
Your concerns are far different. I would suggest that you get in touch with the National Foundation for Credit Counseling (NFCC) to deal with your debts. It's the largest national nonprofit credit counseling organization. Their website is www.nfcc.org.
Co-Signing for Sister
Question: I have a sister who is currently applying for private student loans. She has no co-signer and is therefore subject to higher interest rates and is finding it more difficult to be approved for a loan. I've thought about offering to be her co-signer, but first I'd like to make sure I am fully aware of the consequences of being a co-signer. Would it affect my credit or ability to get other types of loans in the future? She needs to borrow around $16,000 for the entire year. I personally have nearly $40,000 in student loan debt myself. I'm 24 and have a stable income. I'm also very confident that she would pay the loan back herself. Thanks for your help! Any advice would be appreciated. Elizabeth. Eagan, MN.
Answer: Put it this way: When you co-sign you are taking on the responsibility to pay off the loan if your sister can't. Period. It can affect your credit score and your ability to take out another loan. My personal preference is for family members not to help each other out financially by cosigning. It's a legal document that carries a serious obligation, especially for someone like you who is just starting their career. If she does need your financial help and support, it's much better to lend her some money privately in a pinch. The two of you just need to have an understanding of what that means-as sisters--without involving legal documents, credit reporting bureaus, credit scores and the like.
07/10/08 by Chris FarrellPay Down Debt Too Fast?
Question: Background: My wife and I are recently married. She has a good entry level job with the university in town, which pays about 30,000 dollars a year. I am finishing up my last semester of college and with some successful job hunting will be in a similar situation. My wife has some substantial student loan debt ($40,000). We are planning on paying of the debt as aggressively as possible in the next 5 years.
Question: Is it possible to pay down debt in an overly aggressive manner? Blake. Fort Collins, CO
Answer: It is possible to try to reduce debt too quickly. It's terrific to be ambitious about getting rid of a loan. And there will be a real financial and psychological relief when you make that last payment to your student loan lender. But 5 years seems like a very difficult schedule to keep unless you sacrifice other goals to getting rid of the debt.
Personal finance is always about trade-offs. You want to pay down the student loan quickly, but you also want to save for your retirement. In all markets--but especially today--it's important to build up a cash cushion. The reason is that the job you accept on graduation may not work out for you. Savings allows you to take a risk and try another employer. You could also lose your job through a downsizing or restructuring (pick your favorite euphemism). You and your wife may decide to have a child. And so on.
So, yes, attack those student loans with discipline. But don't strap some other important goals in your young married life in the meantime. I consider student loan debt to be "good" debt. It's an investment in her career and future earnings. On a more pragmatic note since there is no prepayment penalty with student loans, as you're incomes improve over time you can always pay more.
Borrowing Against 403(b)
Question: Most of my 403B money (Thrift Savings Plan) is in the government securities (G) fund. I have a mortgage on a commercial real estate investment property that has a 3 year variable interest rate currently 4% above the rate I can borrow from the TSP. Should I borrow against the TSP, moving the limit of $50,000 to a general loan against the TSP, saving on interest by applying the amount to the mortgage? No prepayment penalty, the property has a positive cash flow, and I can make both payments (TSP loan & the ongoing mortgage payment) Mark. Billings, MT
Answer: I wouldn't do it. I think there is too much risk and not enough reward to this maneuver. You have a solid retirement savings plan. You have a commercial real estate investment property with a positive cash flow. I'd leave them be.
Borrowing against a retirement savings plan is more expensive than it appears. For one thing, you repay the loan with after-tax dollars. You're also losing the benefit of compounding. If you do lose your job you have to repay the loan quickly or it's treated as an early distribution. That means you'll pay a 10% penalty (assuming your under 59 ½) plus ordinary income taxes on the money you've taken out. You're also leveraging up your investments, putting a portion of your retirement money at risk to the property.
Debt Trouble and Reverse Mortgage
Question: My husband and I have accumulated $75K of credit card debt. Over the past five years we have suffered a few layoffs, and I now make half the salary I used to. We are not living high on the hog or spending extravagantly. We used the credit cards for lots of necessities and airline tickets to visit family.
Our combined income is now $60K per year. We are current on our bills and our mortgage, but we keep adding to the credit card balance to stay afloat.
We are considering asking our in-laws for a $75K loan to pay off the debt. They own their $900K home outright. Would a reverse mortgage be the best way for them to get the money? If they do agree to the plan, should it be a gift or a loan? We're agreeable to any plan -- we're drowning. Help! Please withhold my name. Denver, CO.
Answer: You have a lot going on. But let me get right to your question. No, your in-laws should not take out a reverse mortgage. It would be a bad financial move on their part. Yes, reverse mortgages are an option for aging homeowners. But they're expensive. The way I look at them is as a last resort, a safety net after all other options have been exhausted.
It also seems to me that they are taking on a real risk lending you money Do you really want to get financially entangled with family? And if they do loan you the money how will you pay them back and over what time period? I understand that you've head some real setbacks and are deep in debt. I'd really run the numbers to make sure you have a plan for getting out of debt. I would also think about working with a debt management company. You can check them out at the National Foundation for Credit Counseling at www.nfcc.org.
07/29/08 by Chris Farrell
Out of Debt. Now What?
Question: I just paid off the last of all my debts! After getting into some serious spending problems in my 20s, I've poured everything extra over the last three years to pay off nearly $25,000 in personal debt. I've been so focused on that goal that I haven't considered much else. So, my question for you is: What do I do now?
A few extra pieces of information: I'm 30 years old. I'm currently putting 8% of my pre-tax income to retirement, and my job as a public school teacher includes a pension. I'm not married, have no kids, and rent my apartment in New York City, though I'd like kids and a house at some point.
I'm building an emergency fund. (Right now, it's about one paycheck. I'm working for three months' salary.) After that, what else should I be doing now that the debt is gone? Thanks for your insight, Kara. Astoria, NY
Answer: Congratulations. In the current environment I think you should continue what you're doing: Build up your cash savings in a mix of FDIC insured savings accounts and conservatively run money market mutual funds. Your savings will hold its value, although it might lag inflation a bit.
This approach also gives you time to see how you manage your money now that your out of debt. I'm sure you have some delayed purchases--clothes, vacation, maybe a bike. I would slowly buy some stuff and see how you do. You might also use this time to research the real estate market, see what you like, how buying would affect your income, and whether it makes financial sense or not.
Last, I'm a big believer in investing in long-term savings in a taxable account. That could mean regularly putting some money into a broad-based equity index fund. The advantage of this approach is that money compounds over the long haul, but if you do need it you can sell some stock and pay capital taxes on it. But unlike money held in a tax-deferred retirement savings account, you won't pay the 10% penalty if you take the money out when you're under age 59 ½.
Borrow to Fund 529s?
Question: My wife and I have no debt except for $23,000 from a home-equity line. This year, she took some time off, reducing our income and meaning that we might not be able to save into our 529s for two sons, ages 6 and 4. (We will save $36,000 for retirement this year.)
My question: Should I borrow $10,000 from our Home Equity line to fund these 529s? My argument is that I immediately get the NYState 6% tax reduction for that whole $10,000 ($600), that the Home Equity interest rate is small (4.75%) and deductible so effectively even smaller (3.5%), and that there is a lot of upside with the market at about 11,500. My wife's argument is that I am completely nuts. Thank you for your (gentle) reply. David, Amherst, NY.
Answer: No, I'm not going to say you're nuts. And you can make the numbers work if you use the stocks market's average annual rate of return of some 7% (after taking inflation into account). Problem is, the flaw with using averages is that Lake Erie never freezes and stock market returns don't fluctuate.
We get variations of this question all the time. What's unusual about your query is the timing. Usually people want to borrow and put the money into whatever asset is flourishing at the time--Internet stocks, residential real estate, and so on. Right now, it seems that just about everything is weak: The economy, the job market, homes, stocks, even commodities.
Leverage is risky. Borrowing to invest in stocks and bonds can backfire badly since you need to make those interest and principal payments even if the assets you've bet on cratered. So I wouldn't do it.
To put it somewhat differently, I don't think the potential rewards justify the risk. It's wonderful that you are saving for your children's college education. But they'll still be able to go to college even if you don't save in their 529s for a year or two. Maybe they'll have to borrow a bit more to pay for college. But that's the biggest downside I can see.
Which Debt to Pay Down?
Question: My parents gave me a check to help with debt reduction. I am somewhat overwhelmed with the possible uses for this check. I have a loan with 12% interest which would be close to being paid off with their check; a credit card at 0%; and credit card at 10%. My first instinct is to pay off the loan and be nearly done with my 2nd highest monthly payment. However, credit card debt is less favorable to my credit than a loan. I also wonder if I should split the payment and pay off some debt and put the rest into a 2-year CD? Or finally, much needed home repair that I could pay up front rather than financing. What's best: loan repayment, credit card repayment; repayment and savings; or home repair? Kate, Minneapolis, MN
Answer: In a sense you can't go wrong. But there are trade-offs, and that's where the paralysis comes in. Here are some ways to think about it.
The standard advice--with good reason--is to attack the high interest debt first. By definition, it's the most costly. However, all of us need some positive reinforcement and there is a "whew" factor to consider when we finally get rid of a debt. That's why it can make sense psychologically to attack the debt with the smallest amount due even if financially the logical course is paying down the high interest rate debt.
Now, reminiscent of the fierce debate over whether to tie a kid's allowance to household chores, either approach has passionate advocates. I fall in the agnostic camp. Either way, you're getting rid of debt. The real question is, which approach will work best for you? Paying off a loan or tackling higher rate debt?
That's one big issue. The other one is the home repair. You say it's "much needed." I interpret that to mean the repair will help maintain the value of your home. I know that the housing prices are falling now and for the foreseeable future. But over a longer period of time your house is a major investment. In that case, using the money from your parents as investment money, and setting up a debt repayment plan to attack your other debts, seems sensible to me.
Last, understanding how you got into debt in the first place and how you plan to stay out of debt once you get all your debts paid off. Part of this process is the proverbial "know thyself" and part of it is creating a practical budget you can and will stick to over time.
So, with all this in mind, here is how I would approach it.
If you haven't done so already, take the time to make a realistic budget for paying off your (remaining) debts. Next, while in most cases borrowing to make home improvements is good debt that should pay for itself over time, it might be the best course to avoid taking on new debts. This way you can get your home fixed up, and focus on your debt reduction plan.
Does anyone have another thought or approach?
Borrow to buy?
Question: The stock market meltdown that we're facing today looks like one of the best stock buying opportunities that I am likely to face in my lifetime. I don't have a lot of spare cash, so I'm considering borrowing some money to buy some mutual funds. I'm 34, have a stable job in a good company. I have a 30-year fixed mortgage and a HELOC that currently offers an interest rate of 5.25%. I don't have much debt other than a car loan that I'm paying down. I am going to school part time on a student loan. I'm thinking about taking $4,000 or $5,000 out of the HELOC and buying an index fund or a financial sector fund. What do you think? Patrick, Atlanta GA
Answer: Big mistake. Yes, stocks may offer a high potential return, but only by taking on a considerable amount of risk. Remember, stock market returns are not guaranteed, but you will have to meet the interest payments on your loan no matter what--or put your house at risk. Borrowing on your home to invest in the stock market is always a bad bet. And in the current environment people need to be paying down debt, not adding to it.
That said, you could be right about the stock market. I don't know when or where the stock market will hit bottom, but there is value in the market. And there was a spectacular raly today of some 11%.
Warren Buffet, the famous stock picker, is buying. So is Marty Whitman, another well-known value investor of Third Avenue Management. Jeremy Grantham, the legendary investor at Boston-based GMO told Business Week that stocks are now cheaper than they've been since 1987. "You are looking at the best prices in 20 years, and you should be making 7% to 8% to 9% real [inflation-adjusted] returns," he said. "The last time I was this optimistic was in the summer of 1982."
These three long-time investors have built sterling money making reputations over a long period of time. Here's what Jack Bogle, the octogenarian founder of the mutual fund giant Vanguard, told me in a recent interview: "We can, however, look ahead and make reasonable predictions. In the bond market, we know with 90% probability that return in the next 10 years will be 4.5% to 5%. That's the historical number. If we have huge inflation and a Great Depression, and lots of bonds default--this is why I like Treasuries--then that's something else again. In stocks, we know the sources of stock returns. Dividend yield is almost 2.5%, and earnings growth from these levels ought to be 6% over the next decade. That's an 8.5% return."
Grantham notes that when bubbles burst markets historically overcorrect by a lot. Your idea is a reasonable bet. But don't borrow the money. Use cash.
10/28/08 by Chris FarrellCo-sign a loan?
Question: My daughter and son-in-law have an empty "underwater" condo. We all shudder at the thought of renting it out! It's hurting them to be paying a mortgage and other expenses while not living there, so they hope to sell it in 2009. They will owe around $25,000 more at closing than they will receive. I am considering either loaning them the money at a rate about what I can earn on a CD or other savings, OR co-signing a loan from their bank or credit union. I trust them to make payments either way. What are the advantages and disadvantages of either of these plans - for them AND for me? Carol, St. Cloud, MN
Answer: I am not a fan of anyone co-signing a loan from a bank or credit union no matter how much you trust the person. You know them, and you know that they are trustworthy people. But sometimes even very good people can't pay a loan because of a lost job or big medical bills. And then you are on the hook to make the loan payments if you co-signed the loan.
I have been getting more questions lately about co-signing. It's a reflection of tough economic times. Although the circumstances are very different from yours, I want to highlight another email I recently received from a listener. It's from Gregory in Irvine, CA, and it offers a grim reminder of the risks of co-signing:
I co-signed a car loan for a friend and right now there is about 4,000 owed to it. This was a mistake that I regret a great deal because it turns out my friend is not responsible with money and I have just learned he lost his job a few weeks back. I no longer talk to this friend of mine and I do not want any communication. Last week Wachovia, the loaning business, called me and told me that this last months car payment is 15 days over due and they will report the late payment in another 15 days. Please help. I do not want to bail out my former friend for a car he never should have bought in the first place, yet I do not want my credit to be destroyed. Can I refinance the car in his name alone? If the car gets repossessed will it really upset my credit that much? What should I do? What would you do?
Greg is legally obliged to pay up. The only solution I can see is Greg needs to swallow his distaste and approach his former friend and see if they can negotiate some kind of solution.
Since family relations are strong in your case, and everyone wants to avoid the renting option, I would lend the money with an interest rate to your daughter and son-in-law. Then if they fall on hard times the three of you can renegotiate the loan without the involvement of credit reporting bureaus, credit scores, or an impersonal financial institution.
Credit problems
Question: I have been working to eliminate my personal revolving debt for more than five years by paying the minimum monthly or more. It is evident that I'm not really making any headway and may be going in the opposite direction with creditors raising my interest rates to well above 25%. As you know, creditors check credit scores regularly and arbitrarily raise their rates and charges.
Now that my income has unfortunately dropped, I'm wondering if under the new bankruptcy law I'm better off negotiating a settlement with each credit card creditor. I'm not looking for a write-off, but a negotiated settlement with payment terms.
My question is should I take this course, suffer the consequences on my credit score, and rebound down the road? Ron, Escondido CA
Answer: It's outrageous that banks are hiking credit card interest rates when the economy is in recession, job losses are mounting and taxpayers are bailing out the financial system with at least $1 trillion dollars. It seems to me that raising credit card rates now is bad for households and the economy. (Longer term tighter credit terms might be good, but in the short-run it looks bad.)
For instance, both American Express and Citigroup have said they're raising rates by 2 to 3 percentage points on some customers. I expect we will also see many people get hit by "universal default" and the default rate of around 30%. About half of all credit card issuers have a universal default policy hidden in the fine print of a credit card agreement. Late on any payment to any creditor, and the rate on the card could automatically jump to the default rate--even though you're up to date on the credit card payments. I don't see how anyone ever gets out of debt at a 25% to 30% interest rate. That's loan sharking.
Here are three practical suggestions. First, get a copy of Gerri Detweiler's "The Ultimate Credit Handbook: How to Cut Your Debt and Have a Lifetime of Great Credit." It's in its third edition, and is very helpful. However, my guess is that your way past the kind of advice she gives since you've been working on paying down your debts for 5 years. (But it's worth a look for anyone worried that they're carrying too much debt and trying to pay it down.) I am also a fan of the credit advice at the non-profit organization Nolo.com. Its web address is www.nolo.com.
Second, contact the National Foundation for Credit Counseling (NFCC). It's the largest and oldest national nonprofit credit counseling service. You can find a branch near you at www.nfcc.org. I'd set up a meeting with a debt counselor, and see what can be done with their help and guidance.
Third, consult with a bankruptcy lawyer to what are your options for wiping the debt slate clean.
You'll then be able to make a reasoned decision.
I wouldn't worry about your credit score right now. The key is to figure out the best, most practical way to eliminate your financial burden and, at the same time, to make sure you won't end up in the same place 5 years from now.
Negotiating credit card rates?
Question: do you think paying for a service to lower interest rates on credit cards can work? AFL Financial Services charged 990.00 to negotiate with my credit card companies, to lower interest rates. I have personally been able to negotiate with the companies in the past but now they aren't working with me. thank you karen, Seneca Falls, NY
Answer: More and more people are falling behind on their debts, thanks to the twin pincers of a financial crisis and a deep recession. That said, I'm not a fan of paying big fees to any outfit to renegotiate consumer credit card charges.
Here's a checklist for anyone carrying too much debt and looking for help. (My assumption with this list is that the debt burden has created a financially precarious situation calling for strong remedial action.):
First, check out a branch of the National Foundation for Credit Counseling (NFCC). It was founded in 1951, and it's the biggest and oldest national nonprofit credit counseling service. The website is www.nfcc.org and the toll free number is 1-800-388-2227. For example, I looked at the branch nearest you, which is in Syracuse. It offers Internet, phone and in-person counseling and the fees range from zero to $30. Low fees matter. You're already cash-strapped.
Second, for anyone that can't see their way out of debt (and it seems to me from your email that isn't you) consult with a bankruptcy attorney. Sometimes bankruptcy is the best path toward getting a fresh financial start. Sometimes it isn't. But you should be able to make an informed decision. A good source of unbiased information on bankruptcy and other avenues for getting out of debt is www.nolo.com.
Third, don't give up yet on renegotiating rates with lenders. Right now, it appears that your experience is fairly typical. But there is growing pressure on financial institutions benefitting from a taxpayer bailout to work with customers rather than take a tough stance. I'd get back in touch with your creditors in the New Year.
Last, whatever you do to get out from under your debts, congratulations. But the real trick is to make sure you stay out of debt. Create a plan--and stick to it..
Savings vs debt repayment
Question: So my wife just graduated with a masters and started working, and i just got a 25,000 promotion. Combined we are making about 3-4 times as much as we were last year. Our expenses have grown cause we were living in upstate NY, but now live in the bay area. But my question is should we try and pay off some of the college loans sooner, or should we try and save all the excess money for a down payment for a house? In reality it could take us a few years to save the 20% we would need for a down payment because of the outrageous cost of housing here. howard, los gatos, CA
Answer: You aren't kidding when you say home prices in the Bay Area are outrageous. Home values are down sharply, but the median home price is still about $350,000. That means if you bought the median home you'd have to save $70,000 for a 20% down payment. (And really you'd need more than that considering closing costs, moving costs, and the annual costs of homeownership. You don't want to be house poor.)
It's wonderful you have the money and discipline to save. How about this for an approach? First, let's put the bulk of the extra money toward savings. The money may go toward a home in the future. But the savings will work double duty in the meantime. The amount of money available will grow in case of a financial setback, such as a layoff. Plus, an emergency savings fund is also an "opportunity fund." Savers eventually get to take advantage of good bargains during downturns. You build a strong financial safety net, have money to take advantage of deals and, create a nest egg for a home.
Second, I would then take some of the extra cash and accelerate your student loan payments.
The thought is not to treat this as an "either/or" question, something all too common in the world of personal finance. Instead, play with the percentages and decide how to divide the money pie. Because of the recession, I would lean toward putting more of the money into safe savings and only slightly accelerate the student loan payments. But you and your wife may be more comfortable dividing the money in half--half into savings and half into extra student loan payments. Or the two of you may decide to put the bulk of the savings toward student loans because you can't stand living with a loan. There is no right or wrong course. You're saving--and that is what's critical in good times and bad.
Leverage up?
Question: I can tap my home equity line of credit at an interest rate of 4%. I'm thinking about using my HELOC to fund an investment in a no-load tax-free bond fund earning a dividend of 5%. The dividend income would be tax-free, and the interest expense would be tax-deductible. What are the downsides or risks to this idea? Andy, Ankeny, IA
Answer: I am consistently against individual investors borrowing to invest. Borrowing against your home to invest in the financial markets is a bad speculation. Remember, market returns aren't guaranteed. But you will have to meet those interest payments on your loan no matter what.
We've gotten variations of this question over the years. Several years ago, a typical question involved taking out home equity and invest in stocks. After all, stocks have an average annual long-term return of 10% or so. Problem is, on average Lake Eerie never freezes and the stock market doesn't plummet by more than 40%--as it did last year. The numbers always appear to work on paper, but the investment history says leveraging up (the jargon term for borrowing) is a recipe for financial trouble.
To be sure, muni yields are intriguing. Since Uncle Sam doesn't impose a levy on muni bond interest payments. Tax exempt securities typically yield between 75% and 90% of their taxable Treasury equivalent. Yet muni's now yield more--considerably more. For instance, the yield on a 30-year general obligation (GO) single-A+ rated muni bond is around 5.5%. (General obligation bonds or GOs are considered especially safe since they're backed by the state's taxing power.) For an investor in the 35% federal tax bracket that's the equivalent of an 8.46% yield--instead of the less than 3% taxable yield on the 30 year Treasury bond.
The catch: The worst financial crisis since the Great Depression is fanning fears of widespread municipal bond defaults. Credit risk is an anathema to investors.
You want to put some risk money into a muni mutual fund? That's fine, but tap into savings. Don't double down on your bet.
A loan from family friend
Question: I'm turning 25 years old in a few months and am finally getting serious about eliminating my debt. I have a credit card with a $3,000 balance. It was at 24% APR until I called this summer and asked them nicely to lower it. It went down four points. Twenty percent is still too high. As our economy sours, my mom is preaching about this being a time for neighbor to help neighbor. During a conversation on the subject over the holidays, it came out that a family friend had a few thousand sitting in a savings account earning hardly any interest. She wasn't putting it in a CD because it wouldn't earn much more there. My mom pointed out that if Beth loaned me $3,000 to pay off my high interest credit card, Beth could earn more than one or two percent offered in a CD and I could get a lower interest rate on my debt. It's a win-win for all parties. Laura is ready to write the check and I'm ready to lower my interest payment. Do you have any advice as to how we structure the agreement? What's fair for all parties? Is there a precedent for this? Are there any online resources? I really enjoy your show. I learn new things ever week. Thanks for making us all better informed. Kindly, Virginia, Cincinnati, OH
Answer: Congratulations on getting rid of your debt. Now, what you're proposing isn't uncommon. There are a couple of important caveats. If I were writing to Beth, I would warn her to think seriously before mixing money and friendship. It's always risky proposition. Then, assuming she's still comfortable with it, just remember you are taking on an extra burden of making these payments no matter what. She's a family friend.
That said, it is a favorable deal to both parties, and it's done all the time. I strongly urge you to write-up a formal document laying out the interest rate, when the payments will be made, and when the loan will be paid off. This document will lay out her expectations and your obligation. A document like this for a small loan will also satisfy the Internal Revenue Service since she'll be receiving an interest income from the loan.
There are plenty of do-it-yourself documents on the web. For instance, Nolo.com, a legal self help company I admire a lot, has a standard form on its website here. You could also just do one on your own. However you do it, everyone signs it. Good luck.
Consolidate loans to mortgage
Question: Please help... Would it be a good or bad decision to put a non-consolidated Parent Plus Loan into a home refinance? The refinance rate is 4.5 and the student loan is 7.9 (!) I have two other consolidated loans at 3.25 and another at 5.875. I'm currently over the limit (2x) of interest I can deduct, so if included it, the interest it would be deductable, but does it make sense to increase my mortgage by so much (an additional 32K on a 156K mortgage? And I will have to pay an additional .25 point to do the cash out. Will the Plus Loan interest rate be reduced in July? Would it make sense to wait and consolidate? My refinance will settle before I know the next rate. Will the deductable student loan interest rate be raised? I have a line of credit rate currently at 2.5, but they will average 3 years interest to do a fixed loan, so that w on't help now. I would rather keep it separate, but am temped by the 4.5 rate. I want to make the best short and long term decision.... Thanks in advance for considering my question. Mary, Garrett Park, MD
Answer: I want to address the core of your question. I believe one reason why so many middle-income homeowners got into financial trouble in recent years is that they consolidated their debts into first and second mortgages. Yes, the interest payments are tax deductible. But I don't think the tax deduction is worth the extra risk.
For instance, it always upset me when financial advisors would recommend consolidating credit card debt into a mortgage. That's crazy. I feel the same way about student loans. There is financial flexibility with Parent Plus loans, such as a graduated payment plan, income sensitive payment plan, and an extended payment plan. (Of course, the price for taking advantage of these options is the overall cost of the loan goes up.) If you pay off the loan by rolling it into your mortgage you'll lose that flexibility, and increase the risk of losing your home if you have a job or income setback.
Graduate school debt
Question: I'll be starting veterinary school in the fall, which means that over the next four years I'll take on something like $150,000 in debt. This will be mostly in the form of subsidized and unsubsidized Stafford loans, with rates in the neighborhood of 5 to 6%. My question is, is this an awful time to take on this kind of debt, or is it the perfect time? I haven't heard a single thing in all the coverage of the current crisis about how this might affect current student borrowers. Sarah, Portland, ME
Answer: At the moment, the federal government's focus when it comes to higher education seems to be twofold. First, make sure that there is enough loan money available for students, especially undergraduates and, second, to direct more financial support for college to low income families though a combination of more generous grants and tax benefits.
The downturn in the economy is unusually scary. But I don't think it's a terrible time to borrow and invest in your education or a perfect time.
Instead, I would go back to the fundamentals. What you're facing is the classic graduate school question: Do my future job prospects, measured in terms of career satisfaction, income and job security, justify taking on all this debt? Medical school students, law students, MBAs, MFAs, PhDs, future veterinarians like you and anyone else thinking about earning an advanced degree needs to weigh the income-in-the-future versus the debt-burden-to pay-down trade-off. Is there a good chance that you will earn a sufficient return on investment to pay down the debt within a reasonable period of time? What's the downside, and is the risk worth it to you? Those are the questions to research.
That said, it's smart to get more education and improve skills during an economic downturn. Hopefully, the economy will pick up before you get your professional credentials and get a job as a vet.
03/05/09 by Chris FarrellExtra money
Question: My wife and I have transitioned to using cash to pay for daily expenses versus a credit card. As a result of this transition, we have are able to save more money. Now the question for us is where to put the extra savings? We are both in our early thirties, own a home with a mortgage, and have a car loan, a student loan, and a home improvement loan. We have 401K investments, which I have been contributing to since I was 22, but we do not have 6 months of expenses in liquid funds. Should we using our increased savings to increase our 401K contributions, we are not at the contribution limit today, increase emergency savings, or pay down debt? I appreciate any suggestions you can provide. Regards, Tim, Victor, NY.
Answer: Congratulations on getting your finances under control. It's nice to take a question, too, where all three of the money alternatives are good. You can't go wrong if you decide to hike contributions to your retirement savings plan, add to emergency savings, or pay down debt.
Still, I would recommend dividing the extra money into two small streams, one channeled toward extra debt payments and one siphoned off into savings. I'd accelerate debt payments on the car loan and the home improvement loan. I'd put the remaining extra money into an FDIC insured savings account or FDIC insured short-term certificate of deposit (or comparable products at a federally insured credit union). You won't make much money on the savings (okay, that's an understatement these days) but the money will be there if you need it.
One other thought to raise, this one concerning retirement savings. Just make sure you're taking full advantage of the company match if there is one. That's too good to pass up.
Co-sign for brother
Question: I'm planning to cosign a home loan for my brother. What's the best way to insulate myself from unforeseen liabilities? Are there any pitfalls in joint ownership? I'm going to ask them to buy a life/disability insurance in my name. Though I'm not sure if the benefits of paying the insurance outweigh the cost of getting mortgage in their name. I'm cosigning to get them a better mortgage terms. He and his spouse earn a decent salary and want to buy a town house in LA suburb. They have recently moved to US, have less 15 month of credit history and 600+ score. House value: 350K. Income > 90K. Down payment - 10%. Naren, Boston, MA
Answer: Lenders love it when a loan is co-signed. It increases their security. More borrowers than ever are seeking better loan terms by turning to family members or close friends to co-sign loans. All I can tell you is that if your brother and sister-in-law can't meet the loan payments you are on the hook. There is no way out of it. There is no way to insulate yourself from that obligation. That's the risk you're taking.
It's wonderful that you want to help them out financially. The problem is we live at a time in our history when job security is vanishing, the depth and length of the recession is uncertain and the risk of unemployment unusually high.
I have two recommendations. The first is to question whether it makes more sense for them to continue renting for now, build up their credit and learn more about their new city. They have plenty of time. Home prices are not rising anytime soon. The other suggestion is not to co-sign but to help them out financially. For instance, you can gift to them up to $24,000 a year--$12,000 each--with no tax consequences. But you're not taking on the legal obligation of the loan.
Borrow to boost credit score?
Question: Hi Chris: Thanks to you and Tess for your informative show. It's appointment radio for me on weekends. :)
Here's my question: I've worked to get my finances in order and bring my credit score up over the past several years. Currently I have only one credit card with a very low limit, which I can and do pay off in full each month. I have no student loans or other debts and no mortgage. I've been contemplating trying to buy a house for the first time this year and have been watching my credit score through Equifax. This month when I pulled the report, the summary told me that one of the factors that could work against me was that I had had no new credit or loans in several years.
I had intended to put off buying a car for another year or so, but could afford it now, though it would mean saving a little less each month. I want to get the best interest rate possible when I finally get a mortgage, so I've been paranoid about adding any new debt. Has being prudent held me back? Could taking out a small loan (less than 10k,) for something like a car, and making on-time payments actually help my score in advance of trying to get a mortgage? And if it lowers my score initially, how much of a penalty would it be? And at what point in the loan is it actually helpful? 3 months in? 6? a year? Thanks, Kerri, Washington, DC
Answer: When it comes to question like this my starting place is good savings and debt management practices. The peculiar dynamics of the credit scoring business comes second (or third or even farther down the list). My basic belief is good savings and debt habits will pay off in all economic and financial seasons, and those sound principles will pay off in a good credit score. Not everyone agrees with me, and their personal finance advice is more tailored toward manipulating credit score higher. I don't agree. What's good for the profits of the credit reporting and credit scoring industries is not necessarily good for your personal fiscal health.
We're in a recession. It's unclear how deep the recession will go and how long it will last. You've already gone through the tough slog of getting your personal finances in order. You pay off your credit card bill in full every month. Bravo. I would not take out on unnecessary debt and create a more fragile balance sheet in an attempt to boost your credit score. My fear is that the strategy could backfire on you badly.
What's more, my educated guess is that you'll be fine when it comes to buying a home. Remember, there is a range to credit scores and if you keep paying off your bills on time you'll be pretty high up. Take this example drawn from the FICO website. The key assumptions: The mortgage loan is for $150,000 and the borrower is making a 20% down payment on the home
FICO Score Mortgage Rate
720-850 4.760 %
700-719 4.885 %
675-699 5.423 %
620-674 6.573 %
560-619 N/A
500-559 N/A
The reason for the "NA" or Not Available for the two lowest score levels is that borrowers with such a low score and damaged credit can't qualify for better loan terms.
It would be much better for you to spend the time researching the home you might buy, and the neighborhood you want to live in. Remember, you have a lot of negotiating power in this market. You should visit with a bank loan officer or credit union lender to see what rate you qualify for currently.
Let us know how it goes for you.
Retirement vs. student loans
Question: Hi Chris, my question relates to two subjects: a student-loan for graduate studies and funding my retirement. I am 27 years-old and am planning to enroll in a graduate program (MBA) in the fall of 2010. The total cost of this education is in the vicinity of $100,000. By the fall of 2010, my savings should amount to at least $25,000. So, I will have to obtain financing for the majority of my education costs.
Since I will require a loan for such a large percentage of my educational costs, should I immediately cease contributing to my retirement accounts and, instead, add that money to my savings? Currently, I am contributing 5% of my pre-tax income to my 401k through my employer. Moreover, I am making regular contributions to a Roth IRA so as to achieve a total contribution of $5,000 by the end of the year. Please let me know what I should do. I worry about taking on such a large student loan. But also, I worry about the long-term consequences of not regularly contributing enough to my retirement.
Here's some information about me that you may find useful when crafting your reply. I am currently employed and am quite confident that my income ($70,000/year) will remain steady for the remainder of 2009. My savings currently amounts to $25,000 and my credit score is 770. I do not have any debt. Thanks Chris. I love the show and it's really helped me in so many ways. Cheers. Mark, Los Angeles, CA
Answer: Thanks for your note. You're making a big investment in your job and career by getting an MBA. You've done the research, and the rate of return on that investment measured in terms of job options, total compensation and career satisfaction will more than pay for the money you borrow. In a sense, your standard of living in retirement will largely be influenced by how much your investment in an MBA pays off over time.
Price matters, and the less you go into debt to get your MBA the more financial and job flexibility you'll enjoy at graduation. That's why I think your instinct to reduce contributions into retirement savings and, instead, put the money into a bank or credit union savings account, certificate of deposit, or some sort of very safe parking place for money is sound.
Here's another thought: Stop contributions into the 401(k), but continue to fund the Roth-IRA up to the $5,000 limit (and that's how much you are setting aside in total anyway). A Roth is a unique retirement savings vehicle. It's a retirement plan and a parking place for emergency savings. The reason is that by law you can withdraw contributions without any tax bite or early withdrawal penalty. You can't tap the earnings without taking a big hit, however. You leave the earnings alone.
You keep your financial options open by funding the Roth. If you decide the smart strategy is to borrow less you can withdraw your contributions from the Roth and just leave the earnings in the account. If it turns out you're borrowing less than you anticipate, well, you leave the Roth alone and let the money compound over time.
Since a Roth is funded with after-tax dollars will give up some income tax advantages with this tactic.
Credit counseling
Question: I have, unfortunately, managed to rack up about $30,000 in credit card debt. Financially I'm okay and working to pay off the debt and not in danger of bankruptcy or anything right now. I am considering using a credit counseling service to help me negotiate a lower interest rate on some of my cards, and am wondering how it works if you have a balance on a card but close the account? How does it reflect on your credit report? Thank you, Mark, Ashburn, VA
Answer: The answer lies in a world of "sometimes," "maybe" and "not always." Fair Isaac, the 800-pound gorilla of the credit scoring industry, explicitly states that participating in credit counseling doesn't factor into your credit score. That's the right approach. Problem is, there are other credit scoring companies and it could show up elsewhere. Closing a credit card account will usually nick your credit score.
Of course, my reaction is "so what"? The real concern is getting rid of the debt, and congratulations on working so hard to pay off your credit card bill. Your credit report and your credit score will rebound with good debt habits.
One last thing: Be careful when you look for a credit counseling service. It's an area ripe with fraud, malfeasance and fly-by-night operators. The nonprofit affiliates of the National Foundation for Credit Counseling are legitimate. The quality of the service can vary, but it's a good organization and a good place to start. The United Way and a number of churches also offer honest services.
By the way, they may tell you you're doing fine on your own. But it's always good to talk to someone knowledgeable and have them review your situation and go through your options.
Credit freeze
Question: My question involves job applications and my social security number. When I fill out a job application, I need to submit my social security number. If I place a credit freeze with the credit companies, would this still allow an employer to access my credit report to see that I am financially responsible, but also prevent an unscrupulous person from abusing my credit? Jeff, Portage, MI
Answer: A "credit freeze" or "security freeze" lets you block the disclosure of your credit report by the credit bureaus. It's standard practice for anyone that is a victim of identity theft, and more and more consumers are embracing the tactic these day.
You're right, a credit freeze can be an issue depending on where you live. About a third of the states allow landlords and employers to check out a frozen credit report. That said, even if you live in a state that doesn't permit employers to take a look freezing may be a sensible strategy. It just means you'll have to plan ahead if you're in the market for a new job, apartment, credit card, mortgage, refinancing or other large financial transaction. The thaw typically takes several days. In most cases the thaw fee is in the $10 range for each bureau, and you'll pay another fee to put it back in the freezer.
You can look at the different state rules about credit freezes here. The web sites of state attorney generals also have good information about a credit freeze. In Michigan there is no state credit freeze law so you'll follow the rules established by the three credit reporting bureaus, Equifax, TransUnion and Experian.
Borrow to buy land?
Question: My husband is the primary income, and I work 12 to 15 hours per week from home while I take care of the kids. We have a 5 month emergency fund, and he is saving 10% from his pay for retirement. Our only debt is the mortgage. We would love to build a house one day. The question is ... should we take money from our emergency fund to buy the land? We are nervous about doing this. We also hate to add another debt payment. Additionally, we are not investing other than in his 401k fund. Should we do anything differently? It is very hard because the emergency fund was a long hard process to build. Litsa, Charlotte, NC
Answer: When I read your question my first thought was that you've already answered the question. You don't think now is a good time for you and your family to drain your savings and take on debt to buy land. I would agree. Even though the economic news is less bad these days the economy remains weak with the unemployment rate at 9.4% and home prices still trending lower.
That said, it's terrific that you've managed to set aside a 5-month emergency savings account. That isn't easy to do. I would focus on continuing to add to that savings. It's a strong financial foundation for your household.
You should also have your own retirement savings plan. A SEP-IRA is an easy retirement savings plan to set up for the self-employed. You could also open up a traditional IRA (funded with pretax dollars) or a Roth-IRA (the contributions are with after-tax dollars.) You can learn more about these retirement savings IRA options on the Getting Personal site.
Make minimum credit card payments
Question: I recently gave 2 weeks notice at my job which I recognize is slightly insane in this economy, but I'm confident that it was the right decision. I have enough savings and annual leave to not work at all for at least 6 months, but I'm not expecting that to be the case as I also have some freelance work lined up and on the horizon. Over the last year, I've made a significant dent in my credit card debt. My question is: while I'm unemployed, should I continue to pay over and above the minimum balance as I've been doing or should I pay only the minimum balance until I have a full time job again? I should say that my budget calculations for not working for 6 months were based on paying only the minimum and on not having any freelance work coming in. Thank you, Antoinette, Brooklyn, NY
Answer: No, you are not insane. Far from it. Despite the economic downturn and all the financial problems we're living through you still need to weigh the odds and, when it makes sense, take a risk. It seems to me you've thought through your job change well. You have a plan and you have savings. For now, I'm comfortable with you keeping financial flexibility by making minimum payments for a couple of months.
Here's a small trick I picked up from a new book by Gerri Detweiler, Nancy Castleman and Marc Eisenson, Reduce Debt, Reduce Stress: Real Solutions for Solving Your Credit Crisis. (I know you aren't anywhere near a credit crisis, but I like the tip. I'll write more about the book another time.) It might be a smart financial move for you. It's at least worth considering assuming you don't add to your credit card balance.
The basic idea: You pay the minimum required credit card payment this month. Your minimum payment should go down slightly next month. But you send in last month's required payment and you continue to do that for the next several months. The financial impact is very slight at first, barely noticeable. Yet applying just a little bit of extra money every month eventually gathers momentum. With this technique you won't strain your finances, but when you get your next job it will be that much easier to eliminate the credit card debt.
I hope you find the kind of work you're looking for.
06/09/09 by Chris FarrellMortgage tax deduction
Question: hey guys. someone had written in with a question recently, asking Chris if they should pay cash up front for a Townhouse, or take out a mortgage.
Chris responded that it was a good idea to start with a mortgage, which could be paid off a couple years down the road if the situation was right, giving the buyer some leeway with their finances. however, what he didn't address, and what I was expecting to hear, was a comment about the tax implications of having mortgage (aka, being able to deduct interest payments), versus paying cash upfront. so my question is: is it at all worth it to take out a mortgage in this case for the sole reason of being able to deduct the interest payments? thanks. Thomas, San Mateo, CA
Answer: No, I don't think it makes sense to take out a mortgage because of the interest deduction. What's more, the advantages of the mortgage interest deduction are exaggerated. It's a nice benefit for anyone with a mortgage but it's far from a financial windfall.
For one thing, most couples living outside the most expensive metropolitan areas or the more exclusive neighborhoods around the country can do almost as well taking advantage of the standard deduction. Put somewhat differently, the mortgage interest deduction becomes valuable the higher your income and the more expensive your home. But for most people it isn't that big a deal. For another, the mortgage interest deduction seems to encourage people to buy a bigger home than they need, and I think that's a mistake. Most importantly, the debt needs to be repaid and the interest payments add up over time.
So, the real question doesn't involve the tax deduction. The cash vs. mortgage issue is all about investment opportunity. Does taking out a mortgage let you put the cash into investments that potentially offer a higher rate of return? Is that what you want to do or would you prefer the security of ownership?
My bottom line: Don't let taxes determine your borrowing and investment strategy. It's the underlying economics of your household finances that matter. Only then take taxes into consideration.
06/11/09 by Chris FarrellThe mortgage lock-in
Question: I am a first time homeowner ready to go ahead with the purchase except for the dreaded "lock" of the interest rate. My closing is set for August 10 so I am still at the 60 day lock rate which today at 4 pm is 5.375%. (Of course, if I was closer to my closing AND I had watched the rates after Obama's speech this morning, I could have locked in at 5 and 1/8!!) Am I the only one who is not only confused but resentful at just how much of a crap shoot this is? Who has the time or moxy to watch rates minute by minute? All I know is that for me the difference between 5 and 5 375% is $13,000. A lot of money in my book. Will rates come down before my closing? Is there any truth to the rumor that if unemployment rates are up at the end of the month, rates will be lower? Are there indicators that you can watch for? Or should I just resort to an Ouija board or the Psychic Hot Line? HELP! I am an avid listener and look to you for sage advice! Carol, Jordan, MN
Answer: No one knows where interest rates will be come August 10. You can consult an Ouija board, tea leaves, entrails, a psychic hotline, an economist or Wall Street money maven and the value of their prediction will be pretty much the same--not much. The unemployment rate could be higher at the beginning of next month and interest rates could be lower; then again, rates could be higher; and so on. As the movie mogul Samuel Goldwyn once remarked, "Predictions are very difficult to make--especially about the future."
Here's the thing: The advantages and disadvantages of a mortgage rate lock-in has nothing to do with forecasting interest rates. It's a risk management tool. If you lock in current mortgage rates you eliminate the risk that rates will be higher in the beginning of August. The price you pay for that security or promise is this: If rates go down you don't enjoy the lower rate.
You can't get rid of the uncertainty about interest rates. What you can do is manage the risk. The question for you then becomes which gamble makes the most financial sense. For most of us, it pays to get rid of the financial danger of rising rates before the closing date. That's what I would do. But some people are flush enough and have sufficient financial resources that it's a reasonable not to take the lock-in and bet that rates will be lower in the intervening weeks.
You can learn much more about the costs and benefits of the lock-in at this consumer guide published by HSH here.
Stick with adjustable rate mortgage?
Question: My wife and I have an Adjustable Rate Mortgage on our home with a current interest rate of 6.125%. We recently received two letters from the lender presenting us with two options. The first is to accept an interest rate adjustment which would decrease the rate to 4.125% and lower our mortgage payment by about $300 / month. The second option is to convert the loan over to a fixed rate mortgage with an interest rate of 5.00% for a one time fee of $250. This would decrease our current loan payment by $175.00 / month.
We will also have the option to convert the mortgage next year. My question is should we wait on converting the loan to a fixed rate and take advantage of the 4.125% interest rate for the next 12 months, and convert next year and hope to get a decent fixed interest rate. I know we are taking a gamble on the interest rates a year from now, but having an extra $300 / month for the next to put toward our savings would be pretty nice. Paul, Olive Branch, MS
Answer: Boy, the trade-off between risk and reward would push me to grab a fixed rate mortgage at 5%. That's an attractive rate. The $250 conversion fee is minimal. Once you have locked in the fixed rate it doesn't matter how high rates go in coming years. You're protected. If rates trend lower, you can always refinance. I wouldn't minimize the risk of higher interest rates when it comes time to reset the rate next year.
The savings aren't great with the ARM anyway. If you stick with the ARM you'll have an extra $3,600 for the year. That's a nice piece of change. But if you convert to the fixed rate mortgage you'll still have improved your yearly cash flow by $1,850 ($175 a month in savings minus the $250 fee). And you will have locked in that extra monthly cash cushion. So, for an extra $1,750 (he difference between your savings with the ARM and the fixed rate) you're accepting the risk of a higher rest rate a year from now. There's no guarantee the lender will offer the same deal, either. It doesn't seem worth it to me to stick with the ARM.
Why gamble? Our money lives are difficult enough these days. There is a lot to be said for grabbing for some financial certainty.
by Chris FarrellPay off student loans
Question: My only debt after I sell my house will be a student loan. Here is the info on that loan:
Principal: $13,741.43
Rate: 1.65%
Monthly payment: $123.63
I don't think that there is an early pay off fee. I'll have enough $ from the sale of the house and cashing in other investments to pay it off. Should I? Or should I invest it in something that is uber secure with a higher interest rate? I like the idea of living debt free...aside from house payment. Just want to know my options. Would love your thoughts. Thanks, Austin, Louisville, KY
Answer: It's wonderful to live debt free. Even though the rate on your student loan is extremely low it's still better to be free of a monthly debt obligation. I certainly felt that when I paid off my car loan. It's much easier to build up savings every month when you aren't paying down a loan, too.
Why wouldn't you eliminate the debt? The main reason would be if you're nervous about losing your job. I would park the money into an ultra-safe government-insured savings account if a layoff is in your near future or even if there is a strong possibility that you might get handed a pink slip. Another reason to hesitate might be if you don't have any emergency savings set aside. In that case, you might want to some of the money into savings and the rest into paying a chunk of the loan.
Still, if you're reasonably secure I'd pay off the loan.
Getting debt help
Question: My daughter recently lost her job in Las Vegas, NV, had to vacate an apartment & will be unable to complete the lease. She forfeited her deposit, a month's rent and otherwise fulfilled all terms of the lease. She advised the manager immediately but has since moved to another state to find other employment. She has gotten a notice stating the matter is being turned over to a collection agency to pay the remainder of lease, about $3,500.00. In addition to this, she also has outstanding student loans and the bank representatives have refused to discuss a reasonable payment program, meanwhile the payment amounts are rapidly escalating due to interest.
Where can she go for help to guide her through the process of negotiating rather than allowing the situation to get worse & worse? She simply cannot meet these obligations and is down to bare essentials of living and whatever small amount of help I can provide. Thanks, Claire, Tallahassee, FL
Answer: That's a tough situation. She should steer clear of the outfits that advertise on the radio and cable saying they'll renegotiate your debts for a hefty fee. Too many of these outfits take advantage of people already down on their luck. It's hard to figure which ones are legitimate and which ones aren't.
I'm not sure where your daughter is living right now. But to get started she should go to the website of the National Foundation for Credit Counseling (NFCC). It's the largest national nonprofit credit counseling organization and their website is www.nfcc.org. It's a legitimate organization, and she should set up a consult with an office near where she is living. A number of the NFCC consumer credit counseling services offer credit and bankruptcy advice over the phone and the Internet, too, and she can learn which ones at the website. But I always think it's good to have at least an initial meeting face to face, especially with such a difficult, emotional topic.
If you would like to check out this possibility on your own for your daughter, there is the CCCS of Central Florida and the Florida Gulf Coast in Tallahassee.
Borrow to invest?
Question: My husband and I are both 50+, with two children of college age. Our house is paid off and we are without debt. He wants to take out a mortgage for 1/2 of the appraised value of our home, betting that inflation is inevitable and invest it in higher interest CDs.
Safe bet or stupid investment? Thanks Mary, Towson, MD
Answer: I get variations of this question all the time and my answer is always the same: I don't like it. I wouldn't do it. It's an extremely risky investment strategy. I don't even consider it an investment. It's a speculative bet.
Right now, millions and millions of Americans are envious of your financial situation. You have no debt. You own your house free and clear. You have a great deal of financial security. Why gamble away your security?
If you borrow half the value of your home to invest in CDs you'll have to make those interest and principal payments no matter what. The interest payments on the debt will be higher than what you can earn on a short-term CD at the moment. You'll pay a steep "fee" while you wait to profit from your strategy.
Of course, there is a school of Wall Street thought that believes high and rising inflation lies in our future. A number of economists worry we could suffer through a reprise of the 1970s inflation rates following the extraordinary actions the Federal Reserve has taken to bail out the banking system and avoid a depression. It could happen. It's a real risk. Thing is, it might not happen. Inflation could stay tame.
Instead of borrowing I would buy shelter from the potential inflation storm by investing in safe, high-quality securities that offer a hedge against inflation. Treasury bills, for example, hold their value even during inflationary times because you can reinvest the money at higher interest rates if inflation does stir. The same holds for a mix of savings accounts, short-term CDs, I-bonds and Treasury Inflation Protected Securities.
Best of all, you'll still be debt free and own your home.
Pay off auto loan
Question: I have a car loan that I could afford to pay off. However, is the loan, which has been paid on time for about 2.5 years, helping my credit score? By paying it off, might I lower my credit score in the short term? The long term? Ardimus, Houston, TX
Answer: I don't see any reason to increase the profits of your lender by continuing to pay interest. Why drain your bank account of that money when you could put it elsewhere, say, into savings or entertainment? I'd get rid of the loan. It's a nice feeling to own your car free and clear. We shouldn't let the credit score tail wag the debt dog. It's always financially smart to pay off consumer debts as fast as possible. As for your credit score, it will reflect a history of paying bills on time. That's the key to a decent credit score short-term and long-term.
29% interest rate
Question: I am rec'ing notices that my credit card rates are jumping to 29%. I owe about 35K. I tried to get a consolidation loan to pay them off and reduce my interest. Loan denied. I have no other obligations and work part time 30 hours a week as well as receive a pension of $2500 a month. I called the credit companies and asked for a reduced rate and was told I could pay off my balance and opt out of the cards but no reduction. What can I do short of declaring bankruptcy? John, Rome, NY
Answer: You're carrying a lot of credit card debt. The financial hole is only going to get deeper at a 29% rate of interest. That's a lot of vig. You need a plan.
I'd get help creating that plan. I would do is go online to the website of the National Foundation for Credit Counseling. There are a couple of consumer credit counseling service offices near you. For instance, one is in Utica and another in Syracuse. I would schedule a meeting with a financial counselor to go over your finances and get their recommendation for a budget and a debt repayment plan. Neither office charges a fee for a consultation. There are small fees to pay if you decide to create a repayment plan with one of the services.
That's task number one and, hopefully, by going over your monthly income and monthly expenses they'll see ways of freeing up cash to attack the debt. They can also negotiate on your behalf with the credit card companies. It's a practical step toward getting rid of the debt--and the 29% loan shark rate of interest. Good luck.
07/24/09 by Chris FarrellHome equity line of credit
Question: I have a $50,000 mortgage on my condo and was just approved for a $150,000 equity line of credit (no processing fees). I have no emergency funds and was planning to use the LOC to pay for major dental work (not cosmetic) I have been told I need - cost approx $10,000. I am financially very conservative and very uncomfortable with the idea of a second mortgage on my home - would I be better off canceling the equity LOC (I have 3 days) and charging the dental costs on a credit card? I have an excellent FICO score and don't want to do anything to jeopardize that rating. Thank you! Annel, Norwood, MA
Answer: My strong bias is against borrowing against your home to pay for dental work. It isn't just dental work. My general rule of thumb is that any money borrowed against the equity in a home should go toward improving the value of the place and your enjoyment from living there. I think your financially conservative instincts are spot on.
Here's my overall perspective. It was commonplace during the great real estate bubble for homeowners to take out second mortgages to consolidate their debts, pay for vacations and meet tuition bills. It's cheap money, right? The interest rate on a home equity line of credit is lower than the rate on credit cards. You also get to deduct the interest on your taxes. But treating a home like an ATM backfired when the boom went bust. Fact is, too many people needlessly put their homes at risk. For instance, credit card companies can't go after your home if you miss credit card payments. But a lender can start proceedings on the home if you start skipping equity credit line payments.
Now, to be realistic you're far from needing to worry about financial trouble. After all, the lender is willing to set up a very large line of credit with you so I know that you have a lot of equity wealth. The dental payment is comparatively small. You could handle it easily.
Still, I'd prefer that you pay for it on a credit card and then focus on eliminating that debt as quickly as possible. To me, it's a better strategy and money habit. By the way, no matter what you decide to do your FICO score is fine.
Closing credit card account
Question: I have a high interest credit card--24.9% with Bank of America, with a large balance $12,000. I am closing the account and Bank of America says the interest rate on paying off the balance is 5.5%. Is this ok under the new credit card law signed into affect? Dennis, San Diego, CA
Answer: My guess is that you got an offer of a lower interest rate in return for closing the account. It's common practice these days.
Although many finance experts recommend against closing an account because it will nick your credit score, I often think it's a good move on your part, especially if money is tight. It can be tough to pay off a large balance at a loan shark rate of almost 25%. A 5.5% rate of interest can make a big difference. Just doing a quick calculation, if you paid the minimum payment at 24.9% you would fork out $5,095 in interest payments alone. At 5.5% the interest charge adds up to $774. Hopefully, you can put even more than the minimum toward getting rid of the loan.
The new credit card law that comes into effect in stages basically protects cardholders from unexpected interest rate hikes and significant changes to the terms of the loan. It also bans some bad practices, such a universal default. (A "universal" default policy hidden in the fine print of a credit card agreement meant that if you were late on any payment to any creditor, the rate on your credit card could automatically jump to the default rate of 30%.) I would imagine in the future that so long as credit card issuers give their card holders sufficient, clear notice they should be able to offer a lower rate in return for closing the account.
Credit problems
Question: I think that my daughter is in deep credit card debt. I would like to pay off some of her credit cards. Is that possible to do on my own without alerting her? Martha, Asheboro, NC
Answer: I don't think so. My answer is going to be short because the solution is for the two of you to talk. I don't know the circumstances, but it's probably much easier for me to say than for you to do. But if you want to help her out she needs to know what's going on and the two of you should come up with a plan together. Good luck.
Mortgage and taxes
Question: I always enjoy listening to your comments and hope that you have a moment to settle a discussion a friend and I are having. Is the "benefit" of the itemized tax deduction on one's income tax worth retaining a mortgage if one is able to satisfy that debt? In this case, we are discussion someone who has about fifty thousand dollars on the mortgage and is of retirement age, no children and few other itemized deductions. There is no other debt. Thank you for your thoughts on this matter. Judith, Reading, OH
Answer: Sure, I'd love to weigh in on your discussion. The short answer is that any financial benefit you get from the mortgage deduction is swamped by the cost of paying interest on the loan. My guess is that the value of your mortgage interest deduction is not only minimal, but it's below what you can get by simply taking the standard deduction. (It's worth finding out.)
The main reason not to pay off the mortgage has to do with your personal financial safety net. You don't want to put all your savings into one asset, like a home. But if you have a well-diversified portfolio and adequate savings why not get rid of the mortgage. And that sounds like you or your friend.
Responsible for debt
Question: In 1999 I opened a credit card with my nanny to help her establish credit. I have never used the card so all of the charges on it are hers. Last year in July I was informed by the bank that she was late on a payment. I canceled the card. Since then she had been paying regularly until this past May. She is over 90 days late and it is now in collection. I had her fill out a form to assume financial responsibility for the card. The bank will not allow that because she has been late. Technically it is my responsibility. The total due on the card is around $10,000. What can I do so this doesn't ruin my credit? Vivian, San Mateo, CA
Answer: I know you don't need me to say this at the moment, but for other listeners and readers your experience is why it doesn't pay to co-sign or open a joint account with non-family members--no matter how trustworthy. Life intervenes, and many of us fall behind on our payments for a number of reasons. (Even with family members I urge caution; there are other ways to help them out financially without taking on a legal obligation.)
Fact is, the bank and collection agency has every incentive to enforce your legal responsibility for the payments. You can't get off the financial hook. Still, the good news is that you've closed the account. The potential damage is limited to the $10,000 remaining on it. Now that it's in collection the simplest way to minimize any damage to your credit is to pay it off and then work out a payment plan with your nanny. Of course, this course of action depends on your relationship with your nanny.
Does anyone else have a suggestion?
Refinance, or not
Question: I own a home which I'm in the process of refinancing under the Keeping Homes Affordable program. As part of the refinancing, the mortgage lender wants to subordinate my home equity line of credit (which is through a different lender - my bank) to the mortgage. In order to do this, my bank wants to lower my line of credit from $28,000 to $10,000 and they want to freeze it for the time being.
I'm very uncomfortable with this as it has been serving as my "safety net" to pay for unexpected expenses in the past year, which I know isn't ideal, but things have been challenging economically because I've had to take a 20% pay cut at my job for the past 9 months. In the long run, refinancing will save me thousands of dollars, but it will also extend my mortgage 5 years and could put me in a difficult situation if anything happens in the short term. What should I do? Laura, Minneapolis, MN
Answer: I understand your trepidation. Pay cuts are tough to absorb, especially when it's unclear when you'll get back to par. My bet is that it won't happen anytime soon. Companies are in no hurry to act with an unemployment rate of 10.2% and the broadest measure of underemployment at a record 17.5%.
That said, from what you've told us the refinancing is putting you on the path toward a stronger financial position. I would take the lower line of credit limit. I would focus on reducing your spending--yes, budget--to shore up your savings instead. Of course, it's always easy for me or anyone else to say "budget." It's always hard to make cuts in spending. Nevertheless, It will pay off for you to go over your spending carefully, see where you can nip and tuck, and add to your savings. The sums may not seem like much at first. But save a bit here and a bit there and all of a sudden your talking real money.
By the way, there should be no prepayment penalty with your mortgage. So, when your income and finances take a turn for the better you can always start paying off your mortgage more aggressively.
What do other members of the Getting Personal community think? Send Laura your thoughts and suggestions.
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Chris Farrell Marketplace Money personal finance guru
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