With the savings rates falling like bricks lately, there is no advantage to me keeping my student loan payments low while keeping my bank account in the stratosphere. My student loan interest rate is 4.25% and I may not qualify for any tax advantages which would otherwise effectively reduce that interest rate. My savings aren’t earning much more in interest, and after income tax, it’s likely less.
I’ve decided to speed up my student loan payments. I’ll end up with less cash on hand in the next few years, at the same time I might be purchasing a house, but the lack of debt will put me in a better position to afford a mortgage.
This week, I sent $5,000 to my student loan.
The most basic piece of knowledge one needs in order to be in control of their finances is the importance of awareness. Many people will go through their lives blissfully ignorant of their own financial details. Why? For one, ignorance is bliss. The more financial trouble you are in, the easier it is to ignore financial details because it keeps stress out of your life. David Bach is professing tips for dealing with home equity and debt, and for his fourth informative piece, he underscores the importance of being aware of how much your debt is costing you.
First, shop around for the best rates (check out Bankrate.com or LowerMyBills.com to compare lenders’ rates). Then, see if your primary mortgage lender can offer you a deal. But make sure you understand how it works.
For instance, is the loan tied to the prime rate? Is it fixed or variable? Variable rates can hurt if rates keep going up. Determine when that variable rate adjusts and what your new payment amount will be when it does.
Read the fine print: Is there an origination fee (even if you don’t use the loan)? Is there a property appraisal or application fee? Will you incur closing costs? Will your payment amount increase if you’re ever late? And finally, are there fees if you pay the loan back early?
When I was in debt and ignorant of that fact, if I didn’t start writing down my credit card and loan balances, the interest rates, and my monthly obligations — and later entered my information into financial software to track my spending and expenses — I never would have gotten myself in a better position. When you’re comparing home equity products with the intent of making decisions about home equity loans and HELOCs, you will not be able to make competent decisions until you understand the details.
You can’t just stop at the interest rate, either; as David Bach mentions, prepayment fees are important as well. If you want to pay your loan off faster than the provided amortization schedule, prepayment fees can take the place of the interest you think you’re saving. It gets worse. The more customers become aware of the “hidden” fees, the companies seemingly find new ways to confuse and distract.
Seven Ways to Be Home Equity Savvy [David Bach]
Just a week ago Capital One did the right thing by changing its policy about reporting true credit limits to the agencies that calculate credit scores. Hot on the heels of this positive change is another change that could be a good change for the company. Cap One is eliminating its GreenPoint mortgage company, which specializes in no-documentation and Alt-A loans — mortgages generally sold to people who probably shouldn’t qualify for borrowing.
Capital One Financial Corp. said Monday it will cut 1,900 jobs and shutter its wholesale mortgage banking business, a move that comes as lenders continue to struggle in the nation’s housing and mortgage markets.
Capital One said it will shut down GreenPoint Mortgage and eliminate most of the jobs by the end of year. The McLean, Va.-based company will close 31 GreenPoint locations in 19 states and “cease residential mortgage origination” effective immediately but said it will honor commitments to customers with locked rates who have loans already in the pipeline.
“Over the past few months, we have experienced an unprecedented disruption in the secondary mortgage markets,” Capital One Chairman and Chief Executive Officer Richard D. Fairbank wrote in an internal memo to employees. “I made the decision to wind down the business with a heavy heart.”
This isn’t about improving the company’s image by eliminating disrespected business, it’s a liquidity issue. These sub-prime loans are turning out to be not necessarily a bigger risk than expected, but the money is not coming back to the company. Regardless of whether it looks good to the media, Capital One is getting out of the business because it’s no longer the money-maker it was at the beginning.
Thanks to Kai who forwarded me the Associated Press article.
If you’re going to borrow against your home equity, you might want to understand the different options are available. David Bach in a recent column outlined the differences between home equity loans and lines of credit.
Home Equity Loans. Generally called a second mortgage, this type of loan allows you to borrow a set amount that you receive in a lump sum up front. You pay it back over a specified period (typically 10 or 15 years) in monthly repayments. The interest rate is usually higher than a first mortgage but lower than most credit cards, and fixed for the life of the loan.
HELOC. This stands for “home equity line of credit,” and generally works like a credit card. Your lender assigns you a maximum amount up to which you can borrow. You can use only what you need if and when you need it, up to the limit. Interest is typically variable, but usually lower than credit cards because the credit is secured by your home.
There are slight but important differences between the two types of products, and different lenders will throw in additional twists and turns.
Seven Ways to Be Home Equity Savvy [David Bach]
If a home equity loan is not ideal for paying off credit card debt, what other options are there for making the most of the cash that would otherwise be locked away? David Bach has a suggestion, and it is his second tip out of seven for dealing with your home equity.
2. Use home equity credit to build assets.
Besides a financial emergency, the most worthwhile reason to tap your home’s equity is for the purchase of, or investment in, appreciating assets. Buy an income-producing property or a second home and you’ve got a great investment.
Adding onto or upgrading your present home can be another good use for your home equity, if done carefully. According to Remodeling magazine, remodeled kitchens and bathrooms usually hold their value the best.
Using Remodeling magazine for an opinion about the value of remodeling a house is like asking a real estate agent if right now is a good time to buy (or sell). The answer will always be positive despite any evidence to the contrary. The evidence is that any amount you use for home improvements will likely not be fully recovered when it is time to sell. If you want to spend money on a new kitchen, a pool, or any improvement that’s not necessary, it should be for the enjoyment of the improvement. I’ve heard people try to “justify” their spending by saying it increases the value of the house, but the amount of that increase will almost certainly fall short of the amount spent. We all lie to ourselves occasionally, so I don’t pass judgment.
It’s a better option to use leverage, like the debt of a home equity loan, to buy assets that increase in value or produce income. That is why you will see savvy real estate investors use home equity from one property to make a down payment on a rental property. There are some calculations that need to take place in order to make sure the property will pay for itself, but this would be a smart use of debt. Bach also suggests using home equity to invest in a business, but this can be risky. Putting your home equity on the line may not suitable for the risk-averse.
Seven Ways to Be Home Equity Savvy [David Bach]
Does it make sense to use a home equity loan to pay off credit card debt? As with anything, the answer is sometimes. While proponents of certain mortgage payoff acceleration loans might disagree, David Bach is offering some good reasons to let your home equity build without the burdens of extra loans or lines of credit hanging off your equity.
Here is David Bach’s first tip for exuding savviness with your home equity.
1. Don’t rely on home loans to pay off credit card debt.
In my experience, when people borrow against their homes to eliminate credit card debt, they typically just slide right back into it — at the same level or worse — within two to three years. That’s because even after wiping the slate clean, they don’t change their spending habits. They max out their credit cards all over again and find themselves in an even deeper hole.
Is it possible to use your home equity to pay down debt and then stay out of debt? Of course, but generally those disciplined enough to pull this off don’t let their credit cards run amok in the first place.
For the record, from what I understand, David Bach’s experience is dealing with people who seek him out for his financial advice. Therefore, he might be exposed to a lopsided view of the general population. It is hard to ignore the fact that a home equity loan at a lower interest rate will sound attractive to anyone with a lot of credit card debt. I say go ahead and consolidate if doing so will only eat a small portion of your equity, but don’t do so until you’re truly ready to get out of debt. That means you’ll need to change your habits, a hard thing to do if you’re not mentally prepared. Some of the points in 6 Steps to Building a Better Snowball might be helpful before playing around with moving credit card balances.
Mathematically, it can be enormously beneficial to consolidate high-interest credit card debt with a low-interest loan. The brain isn’t ruled by numbers in all cases, so if you continue spending more than you can afford, up to your newly restored credit card limits, you’ll just dig yourself a bigger hole. David Bach thinks that this is the most likely case and will prescribe advice for everyone in that fashion, but I believe it depends heavily on the individual.
Seven Ways to Be Home Equity Savvy [David Bach]
The “snowball method” for paying off debt isn’t something out of Clerks. It is a way to organize your outstanding debt in such a way that the funds you have available for paying off debt are optimally distributed in the manner that will allow you to pay off that debt quickly and cheaply.
There are two opposing philosophies or approaches to the snowball method. The first system was popularized by financial guru Dave Ramsey. In his own words, here is his approach to the snowball method:
List your debts in order with the smallest payoff or balance first. Do not be concerned with interest rates or terms unless two debts have similar payoffs, then list the higher interest rate debt first. Paying the little debts off first gives you quick feedback, and you are more likely to stay with the plan.
Once you have your debts listed in order, pay the minimum payment required to all the debts except for the debt on top, which should receive all the remaining funds for debt service. The value of this approach is in the small victory. By paying your debts off from smallest balance to highest, you will reach satisfaction quickly. For someone who has made debt their way of life, has made the commitment to turn over a new leaf, and requires small successes for motivation, this approach may be beneficial.
Debtor beware: If you choose the above method, you could be paying more interest than necessary for a longer time period than necessary. Simple financial calculations show that if you order your debts from highest interest rate to lowest interest rate rather than lowest balance to highest balance, and then follow the same steps outlined above, you will pay off the debt sooner and spend less on interest throughout.
The big assumption is that you will be able to focus on the larger goal of paying off the entire debt without a quick rate of successes to constantly motivate you. The higher interest rate method still sees you paying off smaller debts throughout the process, so it’s not completely without motivational cues.
This calculator is one of the best I’ve seen that illustrates this point.
Let’s assume I have three credit cards to pay off. The first is an American Express Business Gold Rewards Card with a $13,000 balance and an interest rate of 14.99%. The second card is a Discover Business Miles Card with a $9,000 balance and an interest rate of 13%. The final card is a Starwood Preferred Guest Business Card with a balance of $7,000 and and APR of 7%.
Remember, this is a hypothetical example and not my personal debt situation. Here’s how to use my improved snowball, Flexo’s Debt Avalanche.
Like Dave Ramsey says, the first step is to establish an emergency fund. That’s important, but not directly related to paying off the debt, so let’s use that as our initial starting point and call it Step 0: [click to continue…]
Everybody Lies. That’s the mantra from House, a simple but entertaining television show, whose premises are strangely applicable to personal finance. Recently, Liz Pulliam Weston evaluated a survey about consumer credit card debt that used a mistaken assumption to create misleading data about average household debt.
When a survey says 90% of Americans are either liars or in denial about how much they owe on credit cards, you can bet it’s the surveyors who are the delusional ones. In June, CreditCards.com released a GfK Roper poll that purported to detail Americans’ relationships with credit cards. The survey contained plenty of interesting tidbits, but the poll takers went aground when they tried asking how the respondents’ credit card debts compared to the national average.
The survey started with the assumption that the average household owes $9,300. The surveyors then proceeded to ask respondents if they had less than $9,300 in credit card debt. When the good majority responded that they do in fact have less than that amount, the survey concluded that Americans are in denial or simply lying.
The problem is the $9,300 figure comes from a faulty or misunderstood study from CardWeb.com, which among other things, considers businesses in their end-of-the-year credit tally.
Well, for one, it’s irritating seeing a lie quoted in so many news stories, speeches and blog entries about credit card debt. Our national discussions about consumer indebtedness and bankruptcy are being distorted by the idea that we’re waddling around with four- and five-figure credit card debts.
The myth also gives false comfort to folks who think they’re “average” for having credit card debt, when they’re actually charging down the road to financial ruin. (Those folks are also the ones I’ll hear from after this column is published, by the way. Their arguments usually boil down to “I have credit card debt, so the myth must be true.”)
But mostly, the myth reflects badly on Americans. Most of us tell the truth, most of us aren’t in denial, and most of us aren’t nearly as stupid as some pollsters would like to think.
Liz also writes about how an “average” (mean) figure in populations with a high standard deviation can be relatively meaningless. If three three-year-old cousins spend the afternoon with their 85-year-old grandpa, you could say the average age of the four individuals is 23.5, but the number 23.5 is not representative of the four individuals in any way that’s relevant. It might be better to take Grandpa out of the calculation and focus on the average age of the children. Similarly, the CardWeb statistics include the year-end balances for those who pay their bill off every month. These are individuals who don’t carry credit, so they should not be included in the sample.
It’s very easy to simply trust numbers that are published in conjunction with a survey or scientific study, but that easily leads to misunderstandings. Misinformation can be distributed as easily as information throughout the world and applied to other data, as CreditCards.com did with this particular survey.
Now, here’s a question. Should people who play the 0% APR arbitrage game be included in statistics for credit card debt? They do hold the debt, but the debt was not obtained from a normal consumer action, like purchasing goods or services.
The Big Lie About Credit Card Debt [MSN]
Image credit: dan taylor
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