Free Money Finance

Three Reasons to Love and Hate a 15-Year Mortgage

The following is a guest post from Stephen from The Fire Lane.

Interest rates are rising.

At the end of 2018, it is still a good time to refinance for many. Nobody can predict the future, however, it's easy to visualize 6%+ mortgage rates in a couple of years.

If you are on the fence about a new home purchase, locking in a low rate now could save you thousands of dollars.

Wherever you are in your home ownership journey, there may be a lesson in our recent home purchase and the decision that we made.

Our Story

In the fall of 2016, we took out a $287,500 loan on our new home. My wife and I weighed our loan options. Choosing between a 15-year mortgage at 2.75% or a 30-year mortgage at 3.4%.
Ultimately, we decided on a 15-year fixed loan.

Our mortgage with an interest rate of 2.75% carries a principal and interest payment of $1,951.04 per month. We'll make 180 payments overall.

We've been making payments on this loan for 2 years and have had ample opportunity to reflect on our mortgage decision. There are a few things about our 15-year mortgage that we love and also a few things that we hate.

If you are considering a new mortgage consider these points as you are making the decision between a 15-year and the more standard 30-year mortgage.

What We Hate

1. The payment amount.

In 2018, our take-home income is $9,990 per month and our gross income is approximately $12,500 per month. Housing is a large portion of our spending.

The old-school rule of thumb for mortgages is to not spend more than 28% of your gross monthly income. This rule gives us a cap of $3,500.

With our $1,951.04 mortgage payment, we also consider the $830 we pay each month in property taxes and the $190 per month we spend on property insurance. Our total home payments of $3,000 are just shy of that 28% rule.

Our percentage is 24%.

A 30-year mortgage financed at 3.4% would have cost us $675 less each month. These savings would provide a much easier to budget 18.5% mortgage spending.

2. A 15-year mortgage is not flexible.

A job loss, a disability, loss-of-work, a death. All of these things would quickly affect income if they were to take place.

The payment on a mortgage is not flexible. The 15-year decision cannot be undone easily or quickly. It can also be tough to tap into home equity if you need it for an emergency.

For those with uncertain jobs, a shorter duration mortgage may be more desirable. You will lose some advantages to the shorter mortgage but gain the flexibility you need to keep you off the ropes in the event of an emergency.

Our jobs are relatively stable. Instead, we rely upon an emergency fund that can cover our home expenses if needed for a few months.

3. We could be achieving similar results with a 30-year mortgage we make extra payments on.

A 30-year mortgage at 3.4% would cost $675 less per month than the $1,950 we pay for our 15-year mortgage at 2.75%.

If instead, we had taken out the 30-year we could have sped up the mortgage. To do this we would have applied the $675 savings each month towards principal. Most mortgage lenders make this extremely easy to do through online payment portals. The process can be automated in most cases.

Tip: Related to the above comment on flexibility; This method will quickly allow you to reduce your monthly payment by hundreds of dollars in the event of a job loss or similar. If you need the income, just stop making the additional payment.

Making this extra payment each month reduces the mortgage payoff time to 16 years!

You'll pay the same total payment amount as the 15-year mortgage but the increased flexibility will cost you more interest which slightly increases the payoff time.

What We Love

We certainly don't hate our 15-year mortgage. These are the things that make us love the loan terms. Ultimately, they are why we decided to finance this way.

The 15-year mortgage has a place in our financial plan.

1. The amount of interest we are paying over the life of the loan.

Total interest that will be paid on my 15-year 2.75% loan will be $63,686.70.

Total interest paid on a 30-year 3.4% loan would be $171,503.08.

That's right. The numbers do a great job of speaking for themselves. A 30-year loan could easily cost 3 times the 15-year in interest fees. Who wants to make a bank rich?

As interest rates go up, which they most certainly will, these interest numbers are going to get larger.

At today's 30-year 4.76% average rate, the loan would cost you $253,029.02 in interest payments. Look at what that extra 1.36% means. How many years of additional work is that?

2. The Forced Savings which comes with a mortgage.

That same lack of flexibility stated above allows us to save in the ultimate forced savings account.

Each month we pay off the principal on our loan. If we assume a level or increasing real estate market we are increasing our equity in the home. Eventually, we should fully own an asset worth over a half million dollars.

Today we are paying $1,365 per month towards principal. That's $16,380 saved each year. But, this savings amount goes up each month as the loan amount is reduced. In 3 years we will be paying the mortgage down $17,800 per year.

On a 30-year mortgage, the amount going towards principal would be $492 per month or $5,900 per year. The 15-year mortgage allows me to save $10,000 more per year.

Tip: This can be a good tool for those that have bad self-control when it comes to tapping savings. Principal in a mortgage is illiquid and difficult to get at. It's tough to spend your home equity on a new motorcycle or other materialistic purchases.

3. We won't have a Mortgage Payment in retirement.

I believe the 30-year mortgage, as it's designed to be paid, is too long a period for anyone to reasonably consider. The average age of most first time homebuyers is 31. A 30-year mortgage has them handcuffed to the payment until the age of 61.

Our 15-year mortgage, taken out at the age of 34 will mature when I am 49.

Not having a mortgage payment allows us the flexibility to do the following:

Retire early. We'll have $2,000 less each month in required spending which reduces retirement expenses massively.

Trade down and pad our nest egg. We could sell the home and downsize to something smaller (and pay cash from proceeds). The difference in value could help add hundreds of thousands to our nest egg immediately.

Sleep better. Loans = Risk. Even if the perceived risk is small it is still there.

Did We Choose Correctly?

The loan decision is very personal. Weigh for yourself the pros and cons before accepting the standard 30-year fixed rate loan. But, do not make the decision solely on the monthly payment.

If our jobs were riskier I would have opted for the larger timeframe loan with increased payments. But for us, the positives of the 15-year mortgage outweighed those of the 30-year.

We chose correctly for our needs.

Average Debt by Age

Here's a list of average debt by age in the U.S.:

Under 35: $67,400
35–44: $133,100
45–54: $134,600
55–64: $108,300
65–74: $66,000
75 and up: $34,500

It includes mortgages, student loans, etc.

I'm thinking it's a lot better than I would have guessed. Maybe the average is lowered by a bunch of people on the low-end with zero debt?

What do you think?

Advanced Payments Made Easy

The following post is from FMF contributor Brad Richardson.

It isn’t always easy to get a loan from a bank or other financial institution when you need it. But sometimes life throws overwhelming circumstances our way and the only way we can try to get by is by having that extra cash because, let’s face it, everything costs money.

Auto loans are often one of the most frequently issues types of loans. When family circumstances change, purchasing a vehicle may be required. And not everyone has the means to come up with funds to buy a car. The same goes for buying a house; many people take out homeowner loans because not everyone can afford down payments. Sometimes emergencies occur and someone becomes hospitalized. Medical bills can skyrocket, and it’s important to at least be able to have peace of mind knowing you can pay them.

Many people fall into debt for these major reasons. And speaking of debt, folks often attempt to correct it with bill consolidation loans. Everybody winds up in some kind of debt at some point in their lives. People experience debt from auto loans, mortgages, credit cards, student loans, monthly bills, or anything else that could set you back too much. U.S. consumers have created a total debt in the billions and trillions of dollars.

There are many reasons why people might take out a loan, but not everyone is easily approved. However, if you need advanced payment now and can’t meet a bank’s criteria or don’t have the time to wait for it to be approved, there are steps you can take. 

How It Works

The way it works is you will be matched up with a lender from the network in a matter of seconds, who will then contact you for additional information. You might have to fax some documents back and forth, at least be able to provide proof of employment, ID proving you are a U.S. citizen 18 or older, and proof of a checking account in your name. You’ll also need a working email address and be able to provide a home and work phone number to reach you at. When the lender approves you, your loan will be transferred to your checking account using the most secure and advanced encryption technology to protect your private data.

What to Do If I Default

The loan and its fees will automatically be withdrawn from your account when it’s due. But be aware that each lender has their own late payment policies, and it also often depends on state laws that determine whether a lender can even provide an extension and what kind of late fees can be incurred. It’s up to you to understand the policies prior to applying and signing your legal obligation for repayment. Defaulting on the loan may incur even more fees, so also be sure to calculate the costs before applying if you think you might have trouble with repayment. Or else you might find yourself in the same hole all over again.

A sudden shortage in money can be due to a variety of reasons. Some things just happen without warning. But you can rest assured you can find the help out there you need. This service is completely free. No cash loans will be provided, but you will have access to one of the 100+ partnered lenders.

How to Come Back from Bankruptcy

The following post is from FMF contributor Jess Holmes.

After spending several years fighting with creditors, you decided to file for bankruptcy. You never thought to find out how long bankruptcy can affect your credit score. And now that your credit score and confidence have taken a hit, you feel hopeless. But don’t fret because there’s a light at the end of the funnel. Keep reading to discover how to start rebuilding your financial life. 

Ways to Recover From Bankruptcy

1. Shift your mindset

If you’re going to pick up the pieces and rebuild, a mindset shift is paramount. It’s normal to feel like a failure. But the goal is to focus on getting to the root of the problem so you can move forward.

2. Create a spending plan 

Once you’re committed to improving your financial situation, create a budget. A few factors to keep in mind:

• Expenses should always be lower than income. If not, trim unnecessary expenses.
• Filing for bankruptcy should have alleviated some of those debt payments.  So, use the extra money to pay off other debts and start saving.
• Always be realistic with your expenses and income or you’re setting yourself up for failure.

3. Build a cushion

Each time you get paid, it’s important to set aside a part of your income into a savings account. As the balance builds, you’ll have an even greater cushion to fall back on if a financial emergency arises. Even better, you won’t have to rely on debt to get by or put yourself at risk of falling back into the same trap that led to the initial bankruptcy.

4. Start rebuilding credit 

Are you thinking that filing for bankruptcy bans you from the credit world for several years? Think again. The easiest way to start rebuilding credit is by using credit responsibly. There are lenders that will give you a second chance without charging a fortune in interest. But it’s usually in the form of a secured credit card or loan product.

Both need a deposit for collateral in the event you default. Start with your financial institution when researching options. They may be more willing to approve you on the strength of your positive account history. But be sure to keep your balances low to derive the greatest benefit.

You could also become an authorized user on some else’s credit card to start rebuilding credit. You’ll benefit from positive account activity without being liable for the debt. 

Lastly, don’t forget to see investigate chexsystems to see if have an account listed. It may have been removed but if it hasn’t, now is the time to take care of it. 

5. Avoid late payments at all costs

Payment history accounts for a whopping 35 percent of your credit score. In fact, one late payment on a credit card or installment account can tank your credit score by up to 100 points. Even worse, the negative mark will remain on your credit report for seven years. So, if you’re serious about rebuilding your credit score post-bankruptcy, you can’t afford to let accounts slip through the cracks.

Instead, use your budget to stay on top of your expenses and due dates. You may also want to take it a step further by automating payments to avoid missing any due dates. And if you know you’re going to be short on funds, call the creditor in advance to set up a payment arrangement.

6. Keep an eye on your credit report 

When was the last time you checked your credit report? The thought of taking a peek may be frightening. But your report could contain material errors that are dragging down your credit score. In fact, one in five credit reports contains errors. So, visit AnnualCreditReport.com to retrieve your free copy and dispute any mistakes. 

If you need additional information or assistance with disputes, the Federal Trade Commission has a handy template for you right over here.

Bonus Tip: Avoid credit repair scams

Recovering from a bankruptcy takes time. You’ll need to work on managing your finances, keeping debt under control and making timely payments. Over time, your efforts will pay off. So, avoid falling for promises made by credit repair companies to remove negative payment history and bankruptcy or you’ll be sorely disappointed hundreds of dollars later. 

Three Ways to Pay Down Debts

The following post is from FMF contributor Brad Richardson.

It always seems like no matter how hard we try, we can’t get ahead of our debts. They are always there, looming in the background, taunting us and reminding us of our spending sins. You know the only way to pay down your debts is to actually just start paying them, right? It’s not rocket science. People would like you to think it is, because if it wasn’t hard, we’d all be debt free. The truth is that paying down your debts, while it can take a while, is not impossible. Here are three ways to help you pay down your debts.

Step One: Identify how much debt you actually have.

This sounds simple, but a lot of people don’t actually know the total amounts they owe on their debts. And you would be surprised at the number of people who don’t consider certain types of debts, like a vehicle loan, to be actual debt. Sorry friend, it is actual debt. So start by determining how much debt you have. Include all of it in your list. Then determine how much interest you are paying on each debt. Again, consumers often don’t know the percentage rates of how much they are paying in interest. You need to know this to build your repayment plan, so put the work in ahead of time.

Step Two: Go through your newly formed list of debts and interest rates and number them in order of highest interest rate.

Regardless of how much you owe, your interest rates are what kill your repayment plan. You will start with the highest interest rate first. So how much do you owe on your highest interest rate debt? $5000? $10,000? $100,000? Whatever it is, start with that. Even if other amounts are higher, if they have less interest, forget them for now. Figure out how much you can afford to throw at that high interest debt. Then figure out how long it will take you to pay that debt off. Frankly, you might need to get another job to help you tackle the debt. Be prepared to have to work hard to get rid of the debt, and you will be able to do it. Once you know how long it will take you to pay off the first high interest debt, figure out the second. Then move to the third, and so on. Realistically, it could take you 10 years to pay off your debts. But if you plan it right, you can do it so that you don’t continue to accumulate more debt while trying to pay off old debt.

If you aren’t sure how to proceed, you can seek the help of a professional debt solution manager. Doyle Salewski is a professional debt solutions company that can help you figure out the best way to tackle your debt. Don’t be afraid to reach out to someone who knows more about you than debt. If you knew everything there was to know about debt, you wouldn't be in this position in the first place. Put your pride aside and ask for help.

Step Three: Save.

It may seem counter-intuitive to save money when you could be paying down debts with that money, but it is important to always consider your future. Even when you are dealing with your past. What if you lost your job? What if you suddenly made less money? Even if it’s $20 a month, put it away for safekeeping. And don’t spend it. It’s for your future. You can’t keep spinning your wheels in a cycle of debt and repayment, and saving a little money on the side can help you get out of that cycle. For instance, when your credit cards are paid off, you might want to stop living on them. You’ll need cash to overcome that hurdle. The money you saved while you were paying down your debts can help you do that. Looking ahead to your future can be a great way to help you deal with the stresses of paying down debts. Commit and start paying down your debts today. You won’t regret it.

Five Debts to Tackle Before You Retire

Bankrate lists the five debts to tackle before you retire as follows:

• Mortgage debt
• Credit card debt
• Student loan debt
• Auto loans
• Medical debt

This is a weak article IMO. Instead it needs to be titled "The Five Debts You Must Eliminate Early if You Ever Want to Retire."

Most, if not all, of these debts need to be long gone well before you retire. If they aren't, guess what? You're not going to retire.

Here's what I recommend:

• Get out of all your debt as soon as you can because debt costs a fortune and will hold you back from retiring.
• You should never have credit card debt in the first place, so I don't know why this is even on the list. Use credit cards to MAKE yourself some money, not cost you money.
• Other than at the start of your career, you should never have auto loans. Maybe for your first car or two, but after that save the money in advance and pay cash. No car debt past 35 for sure!
• Student loans can take longer to pay off, but certainly not 30 years! Especially if you plan in advance and get the most out of college for the least cost.
• The mortgage is the big one, but should still be eliminated well before retirement. How can you do this? Buy a house you can afford and do everything you can to pay it off in ten years.

Here's the bottom line: if you don't pay these debts off early in your life, they will KEEP you from retiring. The longer you hang on to them, the longer it will be before you retire.

How to Consolidate Student Loans

This post is from FMF contributor Antonio Williams.

Getting a degree is more expensive than ever. Many college and graduate students are required to take out student loans in order to finance their education. The average debt per borrower for undergraduate students rose to new heights in 2016, and the record gets broken every year. For graduate students, the number was even higher, at $57,600. Many borrowers have multiple loans, leaving them struggling to pay several bills each month on top of their other financial obligations.

For many graduates, there are plenty of things they can do to help themselves. Loan consolidation or refinancing may be an option to combine many loans into a single loan. For private student loans, it may also be a way to obtain a lower interest rate or convert a variable interest rate loan to a fixed interest rate student loan. For federal student loans, consolidation can be a tool to help you stay on top of your student loan payments.

There are two different types of consolidation: federal and private. Federal student loan consolidation involves a specific process through the United States Department of Education where multiple federal student loans are combined into a single federal student loan. It can only be used for federal student loans — not private loans — and typically will not result in a new, lower interest rate. Instead, the interest rate for a federal loan consolidation is based on a weighted average of the old loans’ interest rates.

The primary benefit of federal student loan consolidation is that it results in a single monthly payment. In addition, borrowers may be able to extend the repayment of their loans, lowering their monthly payment. They may also be able to switch to an alternative repayment schedule or move from a variable interest rate loan to a fixed rate loan. However, changing the length of a loan repayment schedule will result in paying more over the life of the loan. For example, by extending the payment term from 20 to 30 years, a borrower could pay thousands of dollars more in interest even with the lower monthly payment. Consolidating federal loans may result in losing certain borrower protections that only apply to specific federal loans, such as interest rate discounts or loan cancellation benefits. Carefully consider the advantages and disadvantages of federal loan consolidation before deciding to consolidate. You may be eligible for deferment or forbearance if you are struggling to make your payments. This may be a better option for some borrowers than consolidating your federal student loans.

If you do decide to consolidate your federal student loans, go directly to the Department of Education’s website. Never respond to pop-up ads, letters, or email solicitations about consolidations; it is free through the government, and you should never be charged a fee. Once you are on the site, simply log in with the identification that you created to apply for your student loans. Then complete the application form, choose a repayment plan, using the repayment estimator to see how much you will pay each month. You can then choose your new loan servicer from the list of available options. You will then receive a statement from this new servicer, and will make your payments directly to this company.

Private loan consolidation is also known as student loan refinancing. This process involves applying for a new student loan, which is then used to pay off your existing student loans. Private loan consolidation can be used for both private and federal student loans, or just private student loans. The main benefit of private student loan consolidation is to obtain a lower interest rate, usually based on a better credit score, a higher income, a history of on-time payments, or other factors. Private loan consolidation may also be used to switch a variable rate loan to a fixed interest rate loan.

Refinancing or consolidating private loans often saves borrowers money through lower interest rates, or by going from a variable interest rate to a fixed interest rate. A refinanced private loan involves an entirely new interest loan based on the borrower’s application and creditworthiness. This generally means a lower monthly payment. Typically, repayment terms for a private loan consolidation are shorter, from five to twenty years, which means that private loan consolidations allow borrowers to pay off their debt more quickly. However, if borrowers consolidate both private and federal student loans together, they will lose the benefits of federal student loans, such as income-based repayment options, deferral, loan forgiveness and more. If you are considering refinancing your private student loans, think twice before consolidating your federal student loans with your private student loans.

If you decide to refinance your private student loans, you should begin by examining your student loan servicing documents to determine if it makes financial sense to consolidate your loans. You can obtain this information directly from your lenders by requesting a free copy of your credit report from one of the three major credit reporting agencies. These documents will list your outstanding student loans, including the companies that hold them. Once you have these documents, you can then use online calculators to determine if you will save money by refinancing your student loans. Online sites such as LendEDU will then allow you to compare a number of lenders based on their interest rates, terms, rank and other factors so that you can make the best possible decision about which lender to choose for your student loan refinance.

Apply for a private student loan consolidation directly with a lender; as with federal student loan consolidation, it typically will not cost you any money. Your eligibility for refinancing will be based on your creditworthiness and oftentimes your projected income. Generally, your credit score must be at least in the mid-600’s to qualify for refinancing. The higher your credit score and other indicia of creditworthiness, the lower your interest rate will be. According to Investopedia, there are five major factors that determine our credit score.

Whether you are consolidating private or federal student loans, consolidating your debt can help you organize your finances and may save you a significant amount of money on your student loans. Carefully consider all aspects of consolidation before you make the decision to make sure that you are making the best choice for your finances!

The Big Financial Advantages of a 15-Year Mortgage

Here's an interesting piece from Money magazine that reminds us of the advantages of a 15-year mortgage over a 30-year mortgage -- namely, the cost.

They list four reasons a 15-year mortgage is better but the main reason is point #1 -- it saves a TON of money!

Key quote:

Taking out a 15-year mortgage dramatically cuts your home-loan repayment time. The faster you repay the loan, the less in interest you need to pay. This can save you tens of thousands of dollars over the (shorter) life of your loan. A 15-year mortgage also usually offers better interest rates than other loan products.

Exactly how much money?

I went to Google, typed in "mortgage calculator" and they had an easy on-page calculator that covered the basics.

I then searched for current mortgage interest rates and got to Bankrate's list of mortgage rates. 

So let's assume:

• $300k home
• 20% down, so the buyer is borrowing $240k
• Two loan options: 15-year fixed (2.87% interest) and 30-year fixed (3.56% interest)

The results:

• 15-year mortgage has a monthly payment of $1,642 with total cost of $295,638
• 30-year mortgage has a monthly payment of $1,086 with total cost of $390,874

In other words, you'd save $100k by using a 15-year mortgage versus a 30-year one.

But someone might object that they can't afford the house they want with a $1,642 per month payment.

That's correct -- they can't afford it. They should instead be looking at something they can afford.

There's a tried and true method for buying a house and paying off the mortgage in 10 years. One way to implement this is to get a house you can afford with a 15-year mortgage, put in extra payments, and have it done in a decade.

You'll save yourself $100k which you can then invest over the next 15 years (versus the 30-year mortgage people). This $6,667 per year invested at 8% is equal to $181k! So by choosing a 15-year mortgage over a 30-year mortgage, you're saving yourself/earning almost $200k!

Furthermore, if you let that $181k ride for the next 15 years at 8% it's worth $574k when you retire (if you're wondering, this assumes you buy the house at 25, pay it off at 40, save/invest the $181k by 55, and keep it invested until age 70).

So it seems to me that the 15-year mortgage is a clear winner. Thoughts?

Seven Steps to Get Out of Debt

Let's face facts, many Americans are deep in debt.

The general attitude of American consumers has long been "I want it and I want it now." Unfortunately, this line of thinking often doesn't line up with a person's level of income. And so they have to borrow to get what they want when they want it. Then in no time they are up to their eyeballs in debt and in deep trouble financially.

The recent economic issues have put this situation on hold for a bit, but don't be mistaken -- it's only hidden, not dead. This isn't like the depression where it was so bad that people changed their ways of managing money forever. No, I think that Americans will return to their borrowing ways at the first sign of recovery. I could be wrong, but I don't think so.

I have seen the impact of debt firsthand. My wife and I used to counsel couples in debt and were appalled at how much money people can borrow for so many (usually worthless) things.

Anyway, since being in debt is such a big issue for so many people, I thought I'd offer some suggestions. Here are my bullet-pointed steps/thoughts for getting out of debt:

Step 1: Stop digging the hole.

If you want to get out of debt, you have to stop accumulating any more debt.

Do what it takes to make this happen – cut up your credit cards, freeze them in ice, make credit card cookies, whatever.

You have to stop the hemorrhaging before you can begin to work on the debt.

Step 2: Develop a budget.

John Maxwell says, “A budget is telling your money where to go instead of wondering where it went.”

With a budget, you know where your money is coming from, where it’s going, and you have the ability to control it.

Put together a budget based on what you have been making and spending.

You can get a simple budget form from Crown Financial Ministries.

Step 3: Look for ways to improve your cash flow.

If you want to improve your cash flow, there are only two ways to do it – earn more and spend less. So work to create a big gap between what you make and what you spend – the bigger, the better.

Have a trusted, successful friend to look over your budget. He or she can suggest ways you can make more and spend less.

Then you’ll likely need to make some hard choices. I say “likely” because the toughness of the choices will depend on the amount of debt you have as well as the size of your income/expenses gap.

If you currently have a lot of debt and not much gap, it will be difficult. You may need to cut your cable TV, take vacations around home, etc. You’ll probably have to give up many things you like. You may even need to sell some things. Getting into debt is fun – getting out of debt, not so much. But the freedom is worth it.

Step 4: Get a basic emergency fund.

As you create your income/expenses gap, save $1,000 so you don’t have to borrow again when emergencies pop up. And they will pop up. Washing machines break, cars need repairs, kids need braces, and so on. It’s a fact of life.

Here’s one idea: use your tax refund to get started. TurboTax says the average refund is $2,869. That will get your emergency fund established and still leave extra for debt repayment.

Step 5: Begin the debt snowball.

Make a list of your debts in order, from the smallest balance to the largest.

Include the amounts owed, the dates due, and the minimum or required payments

Don’t be concerned with interest rates, unless two debts have a similar payoff balance. In that case, list the one with the higher interest rate first.

Pay minimum payments on all of your debts except for the smallest one. Then, you need to attack that one with what Dave Ramsey calls “gazelle intensity!” In short, this is the intensity a gazelle has when he’s being chased by a cheetah – he’s focused, he’s determined, and he’ll use all his might and wits to succeed.

In short, every extra dollar you can get your hands on should be thrown at that smallest debt until it is gone.

It’s worth noting that the math seems to lean more toward paying the highest interest debts first. However most people in debt need some quick wins in order to stay pumped enough to get out of debt completely. Once they start knocking off the easier debts, they start to see results and have the motivation to keep going.

Once the first debt is paid off, attack the second one. Every time you pay a debt off, you add its old minimum payment to your next debt payments.

Just as the snowball swallows up more snow as it rolls, your debt will get swallowed up in a financial avalanche.

Step 6: Make the income to expense gap bigger.

Keep working at increasing income and decreasing expenses.

Consider selling some of your stuff to get some bigger wins.

Take the funds freed up and put them against your debt.   

With focused effort, you can work down your debt rather quickly.

Step 7: Max out your emergency fund.

Once credit card and consumer debts are paid, start saving six months worth of living expenses.

This is a fully funded emergency fund and should help you survive all but the worst financial emergencies.

Best of all, it will keep you out of debt in the future.

That’s it! Those are the seven steps to get anyone out of debt. Apply them and you'll ultimately be able to enjoy freeeeeeeeedoooommmmmmmmm from debt!

A Co-Signing Horror Story

For those of you new to Free Money Finance, I post on The Bible and Money every Sunday. Here's why.

After posting a couple times recently on what the Bible says about co-signing loans (see Free Yourself from the Debts of Another and Do Not Co-Sign for reference), I found this piece from MSNBC. It details the story of Sibylla Nash whose credit score plunged 200 points and she became responsible for thousands of dollars of debt because she co-signed a friend's loan.

Here's a summary of what happened to her:

• A close friend wanted to buy a home -- they had been friends for 20 years (like sisters).


• At the 11th hour, the bank told the friend that she needed a co-signer in order to close on the property (note: this should have been the hint that told Sibylla that her friend was not a worthwhile credit risk). Mistake #1.


• Sibylla either volunteered or was asked to co-sign -- she can't remember which.


• Sibylla "didn’t fully investigate exactly what would happen if she missed a payment because I assumed it wouldn’t be an issue." Mistakes #2 (not fully investigating) and #3 (assumed it wouldn't be an issue).


• Sibylla told her friend she "didn’t want to be on the loan for more than a year." They had a plan that the friend would refinance the home on her own after a year of payments.


• Even before the default, Sibylla found out that co-signing increased her debt-to-income ratio, which was a problem since she was moving (and wanted to buy a house).


• Then the housing market crashed and banks quit offering easy money. The friend was unable to refinance.


• Then this happened: "It wasn’t until the fall of 2009, when I was thinking about getting satellite television, that I checked my credit report and discovered $10,000 in past due payments. My friend had missed not one, not two, but three mortgage payments!"


• It goes on: "My credit score plummeted from 800+ to the low 600s after she defaulted on her mortgage. Several credit card companies dropped me, while others lowered my credit limit to the balance due. I was embarrassed and ashamed about the multitude of letters I received from my creditors telling me they were cutting off my line of credit. Basically, I was left with no credit, no access to more credit and a horrible credit score. I was devastated, all because of my own mistakes." Mistake #4 -- she didn't monitor her credit. As such, she didn't find out about the mess until the third missed payment (when she went to sign up for TV.)


• There were no extenuating circumstances (like loss of a job, health problems, etc.) that led the friend to default.


• While this was all going on, the friend acted as if nothing was wrong -- things were normal. When Sibylla found out about the issue, it ended up destroying their friendship. Today they barely speak.


• It looks like the house will short-sell and she will be on the hook for $30,000 to $55,000 in debt once it's sold.

Here's her advice on co-signing:

I wouldn’t recommend co-signing on a stick of gum for anyone after going through this. It is more trouble than it’s worth. If the friendship has to end because your friend insists that you co-sign, at least you still have your credit.

Sibylla says not to co-sign.

I say not to co-sign.

The Bible says not to co-sign.

So co-sign at your own risk. You have been warned.

Many readers have commented here and offered various reasons why/situations when a person should co-sign. My thoughts:

• You need to realize that co-signing will make the debt yours as much as it is the debt of the other person's. It will impact your credit immediately.


• You have to be ready to act as if it's all yours if the friend/relative doesn't pay it back. In other words, you have to pay it back.


• You have to monitor the situation to make sure all loans are paid on time -- or else you will suffer.


• Obviously the higher the amount you sign for the worse the situation could be. A car is one thing, college is another, and a house is another.


• Options to co-signing: give the money to the friend, loan the money to the friend (I don't like this option but it's better than co-signing), or help the friend save up to pay in cash.

This is my last co-signing post for a while. Co-sign at your own risk. You have been warned.

Securing Your Credit

The following is a guest post from Marotta Wealth Management.

If you plan on applying for a new job or applying for a credit card, car or home loan, you may want to check your credit report first. A U.S. Public Interest Research Group report in 2004 found that one in four credit reports have serious errors that could significantly lower your chances of being approved.

Employers and potential creditors look at your credit report as an indication of your character and creditworthiness for short- and long-term loans such as a credit card, car loan or home loan. Even if you think you have good credit, begin the new year by checking the facts on your credit report anyway. Your credit report will outline your full credit history. And it can help you verify you have not been the victim of identity theft.

Establishing good credit or bad credit takes time, as does fixing errors that appear on your report. Discovering these problems while sitting in your bank's loan office is no way to win.

An amendment to the Fair Credit Reporting Act and the Fair and Accurate Transfers Act (FACT) now requires each of the three consumer reporting agencies to provide you with a free copy of your credit report annually. To get a complete look at your credit report card, you'll need to request a copy from each one: Equifax, TransUnion and Experian.

What is in my credit report?

Your credit report includes both personal and credit repayment history. Included in the personal information section is your name, address, Social Security number, current and previous addresses, and employment history. I recently checked my credit history and discovered that one of the digits of my Social Security number had been incorrectly entered on an account. It was listed as an SSN alias in the report.

The body of your report outlines your current lines of credit, your payment history and any potentially negative items such as companies that have denied your requests for credit. It also lists companies that have requested your credit history and any companies you have authorized to view your credit for business or insurance purposes. Review this information for accuracy.

How can I check my credit report for free?

To request your free credit reports, visit the central source for credit reporting at www.annualcreditreport.com. From that site, you can view a copy of your credit report from one or all of the bureaus. Or call toll-free at 1-877-FACT-ACT to request your free annual disclosure from the agencies. Your report will be mailed to you within 15 days.

For verification purposes, you will be asked a series of security questions. In my case, I was asked how much my mortgage payment was each month, what county I live in and the make and model of my car.

Beware of bogus credit companies claiming to offer free credit reports. Entering the wrong web address may land you at a bogus site claiming so-called free credit reports. These may be a trap to garner your personal information. Remember, there are only three official credit reporting agencies.

Each of the credit bureaus will try to sell you a detailed report. Some offer credit reporting packages for as little as $5.95 or as much as $68.70. You do not need to purchase these products. Proceed carefully on the websites, and click only on the free credit report offer.
How can I check my credit report regularly?

To get the maximum benefit, stagger when you check your free reports throughout the year. Your spouse is also entitled to free credit reports. By alternating with your spouse, you can check your shared credit every two months.

• January: You request a report from TransUnion
• March: Your spouse requests report from Equifax
• May: You request a report from Experian
• July: Your spouse requests a report from TransUnion
• September: You request a report from Equifax
• November: Your spouse requests a report from Experian

You can add a fraud alert message to your credit report to help protect your credit information. Fraud alert messages notify potential credit grantors to verify your identification before extending credit in your name in case someone is using your information without your consent. Review a copy of your personal credit report. If you believe that information in your credit report is inaccurate due to identity theft or fraud, contact the bureau at the phone number on your report for assistance from a representative specially trained in consumer credit fraud.

What should I do if I suspect someone has applied for something in my name?

Identity theft hits about 7% of households each year. If you receive any notice that someone has applied for something and you did not originate the application, you may be victim of an attempted identity theft.

The first step is to call the credit reporting companies and add a fraud alert to your credit information. Start by calling Equifax at 1-800-203-7843. Follow the prompts to have a fraud alert added to your credit information. If you are married, call separately for your spouse. They will ask you for your Social Security number, and they will offer to sell you credit monitoring services. Putting a fraud alert on is what's important.

A fraud alert notifies potential credit grantors to verify your identification before extending credit in your name. This helps prevent your personal information being misused for the next 90 days. When you place a fraud alert with one credit bureau, they will notify the other two bureaus. For the next two years, your name will be removed from all preapproved credit and insurance offers.

At the end of 90 days, you can reactivate the fraud alert for an additional 90 days. If you can provide proof you have been the victim of fraud, you can put an extended fraud alert that will last for seven years.

Is there a way I can lock down my credit completely?

You can place a complete credit security freeze on your credit record. A credit freeze does everything a fraud alert does and more. First, it is permanent, not just for 90 days. Second, it prevents lenders from accessing your credit report entirely unless you specifically grant them access. This strategy prevents identity thieves from getting new credit in your name even if they have every bit of your personal information.

In some states, each credit bureau is allowed to charge a onetime $10 fee. If you have already been the victim of identity theft, the charge is waived. And some states do not allow agencies to charge for placing a security freeze. We recommend a credit freeze for people who have already established the credit they need. A freeze both reduces the frenzied marketing of additional credit opportunities and the potential harm of compromised personal information.

After a few minutes of effort and $30 in payments, your credit should be locked for life. Couples should lock down the credit file of each spouse. Here is how to accomplish securing your credit at each bureau:

• At Experian (888-397-3742), go here
• At TransUnion (888-909-8872), go here
• At Equifax (1-888-766-0008), go here

The process is not standardized across the three credit bureaus. Each uses a different method. But with a little effort, your credit will be safe and secure.

Can I lift the credit freeze later if necessary?

Each bureau will give you a personal identification number (PIN). They are likely to be all different. Don't lose these. Trying to get a security freeze lifted when you have forgotten the PIN necessary to change your credit security is a catch-22 you don't want to experience.

If you do apply for additional credit, you will have to remove the freeze temporarily.

If you plan on applying for additional credit cards or getting a new cell phone provider or cable package, a credit freeze may not be advisable. And those promotions linked to new credit card applications will no longer flood your mailbox. But these deals are never a way to build real wealth anyway. Get the few credit cards you need, and don't let any promotional offers suck you in.

Reader Story of Paying Down Debt

Here's a story a reader emailed me recently that he wanted to share with FMF readers:

We bought our house in 2000 for $217k, putting down $90k from the profit we made on our other house and taking out a $127k 30-year mortgage. I paid some additional principle on but nothing too much.  If the mortgage payment was $1235 I would add either an additional $65 or $165 to make it a nice round number. Some months I just did not do it. After 4 years (with a balance of $115k) I had the opportunity to refinance at a lower rate for the same amount of mortgage payment but for a 15-year mortgage. Since I knew I would be paying more toward the principle each month, this encouraged me to pay down the principle even more. This was 2004, and all the pundits and gurus of Wall Street were saying don’t pay down the mortgage but invest that money in the stock market. Umm yeah.

Well I kind of did both for a while until I came across FMF. Finally someone who said it was OK to pay off your mortgage ASAP. So this encouraged me and I upped the mortgage payment by to around $1500 to $1750. This allowed an extra $250 to $500 more per month applied to the principle. I remember for a while I tried to be in the area of adding to the principle mortgage payment what was being applied from a normal mortgage payment.  

When things were getting shaky in 2006 the financial market with the sub-prime debacle I said let's pay even more toward the principle so now I was up to $2000 to $2500 but also up my cash reserves. I was still investing money to save for my kids’ college education but I did not trust the stock market as much. Then in 2007 all heck broke loose and that is when I said I am still going to keep up the pace of trying to pay off the mortgage or even a little more and also cash.

In the year 2010 I needed to do my first FAFSA for financial aid for my son. They ask you to list all assets that could be used for college. Well having a 529 plan, stocks, mutual funds and CD’s, our Expected Family Contribution (EFC) was twice the amount that it would actually cost to send him there. This would mean that there would be no subsidized loans or grants or anything. That was OK but the kid had some money (but not enough to send himself to college.) It was because of the assets that I had. This is when I realized that these assets that I have are actually a hindrance to him getting any financial aid other than an unsubsidized loan at 8% interest which would start charging the day you sign the loan. Ugh! So I took some of these assets that the FAFSA said I could tap for college and started to be even more aggressive in paying down the mortgage. Even with taking some of these assets to pay down the mortgage VERY aggressively our EFC is only $4k less than last year.

This April first I will have paid off my 15 year mortgage in 7 years 9 months. Now I will be now able to save that money that was going toward a mortgage payment and continue to applying it to our Roth IRA's and college savings. In another year our other son will be starting college and having the mortgage paid off is a nice relief having the mortgage gone. Depending on where our sons want to go to college they will not be strapped with a boatload of debt when they get out.

A few comments:

• Notice how he paid down his mortgage AND continued saving/investing? I did that too. If you have a large enough gap and buy a house you can afford, you don't have to sacrifice saving when paying down a mortgage.


• Yep, I'm going to get killed on the FAFSA too. I know my kids won't be getting any aid (other than potentially academic) since our asset levels are high. Good thing we have the money saved for them.


• Congratulations!!!! It's great to be debt free, isn't it? ;-)

How to Pay for Your First House in Cash

Here's a piece from Fox Business that details how one couple purchased their first home with cash. I've selected the key nuggets of what helped them accomplish such an awesome feat and have highlighted them below:

We crunched a bunch of numbers and realized that, if we continued to live simply and frugally and worked hard to bring in extra money through side jobs, we could save enough over the course of five years to pay cash for a starter home.

We knew that we could buy a decent starter home in the area where we were planning to move for around $100,000 to $110,000, so we divided $100,000 by 60 (since there are sixty months in five years) and set a goal to save $1700 every month. Because we didn't have any debt or school loans, and because we lived simply and frugally, we were able to live on significantly less than we were making, thus freeing up a good chunk of money to put towards our house savings each month.

We used coupons, ate a lot of meatless meals, shopped at thrift stores, cooked from scratch, brown bagged it, continued to use our old and worn-down furniture, didn't replace anything that wasn't an absolute necessity, limited our going out to eat, only had one car, stayed home a lot, used gift cards from Swagbucks to buy any non-necessities, bought eye glasses from Zenni optical, learned to be content with what we had, and continued to live on a strict written budget.

Meanwhile, we also looked for ways to increase our income.

As our house savings fund increased, we began to get so excited that we kind of went overboard and worked long, long hours in order to meet our savings goal even faster. I wouldn't recommend putting in such long hours, missing so many social events, or sleeping so little, but the effort paid off because, at the end of two and a half years, we paid 100% down on our first home!

So let's summarize the keys here:

1. They spent less than they earned from the get-go.

2. From here, they tried to cut/limit spending as well as increase income, making their gap as large as possible. A key part of this was that they didn't have any school or other loans to hold them back.

3. They bought a house they could afford. Note that they didn't start out with a $500k house -- they bought a much more reasonably-priced one. This is a key step in my formula for buying a house you can pay off in 7-10 years. 

As most of you know, we paid off our mortgage early as well (just about 15 years ago now). We didn't wait to buy the home until we had all cash, but the methods we used were similar to those the couple above employed. We watched spending, grew income, and put almost every extra penny we had into getting out of debt.

We didn't get as crazy as they did at the end, but I do admit we moved our saving up several notches as we got closer to the goal. Somehow being close enough to see the end in sight motivated us more and more to get the mortgage paid off NOW!

The piece ends with the following:

Not having a mortgage payment has freed us to continue to save aggressively toward other goals, increase our spending in areas that really matter to us, and give generously to needs in our community and around the world.

We've found this to be true in our lives as well. Once you are completely debt free you are really FREE. You can substantially increase your savings AND giving and still have plenty left over to enjoy.

Why a Personal Finance Expert Recommends Credit Cards

In the book 7 Money Rules for Life®: How to Take Control of Your Financial Future, author Mary Hunt tells why she recommends her readers use credit cards:

The truth is that a credit card -- the right credit card -- used smartly by someone with a modicum of financial intelligence can be a useful financial tool that can also contribute to a high FICO score.

She also has a lot of qualifiers as you might imagine. Things like only buy items you have budgeted for and never carry a balance. The same sorts of caveats I make.

Her recommendation might surprise you because she was once herself in deep credit card debt. From her website:

It took us 13 years to pay back more than $100,000 in unsecured debt, plus all the penalties and interest. Had I known then what I know now, we could have paid it back in six years or less. But, that's not important now. What matters is that we did it...we persevered and we are so much better for having gone through it.

The same reason she recommends credit cards is the same reason I recommend them -- if used correctly they can be great financial tools. And the same caveats she lists are the same ones I list. If you can't handle credit cards, you need to stay away from them. That said, I do take it a bit farther as I actually try to maximize my credit card earnings (almost $2,300 in earnings last year.) Why not earn a bit extra to boot? ;-)

Of course on the opposite side of the credit card debate is Dave Ramsey who is 100% against credit cards in any way for any reason. I understand where he's coming from, both personally as well as for those he advises, but to me there are too many benefits of credit cards to throw out the baby with the bathwater. Use them in a way that benefits you financially and keep them from harming you in any way, and credit cards can provide a nice boost to an overall solid financial plan.

The Cost of Bad Credit

The October issue of Money Magazine had a chart in it (I can't find it online) that compared the cost of various loans for people with excellent credit and those with below-average credit. Their findings:

• Car loan of $25k -- Excellent credit rate: 4.2%; Below-average credit rate: 11.3%; Difference in monthly payments: $81


• 15-year $50k home-equity loan -- Excellent credit rate: 7.1%; Below-average credit rate: 11.4%; Difference in monthly payments: $130


• Credit card with $10k balance -- Excellent credit rate: 7.9%; Below-average credit rate: 29%; Difference in monthly payments: $176


• 30-year fixed $200k mortgage -- Excellent credit rate: 3.8%; Below-average credit rate: 5.4%; Difference in monthly payments: $190

You can see how a poor credit rating can cost you a fortune if you're a borrower. Then again, why are you borrowing so much? If you pay cash for a car, pay off your credit cards every month, and don't need a home-equity loan, then you only have your mortgage (and it's likely that you have good credit.) But if you are pushing your debt to the max and have poor credit, all of these combined will cost you an extra $577 a month. Ouch!

How Does Your Credit Score Compare?

Yahoo lists the average credit scores by age as follows:

• 18-24 years old; Average credit score: 638
• 25-34 years old; Average credit score: 652
• 35-44 years old; Average credit score: 659
• 45-54 years old; Average credit score: 685
• 55+ years old; Average credit score: 724

Obviously credit scores get higher as people get older. They end the piece by offering these thoughts:

The study found that people in the 18-39 age group had the greatest number of late payments during the previous 12 months; that the 40-59 age group held the greatest amount of debt; and the 60+ age group had the lowest average credit utilization (used the least amount of credit that was available to them).

Though it is not unheard of for a young person to have a stellar credit score, more commonly these ratings rise as people acquire credit, make careful credit decisions, pay bills on time, and gain depth and length in their credit histories.

Last time I checked (which was a couple years ago) my credit score was just under 800. Not sure where it's gone since but my guess would be that it's been pretty consistent. I haven't borrowed, missed any payments, etc. I have applied for a few new credit cards, but haven't cancelled any yet so there would be much change for those reasons either.

How about you -- where do you rank in comparison to the averages for your age group?

The Dangers of Life Insurance Policy Loans

The following is an excerpt from The Questions and Answers on Life Insurance Workbook: A Step-by-Step Guide to Simple Answers for Your Complex Questions.

Policy loans can be a useful short-term option when immediate cash is needed, but they are not the long-term solution so widely proclaimed. In fact, policy loans (available with most, but not all, forms of permanent life insurance) are one of the most complex, misunderstood, and misused components of a life insurance policy. Out-of-control policy loans can erode a life insurance policy over time, eventually draining the death benefit—and saddling you with a substantial tax bill.

Here’s a frightening example. As part of a divorce settlement, a woman owned a whole life insurance policy that had been issued to her ex-husband in 1967, who was 38 at the time the of issue. The death benefit was $100,000 to be paid upon death or at age 90.

Five Dangerous Debt Payoff Strategies

US News lists five dangerous debt payoff strategies as follows:

1. Paying off credit card debt too fast.

2. Using emergency funds.

3. Tapping a home equity line of credit.

4. Withdrawing from a 401(k).

5. Filing for bankruptcy.

IMO, these are good tips.

I'm a big believer in paying off debt -- all debt -- but you can't get too crazy about it. You have to do it in moderation, making sure all your other financial bases are covered while you whittle it down.

I often get asked if we made compromises in financial plans when we paid off our mortgage. Yes, we made compromises. But our compromises were in spending -- we didn't spend money we could have, instead we saved it and paid off debt. As for other financial compromises, we didn't make any. In particular:

• We had fully-funded emergency savings.


• We contributed the maximum amount to my 401k.


• We didn't accumulate any other debt.

We paid off our mortgage simply by "doing the basics":

• Buying a house we could afford.


• Spending a lot less than we earned.


• Applying everything we could to retire the mortgage: pay raises, bonuses, income from a side business, my wife’s income, and gifts.


• Sticking with it for several years (five to be exact.)

We lived in that house for a year or so totally debt free, then when we moved to Michigan, the equity in that house paid 100% for our new house, so we've never had a mortgage on it. It's been a GREAT decision and one I'd do again in a heartbeat.

If you're wondering what it would be like, imagine not making a monthly mortgage payment for over a decade and you'll get a taste of the feeling. ;-)

The Psychology of Paying Off Debt

Moneyland does a great job of detailing the psychology of paying off debt, telling why the debt snowball (listing and paying off debts from least owed to most owed) is often more effective than the statistically better listing and paying off all debts from highest interest rate to lowest. The summary:

The debt snowball method has vocal detractors who complain that the math doesn’t make sense. It’s true that if you use this method, you’ll pay more in the long-run than if you had the discipline to pay off your debts from highest interest rate to lowest interest rate, but what’s important is to find a repayment plan that you’ll stick to until the debt is gone.

Here's my take on the debt snowball versus the highest interest debate:

• I used to be in the "highest interest" camp. After all, it's the one that makes the most sense, right? It's the one that mathematically has the borrower pay the least amount of interest. It's the most logical. It's the one that will "work best", right?


• Then I started to counsel people in debt. Let me tell you a bit about them. If they were logical, looking to make the best money move possible, they wouldn't be in massive debt now would they? If they made financial moves that made the most sense, they wouldn't be deep in debt now would they? In other words, these people are not rational, logical, or even able (in most cases) to make sound financial decisions. They need all the help possible to get out of debt. Otherwise, they'll never make it.


• The debt snowball is this sort of help. It has them making progress (by eliminating debts faster) which in turn keeps them going. Yes, it's a financial "crutch", but it works. I've seen it work time and time again with people who tried the highest interest approach and failed. This is why I'm now a believer in the debt snowball for people who are deep in debt.

What's your take on the issue? Have you used one of the above methods (or even a different one) to pay off a good amount of debt?

Financial Strategy #6: Savings Over Debt

The book Your Stronger Financial Future: The Eight Essential Strategies for Making Profitable Investments lists eight misconceptions, truths, and strategies to help readers deal with a variety of major financial issues. I'll be highlighting these in several posts and giving you my thoughts on them.

Today we'll look at strategy #6 which deals with accumulating savings over accruing debt. The book says the following on this subject:

• The misconception: Leverage is the key to prosperity.


• The truth: Leverage is debt -- and is almost always a bad idea.


• The strategy: Rather than accruing debt, accumulate savings.

They go on to say that there are three instances where debt is tolerable:

• A mortgage on a house, especially if the note is a maximum of seven years.


• A car loan for two years or less.


• A student loan, where your expected future compensation is clearly able to repay the debt quickly.

The book hates credit card debt and suggests that you should start saving 10% of your income.

Here's my take on all of this:

• I agree that a mortgage can be much shorter than 30 years and even 15 years can be beaten fairly easily. How? By using my formula for buying a home. It's how we paid of our mortgage early.


• Personally, I don't like car loans at all. I'd give someone the grace for a two-year one while they were working up to save completely for the next one, but I'd only offer a one-time exception per person. (FYI, if there was a 0% deal, I'd be ok with taking that loan -- as long as you negotiate the best price you can before you talk loans. In other words, I wouldn't pay more for the car to get the 0% deal.)


• Got to agree on the borrowing for college thoughts. For more info, here's my take on how to get the most financially out of college.


• I hate credit card debt too. But if you can use credit cards correctly, you can make a good amount of money using them. I prefer cash back as a credit card rewards system and that's why I list the best cash back credit cards on my site.


• Ten percent is a good place to start saving, but you do need to up that as the years go on, as I said when I discussed the 10-10-80 budget.

Any thoughts to add?

Winning My Battle with Debt with Contests

The following is a guest post from Matthew Fletcher, author at Contests for a Year.

I have a thing for hummus. I can go through an entire container in one sitting, though I try to leave just enough at the bottom so I don’t feel like too much of an addict. And there’s one particular brand that I’m absolutely in love with: Sabra. One afternoon while inhaling enjoying Sabra and pita chips, I noticed that the container was advertising a contest. Make a commercial for them and you could win a trip to the Mediterranean as well a year’s supply of their chic-pea ambrosia. Amazing! So I decided to take a dip into the world of contests. I shot the commercial, submitted it, and won. Here’s the video:

(PS- That’s me playing the Borat-type hummus lover in the Greek dancing costume. Opa!)

After the trip and my year’s supply of deliciousness, I had developed a new appetite…for contests. I entered a few more, and won those too! Now I was winning cash. It got me thinking that maybe I could get serious about this and use contests to develop an additional source of income. I mean, it worked for Julianne Moore in “The Prize Winner of Defiance, Ohio” (It’s a B-minus movie, but a total A-plus true story about a woman who kept her family afloat by winning competitions in the 1950’s).

So, I started a blog where I enter an online contest every day for a year to see if I can win money in order to get out of debt.

So far, in 2011, I have won exactly $12,338 in cash and prizes. I have been able to put a lot of that towards my debt and have paid it down by about a third.

I’ve won for shooting commercials, creative writing, random sweepstakes and submitting crazy photos.

The world of contesting is vast. Companies host all kinds, ranging from the very straightforward to the totally bizarre-o. I’ve entered ones where I’ve wrapped myself in gold foil while playing tennis, guessed the cost of shipping a stuffed tiger (it’s $310,FYI) and designed a horse themed birthday party for girls who are horse mane-iacs. Some of the prizes are big, like the 10 grand I won for a Barbie commercial. And some of them are small, like the musical download I won of the Hot Pockets jingle. (Yup, that jingle. It was in my head for days…I nearly had a Hot Pocket melt down).

One of my best sources of winnings has been from the website Tongal. They are a commercial creation website. Through them, I’ve won over $11,000 by submitting concepts and commercials for Benjamin Moore, Lipton Iced Tea, Mattel, and Robert Half.

Do I always win? No. Do I think I should? Hello!!

Do I think that contesting is a smart and viable way to get out of debt? Well, somehow in my magical Hogwarts mentality, I actually think it might work. I’m showing up every single day and doing something towards getting out of debt. I’m not hiding my debt in a dark corner and pretending that it’s going away. I’m taking an active role in trying to reduce it.

Now maybe my debt solution approach might be a little fantasy-like, sort of like hoping that the doorbell will ring and it will be Publisher’s Clearing House outside (although I did enter that one, and do kind of think that that might happen. I should probably get an outfit ready for the photo op). But rather than living in fear and shame of my debt, I’m accepting and addressing it. I mean, first off, I’ve admitted to the world on-line that I am actually in debt, which is an important first step into getting debt free. I think that looking at it straight on, on a daily basis, has helped me to put it in perspective. The stigma is gone. A lot of my friends are in debt. They feel suffocated by it and ashamed. In talking about it with them, (and blogging about it) the pressure is released, and I find that I can begin to deal with it in a less hysterical way.

Do I recommend that other people enter contests to get out of debt? Absolutely not! That would totally decrease my own odds of winning (I’m just kidding…well, kinda). I’m good about sharing the wealth. I always post links to the contests on my blog.

If you are going to enter contests here are a few suggestions:

• Do your contest research and find what suits you best. There are LOTS of different contests to enter, listed on of various websites and blogs (photo contests, video contests, recipe contests, guessing games). You can do a search for these websites, or even do a search for exactly what you want to win (win money, win a free sofa, win a trip to Spain).


• Pay attention to the different rules for contests. Some of these contests ask you to get votes for your submission from your friends. This is a way for the companies to get more people’s information. This could either launch you into financial success (if you win) or ostracize you from all your friends and family for continually badgering them about voting (speaking from experience here).


• If you enter a sweepstakes, enter as often as possible. There are people out there who are professional ‘contesters’ who do this practically as their day job and are submitting on a daily basis. Get in as many entries as you can.


• Beware the evil contest taxes. You can’t claim your prize and just say “Thanks guys!” That Macbook Air you won?…there will be a prize tax on it come April 15th.

Contesting and blogging offers me a number of things. It gives me hope. Hope that I’ll be able to wipe out my debt once and for all. And although hope isn’t an action plan, it definitely helps me keep a healthy perspective. The blogging gives me a sense of purpose and direction in relation to my debt; I am actually doing something towards knocking down that beast of a number. And if I do it right, I get some cash. Then I can continue to pay off my debt in large (or Hot Pocket sized) chunks and maybe, just maybe, start to buy some nice things again: like the party sized tub of Sabra. Have you tried the stuff? I mean, I don’t even know where to begin. It’s hummus heaven.

Lessons from Those in Extreme Debt

CNN Money has several stories of people in extreme debt (or at least what they classify as "extreme".) The people profiled have debt ranging from $20,000 to $522k in debt. FYI, $20k doesn't seem that "extreme" to me.

Here are the amounts the people are in debt and how they got there:

• $522,000 - Lost job in 2008 and not employed since. Tried to start a few businesses that didn't work out. Also bought some homes that appear to be money drags at this time.


• $58,000 - School loans and no job.


• $25,000 - Lost a business and then a job. (FYI, this person's story is particularly heart-breaking.)


• $200,000 - College debt and inability to find a job.


• $167,190 - School loans and inability to find a decent job.


• $8,000 (just declared bankruptcy to wipe out $100k in debt) - Lost job, husband died (and lost his income), and went back to school on loans (the current $8k.)


• $20,000 (it's hard to tell if they missed a zero or not -- he says he's spent $200k in the piece but Money lists $20k as the debt) - Funding a business

A few comments on these:

• The economy is taking a real toll on many people. I knew this intellectually, but these stories really bring the suffering to life. Many people are out of jobs and have been for a long, long time.


• For those of us employed, we should be thankful that we have jobs. I know I am.


• Where are the emergency funds? Where are the savings? I know the college students haven't had time to build up any net worth, but those 40 and above should have both large emergency funds as well as significant amounts of investments saved by this time. Apparently they didn't save while they had a chance (and yet they had nice homes with swimming pools) and spent all or most of what they had. Now they are in tough spots financially.


• That said, no matter what you have saved up, it's going to get rough if you're out of work for three years.


• People continue to make the "just go to a great college no matter what the cost and you'll get a wonderful job to pay off all your debt" mistake over and over again. People -- it's not like that! You need to match the costs of college with the expected benefits (salary when you graduate) to make college worth the expense.


• It's interesting that those in debt talk about being in "bondage" or that getting out of debt is "freedom" (maybe not those exact words each time, but the sentiment is always there.) Many people make fun of Dave Ramsey followers when they proclaim debt FREEDOM, but being is debt is a big, big burden. And being out of it is freeing indeed.


• The less debt you have, the better. The less debt you have the safer/more protected you are no matter what happens (like a job loss.) I know many FMF readers will debate the use of debt (arguing that it can be "good") and especially the thought that people should strive to be debt free, but there's no arguing that most of these people would be in much better positions if they had taken steps to be completely debt free before calamity hit them.

So, what are your thoughts on this issue?

Don't Borrow for a Wedding

Check out this problem a reader wrote to CNN Money about:

When we got married, my husband and I decided to have a big wedding that cost $40,000. To pay for it, we took out a personal loan for $20,000 at a 10% interest rate and put the rest on a credit card that initially had a 0% rate but now charges 12%.

We thought that, with both our salaries, we'd be able to pay off this debt in a short period of time. But my husband was laid off and is no longer receiving unemployment. We also have a house payment and a car payment, but beyond that no other debt.

How did this go wrong? Let us count the ways:

• Problem #1: "decided to have a big wedding"


• Problem #2: "cost $40,000"


• Problem #3: "took out a personal loan"


• Problem #4: "$20,000 at a 10% interest rate"


• Problem #5: "put the rest on a credit card"


• Problem #6: "now charges 12%"


• Problem #7: "my husband was laid off"


• Problem #8: "also have a house payment and a car payment"

This situation is, what we call in my family, "brutal."

After a series of bad decisions (IMO), a layoff happens and now things are out of control. This is the way it is when you live life on the edge of your financial limits -- everything has to go perfect to keep the ship upright. But when it doesn't (and it usually doesn't, "real life" seems to happen along the way) then you start taking on water. This is what's happening to this couple.

Here are my suggestions for those of you about to get married:

• Learn from this couple. Do NOT spend a huge amount on your wedding if you can avoid it. Instead, control your wedding costs and start your marriage out on a solid financial foundation. Of course it's your life and you can do whatever you want. I'm just saying this is my recommendation -- keep the wedding costs reasonable.


• If you "must" spend big on your wedding, at least do not borrow a huge amount for it. Pay in cash (or charge the expenses and then pay them off when the credit card bill comes due.) Remember saving up for big expenses? It's a good idea.


• If you "must" borrow (ugh), then at least do it smartly. 10% and 12%? Double ugh.


• And for the rest of us, remember that this is what an emergency fund is for -- something like a job loss. The post doesn't say whether or not they had one, but based on the other financial decisions they made, I'm guessing they didn't.

For some reason, the thought of borrowing for a wedding never really crossed my mind (not sure why not.) Is there anyone out there who borrowed for a wedding (or someone you know did)?

Money Commandment #3

The book The 10 Commandments of Money: Survive and Thrive in the New Economy lists money commandment #3 as follows:

The old-school rules: All debt is bad. Pay it off as fast as possible.

The bubble economy rules: Don't worry about paying off debt. You have better things to do with your money.

The new rules: Pay off toxic debt and use "good" debt to get ahead.

Here are my thoughts on all of these suggestions:

• Again, I'm a mix of old-school and new rules.
• To clarify the book's position, they define "good" debt as "debt that helps you get ahead in your financial life." Examples of what they consider "good" debt: home mortgage, student loan debt, and small business loan.
• My take is that we all should be debt free for most of your life, with a limited time in debt for an education and a house. The small business loan suggestion -- I would say take one only if you had a great reason to believe it would be worth it (like orders in hand that you need the loan to fulfill.)
• Personally, I'm ok with a mortgage as long as the house is purchased correctly and paid off within a decade or so. And yes, you can pay off your mortgage in a decade.  
• I'm also ok with education loans. They worked out great for me. But you should borrow based on what your post-graduate career will earn you. In other words, don't get an education "at any cost" and thus doom yourself to massive amounts of debt that you'll never be able to pay back.
• I recommend getting out of any debt you incur as soon as you possibly can.

What are your thoughts on debt and borrowing?

What's the Best Way to Pay Off Credit Card Debt?

The book Smart Is the New Rich: If You Cant Afford It, Put It Down lists the three most popular strategies (not in any particular order) for paying off credit cards as follows and the advantages of each:

• Pay off the highest interest rate card first - Costs you the least.
• Pay off the card with the lowest balance first - Gives you the psychological boost of making progress quickly.
• Pay off the highest balance credit card first - Doing this will boost your credit score.

I used to be an advocate of the "pay off the highest interest rate card first" method because, to me, it makes the most sense (the math works, right?) It costs the least amount of money so of course it's the "best."

Then a funny thing happened. I started counseling people in massive credit card debt. Guess what? They aren't rationale people (when it comes to money). "Sense" (at least financial sense) is something they don't have. And most of them can't (or won't) learn it. They need extra little "helps" to keep them encouraged -- helps like seeing cards being paid off quickly. That's why I now recommend the "pay off the card with the lowest balance first" strategy when I tell people how to get out of debt. Quite simply, it works better than any other idea I've seen used. (FYI, this is the same idea Dave Ramsey made famous -- he calls it the "debt snowball.")

I've never heard of the "pay off the highest balance credit card first" strategy and it doesn't look that appealing to be honest.

The book doesn't take a stand and recommend the "best" way to pay off credit card debt, so I'll ask you. Which of these methods (or some other) is the best way to pay off credit card debt and why?

The DOLP Method for Getting Out of Debt

WalletPop features the "new" DOLP Method from David Bach in his book Debt Free For Life: The Finish Rich Plan for Financial Freedom (FYI, DOLP stands for  "done on last payment.") Here's basically how it works:

Step #1: You list all your debts.

Step #2: You take each debt's balance owed and divide it by the minimum payment. This gives you the number (which is the DOLP number) of months it will take you to pay off a debt (excluding interest.) So if you have a $2,000 debt and your minimum payment is $50 per month, your DOLP number is 40.

Step #3: You rank all the debts by DOLP number, lowest to highest.

Step #4: Set your calendar to make sure you pay your debts on time. (Is this really something that needs to be part of the official "steps"? Isn't "paying on time" a generally accepted principle for people trying to get out of debt?)

Step #5: Pay the minimum payments on all the debts except the one with the lowest DOLP number. On that debt, pay off as much as you can to pay it off as quickly as you can. Then move to the next debt and so on.

Here are my thoughts on this method:

1. Generally, it's sound.

2. It's not new. It's the snowball method Dave Ramsey talks about (and that I detailed in Seven Steps to Get Out of Debt). Yes, it has a new name and a new calculation, but it's basically the same concept: pay off the lowest debt first.

I'm guessing that most FMF readers have a decent handle on their debt. But if you don't, this method (or the snowball method) will work to get you completely debt free (given enough time and determination.)

There is No Good Debt

In his newest book, Debt Free For Life: The Finish Rich Plan for Financial Freedom, author David Bach shares the following about how he responded when someone asked him about "good debt" versus "bad debt":

Almost automatically, I started giving her the standard answer about how good debts are generally considered to be debts you incur to buy things that can go up in value—like a home or a college education—while bad debts are things like credit card balances, where you’ve borrowed money to buy things that will depreciate or go down in value, like most consumer goods. But then I stopped in mid-answer and looked at her.

“You know something?” I said. “The truth is that this recession has changed everything. Homes are going down in value and people with college degrees are looking for jobs. Forget what I was just telling you. Forget about the idea of ‘good debt’ and ‘bad debt.’ Th e truth is that when you’re in debt, it doesn’t matter what you’ve borrowed the money for. The only thing that matters is whether or not you can afford to pay it back. And if you can’t, all debt is bad debt.”

He follows this up with what he calls the best investment you can make now:

The best investment you can make over the next five years is going to be paying off your debts. So my advice is to pay off what you owe as fast as you can. The faster you pay off your debt, the faster you will achieve financial freedom.

Welcome to the light side, David. ;-)

Ok, so it's not that clear what "good debt" and "bad debt" are these days. But the usual "no brainers" of college loans, mortgages, and borrowing for business now have a long list of caveats that make them less compelling than ever. It's likely these caveats always existed (like don't borrow too much for college unless your post-grad earnings justify it), but most people just never needed them. Today, borrowing is so out of whack, even for "good debt", that every type of debt needs to be considered and weighed carefully -- or else it could sink your finances.

Being too deep in debt is #3 on my list of 10 worst money moves anyone can make because it can cost you a fortune (for example, here's why it's a bad idea to make the minimum payment on a credit card.) IMO, the less debt people have, the better. That's why I've been debt free -- completely debt free -- for over a decade.

If you want to be debt free too, here are seven steps to get out of debt along with some real-life stories of how others became debt free.

I know I'll get some comments that will argue in favor of debt and "leverage", especially from real estate investors. I'm not saying that debt is bad in every circumstance. (There's a situation in which almost any financial move makes sense even though it doesn't in the vast majority of cases.) What I am saying is that there are very few people who can manage and deal with debt in a productive manner -- to the point where the debt works for them instead of vice versa. Even people who go into a situation trying to use debt as a benefit, often come out being burned. So the odds are that most people raeding this are not using debt, but being used by it. And that's seriously dangerous to your financial health.

Why You Should and Shouldn’t Pay Off Your Mortgage

MoneyWatch details the reasons why you shouldn't pay off your mortgage -- then the author tells why he paid it off anyway.

Here are the reasons he gives for why you shouldn't pay off your mortgage:

• You need the liquidity.
• You could probably do better investing the money elsewhere.
• You expect inflation.
• You expect housing to rebound.

Then he tells why he paid off his mortgage anyway:

The logical explanation is that I had enough risk in my portfolio, and as for the low-risk portion of my money, it made no sense  to borrow at 3.0% after taxes and invest it at 2.2% in, say, Treasuries.  That would be acting like a very dumb hedge fund.

But there’s a less rational reason too. Like a lot of post-crisis Americans, I’ve had it with debt. I don’t want to be beholden to a bank and in an uncertain world I’d rather not have the certain obligation of a mortgage payment every month.

I asked Meir Statman, a behavioral finance professor at Santa Clara University about this caution, expecting a lecture about “availability bias,” or the exaggerated  fear of a bad event simply because it is fresh in memory. Instead, I was relieved to hear Statman admit that he’d paid off his mortgage too. “Maybe you could earn a higher return by arbitraging the difference between your mortgage and the stock market,” he said. “But you have to ask yourself what your money is really for,” he said. “Personally, it gives me satisfaction to know that I own the four walls around me.  Satisfaction and peace of mind are a kind of return, too.”

As you might imagine, I have a few things to say about the thoughts above. Here goes:

• As far as needing the liquidity, if your gap is large enough, you can have plenty of cash and pay off your mortgage as well. I was able to manage both.
• As for investing the money elsewhere and getting a better return, maybe you will do better, maybe you won't. This last year you would have done much better by having the money in the market. The couple years before that -- not so much. And, of course, paying off debt is a guaranteed return. Investing is not.
• Do you expect inflation? Or deflation? I don't know what to expect these days when it comes to our economy.
• As for a housing rebound, this sounds like the best bet to me -- if you have five to seven years to wait.
• And for the "had it with debt" argument, this is why I paid off my mortgage almost 14 years ago. I list "being deep in debt" as #3 on my list of the 10 worst money moves you can make, but for me having ANY debt was a bad money move. I wanted to get rid of it all asap -- and my house was the last to go (I didn't have much before that, though). So for the last 14 years, I've had satisfaction, peace of mind, and no mortgage payment. Yes, it's been sweet!

If you're in debt and think you can't get out -- you're wrong. Here are seven steps to get out of debt. Apply them over a long period of time and you WILL get out of debt -- including mortgage debt (if you work at it long and hard enough.)

How to Improve Your Credit While in Debt

The following is a guest post by Michael Robbins from Debt Consolidation. I've added some of my thoughts at the end.

Yes, paying off your debt is the simplest and surest way to improve your credit. But, believe it or not, this is only 15 percent of what goes into your credit score. To have the best effect on your score, you need to improve as many areas as possible.

Step 1: Pay Off Your Lowest Balance First

If you owe a small balance on a credit card, or only have a few hundred dollars to go on a medical debt, then finish it off and close it out. This will have a positive effect on three areas of your credit score: amount of debt, total lines of credit, and debt to income ratio. This will also help you build momentum in your debt elimination plan, and free up more money in your budget.

Step 2: Improve Your Debt-to-Income Ratio

The higher your income in relation to your debt, the better your credit score. Either find a way to bring in more income, or sell something to pay off your debt. Ideally, do both.

Step 3: Eliminate High Interest Debt

Develop a plan to pay off your highest interest debt as soon as possible. Debt consolidation is a great way to improve your score by doing precisely this.

Step 4: Avoid Opening a New Line of Credit

Unless it is absolutely necessary, don’t take out any new loans or credit cards. The more credit accounts you have open, the more lenders view you as a risk. On the other hand, paying off a debt will close a line of credit and improve your score.

Step 5: Check Your Progress Often

Monitoring your progress will help you work towards a goal, and make better decisions. There are a lot of free or low-cost services online that enable you to check all three-credit scores at any time. Keep in mind that you are entitled by the government to a free credit report from each service once a year. Reviewing your credit report will also give you the opportunity to make sure there are no mistakes on your report which can cause significant damage to your score. You'll also be able to ensure that the debts you pay off are removed in a timely manner.

In case you are unaware, this is how lenders generally tend to view your score:

• Excellent credit = 720 and above
• Good credit = 660 to 719
• Fair credit = 620 to 659
• Poor/bad credit = 619 and below

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Here's my take on these:

1. There's the whole "lowest balance" versus "highest interest" debate, of course, over which way to pay off debt is better. I used to be in the "highest interest" camp because that argument makes the most sense logically. However, people in deep debt aren't logical and what seems to work with them is quick wins. That's why I now recommend the "lowest balance" strategy when I tell people how to get out of debt.

2. Of course, making more is always a good idea. Most people can't do this quickly. But they can take the other route -- and sell some things to generate cash. After all, we all have plenty of stuff that can be turned into money.

3. First of all, this seems to be a contradiction to #1. I think what he's saying is that if there's one very high interest loan (like a credit card), try to get rid of it sometime early in the process (not necessarily first.) Second, I've seen debt consolidation work and I've seen it not work. If the people who take out the loan have changed their over-spending ways, debt consolidation can be a good tool to get back on the road to financial recovery. If they haven't changed their ways, debt consolidation allows them to temporarily postpone their impending financial doom and keep their current habits for some time. But eventually they have to pay the piper, and it's even worse if they've spent additional amounts.

4. Yes -- don't borrow anything extra. You have to stop digging the hole.

5. You should check your credit report at least once a year (if not two or three times per year.)

BTW, last time I checked, my credit score was 799. ;-)

5 Times When it Makes Sense to Borrow Money

The following is a guest post by Dan Wesley at Credit Loan. After Dan's thoughts, I've detailed where I agree and disagree with him.

The Credit Card Act made it easier to see what kinds of fees your credit card company is charging, and that’s a good thing. But with the average American household having $15,788 in credit card debt, better notification requirements still don’t make a credit card bill worth looking forward to getting when the mail arrives.

While we recommend having no debt, that’s not realistic for many people. If managed well, some debt is OK. If it’s an investment in your future, it’s good debt. Here are five times we think debt is acceptable:

1. Home loan

Good debt includes anything you need but don’t have the money to pay for it upfront, including liquidating investments to pay for it. Long-term debt, such as a bank loan to buy a home, is one of the most obvious ways that debt can be a good way to pay for something that you can’t afford immediately. Who has $300,000 in cash sitting around?

A large down-payment is a good idea to keep your monthly loan payments down. Mortgages usually have lower interest rates than other debt, so you don’t want to put all of your cash reserves into a down payment.

There are also tax advantages to owning a home. The federal home buyer credit has expired, but mortgage interest, property taxes and other expenses are deductible from taxes for homeowners.

2. College

Borrowing from a 401(k) retirement plan or taking out a loan on your home is a bad idea to pay for a child’s college education. Your children have many more years of earning potential than you do, and giving up part of your retirement fund or possibly losing your house if you default on a college loan is no way to go into more debt.

But your kids can take out government-backed college loans at low rates, and payments aren’t due until after graduation. Of course a better way is for them to work and save their money to pay for college so they won’t have to go into debt, but that’s another tale.

3. Auto

Like a home loan, a car is something not many people can afford to pay cash for and buy outright. Putting down as much money as you can afford is a good place to start. The goal should be to drive the car as long as you can after the loan payments have stopped.

Just make sure to shop around for the best interest rate on a car loan -- your bank and credit union might be able to beat a car dealer’s loan rate. Don’t be fooled by a low monthly price; be sure to look at the overall cost of the car when the loan is paid off.

4. Emergencies

If you pay your credit card bill off every month and don’t use it much, an emergency is a good time to use a credit card. Just try to pay it off before the next billing period. Things happen in life -- a car accident, hospital visit, car breakdown, broken tooth -- and not having the cash in hand can lead to more hardships if you don’t get the problem fixed soon. Not having a car for  awhile could lead to losing your job if you depend on your car for work.

Granted, having an emergency cash fund for such instances is ideal, and is something you should build in preparation for such events. But even with money in the bank, a credit card may be the fastest and easiest way to make an emergency payment. Just don’t let that debt stay on your balance sheet for long. An emergency fund will be a lot easier to fund than paying off a credit card bill.

5. Growing a business

Notice that we didn’t say “starting a business.” If that’s what you want to do,  talk it over with your banker, since starting a business can be a risky proposition. Many businesses can be started cheaply -- $1,000 or less -- with a website to gauge interest.

Once your business is going and successfully making money, then it might be time to take out a loan to expand. Businesses can hit plateaus and can’t grow without more facilities or ways to make a widget, and a loan can jumpstart things.

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Here's my take on these:

1. I think it's ok to take out a loan to buy a home, but only if you use my formula for buying a home, which will have you mortgage free in 7-10 years. For those of you who don't know, I paid off my mortgage approximately 13 years ago.

2. I think it's ok to borrow for college as long as you do it the right way. I had $5,000 in student loans after I got my MBA, but the investment was well worth it. That said, there are ways to go to college debt free if you really want to work at it.

3. No way on the car loan. Save up and pay cash.

4. An emergency fund should cover all but the most severe emergencies. However I'm ok with using a credit card for an emergency -- as long as it's paid off before any interest accrues.

5. I'm not sure about the "growing a business" suggestion. If I was fairly confident of a good return, then I might borrow a modest amount -- as long as I thought I could pay it off quickly. If it was risky and there was no way I could pay it off in a reasonable amount of time, then I wouldn't borrow.

How about you? What's your take on these five times when it "makes sense" to borrow?

How to Be Mortgage Free

The book The Cheapskate Next Door: The Surprising Secrets of Americans Living Happily Below Their Means suggests how people can live mortgage free (after some time, of course) by taking the following seven steps:

1. Buy less house than you can afford.

2. Stay put in the house as long as you can.

3. Make additional payments toward principal whenever possible.

4. Whenever you get a pay raise, allocate most or all of your increase to paying off your mortgage early.

5. Consider setting up a "mortgage acceleration plan" with your lender.

6. If you refinance to take advantage of lower interest rates, do the math carefully and shorten -- never lengthen -- the remaining term on the loan.

7. Keep your eye on the prize.

Sound familiar? Pretty similar to my formula for buying a house. ;-)

We've been mortgage free for over a decade now. If you want to read about how we did it, check out How I Paid Off My Mortgage.

As for their tips above, here are my thoughts on each one:

1. This is a key step in the process. If you buy what you can afford or (worst of all) more than you can afford, you'll probably never pay off your home early. To see what we've done, check out How to Become Wealthy and my comment #6.

2. Moving frequently is expensive (unless you have a company paying for it -- I've never moved without my employer covering all of the expenses) and the less you do of it the more you'll save. FYI -- we've lived in our current home for 11 years now (we did look at moving a couple years ago, but decided against it for various reasons) and plan to live there for at least several more years (probably at least until our kids are in college.)

3. Of course. This is another key step in the process.

4. Same as #3 in my book.

5. Not needed -- you can do it yourself if you have discipline.

6.  Again, of course. You want to refinance to make yourself BETTER off financially, not worse off.

7. You must be disciplined over a long period of time (several years) to make this work. If you are not, you will not pay off your mortgage early.

Basically, it all comes down to three steps:

• Buy less than you can afford.
• Make extra payments.
• Stick with it.

Pretty simple, huh? ;-)

Cheapskates Next Door Hate Debt

The book The Cheapskate Next Door: The Surprising Secrets of Americans Living Happily Below Their Means says that cheapskates next door (CND) hate debt. The details:

• CND don't borrow money to buy their first car while in high school.
• They don't run up credit card debt -- ever.
• They frequently don't take out student loans to finance their college education.
• They will take out a mortgage to buy a home, but usually buy a more modest home than they could qualify for, stay in it a good long time, and pay off the mortgage early.
• They don't take second mortgages, home equity loans, lines of credit, reverse mortgages, payday loans, etc. to pay for home remodeling, the kid's college, a summer cottage, retirement, a European vacation, etc.

Here's where I stand on these:

• I borrowed to buy two cars -- one I had while in grad school and the first one I had out of school. Since then (over 20 years ago), I haven't had a car payment of any kind.
• I never did run up credit card debt -- even when I was younger. Not sure why. I guess I always "knew" it was a bad move, but if you asked me about it then I'm not sure I could have verbalized why.
• I did borrow for college. But the $5,000 I borrowed to get all the way through graduate school has earned me millions since. So I'm calling that a pretty good deal. ;-)
• We have always purchased homes that are much lower in value than what we could afford and we paid off our mortgage early (we're closing in on 15 mortgage-free years.)
• No, we've never taken out any of the loans noted above.

The result? We've saved ourselves somewhere in the neighborhood of $600,000 -- and transferred that money instead to our net worth. ;-)

Yes, we dislike debt and have lived without it for quite some time. How about you? Do you have similar thoughts regarding debt or a different point-of-view?

Banking On Yourself

The following is a guest post from Nick Drzayich, an advisor at Eagle Capital Management where unique and innovative financial strategies such as Becoming Your Own Bank are taught.

We all know that banks are some of the most powerful and lucrative institutions around, so it would make sense to mimic their business model.  I'm not talking about going out and getting a bank charter, buying a piece of land, constructing a bank and then going out to find customers, that is way too much work!  I'm talking about the bank being your source for money when it comes to big ticket items such as cars, boats, remodels, furniture and the list goes on and on.  What if you could hop over the counter and become your own banker?

Let me take a minute to explain that understanding this concept will involve a paradigm shift for the typical person.  We are simply "used to" relying on banks to help us purchase things we can't afford up front, like I said before you have to be able to play both roles, both the banker and the customer.  If you can grasp this concept I can guarantee you will see the potential that lies in Becoming Your Own Bank.

The concept itself if rather simple, keep in mind that it will crumble to the ground if you aren't honest with yourself.  Often I'm asked by those investigating the idea, "what's the risk?"  My answer is always YOU. You are the only reason this concept will not work, if you don't have the discipline to pay yourself back just like you would a bank, the system is worthless.  So let's get into an example to show why it makes so much sense to look into Becoming Your Own Bank:

Let's say you are going to buy a $40,000 truck for your business or personal use, normally you would say there are two ways I can purchase this truck, option 1 is to pay cash and option 2 is to finance (we'll leave out the lease option as it usually worse than financing in the long run).  If you pay cash for the truck you say goodbye forever to the opportunity that $40,000 had to make you any additional money in the future.  5 years later you've got a truck that has depreciated by at least half it's value leaving you 20k in the hole (spent $40,000 and now own a truck worth $20,000).

If you decide to finance your balance sheet looks even worse after those 5 years.  With a car loan at 8% you will have ended up paying $48,663 for the truck, subtract $20,000 from that for the value of the truck you now own and you're left with a negative balance of $28,663.

Here is where Becoming Your Own Bank presents a third option.  Over time you save the capital needed to purchase the truck in your private banking system, when the time comes you borrow from your "bank" and pay for the entire truck ( just like you would if you paid cash), only this time instead of that being the end you treat yourself just like the bank would and pay yourself back plus interest.  After 5 years not only do you have the $20,000 the truck is worth but you've got the $48,663 (principle + interest) in your pocket, putting your balance sheet at a positive $68,663.

It seems silly not to choose a positive $68,663 over a negative $28,663 or a negative $20,000.

Becoming Your Own Bank is not some "get rich quick" scheme, in fact it is a tool that uses one of the safest, most reliable vehicles available to help build wealth over time by doing what you would be doing anyway....buying things.  Not to mention teaching it's users how to save until they are able to afford, something the majority of this country has forgotten how to do.

Your Ignorance Is Not The Lender’s Problem

The following is a guest post from Greg McFarlane, author of Control Your Cash: Making Money Make Sense.

Lenders only take advantage of you if you let them. Read the agreement. If you don’t understand the agreement, find a realtor/attorney/banker/accountant who can, and pay her to explain it to you until you understand.

Or just read this.

Some lenders quote both an interest rate and an APR and/or APY (those stand for annual percentage rate and yield.) What’s the difference between either of them and a plain old interest rate? Plenty, considering that plain old interest rates rarely tell you the whole truth. Plenty, and enough to cost you if you don’t pay attention.

Say you find a lender who expects you to pay 6.1% annually, which is the going rate for a 3-year used car loan. (We’ll leave aside the wisdom of saving up to buy said vehicle and paying cash.) That means for every dollar you borrow, you’ll pay 6.1¢ in interest every year, right?

No. Not only does that figure not take compounding into account, but there’s more. Presenting a trick some lenders use to take advantage of those who can’t be bothered to read an agreement:

First, turn the annual rate into a monthly rate. Or a semi-annual rate. Or a semimonthly rate. Something less than a year. We’ll use monthly.

There are 12 months in a year (trust me, I went to college) so we take the 12th root of the rate.
Using our example of 6.1%, that’s .495%.

Now, multiply by 12 to revert to an “annual rate”. You get 5.94%.

Hey, that’s less than 6.1%! Let’s go with it!

Some unscrupulous lenders would thus argue that you’re getting a 5.94% loan (AMAZING DEAL) as opposed to 6.1% (USURY OF THE HIGHEST ORDER). Either way, they’re lying by 16 basis points*.

Go semiannually rather than monthly, and a 6.1% rate transforms into a 6.01% rate using this method.
This isn’t technically “lying”, but it is throwing a plump juicy orange into the middle of what’s otherwise an apple comparison.

When advertising an “interest rate” under this method, rather than an APR, the lender is playing fast and loose with the truth. Borrow $1000 at 6.1%, and yes, over the first year you’re paying $61. But there’s no set of circumstances under which you’d be paying $59.40 here, as many a lender would have you believe.

Is advertising 5.94% when the actual interest rate is 6.1% that big of a deal? Does it increase business? Well, from a sales and marketing perspective, every numeral counts. Don’t forget, it’s part of the human condition to be pennywise if not pound retarded. There are websites created to cater to that subgroup of morons who will drive across town to buy gas for $2.869 a gallon when there’s perfectly serviceable $2.889-a-gallon gas just down the street. Heck, it’s 2010 and people still buy cigarettes: is blinding them with some of the more esoteric points of high-school level math going to help them behave rationally?

So yes, a 5.94% rate will attract borrowers who’d otherwise be patronizing a different lender who’s offering 5.97% or 5.99%.

To compare interest rates, only look at APRs. Don’t compare one lender’s 18-point boldfaced INTEREST RATE with another lender’s subtly mentioned APR.

Alas, even that’s not good enough. APRs get classified further into nominal and effective. Nominal APRs are what we’ve been getting our heads around so far in this post. Given their name, effective APRs sound like they’d be the more important ones and therefore the ones you should pay attention to. But they aren’t. Effective APRs are supposed to include every contingency that your loan could encounter, and in theory, they sound like they’d be a fairer thing to quote than mere nominal APRs. But effective APRs don’t have a precise legal definition, so for instance, they can incorporate processing fees – which vary widely (and wildly) from lender to lender. If you look only at nominal APRs and nothing else from lender to lender, you won’t encounter this problem. 

But that’s still not enough. Some extraordinarily deceptive lenders will use the ridiculous phrase “APR compounded monthly” or entertain some other adverb. Annual, compounded monthly? Read that again. Then, run away from any lender so gauche as to even mention such a thing. You want unqualified APR, and only unqualified APR, with no weasel phrases preceding nor succeeding it. Do so even if the lender offering you x% APR compounded monthly is giving you a better deal than another company whose APR is unambiguous. Do you really want to do business with someone who gets deceptive before your business relationship even gets started?

There’s no excuse for lenders trying to hoodwink you, but there’s even less for you to be hoodwinked. Consumer protection doesn’t start with a government agency, nor with an email to your local newspaper. It starts with you.

*A basis point is 1/100 of a percentage point. The term was created to make life simpler. Say you have two salesmen working for the same company: one earns 5% commission, the other 6%. (The latter salesman is the owner’s nephew.) How much higher is the second salesman’s commission rate?
Is it 1% higher than the first salesman’s? Well, the number that’s 1% higher than 5% isn’t 6%; it’s 5.05%.
Okay then; is the second salesman’s commission rate 20% higher than the first salesman’s? Maybe, but that might make people think that the nephew’s already generous commission rate is 25%. Rather than be endlessly confused while comparing percentages, better to say that the second salesman’s commission is 100 basis points higher than the first’s. 

We Have a New College Debt Queen

After detailing college graduates with $97,000 and $120,000 in debt, I thought I had reached the peak of "bad ways to finance college." I was so, so wrong.

Here's the story of a young lady who has $200k in college debt (from an undergraduate degree alone.) Yikes! Her words:

The severity of my situation goes a bit deeper than "I owe this money, help me" - I am actually forced to live with my parents (forced = I am lucky! But...) as the monthly payments for just my private loans are currently $891 until Nov 2011 when they increase to $1600 per month for the following 20 years... attached is my payment plan. I also mentioned I have a job - which is great! And I probably have my college education to thank for that! Except there is still no way to make these monthly payments, and live on my own as a contributing member of society. Neither of my parents, nor I, really knew how this would pan out — unfortunately — and now that I'm here, I see no real light at the end of the tunnel.

Ugh! Here's another person who simply didn't think through the college/education/debt/earning issues in advance -- and now she's paying for it.

But she's got another great idea! She's set up a website so people can donate and help her pay off her debt. Yeah, that's gonna be money well spent.

Let me say this again in the hopes that a future college student (or his parents) will read this: to get the most financial benefit out of college, you must compare expected costs with expected post-graduation incomes. And you HAVE to do this before you decide which college to attend and how much you'll borrow (if any) to go there.

And be sure to read Thoughts on the "New" Way to Go to College before you take any actions. It will save you thousands of dollars.

As for the student above, I can't muster much sympathy. I suggest she puts her nose to the grindstone, makes as much as she can, saves as much as she can, and pays off as much of the loan as soon as possible. Yes, it will take her several years to do so, but if she works at it, she may just end up making lemonade out of lemons. I imagine hearing of her in ten years -- she'll have a best-selling book, a well-read blog, and be all over speaking to people on how she paid off $200k in college loans in five years. Here's hoping! ;-)

One-Fourth of Credit Card Owners Get the Message

Last April I detailed why it's a bad idea to make the minimum payment on a credit card. In that post I noted that my credit card statement had added a box detailing what it would cost me to pay back my balance under a couple different scenarios (If I made no additional charges on the card and only made the minimum payment and if I made no additional charges on the card and only made a payment of $95.36 each month -- the 36-month pay-off amount). The point of it was to show me what a stupid mistake it was to simply pay the minimum payment (or to pay only $95 for that matter).

Well, the point is getting through to some Americans. In the November issue of Consumer Reports, they note the following:

23% of respondents were motivated to pay off their credit cards faster by the Minimum Payment Warning on their bills mandated by the Credit Card Act of 2009.

That's better that I thought it would be. If I had to guess I would have said 10% or so changed their habits because of the information. So 23% is a big win, huh?

I guess. Then again, 77% were not motivated by it. Even if half of these were people who didn't need motivation (it doesn't say if these were people who always carried balances or all credit card users -- if the latter, some surely paid off their cards every month already), there are still a large percentage who were not motivated by the fact that leaving a balance on a credit card is a bad, bad idea. But perhaps these were people with no choice -- people who are out of work due to the economy. It's hard to tell.

In the end, it's progress, I guess. I just wish it was a bigger number.

As for me, I don't carry a balance and never have, so it's not a big deal. I'm assuming this is the case for most of FMF readers as well.

One final comment: I still look at the information box each time I get my credit card statement because the information is so compelling. For instance, if I have $2,888.74 in charges (what I had in April), made no additional charges on the card, and only made the minimum payment ($28) each month, it would take me 18 years to pay off this debt and end up costing me $5,546.01. Ugh.

Stories of Getting Out of Debt

I've listed the seven steps to get out of debt. If you're in debt and want to crush it, these tips offer a proven, methodical way to do so. However, this isn't the only way to unload a big debt burden. Yahoo tells the real-life stories of people who had a boatload of debt and took specific steps to get out of it in a few years. Here are some of their tips:

Anna Newell Jones -- Strategy: Go on a spending fast for a year. Advice: Get creative. There are endless ways to save.

Lance Pickett -- Strategy: Live without the little things. Advice: Don't go too far -- like trying cloth diapers to save $60.

Jowharah McNeil -- Strategy: Put spare change to work. Advice: Cut back, use cash.

Brian Leigh -- Strategy: Track your expenses. Advice: Don't limit yourself too much, or you will give up.

Jaime Tardy -- Strategy: Budget! Advice: Save, save, save before you quit your day job.

In addition to cutting costs, they also increased income by taking side jobs and selling stuff they owned (even big items like cars). By doing all of these things, they eliminated fairly good amounts of debt in a relatively short period of time. Good for them!

Getting out of debt really boils down to two simple steps:

• Create as much cushion between what you make and what you spend by increasing income, decreasing spending, or both.
• Use this cushion to pay down your debts.

But there's a hidden element of paying off debt that is vital to the process and is rarely mentioned in pieces on "how to get out of debt" (I think it's kind of assumed.) What is it? D-E-T-E-R-M-I-N-A-T-I-O-N.

Yep, determination. Without it, you'll never get out of debt. With it, eliminating your debt is simply a matter of time -- just like it was for the five people listed above.

Student Loans and Earnings

I have been reading the best book I've ever read on preparing financially for college. The book is Debt-Free U: How I Paid for an Outstanding College Education Without Loans, Scholarships, or Mooching off My Parents and I'll be sharing a bit of it over the next several days. Today I want to share some of the book's thoughts on student loans and earnings. Let's start with this one:

College costs have been rising at more than two times the rate of inflation, and that cost increase is being financed by student loans. Wages are essentially flat after inflation, and experts believe that the robust economic growth that the United States achieved over the past century is a thing of the past.

These two factors (college costs increasing but incomes remaining flat) are the reasons we're even asking whether or not a college degree is worth the time and cost these days. A couple decades ago it was a "no brainer" -- a college degree was almost always the better choice (over no degree.) But these days the answer is often "it depends". And what does it depend on? Basically it boils down to the costs of what it takes to get the degree and what you can expect to earn with it. The more you can lower the former and increase the latter, the more likely it is that getting a degree is a "good deal."

The book goes on to give some interesting insights into the impact school loans have on students/graduates. Here's the first:

A 2008 Yale study found that for every $10,000 in student loans students graduate with, they accept jobs that pay $2,000 more in annual salary. [It also found that] every $10,000 in student loan debt results in a 5 percent reduction in the chances that a student will become a teacher, work at a nonprofit, or take a similarly low-paying, high-karma job.

I've been saying this a long time, but these numbers bear out that it's happening: if a student takes on a lot of debt, he needs to be sure he is going to get a job that males taking on the debt worth it. (BTW, I've also been saying that if you want to go into a low-paying field you need to make sure your college debt is low to non-existent.) This is where most people that have college debt problems get into trouble -- they take on a huge amount of debt while getting a degree that doesn't allow them to earn much. It's a financial double whammy!

Here's the next finding:

A 2008 Experience Inc. survey found that 40 percent of recent graduates took a job that offered higher pay, but less career satisfaction, in order to help pay off their student loans.

Well, money is a factor in where you want/need to work -- especially if you rack up tons of debt. As such, your best bet is to keep your college costs as low as possible to give yourself (or your student) as many choices as possible.

The book lists several other findings but they boil down to one main thought: debt (in this case from student loans) limits your life in many different ways. As such, you want to limit debt as much as possible. We've known this to be true in other areas of life (think consumer debt) for quite some time, but it appears that people may be starting to get the clue that the same principle applies when it comes to student loan debt as well.

Riding the Wheel of Debt

The following is a guest post from MasterPo.

Recently MasterPo had an insightful (and rather unsettling) conversation.

The other person, a woman in her early 40’s, said she has $50,000 in credit card debt. Like most credit card debtors she’s paying very high interest which causes less and less of the minimum payment to be applied to principle. Thus, according to the disclosure on the statements, indicate at min payment it will take 20 years to pay them off (presuming of course no additional charges).

And, like most credit card debtors, this didn’t happen overnight but built up over time as she charged this or that she didn’t have the cash to pay for but felt she “needed”. In truth, some of the things she charged were really needed like gas for the car to get to work, food, basic clothing (this person doesn’t at all dress lavish), etc.

So MasterPo asked her a question: “If you could make all these debts just go away, have a totally clean slate, what would you do differently to prevent yourself being back in this situation a couple of years from now?”

Her answer: “I don’t know. Probably nothing.”

MasterPo has sympathy.

MasterPo has been in the situation where you do need something urgently so it gets bought on credit. Yet, even while signing the receipt, having no idea where the money to pay the bill will come from and just hope to figure it out later. Not a fun way to live!

Yet it is the response that most troubling: This woman has not recognized there is a fundamental flaw in her living style that encourages frequent over spending and high debt. Plans can go astray and certainly life comes at you fast from odd directions you never see until it’s upon you. But not even considering a plan to remain debt free (if she could erase her debt) is all too typical these days.

But then again, why not?

Why do the right thing?

There are no debtors prisons anymore.

In spite of various bankruptcy reforms passed it’s still pretty easy to declare.

The government (regardless of administration) keeps demonizing banks and lenders for wanting to be repaid (how absurd to loan money and expect repayment on time and in full!)

The government keeps forcing lenders to “work with” people to pay off debt instead of enforcing the original terms of the agreement.

You can’t really be denied much for having bad debt – the rates may be higher but there’s always somebody willing to lend to you.

A person can’t really be denied a job or advancement (in spite of the claims of a credit check – something MasterPo never understood anyway but let’s not digress…)

MasterPo doesn’t know how this woman is going to get out from under, nor even if she really wants to be! Even if she does odds are pretty good she’ll be right back in the same situation.

Still, why condemn her when our own government is basically doing the same thing.

If we all just had a printing press in the basement…

Gas Companies Aren't Selling Me Their Credit Card

It seems like all the "rage" now in my city -- every time I fill up my car with gas I get a commercial on the pump screen before they print out my receipt. It always says something like, "You could have saved 5 cents per gallon today if you had used the Shell Credit Card." Yeah, yeah, yeah -- can I just have my receipt?

The reason this may look like a good deal is that while it says "5 cents" some people might translate this into "5 percent." If the card did pay 5 percent, that would be a pretty decent return. But it doesn't offer that -- it offers 5 cents per gallon off.

Let's say a gallon of gas costs $2.60 (I've paid more than this on most recent gas purchases, but I'll go low to help the card companies out). That's a 1.9% discount per gallon. Not bad, but my Schwab Visa gives me 2%. In addition, it gives me 2% off EVERY purchase -- and I buy a whole lot more other stuff on it than gas. Many (most?) of the gas cards pay 1% on non-gas purchases -- even those that do offer (usually for a limited time) 5% back on gas purchases. So the cards aren't really that great of a deal. And yet, I have to endure a commercial every time I fill up.

Could you just give me my receipt, please?

11 Smart Ways to Help Get Out of Debt

The following is a guest post from Right Start LLC. I've written about these issues myself at length (including how to get out of debt and the two equations that lead to financial success), but I think it never hurts to review the basics.

Millions of Americans are currently facing a crisis with their credit card debt. The rise in unemployment and underemployment, the bursting of the housing bubble, the extraordinary tightening of lending standards and poor consumer spending habits have all contributed to this situation. Getting out of it can be extremely difficult, especially if the interest rates are high and minimum payments are all that can be made towards the debt. Repayment timeframes can literally extend to decades in many cases if the consumer continues to pay down the debt in this fashion, meaning that it can not only cover the remaining working lives of these borrowers but it may even continue into their retirements as well. In the event that you’ve found yourself in such a plight, here is a list of tips that I hope will help to save you some money, ease your financial burden and bring the light at the end of the tunnel (becoming totally debt-free) within sight.

1. Stop using your cards

This may go without saying, but I want to make sure that you don’t add to your present problem or undermine your future efforts to pay off your debt. Use only cash for your purchases and if you can’t afford it, then don’t buy it. You may not be able to do this completely at first without passing on some necessities, but try to reach the point where you’re living on cash as soon as you possibly can. Then take the cards out of your wallet and leave them at home in a safe place to use only for true emergencies.

2. Contact your creditors

Collect all your most recent account statements and organize their pertinent information on a separate page. Note the account number, balance, interest rate, minimum monthly payment and payment due date for each. Then call each creditor and tell them that you’ve been struggling to make the minimum monthly payments on your accounts, but that you are trying to do the right thing and pay off your debts. Ask them if they would consider reducing your interest rate so that you can pay them what you owe them. If they decline to help you, be polite and try asking them again periodically.

3. Pay off your highest-rate cards first

Pay as much as you can reasonably afford each month towards the card with the highest interest rate. This could change at times if you’re able to get your creditors to reduce their interest rate at a later time, so stay on top of any changes that may affect to whom you’ll be paying the most money. Make sure that you continue to make the minimum payment each month on all of the other accounts.

4. Analyze and reduce your expenses

Make a detailed list of all your monthly expenses and see where you might be able to reduce them. Then use the money you save to pay off your credit cards. Another good idea is to carry around a pocket-sized notebook for a month noting all your expenditures, no matter how small. You may be surprised at how much money you’re spending on items that aren’t essential. (Remember that any extra money you can come up with will pay down the principal balance of your highest-rate card.) Use the new information to revise your earlier list of monthly expenses, and once again see where you can free up some more money to pay down your cards.

5. Consider moving into a less expensive place

This may or may not make sense for you, but perhaps you’re living in a place that’s larger or more extravagant than you may actually need. This could save you considerable money over the long term. Don’t forget to consider the moving costs into the equation if you’re thinking seriously about this.

6. Consider renting out a room

Again I realize that this may only apply to some of you, but if it does it’s a great way to pay down your debt faster and save yourself some big money in finance charges over the long term. You may even already know someone who would be a good candidate. Consider this option carefully, as you don’t want to make a mistake that will end up costing you your tranquility at home.

7. Have your paycheck direct-deposited

Many employers offer this option to their employees, so check with them and see if you can do it. It’s much easier to keep from spending unnecessarily if the money never passes through your hands in the first place. There is some truth in the adage: “out of sight, out of mind”. Having direct-deposit can also save you the time and hassle of going to the bank to deposit your check, and it then makes a special trip necessary if you want to take some of your paycheck in cash. Don’t make it too easy for yourself to spend money.

8. Get a part-time job

Having another source of income can help speed up the repayment process too. When you consider that everything you take home can go directly towards the balance on your highest-rate card, it increases the value of the extra income you earn. Compare this scenario to the current one in which you’ll otherwise be paying additional finance charges from your present lower income amount. Over time this can make a big difference for you.

9. Find creative ways to make some money

Try selling some things you don’t really need on eBay, Craigslist or Amazon such as CDs, DVDs or other items that you may no longer be using. Garage sales are another great way to raise some cash and simplify your life at the same time. Remember that the proceeds can all be used to pay down your principal and reduces your finance charges on your debt.

10. Eat more home-made meals

This is a great way to save some extra money and get better control over what you put in your body at the same time. Eating meals out at restaurants can add up very quickly. When you do have to eat out, consider a place where you don’t have to tip, and just drink water instead of ordering a beverage all the time and padding your bill. Bring snacks with you to work instead of pumping money into a vending machine. Keep some snacks in the car to avoid having to stop at a convenience store if you get hungry.

11. Learn to become a smart shopper

There are many ways to cut down on your shopping bill, and I won’t try to cover them all here. But consider the fact that a good used CD or DVD will play the same as a new one, and that many people end up selling barely-used exercise equipment and recreational items at big discounts. Stock up when you see exceptional sales prices on good, nutritious foods that you enjoy from the supermarket. If you have more time than money, you should know that thrift stores can have new or almost-new items at ridiculously low prices that can substitute for something you would otherwise buy at the mall. You’ll be amazed at how much fun treasure-hunting can actually be, as you never know what may show up in these stores. I’ve seen everything from brand new furniture, high-line TVs and stereo equipment in perfect condition, and brand new designer shoes and clothing with the tags still attached, all selling for literally pennies on the dollar. Just remember that not all thrift stores are created equal, so don’t just try once and then decide that it’s a waste of time.

Debit or Credit: Which Card to Use?

Consumer Reports notes that 52% of all payment-card transactions will be on debit cards in 2010 -- and they expect the trend towards more use of debit cards to continue. But they note (kinda) that there are times we should use debit cards and times when we should use credit cards. Here's how they break the two down.

Use a credit card:

• For big purchases. Credit cards allow you to withhold payment if something goes wrong with your purchase, and the card issuer often investigates the problem for you. Some credit cards add up to a year to the manufacturer's warranty on the products you buy with them. You may also get additional protections against fraud, damage, identity theft, or plain old theft.
• For gas, hotels, and car rentals. Some hotels, gas stations, restaurants, auto rental companies, and retailers put a hold on the money in your checking account until a debit transaction is processed, which might take up to several days for signature-based payments. What's more, the amount that's blocked can significantly exceed the amount of your purchase. These holds can prevent you from accessing the funds in your bank account and result in bounced checks, declined transactions, or overdraft charges.

• To earn rewards. Fewer debit cards have rewards programs, and the programs of the ones that do aren't as good as those of credit cards.

When safety is paramount. Under federal law, your liability for fraudulent charges on a debit card can be greater than it is for a credit card. You're responsible for up to $50 in unauthorized purchases on your credit cards. But with a debit card, you can lose up to $500 if you don't report the theft or loss of your card or PIN within two business days of discovering the problem.

Use a debit card:

• For budgeting. You may be inclined to spend less using debit, since you generally know how much money you have in your bank account.

Ok, so much for the benefits of using a debit card. If you can't keep a handle on spending, use a debit card. Otherwise credit cards are always better. Is that what they are saying?

Personally, I prefer credit cards, especially for the rewards. I'm going to rack up a boatload of extra cash this year by using my 2% Schwab Visa on things I would have paid for by check or cash -- so why not get the extra 2%? I'll give you the final details at the end of the year, but I'm  guessing it will be $600 or so by the time the year is over. I'll take it!

The Cruel World of Payday Loans

Here's a piece from MSN Money on how payday loans became big business. I'm sure that most of you know what payday loans are, but just in case someone reading this doesn't, here's how Wikipedia defines them:

A payday loan (also called a paycheck advance or payday advance) is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday. The loans are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card (see cash advance). Legislation regarding payday loans varies widely between different countries and, within the USA, between different states.

Some jurisdictions impose strict usury limits, limiting the nominal annual percentage rate (APR) that any lender, including payday lenders, can charge; some outlaw payday lending entirely; and some have very few restrictions on payday lenders. Due to the extremely short-term nature of payday loans, the difference between APR and effective annual rate (EAR) can be substantial, because EAR takes compounding into account. For a $15 charge on a $100 2-week payday loan, the APR is 26 × 15% = 390% but the EAR is (1.1526 − 1) × 100% = 3,685%. Careful reporting of whether EAR or APR is quoted is necessary to make meaningful comparisons.

Ok, so I'm not going into whether you're paying 390% or almost 4,000% with a payday loan, all I'm going to say is that they are BAD DEALS! Who in their right mind would take out a loan that costs them 390%????????

And yet business in payday loans is booming. From MSN Money:

In 2001, the industry passed the 10,000-store mark, and entrepreneurs with national ambitions were still lined up at the door. At the industry peak, in 2006, there were 24,000 payday stores in the U.S., according to Stephens, an investment bank in Little Rock, Ark., that has carved out a specialty in subprime businesses. That was more than all the McDonald's and Burger Kings in the United States combined.

And from a payday industry website:

At 2005 yearend, analysts estimated that there were between 23,000 and 25,000 payday loan outlets in the United States conducting $40 billion in loans, with $6 billion in loan fees paid by consumers. Payday lending has grown very fast over the last few years. In 2000, the industry consisted of 7,000 - 10,000 payday loan offices, accounting for 41 million transactions and $1.4 billion in fee revenue. By 2003 yearend, there were about 22,000 payday offices generating $6 billion in fees, and around 100 million transactions. Total sales grew from $10 billion in 2000 to $40 billion in 2003. In short, the payday lending industry quadrupled in size within three years.

The tremendous growth in the payday industry has been fueled by extremely high profits: an estimated 34% pre-tax return. Payday lenders only need a small amount of cash to make profitable loans. After the first loan, the borrower is simply re-borrowing the money they just repaid, minus the service fee. Lenders charge annual interest rates of 400% or more. In comparison, the highest credit card rates rarely exceed 29% APR -- less than one-tenth the APR charged on a payday loan.

Payday loans are controversial not only because they are such a bad deal but because they seem to prey on those least able to afford the loans (I say "seem" because that is still up for debate.) From Wikipedia:

People who resort to payday lending are typically low-income people with few assets, as these are people who are least able to secure normal, lower-interest-rate forms of credit. Since the payday lending operations charge such high interest-rates, and do nothing to encourage savings or asset accumulation, they have the effect of depleting the assets of low-income communities.

However, information gathered in a 2008 Dartmouth University/Federal Reserve Bank of Philadelphia study suggests that this portrait of the average payday loan customer as being "typically low-income" with "few assets" may be inaccurate. The study found that while payday loan customers frequently do not have perfect credit scores, their average household income generally falls below $50,000 but above $20,000. The U.S. Census projects that the average household size for 2010 is 2.53 persons. Rounding 2.53 to the whole number of three, we see that the poverty baseline salary outlined by the U.S. government for an average household of three persons, is approximately 35 percent or higher than the national poverty standard. And that only takes into account payday loan applicants in the Dartmouth study that are at the very lowest end of the income scale. The study sample distributes evenly across the above $20,000 but under $50,000 annual household income range, according to study author Professor Jonathan Zinman. 

To counter the claim that payday loan customers are "typically low-income" and have "few assets" further, customer data for all payday loan applicants at one high-traffic online payday loan application portal show that applicants earn an average of $31,690 per household, which is 175 percent of the federal poverty level in the United States. That's effectively double the national poverty rate of income. In both the Dartmouth/Federal Reserve study and in this example, we see that "typically low-income" and having "few assets" does not accurately describe payday loan customers.

That's about all I can take on payday loans for one day. Let me summarize my thoughts on them and get out of here:

• They are bad deals financially. You should never, ever take one out.
• Unfortunately, it seems like they are here to stay. Our "have-it-now" culture seems to demand them.

I've never taken one out and (to my knowledge) don't know anyone who has (but how can I be sure?) How about you? Any of you ever taken out a payday loan? How was the experience (I don't even know where I'd go to get one)? Or do you know people who use them regularly? Why do they do so?

And Yet Another College Student Who Needs a Clue

Here's yet another in what seems like a long line of clueless college students (for others, see College Debt Run Amuck, A College Debt Nightmare, and An Example of What I've Been Talking About.) Like the others, this one borrowed way too much and is now having a hard time paying it back (she owes $97,000). And if that's not bad enough, this article grates on my nerves because the author looks at who to blame for the problem -- it can't be the student and the parent alone, now can it? Is Sallie Mae, Citibank (private loan), or the university at fault? Ugh.

Let's look at a few comments from the piece that I think get to the heart of who is to "blame" for this mess:

Like many middle-class families, Cortney Munna and her mother began the college selection process with a grim determination. They would do whatever they could to get Cortney into the best possible college, and they maintained a blind faith that the investment would be worth it.

The second sentence is the killer. Let's dissect it piece by piece to see where they went wrong:

• "Do whatever they could" -- This can be translated "borrow whatever they need to borrow." Not a good idea no matter what you're buying (a house, a car, or a college education).

• "The best possible college" -- People equate "most expensive" with "best" when it comes to colleges. This is simply a (very) false assumption (as we have seen).

• "A blind faith" -- Having blind faith in anything is not a prudent financial move.

• "The investment would be worth it" -- Unfortunately they didn't do the math to see if their investment would be worth the cost before they borrowed. Big, big mistake.

That's just the first paragraph. We go on:

They and their families made borrowing decisions based more on emotion than reason.

Yep. And when you make financial decisions based on emotion and leave out reason, it's usually not going to end well.

"All I could see was college, and a good college and how proud I was of her," Cathryn said. "All we needed to do was get this education and get the good job. This is the thing that eats away at me, the naïveté on my part."

Yes, she was naive. How did she expect her daughter to get "the good job?" Did she think simply because she went to a specific school that she was guaranteed a certain income? Did they research the sorts of careers the school was getting its graduates? I'm guessing not. More than likely they simply assumed that the daughter would get a high-paying job and all would be well. Bad mistake.

To get the most financial benefit out of college, you must compare expected costs with expected post-graduation incomes. And you HAVE to do this before you decide which college to attend and how much you'll borrow (if any) to go there.

The daughter would simply like to have the debt forgiven (not likely since "federal bankruptcy law makes it nearly impossible to discharge student loan debts.") Her thoughts:

Ms. Munna badly wants to call a do-over on the last decade. "I don't want to spend the rest of my life slaving away to pay for an education I got for four years and would happily give back," she said. "It feels wrong to me."

How exactly is it wrong? You borrowed and now you must repay. Is that a difficult concept to understand?

Most of the rest of the piece is crap -- arguing how others conspired to give her money she could never repay. Take some responsibility, people!!!!

Anyway, here's how the situation nets out now:

The balance on Cortney Munna's loans is about $97,000, including all of her federal loans and her private debt from Sallie Mae and Citibank.

She recently received a raise and now makes $22 an hour working for a photographer. It's the highest salary she's earned since graduating with an interdisciplinary degree in religious and women's studies. After taxes, she takes home about $2,300 a month. Rent runs $750, and the full monthly payments on her student loans would be about $700 if they weren't being deferred, which would not leave a lot left over.

So she makes $46k per year. This is actually much better than I would have expected for a degree in religious and women's studies. Then again, she lives in San Francisco, not exactly a great place to live if you're trying to save money (though a beautiful city). Sure, why don't we just heap another major difficulty on the school loan one and make it even harder to get out of debt? What -- there are no photographers in other parts of the country? Ugh again.

Anyway, paying back $97k on a salary of $46k isn't impossible. She can do it if she buckles down and works at it for some time (no, it won't be easy, but she can do it.) How? Follow my seven steps to get out of debt.

And for those of you about to enter college (or if you know someone who is, please send them a link to this post), please, please, please think about where you are going to school, what you can reasonably expect to earn coming out of that school with the degree you'll have, and what it will cost to attend the school. Then do the math and see if it's a good financial move BEFORE you commit to going there.

Update: I guess others weren't too sympathetic either. Here's the woman's reponse to those who commented on the original piece (telling her to get a clue.) One quote that summarizes the whole mess:

"In retrospect, it’s absolutely clear to me that I should have thought more about the cost of the education versus career prospects. I didn’t think of it as a purchase."

Foreclosure and Bankruptcy

The following is a guest post by Caroline Palmer, and associate attorney at Oak View Law Group.

It seems like only yesterday when the real estate market was booming and everyone was investing, whether it was a home or investment property.  Then the bottom of the sub-prime lending market dropped out, leaving hundreds of people facing either foreclosure or bankruptcy, or more typically, both; and leaving the economy devastated in its wake.

Bankruptcy, whether it’s chapter 7 or 13, affects every aspect of a consumer’s finances, especially their home. Dozens of people facing the loss of their home are filing for bankruptcy, hoping to save their icon of the American dream.  But filing for bankruptcy while facing foreclosure isn’t always the answer.

Most people filing for bankruptcy in order to save their home, hear about the marvelous laws regarding automatic stays and homestead exemptions jump with joy, until they receive notice that the foreclosure proceedings are continuing even after they file.  Here’s why.

The Automatic Stay

Automatic stays are just what they say they are, stays on debt proceedings that are put into place the moment the bankruptcy petition is filed with the Federal Bankruptcy Court.  These stays prevent creditors from starting any proceedings to collect on a debt while the bankruptcy is going on. 

From the first enactment of the Federal automatic stay laws, creditors have been able to get relief from the automatic stay relatively easily, by showing that the creditor’s interest in the property is jeopardized.  In addition, Congress added another exception to the automatic stay provisions in 1994, requiring debtors with a secured loan on a single real estate asset to file a reasonable payment plan or make reasonable interest payments based on the fair market rate on the value of the creditor’s real estate during the bankruptcy proceedings.

Finally, while automatic stays will halt the foreclosure process it can only do so to a certain point.  Once judgment has been given in a foreclosure, then depending on the given state’s foreclosure procedure, it might be too late for the automatic stay to have any affect. And once the foreclosure proceedings have reached the point of being sold, then it is definitely too late for an automatic stay to take effect.

The Homestead Exemption

A Homestead exemption, for those who don’t know, is one of the judgment exemptions every state and the federal government has enacted to prevent judgment debtors and bankruptcy filers from losing all of their equity in their home.  All of these exemptions vary from state to state, and some states allow a debtor to choose between the state and federal government homestead exemptions, except for California which allows their citizens a choice between two different state exemption plans.

In addition, since bankruptcy law does not cover voluntary loans, like mortgage payments and student loans, filing for bankruptcy will not get rid of the mortgage.  Under current bankruptcy law, a debtor is required to reaffirm their mortgage in order to keep their home 45 days after the mandatory 341 meeting with their creditors.  Therefore, even once a debtor has finished the bankruptcy, their mortgage lender can still foreclose on their home.

The best way to prevent foreclosure is to work out a payment or modification plan with your lender.  There are numerous non-for-profit credit counselors as well as commercial debt management companies who can save you time and money in addition to helping you keep your home.

The Seven Pillars of Financial Success, Pillar 3: Beware of Debt

For those of you new to Free Money Finance, I post on The Bible and Money every Sunday. Here's why.

The Bible discusses the keys to personal finance success quite plainly. If you read the book of Proverbs in particular, you'll see that the path to financial success isn't that difficult or extensive. In fact, the wisdom to be prosperous can be found in a few simple steps.

Over the next few weeks, I'll be sharing what I consider to be the seven pillars of financial success from the Bible.  I picked up on the number seven from Proverbs 9:1 where it says:

Wisdom has built her house; she has hewn out its seven pillars.

Today we'll be discussing Pillar #3: Beware of Debt.

In Proverbs 22:7, the Bible says:

The rich rule over the poor, and the borrower is servant to the lender.

And that's about the best thing the Bible says about debt! In fact, the Bible discourages the use of debt EVERY TIME it mentions the subject.

I've covered what the Bible says about debt previous here on FMF. The summary: stay out of debt -- and if you're in it, try to get out as soon as possible.

A few more thoughts on this topic from me:

1. Being deep in debt is one of the worst money moves anyone can make. It can cost you hundreds of thousands of dollars over the course of your lifetime and thus be a very large drag on your net worth.

2. Unfortunately, there's a HUGE difference between the debt Americans "should" have (though I'd say these numbers are high) and what they actually have. 

3. If you're in debt and want to get out, see my seven steps to get out of debt (and here are some follow-up tips to remain debt free once you get there.)

4. Usually the last debt to fall is a person's mortgage. Check out this link if you want some thoughts on how to be mortgage free in five to seven years. 

5. I know someone's going to say (or be tempted to say) something like: "Yeah, but I can make more with the money by investing it than by paying off debt." Really? Can you really? My experience shows me that a very small percentage of people have the discipline, wisdom, insight, patience and skill to actually make this work. Sure, you may be one of them. Then again, you may be fooling yourself.

Do you agree or disagree?

Come back next week as I discuss Pillar #4!

Foreclosure Hitting Well-Off Families Too

The More Money blog reports that foreclosures are hitting well-off families too. Consider these statistics on a recent study of foreclosure filings:

20% of the filings went to households with more than $100,000 in annual income.

35% of homeowners who received a foreclosure filing had lived in their homes for more than 10 years. These were not people who'd bought too much house, but more likely people who lost their jobs and suddenly couldn't afford the payments.

The piece also notes that "it was very rare for just one financial setback to lead to the foreclosure. It wasn't just a high-interest-rate, high-payment subprime loan that might have caused a foreclosure; it was a bad loan and then a job loss. Alternatively, it wasn't a job loss that caused an affordable loan to go bad; it was a job loss and a health issue."

I have a few thoughts on this issue:

1. Without a job, almost any financial plan goes south rather quickly. That's why it's important to have a good-sized emergency fund -- to help you try and recover from a job loss as soon as possible. I'm working on a piece centered on "protecting yourself in case of a job loss" that will give additional ideas on how to prepare in advance for a potential firing/lay-off. I hope to have it done sometime soon.

2. I can see how a one-two punch like job loss/health problem can be very tough. And it's not too difficult to imagine them coming together. For instance, assume you have a working couple, one of them gets sick, loses his job, and now the family gets hit with both a loss of income as well as mounting medical expenses. Tough to recover from this unless your finances are rock solid.

3. The above scenarios are arguments for being debt free. Someone who's been in their home for 10 years should have it paid off (or close to it) IMO -- assuming they used the right formula to buy their house in the first place.  It's not that difficult to pay off your mortgage in a decade if you apply some basic principles.

4. Don't take a bad loan. I know this kind of goes without saying, but it's noted above as one of the two factors needed to derail a homeowner. Why start out with one strike against you, knowing that you only need one more (a job loss, health problem, etc.) to sink the ship?

5. Some of these people (probably a good percentage) had to be in trouble because they bought too much house. So let me reiterate how important it is to buy a house you can afford. Stretching to meet a mortgage is placing your finances at great risk as one major setback can cause the whole house of (financial) cards to come down.

When is Debt Settlement Better?

The following is a guest post by Jessica Bosari from Billeater.com.

Debt settlement sounds so easy. You stop paying bills that you are behind on anyway, save the money up, send it to a debt settlement company. They take care of the rest, right? Well, not so much. Debt settlement is a viable option for some people, but not many.

How can you know if debt settlement is a good option? The answer to that question is simple. Debt settlement is always your last option. If you are thinking, “How can debt settlement be worse than bankruptcy?” you probably don’t understand everything you should about debt settlement.

Debt Settlement Versus Debt Counseling and Consolidation

Debt settlement is not the same as debt counseling or consolidation. Counseling and consolidation are methods for managing and paying off your debt in full. Debt settlement is a way of getting out of paying some of the debt you owe. As you might imagine, getting some of your debt forgiven is not easy. It can also have negative consequences that you may not have considered.

Assuming you can find a legitimate debt settlement company, (one that actually negotiates you debt instead of taking your money and running away with it) the costs can be very high. Complicating pricing structures make it difficult to determine the true cost. Many find themselves paying upfront charges plus monthly maintenance fees for the length of their debt repayment plans. That can add up to five thousand dollars or more.

In some states, this kind of settlement service is illegal. If you live in Arizona, Georgia, Hawaii, Louisiana, Maine, Mississippi, New Jersey, New Mexico, New York, North Dakota, West Virginia or Wyoming, any kind of for-profit debt counseling service is illegal and debt settlement companies fall under that category.

Why Bankruptcy is Better

Don’t misunderstand. Bankruptcy is a final resort for those in financial trouble. But Chapter 7 bankruptcy does have advantages over debt settlement. Chapter 7 bankruptcy lets you discharge your debts in full. This means you are relieved of your legal obligation to pay them back. The creditor retains the right to foreclose upon and take possession of the collateral property.

Both bankruptcy and debt settlement leave black marks on your credit history. While it is true that bankruptcy remains on your credit record for ten years, as opposed to seven for debt settlement, bankruptcy discharged in just a few months. Debt settlement typically takes about two years to negotiate. Those are two years fraught with frustration and anxiety. Filing for bankruptcy also costs less than half of debt settlement at $2,000. So filing for Chapter 7 bankruptcy costs you another year on your credit report, but saves you money and stress.

When Debt Settlement is Better

For some, debt settlement is better, but only when Chapter 7 is not an option. If you don’t meet the “means” test for Chapter 7, then your assets or your income are too high to qualify. In such cases, debt settlement is preferred over Chapter 13 bankruptcy only because it stays on your credit history longer than debt settlement and can be almost as stressful.

With debt settlement, you and the creditor work together to decide how much you can afford to pay back and how long you will take to do it. With Chapter 13 bankruptcy, the matter is taken out of your hands and decided by the court. You are given five years to pay off as much debt as the court decides you can afford.

Seth Godin Hates Consumer Debt

If you're in the marketing business, a must read is Seth Godin's blog. His daily postings are always like taking a drink from a fire hydrant (too much for anyone to absorb) and he ALWAYS makes you think. As a 20-year marketing veteran, I learn something new from him (or are at least challenged by him in some way) with every post.

Recently he posted on the fact that consumer debt is not your friend. A few key thoughts:

Dave [Ramsey] has spent his career teaching people a lesson that many marketers are afraid of: debt is expensive, it compounds, it punishes you. Stuff now is rarely better than stuff later, because stuff now costs you forever if you go into debt to purchase it. He's persistent and persuasive.

It takes discipline to forego pleasure now to avoid a lifetime of pain and fees. Many people, especially when confronted with a blizzard of debt marketing, can't resist.

Resist. Smart people work at keeping their monthly consumer debt burden to zero. Borrow only for things that go up in value. Easy to say, hard to do. Worth it.

A few thoughts on Seth's comments and the whole subject of debt:

1. Yes, there's a very high cost associated with debt. Whether or not you believe the Morningstar estimate that the average American spends $600k on interest in his lifetime, I think we can all agree that the cost of interest paid by most people in their lifetimes is likely in the hundreds of thousands of dollars. So if you make $2 million in the course of your career ($50k per year for 40 years), you're spending 15% of it on interest alone if you pay $300k in interest in your lifetime. If it's $600k, a whopping 30% of your lifetime income goes to interest. It's hard to become wealthy with either of those big expenses dragging your finances down.

2. Consumer debt is an especially ruthless killer. Just ask the people who make minimum payments on their credit cards.

3. Ah yes, discipline. Simple to talk about and understand, not easy to implement. Let's face it, discipline used to be rather common in America (and I'd say one of the characteristics that made our country great.) Today, not so much.

4. "Borrow only for things that go up in value." It's hard to find things that are guaranteed to go up in value. A house? I think we've seen that they aren't guaranteed to go up in value. An education? Probably ok, as long as you borrow smartly. A business? It's hard to know if a business will go up in value or not. So what's the lesson in all of this? Borrow RARELY and with great caution.

5. If you want to escape the debt trap, here are seven steps to get out of debt. As Seth says, it's worth it.

6. Once you get out of debt, you'll want to stay that way. Here are some tips for how to remain debt free.

The Predatory Nature of Student Credit Cards

The following is a guest post by Garrett Driscoll from Debt Eagle.

When the first credit card was invented, it was all about convenience. In the 1950's a man named Frank Macnamara came up with the concept after forgetting to bring cash on a night out with friends. Always carrying money was cumbersome and a credit card solved that problem. At that time credit card companies made their money with transaction fees and yearly fees. Up until the 80's credit cards were seen simply as an easier way to pay for things. As people become more accustomed to their cards they started to be used more like an income substitute. They began buying things, when they didn't have the funds to cover it. They could always make the minimum payment, and pay the rest later. The yearly fees became less important as the industry realized they could make much more by keeping their customers in a constant state of debt.

I've personally never carried a balance or missed a payment. You would think, i would be an ideal customer for the credit card companies. But customers that pay on time, don't make them any money. They've shifted their focus to target populations with appetites for things they can't afford. This brings us to the student population. From loans to credit cards, a college student's existence is bursting with debt. For students, credit cards have become what ARM's were to homeowners back in '08. The industry extended credit to a population they knew didn't have the means to pay it back. They made money by creating debts that would take years to pay off. Low introductary rates lured students in, and the fine print tells them the rates will skyrocket in six months. This type of lending hasn't recieved the attention that the mortgage industry has, but it is no less predatory. The credit industry was singling out a demographic that for the most part didn't even have an income.

In 2010 more than 80% of all students carry a balance of over $2000. With the barrier to getting a credit card being set so low, students have no trouble obtaining a card with a high limit. In fact they get free t-shits, pizza, and ipods to go along with their shiny new credit cards. But by the time they are ready to graduate, they could have accumulated debts that will take them decades to pay for. As they join the work force, they will have to deal with serious student loan and credit card problems. With a struggling economy and poor job prospects, this could become a real mess for new grads.

The government has made efforts to crack down on the sub-prime mortgage industry. But, are they doing anything to stop the direct targeting of students with these types of credit cards?  The answer is yes. Our government has recently taken steps to curb this type of behavior with the CARD Act of 2009 (which took effect in Feb. 2010). This act has put new laws in place aimed at keeping financially naive students out of debt. One new law requires those under 21 to have a co-signer (unless they prove they have income). This is important because it will keep parents in the loop. If they want a credit card, their parents will be forced to monitor it. The 2009 Act also bans all the free swag and incentives kids get to sign up. There will be no more ipods or t-shirt giveaways on campus. Credit card companies will still be allowed on school grounds, but they are no longer allowed to entice students with free goodies.

These new rules will help, but they really don't address the root of the irresponsible spending. People aren't born financially responsible. And lenders shouldn't be profiting at the expense of our students. Huge debts, a ruined credit score, and a bad job market don't bode well for new graduates. Grads think they'll be able to get a good job and pay down debt quickly. But, right now those high paying jobs are hard to come by. Financial education is so important and schools need classes that teach practical financial skills. Info about credit scores, interest rates, and loans provide real world benefits. In 2002 the "jumpstart coalition" gave surveys to determine high school students financial literacy. Over 68% of them failed this basic test. This report also showed that 60% of students believed that they didn't legally have to pay their credit card debt. Most of them did not even know what their credit score was or why it was important. If these students understood basic financial terms, maybe they would learn to read the fine print. A great place to point students for basic financial education is Project Cash on the University of New Hampshire's website. It has free information about credit, savings, and college financing (http://www.projectcash.unh.edu). It can help teach students the true costs of careless spending and may give them the education to stop accumulating debt.