Chapter 4
On the Minus Side
In This Chapter
- Adding up your liabilities
- Mortgages and refinancing
- Dealing with credit card debt
- Getting the best deal on a car loan
- Cutting daily expenses
- Minimizing the financial ouch of divorce
You’ve got your home, your salary, some savings and investments, a couple of vehicles, and the not-so-tangible assets such as your family, friends, and your place within your community.
Sounds like you’re doing just fine.
Of course, life isn’t all assets. Chances are you have some liabilities as well. Hopefully, the numbers you tally up on the minus side of your balance sheet aren’t out of control, and you’re managing nicely.
In this chapter, we’ll take a look at some of the common liabilities most of us deal with, such as mortgages, credit card debt, car payments, and routine living expenses. Some of us have extra expenses we need to take care of such as payments to an ex-spouse or child support.
While bills and payments are parts of life, it’s important to keep them in balance with your assets. If you routinely run up more credit card debt than you can pay off, you’re headed for serious trouble.
Your Mortgage
It’s ironic in a way, that while your home is one of your primary assets, the mortgage on that home factors high on your list of liabilities.
It’s a fact of life that most homeowners need to borrow funds to pay for their homes, and then spend a good chunk of their lives paying the money back, along with a hefty dose of interest.
Mortgage interest, however, has a huge advantage over car loan or credit card interest. As you probably know, the interest you pay on your mortgage is tax deductible. Every April, you get to note on your tax return the amount of mortgage interest you’ve paid that year. Deducting the interest payment can significantly lower the amount of money you’ve got to hand over to Uncle Sam. Financial planners net this figure (interest paid less the tax savings), knowing that being able to deduct mortgage interest lowers the cost of borrowing for the house.
At this point of your life, you may or may not have a mortgage. If you’ve lived in the same house since you got married when you were 24, you very well may have paid off your mortgage by this time. Many of us, though, are still paying—either on our first home, or because we’ve moved to a more expensive home and needed to borrow to cover costs.
If you no longer are paying a mortgage, you’ve hopefully found some other helpful tax deductions. And you can skip over the rest of this section.
Go Figure
A lower interest rate isn’t the only reason people refinance their homes. Many people refinance to accommodate debt consolidation, or to pay for remodeling, college bills, and so forth.
Those who are still struggling with house payments, however, may wonder from time to time whether you’ve got the best type of mortgage you can. Maybe you’ve thought about refinancing your mortgage for a lower interest rate. Some folks refinance every time the interest rate drops even the slightest amount. Others regard refinancing as too much trouble, or not worth the money you have to pay to do it.
Deciding whether it’s worth refinancing your home can be a challenge, for sure. You refinance in order to save money, but how do you know when the interest rates have dropped enough to make it worthwhile? If the drop has been significant, you might be able to refinance into a lower-cost loan, which can put extra dollars in your pocket.
Be aware, however, that just because a loan offers a lower interest rate, does not mean that you’ll save money. To refinance a mortgage or equity loan, you’ll have to pay title insurance; loan fees, such as a broker’s commission and appraisal fee; and points (a fee imposed by the lender that equals a percentage of the loan amount) all over again. These costs can take a big bite out of any savings you’ll realize from reduced interest rates and lower monthly payments.
If you’re thinking of refinancing, you’ll need to find out how much it will cost to do so, and then figure out how long it will take you to recoup those costs. A representative from the lending institution you’re using should be able to help you determine that.
When negotiating a refinancing deal, you’ll have to decide whether you’ll pay the fees up front, or include them in the amount of your loan. There is a type of loan called a no-cost loan, which allows you to waive the up-front costs and have them included in amount of your loan. The interest rate on your loan will increase one-eighth of one percent for every point you opt not to pay at the time you refinance.
If you choose a no-cost loan and pay no points or other loan expenses up front, you can typically expect to pay between half and five eighths of 1 percent higher than you would for the same loan on which you’d paid the expenses up front.
If you plan to stay in the home for more than five years, it’s a good idea to pay as much of the loan costs up front as possible so that you can lock in a lower interest rate. Here’s why.
Let’s say you get a $200,000 loan at 6.7 percent. You pay $5,000 in total loan costs and points. Your friend, however, borrows the same amount of money, but opts to pay no costs up front. His interest rate, as a result, is set at 7.4 percent.
At the end of 10 years, you will have paid about $128,900 in interest, compared to $139,400 for your friend. You’ll have saved $10,000 in interest, from which you’ll need to subtract the $5,000 you paid for fees at the start of the loan. Still, over 10 years you’ve saved $5,000.
Adding It Up
Points are expensive and can be a problem if you have to pay them up front. Equal to one percent of the total amount of the loan, one point on a $100,000 loan is $1,000. Three points are worth $3,000, and so forth.
Another reason you might consider refinancing is to change the length of your mortgage. Many people refinance a 30-year mortgage to get a 15-year mortgage as their financial situation changes.
Or if you have a fixed-rate mortgage, you may be interested in refinancing to get an adjustable-rate loan with a lower interest rate.
Fixed-rate mortgages usually carry higher rates than adjustable-rate loans. They make sense for homeowners who plan on holding a mortgage for a longer term (at least seven years), and who don’t like the rate fluctuations that occur with an adjustable mortgage.
A fixed-rate mortgage is one where the interest rate remains constant over the life of the loan. An adjustable-rate mortgage is one where the rate normally stays the same for a specified amount of time, and then may fluctuate.
Money Morsel
Get all the information you need about mortgages at Mortgage.com. You can find it on the Internet at www.mortgage.com.
When interest rates drop, as they’ve been doing recently, many borrowers rush to dump their adjustable-rate loans for the certainty of fixed-rate mortgages. If you expect to move or refinance over the next five to seven years, however, an adjustable-rate mortgage probably will result in fewer costs.
There also is a type of mortgage known as a two-step, or hybrid adjustable loan. This has a fixed rate during the first three, five, seven, or ten years (depending on your agreement), and then converts to a standard adjustable or fixed mortgage. These loans offer the comfort of a fixed-rate loan during the initial period and have a lower rate than the average 30-year fixed rate.
There are many types of mortgages available, as discussed further in Chapter 13, “Paying for a New Home or Second Home.” If you’re interested in refinancing to get a better rate, a different type of mortgage, or to change the length of your loan, keep the following tips in mind.
- Don’t get a loan with a repayment penalty. This provision typically charges you a fee if you repay more than 20 percent of your loan during the first 5 years.
- Get the lock-in in writing. Some lenders will lock the interest rate on the mortgage for a fee. Some lock-ins allow borrowers to benefit from a drop in interest rates while protecting them from increases.
- Shop around. Compare the fees and terms of at least four lenders. Look at the rates and the total cost of refinancing from each lender.
- Don’t allow every potential lender to run a credit check on you. You can’t blame potential lenders for wanting to be sure that you’re credit worthy, but repeated requests for credit reports can send up red flags at the credit agency and actually lower your credit score. Allow the first lender you contact to run a credit report on the condition that you receive a copy. Provide the report to other lenders as you shop around.
Many mortgage refinancing companies are replacing 30-year loans with 15-year mortgages. A shorter-term mortgage usually offers slightly lower interest rates, which will save a lot of interest over the life of the loan. This means, however, that your monthly payments will be a little higher. Shorter-term loans are a good idea for people who want to pay off their mortgage in time for retirement.
Your credit report is a compilation of information, including your name, Social Security number, date of birth, address from the time you got your first credit card, all places of employment, and how you pay your bills. Your report is stored at a credit agency. You’re entitled to see your credit report and can do so by contacting a credit agency.
Biweekly mortgage payments allow you to make 26 mortgage payments a year, which is equal to 13 monthly payments instead of the usual 12. This is a disciplined approach to paying off your mortgage early. Ask your lender about the possibility of changing a monthly mortgage to a biweekly schedule. There may be a minimal fee, but the extra payment every year will make a difference.
As you can see, there are many factors to think about if you’re considering refinancing your mortgage. It’s a good idea to meet with a representative of a lending company for more information if you’re thinking about changing the terms of your current loan.
Go Figure
The credit card industry experienced a 26 percent annual growth rate over the past 10 years. In addition, the credit card industry’s advertising budget doubled between 1994 and 1998, increasing from $425 million to $870 million.
Credit Card Debt
Much attention has been given lately to America’s obsession with credit cards and spending. A book in 2000 by Dr. Robert D. Manning, a leading expert on the credit card industry, revealed that Americans collectively owe a staggering $600 billion in credit card debt.
Manning’s book, Credit Card Nation: The Consequences of America’s Addiction to Credit, is critical of the credit card industry, which is quick to issue cards to just about anyone, regardless of the person’s financial situation. The book attracted attention from the national media and got many people thinking a bit more carefully about their own relationships with their plastic.
More than 60 million households in the United States are carrying balances on their credit cards. That means they’re not paying off the bills each month and racking up serious interest charges on the money they still owe.
Credit card debt is a big problem in America and a huge liability to many, many people. If you have serious credit card debt, it’s very important to address the problem and figure out a way to reduce or eliminate the debt.
Credit Card Nightmares
Let’s say that you always paid off your credit card bill every month. You get the bill, take out your checkbook, and write a check for the full amount. You don’t even know what the interest rate is, because you never incur any interest.
Suddenly, a series of events wreaks havoc with your financial situation. Your husband loses his job. You need major dental work—and it’s not covered by insurance. Your father gets very ill, and you spend huge amounts of money flying back and forth across the country to spend time with him. You’re depending more and more heavily on your credit cards, and now you’re unable to pay off the balance in full when the bill arrives.
Only after you can no longer pay off your balance do you learn that your interest rate is 17 percent, and you’re paying $28 a month in interest on a $2,000 balance.
Still, you keep using your credit cards to buy what you need, because there just isn’t enough money to pay cash for everything. Your balance keeps getting higher and higher, and although you’re paying a little bit each month, the interest fees keep mounting. Soon you owe thousands and thousands of dollars and have no idea of where the money to pay it back will come from.
This scenario is not at all unusual. Credit card debt has caused nightmares for millions of people, some of whom have been distraught enough over their debt to kill themselves. In addition, the number of American households filing for personal bankruptcy protection each year is on the rise.
So what to do if your credit card debt is out of control? Read on.
Don’t Go There
Don’t think that if you make the minimum payment on each of your credit cards each month, you’re doing well at repaying debt. By paying only the minimum each month, you’re still wracking up big interest fees, especially if you’re carrying a high balance.
Paying Off Your Debt
If you default on your credit card bill—that is, you just stop paying anything for a period of time—your credit card company normally will sell your debt to a collection agency. If this happens, watch out, because the collection agency will add its fees onto your bill. Before you know it, your $3,000 credit card debt has ballooned to $5,000, and you’re in even worse shape than before.
If you’re in trouble with credit card debt, the first thing you should do is get a copy of your credit report from one of the three big, nationwide credit agencies. You can do this online, or by requesting a copy in writing. There’s a charge of about $8.50 for a report, depending on the state in which you live.
Each of these agencies probably has the same information concerning your credit history. They get it from banks, finance companies, credit card suppliers, department stores, mail order companies, and various other places with which you’ve had dealings. Smaller, regional credit bureaus supplement the information.
The big three when it comes to credit agencies are as follows:
- Equifax Credit Services, PO Box 740241, Atlanta, GA 30374; toll-free: 1-800-685-1111; www.equifax.com
- Trans Union, PO Box 2000, Chester, PA 19022; toll-free: 1-800-888-4213; www.transunion.com
- Experian, PO Box 2002, Allen, TX 75013; toll free: 1-888-397-3742; www.experian.com
Once you get a copy of your credit report, examine it carefully for errors, and note when your credit troubles began.
When you fully understand your credit history, try to negotiate a repayment program with all creditors. Some credit card companies and other creditors will work with you to establish a payment schedule that you can meet. Let them know that you acknowledge your debt and will work in good faith to pay it off. Once a payment plan has been established, be sure to stick to it.
Repaying loans on which you’ve defaulted won’t undo a damaged credit history, but it may help you to be able to get credit in the future.
If your credit has been severely damaged and you’re unable to pay back your debt, you should talk to a nonprofit credit advisor. A listing for such as person can be found in the yellow pages of your phone book under credit and debt counseling. A credit advisor may be able to help you consolidate your debt and find a lower-interest loan that you could use to pay off higher-interest credit card debt. Be ready to cut expenses elsewhere until your credit card debt is repaid.
If you’re in trouble with credit card debt, the first thing you should do is cut up all your cards. The last thing you want is to run up more debt. If you really need a card in case of an emergency, give it to someone else to hold for you until it’s necessary—really necessary—to use.
Finding a Better Deal
If you haven’t read over the terms of your credit card agreement lately, take a little time to look at it. What interest rate does your credit card company charge? Ten percent? Twelve? Eighteen? Twenty?
What sort of advantages does your card provide? If you’re not earning any “rewards” from your card, such as flyer miles, you might want to take a look at what’s out there. Many credit cards give you points for every dollar spent, then let you use your points to get free flights, clothing, dinners out, books, CDs, and so forth.
Be careful, though, if you don’t pay off your bill every month. Cards that offer rewards may come with much higher interest rates than standard cards.
If you’re paying an annual fee on your credit card, either look for a card that doesn’t charge the fee, or ask your credit card provider to waive it. There’s intense competition among credit card companies, and many will do whatever’s necessary to keep you on board.
And, watch for late fees on your card. Most providers charge at least $20 if your payment comes in even a day after the due date. If your payment is late once, call and ask to have the fee waived.
Remember that there are hundreds of credit card deals out there, and many, many companies that would love to have your business. Compare the terms of various credit cards, and select one that sounds right for you.
For information and comparisons on many different credit cards, check out CardRatings.com. You can compare interest rates, application procedures, and rewards. It’s on the Internet at www.cardratings.com.
Car Payments
Most of us need to have a car. And, we know that cars are expensive. As a result, many people in their 40s and 50s are still dealing with car payments, which can take a big chunk out of your monthly income.
If you’re still doing car payments, you’ve hopefully negotiated the best deal possible. The following are some tips to keep in mind when looking for an auto loan.
- Don’t finance your vehicle through the dealership. Dealer financing normally costs at least a percentage point or two more than a loan from a bank or credit union.
- Try to get a pre-approved loan from a bank or credit union before you go new car shopping. This puts you in a position of knowing exactly how much money you have and what you’re able to spend. And, the car dealer will know you’re serious about buying and do what he can to get your business.
- Pay as much up front for the car as possible.
- Use rebates to increase your down payment, not to get a more expensive car.
- Take the shortest loan term you can manage. Never pay back a car loan over five years if you can do it in two or three.
- Consider getting a home equity loan to pay for your car. Car loan interest isn’t tax deductible, but the interest on a home equity loan is.
- Pay off the loan early, if possible. Some lenders will penalize you for paying back early, so be sure to look for a deal that doesn’t.
Don’t put yourself in debt for a vehicle that you don’t need. A $45,000 sport utility vehicle might look great in your driveway and make you feel good when you drive it, but a car that costs half that much will still get you where you’re going and cause a lot less damage to your pocketbook.
If you need a new car, you might consider leasing, rather than buying. A third of all new-car customers are leasing today, compared to only 15 percent 5 years ago. More information about leasing a car is included in Chapter 7, “Trading In the Bikes for Cars.”
Expenses, Expenses, Expenses
Groceries; clothing; electric, water, phone, and cable bills; tolls; and gas for the car. Daily expenses add up alarmingly fast and seem to increase continuously. And, if you’re like many people, you’re not even sure where your money goes.
Walk around with $100 in your pocket sometime, and try to account for where you spent it when it’s gone. Chances are you’ll be amazed at how fast the money disappeared, and not all that sure about how you actually spent it. If you’re trying to control or cut back on daily expenses, however, it’s imperative you know exactly where your money is going.
The topic of budgets is covered in Chapter 5, “Getting It All Together,” so we won’t go into too much detail here. Know that in order to control expenses, however, you first must set financial goals. Once you’ve done that, you can determine how much money you have to spend, and then decide where you’ll make cuts, if necessary.
Some expenses are unavoidable. You’ve got to pay your mortgage, meet your car payment if you have one and take care of household expenses such as water and electricity. Keep the following tips in mind, however, for saving dollars on everyday expenses.
- Limit your visits to restaurants. Even the cost of dinner at the local diner adds up if you eat there four nights a week. You really can eat at home for much less than you’ll pay in a restaurant.
- Purchase prepared meals at the grocery store rather than eating in a restaurant. You still won’t have to cook, but the meal will cost less than in a restaurant.
- Use gas cards that give you a discount or a rebate. An Exxon-Mobil card gives you a 3 percent rebate on all gas at Exxon or Mobil stations. The Shell MasterCard takes 5 percent off your gas purchase.
- Don’t use a higher-grade gasoline than your car requires. Check your owner’s manual to verify the lowest grade of octane your car can handle.
- Drop or reduce the comprehensive and collision coverage on an older car. Some insurance experts suggest scaling back as soon as the premiums climb higher than 10 percent of the car’s market value.
- Shop around for your homeowner’s, auto, and liability insurance. The cost of identical policies vary from company to company. Also, raising the deductible on your policies can result in significant savings over time.
- Cut back on cable. How often do you really watch the golf channel? Or TV at all, for that matter? Cable bills are expensive, so if you’re not using all that you’re paying for, consider scaling back.
- Compare alternative utility providers. Consumers in some states are free to choose their own suppliers, and prices vary. Check out www.lowermybills.com to assess your current electric and gas bills and find out if there’s a better deal.
- Comparison shop your phone bills. You can do this at www.ABTolls.com, an alternative rate-comparison site that compares long distance by factoring in all those fees and basic charges to calculate your true rate per minute.
- Get rid of telephone extras such as caller ID. Depending on your rates, you may be able to save at least $10 a month by eliminating services such as caller ID and call waiting.
- Install a programmable thermostat, and go on a budget and/or prepayment plan to lower your monthly heating bills.
- Call your long-distance phone carrier and comparison-shop. Ask a representative to review your current usage and tell you if there’s a better plan available for your needs.
- Use frequent buyer cards if you shop at the same stores all the time. These cards offer discounts after you spend a specified amount of money.
- Bargain shop for major purchases. No one likes going to six stores to comparison shop for a refrigerator, but your savings could be significant.
These are just a few suggestions for saving money on everyday expenses. Just remember that every penny you save can be put aside for more significant costs, such as college, weddings, and retirement.
And Then There’s Your Ex
Divorce can be devastating to your financial situation, there’s no question about it. We spend a good portion of Chapter 19, “Other Changes to Think About,” on the financial implications of divorce, so we won’t go into much detail here.
Know, however, that there are ways to make divorce less financially detrimental for both parties. The catch is that you’ve both got to be willing to cooperate to make it happen.
If you’ve had an ugly divorce, it might be difficult to work with your ex on anything—including your financial situation. If you keep in mind, though, that you may benefit from cooperating, you’ll probably find it easier to do so.
We probably can think of divorce situations that ended in financial hardship for one or both partners. The husband and wife may have fought bitterly throughout the process, hiring lawyers, private investigators, and other professionals without any regard to the cost. Or, perhaps they couldn’t agree on any financial, custody, or property matter, dragging out the proceedings and running up huge bills in the process.
Divorce proceedings can occur in an orderly manner, and much of the need for professionals can be eliminated if both partners are willing to cooperate. If you’re in a divorce situation, it’s important to understand that the cost of legal proceedings can chew up a big chunk of your financial assets.
And once divorced, you could end up paying alimony and child support that will further impact upon your financial situation. Divorce often is inevitable, and we’d never urge you to stay in a bad marriage for the sake of your finances. Resolving to settle a divorce as amicably and cleanly as possible, however, can impact positively on your net worth—and that of your ex.
Once you’ve determined all your assets, along with your liabilities, you can start getting a handle on your net worth. Your net worth, covered in detail in the next chapter, is the indicator of your overall financial situation.
The Least You Need to Know
- You may be able to refinance your mortgage in order to get lower interest rates or other benefits that could lower your costs.
- If credit card debt is a problem, you’ll need to take strong and immediate steps to reduce it.
- Looking around for the best car loan you can find, or considering leasing a car instead of buying, may save you significant dollars.
- Daily expenses can be financial killers, but there are ways to reduce them.
- If you’re willing to cooperate with your ex, you may be able to minimize the financial pain of a divorce.