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Congress Passes Credit CARD Act of 2009, Now What?

by Flexo on May 21, 2009

in Credit

Yesterday, the House of Representatives voted on and passed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009, the Senate’s alternative to the Credit Cardholders’ Bill of Rights. Here are some of the provisions, taking effect in February 2010:

Credit card companies must give 45 days notice before raising interest rates. Under current rules, a credit card company can raise interest rates on a customer for any reason at any time with no notice. Normally, the cardholder can refuse the rate increase and close the account, and the issuer will provide a chance for the customer to pay down the balance. The new bill, once signed into law and put into effect, will require advance notice.

Credit card companies must apply your payments to your highest interest rate balance first. Let’s say you took advantage of a 0% balance transfer offer for $10,000 but ended up needing to use the credit card for an emergency and made a $2,000 purchase at an interest rate of 10.99%. Currently, any payment you make is likely to be applied to your balance transfer until you pay off the $10,000, forcing you to be charged interest on your $2,000 balance. The new rules would change this practice.

Minors will not be able to own their own credit cards. Anyone under the age of 21 requires a parent or legal guardian to be the main account holder. The child or student could then be an authorized user on the account. There is an exception for students who have income and can prove they can be responsible for the charges on their own. Currently, my cat could get a credit card. He’s only twelve years old.

Consumers will need to “opt in” to charge above their credit limit. In the “good old days” of credit cards, if you charged more than the level of credit the issuer decided to grant you, your purchase would be declined, the waiter would return to your table, embarrass you in front of your friends, and cut your card in half with a pair of scissors. These days, you are allowed to go over your limit, but you will be charged a fee for doing so.

Credit card issuers claim this is a service; they would be mortified if one of their customers would be forced to live without air conditioning in the dark because the payment via credit card for the electric bill didn’t go through. Under the new law, consumers would have to “opt in” to receive the benefit of being charged a fee. In any situation, it helps to monitor your usage so you know when you are approaching the limit.

Your existing balance will not be subject to “universal default.” Today, it’s common practice for many credit card issuers to automatically raise interest rates if you are over 30 days late, or default, on a debt payment to anyone else who reports to agencies like Equifax and Experian. If this happens to you, you may find your interest rate to be increased on your full balance. The new law does not outlaw universal default, but it does prevent old balances from being affected. Only new charges will be able to be assigned a default rate.

Anticipating and fearing the future expense of these changes, some credit card issuers have already begun raising interest rates, lowering limits, and reducing rewards across the board. Many people I’ve spoken to, and some who have commented on Consumerism Commentary, are concerned that well-behaved credit card users who pay their bills in full each month and reap the rewards will have trouble finding amazing credit card deals in the future. I’m not too concerned.

The glut of rewards in the past decade is an anomaly. The game of credit card arbitrage, moving balances around from one card to another to take advantage of 0% interest rates while your borrowed money is earning high interest in a bank account, has always been dangerous, and in the end, a losing proposition. The ubiquity of these deals has significantly decreased over the past few years, anyway.

Credit is flowing better than it was six months ago. Yes, there are still people out there having difficulty obtaining loans, but for the well-qualified, like those who pay in full and are responsible, won’t find much trouble with credit card offers.

Credit card companies will still be competitive. They’re not going to drop their rewards programs. Even if they’re not making money on interest fees and late charges, they are making up to 3%, sometimes more, on every regular transaction through merchant fees, and the value of rewards that come back to the consumer is usually less than 1%. Credit card users who seek rewards, like me, charge more on their credit cards, so the issuers make more money on us than we’d like to believe.

Personal responsibility is an important lesson that should be learned prior to opening a credit card account. Paying attention to your own finances may alleviate 80% of the headaches pertaining to credit cards. But as customers get savvier, the industry finds ways to make dealing with them more difficult for the issuer, hiding rules deep in the twenty-page pamphlet of fine print and changing those rules on a whim.

I expect that credit card issuers will continue finding new ways to make money off of customers who either don’t pay attention to their finances or find themselves in financial distress due to external or unforeseen circumstances, and I expect that responsible users will continue to find moderate and reasonable rewards for good credit behavior.

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Number One Frugality Tip: Don’t Be a Woman

by Flexo on April 2, 2009

in Debt Reduction

I will admit that the title of this post is a bit inflammatory. I should specify that the more accurate number one frugality tip should be “Don’t be a woman (or a man, but in our society, mostly a woman) obsessed with beauty.” Newsweek illustrates this by breaking down the cost of female beauty maintenance over a lifetime in a recent article, linked below.

According to the study, the average “modern diva” will spend over $200,000 on hair alone. Add in the expenses for maintaining a beautiful face, body, hands and feet, and the average lifetime expense climbs to almost $450,000.

The Newsweek editors go into further detail by splitting the expense by age group. The graphic below shows how much a woman will spend throughout her “tweens”.

Now, I don’t judge. If you have the money to spend, spend it. But it’s better to be conscious about these costs than to let them go by without thinking about them.

The Newsweek study doesn’t go far enough, however. While they’ve provided details about the expenses, they haven’t studied the effect that spending money on beauty will have on a woman’s income or other levels of success. For example, one theoretical possibility is that a lifetime expense of $450,000 for conforming yourself to what the rest of the world considers “beautiful” will result in a lifetime increase of income of $1,000,000. If that is the case, it would be hard to argue than the price of beauty was not well spent.

Tween's Expenses for Beauty

And in real life, return on investment (ROI) is measured in other ways than money. If for whatever reason, spending money to fit into a certain category makes a person happier, and she can’t find happiness by any other means, how can you argue against spending the money if it is available? If the money is not available, and our diva relies on debt to finance vanity, the true cost out of the pocket could be much greater.

According to the survey’s methodolody, invasive procedures like breast implants and liposuction were not considered in the totals. You can view the raw data here or view the Newsweek story that offers a browsable interface.

Any divas out there? Can you cut back on spending on beauty or is it a justified expense?

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Which Comes First: Paying Off Debt or Starting Emergency Fund?

by Flexo on March 16, 2009

in Debt Reduction

Taking the first few steps to ensure your future financial stability can be daunting. There is so much to do, trying to decide where to start can result in wasted time, and wasted time is wasted money. Eliminating debt is often the first priority, and rightly so. If debt is in the form of credit cards, interest payments could be a massive drag on finances. Credit card companies love offering low minimum payments because they know that consumers who pay only the minimum, and continue adding more debt, will be customers for life. How else could the system get away with taking $20,000 from a customer who purchased a computer worth $1,500?

If you are spending less than you earn, you have the capacity to divert your excess income to long-term savings, debt payments, and an emergency fund. You probably have a desire to put all of you excess income towards reducing that debt, and that’s understandable. Mathematically, that makes the most sense. Credit card interest could accrue at an annual rate of 9.9%, 14.9%, 29.9%, or even worse. It’s highly unlikely that your money can earn that much in any other safe investment over the long term, so paying off debt gives you the most bang for your buck. It’s simple math.

Simple math doesn’t always have the answer when it comes to your money. No, I am not advocating taking emotions into account. Doing what “feels right” isn’t the best option here. But the point is that there are more mathematics to weigh than just interest rates, and it’s the type of math that you can’t plug into online debt payment calculators.

I’ll explain. By diverting all of your excess money to debt repayment without beefing up your savings, you are taking a risk. You are betting that nothing will cause you to incur more debt during the payoff process. Even though your money in a savings account will not earn as much as the amount you’ll save by paying off debt, you have to take into account “known unknowns” and “unknown unknowns.” As the chief financial officer (CFO) of your own life, you have to manage that risj in addition to counting dollars and cents in the bank.

People in corporations get paid lots of money to perform risk management, and if the current financial crisis teaches us anything, it’s that risk managers don’t always do their job perfectly. It is difficult when dealing with issues facing large corporations and industry leaders, but for most people who deal only with loans, credit card debt, future expenses, and investments, risk management can be boiled to its most basic form: have an emergency fund. How can this be applied to paying off debt? Is the emergency fund more important?

If you direct all your excess money to paying off debt, you are likely to fall back into debt the moment an emergency arises. If your water heater breaks and all your money has been directed to your credit cards, you will have to use a credit card again to pay for the repair. You’ve taken one step forward, but now you’re forced to take two, three or four steps backward.

My suggestion is to balance building an emergency fund with paying off debt. When you are ready to divert your excess income to improving your financial condition, start with defining two goals: pay off all of your debt without acquiring more and build a solid emergency fund, which depending on the economy and the market for your skills, might consist of three months’, six months’ or one year’s worth of expenses. Don’t know your monthly expenses? Track where your money is going first.

Start by funding a base for your emergency fund. Pay the minimum to your credit cards or other debt, don’t accrue new debt, and send any extra money to a high-yield savings account until you’ve built one month’s worth of expenses. This will allow you to mitigate some risk while paying down your debt.

Once you’ve reached a one-month buffer, start sending extra money to your credit card with the highest interest rate. I suggest allocating 75% of your excess funds to this first targeted credit card (using the Debt Avalanche method) and 25% to your emergency fund. Keep sending money to your emergency fund month after month until your savings account cushion reaches the goal set above.

Once that target is reached, 100% of your surplus can be directed towards your highest interest rate card. You can rest easily with the knowledge that even while you’ve dramatically reduced the money you throw away to interest payments, you’re financially protected against a temporary loss of income or the typical emergencies you might face. This is just my opinion; maybe you have some thoughts that might be better. Doing anything is better than doing nothing. Do what works for you, if you’ve educated yourself.

Got questions? I (Flexo) and Ramit from I Will Teach You to be Rich are teaming up to answer all of your questions about money. Ask us questions today!

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It’s Not Just About the $400 Tax Credit

by Smithee on February 13, 2009

in Economy

When talking about the 790 billion dollar stimulus bill currently nearing the end of its congressional marathon, it’s tempting for people to focus on the direct, short-term benefits, namely a $400 tax credit, and how such a thing won’t go very far in benefiting most people.

I tend to agree, but I’m also the first to admit that I’m no economist, in fact I’ve never studied macro-economics, and everything I know about personal finance I’ve learned by making mistakes. In my case, an $800 tax credit (married, filing jointly) would go toward paying down the $6,000 IRS bill we were surprised with in 2008.

That tax credit is just one part of the American Recovery and Reinvestment Act (AKA stimulus bill, AKA stimulus package, AKA spending bill, AKA “pork-filled liberal wish list”). For those of us who are already struggling in the post-toxic asset economy, here are some other highlights that should, even if indirectly, help make life a little easier:

  • $4 billion for job training
  • one-time $250 payments to Social Security recipients, poor people on Supplemental Security Income, and veterans receiving disability and pensions
  • my personal favorite: $7.2 billion to bring broadband Internet service to underserved areas
  • $24.7 billion to provide a 65 percent subsidy of health care insurance premiums for the unemployed under the COBRA program
  • $5 billion to weatherize modest-income homes
  • $11 billion toward a so-called “smart electricity grid” to reduce waste
  • $44.5 billion in aid to local school districts to prevent layoffs and cutbacks
  • $4 billion in grants to state and local law enforcement to hire officers and purchase equipment
  • About $70 billion to spare about 24 million taxpayers from being hit with the alternative minimum tax in 2009. The change would save a family of four an average of $2,300
  • About $14 billion to provide a $2,500 expanded tax credit for college tuition and related expenses for 2009 and 2010
  • $4.7 billion to expand the Earned Income Tax Credit for low-income families with three or more children
  • $6.6 billion to repeal a requirement that a $8,000 first-time home buyer tax credit be paid back over time for homes purchased from Jan. 1 to Nov. 30, unless the home is sold within three years

Those bullet points were pulled from this Associated Press story. Check out the whole list and see if anything else strikes your fancy. There are bound to be things in there you don’t agree with, but I’m personally proud of our Congress for managing a workable compromise in such a short amount of time.

It’s also important to pay attention to your state and local news to see how they’re planning on using the funds being offered. Try searching Google News for “stimulus bill” and your closest city.

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Smithee Update: January 2009

by Smithee on January 6, 2009

in Credit

Every Tuesday, Smithee presents an article about his own experiences with credit cards and observations about the credit card industry.

So, nobody’s perfect.

After my recent embarrassing splurge that included a digital camcorder, an audio mixer, three microphones and a new Apple MacBook Pro, I was feeling pretty down on myself.

My credit card debt had gone from about $4,500 last July up to about $8,200 in October. Most of that was the computer, which I felt compelled to purchase mostly because I didn’t want to be using a hand-me-down when I started my new job. That sounds like rationalizing, of course, and it probably is. But because of the new job, I can afford to make even larger payments to my credit card. Each of those payments is now $548, and they happen twice a month, as soon as I get paid. I think of each dollar as a bullet that I’m shooting into the armor of my credit card debt. Blam blam blam!

So now, my credit card debt is back around $6,000, just about the same level as last June. I’m about six months away, and I can almost taste the freedom. The freedom to start saving in earnest, I mean.

But it occurred to me that the difference between the post-splurge amount in October and today’s amount is about $2,200, slightly less than the cost of the computer. I paid off the cost of a new computer in less than three months. An overpriced Apple computer, even. Hopefully I will soon be proud of more reasonable things, like owning assets which contribute a cash flow, but for now this small solace will have to do.

Six more months. I can do this.

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The Federal Reserve Cut is Irrelevant

by Flexo on December 16, 2008

in Economy

The Federal Reserve is expected to drop the federal funds rate to 0.5% today, the lowest it has ever been. When the Fed drops rates, its intent is to increase lending between banks. This drop, however, will likely have no effect on the bank’s lending practices.

This rate is just a target, and it doesn’t dictate the exact rates banks offer each other. In fact, banks have been recently offering each other rates much closer to zero, and interbank lending is still moving slowly.

When the Fed has nowhere else to go, they begin “printing money.” I hear this term in the media, and the most obvious assumption is that “printing money” means that the Bureau of Engraving and Printing speeds up their presses and pumps out more $1, $5, $10, $20 and $100 bills. At least, that’s what I thought until recently. That’s not quite how it works.

“Printing money” is what the government calls it when they raise money by buying back short-term debt from the public, call them bonds or Treasury bills. Companies and individuals can buy money from the government, money that doesn’t really “exist” until it is purchased.

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I am Debt Free as of Today!

by Flexo on December 15, 2008

in Debt Reduction

For several years, interest rates on high-yield savings accounts were high enough to justify choosing to leave extra money in savings accounts rather than using that money to pay off certain debts faster. I was paying only the minimum payment on my consolidated student loan. The loan’s interest rate was 4.25% and I had been earning a little more than that in savings after taxes.

At that time, there was no urgency to pay off the low-interest debt, but the financial climate started to change at the end of last year. Interest available on high-yield savings accounts began to dwindle. By the end of 2007, I decided to eliminate my student loan, my only debt, by the end of 2008. At that time, I had about $13,000 remaining on the loan and had been making payments of my minimum, less than $150, each month.

I had enough cash available at that time to write one check for the $13,000 to eliminate the loan entirely, but I decided it was important for me to keep cash in the bank for flexibility. In January, February, and March, I doubled my monthly payment to $250 to cover interest and principal. In April and May, I paid $500 towards the student loan. For the rest of 2008, I continued to increase my payments through September. In October, with about $6,300 left on the loan, I directed half of the remaining balance to the student loan, leaving about $3,150. I again sliced the remaining debt in half in November.

On Friday, I paid off the remaining $1,500. The payment has cleared today, so I am officially out of debt.

At least for the time being.

If I’ve learned anything from television and other debt-focused blogs it is that I should be jumping up and down with excitement. The fight against debt is often a struggle, especially when that debt is acquired through poor choices. But I feel mostly ambivalent about the achievement. It has helped that I’m earning more than just my day job salary, and thanks to this extra income, I did not have to sacrifice much in order to achieve my target of paying off this debt by the end of 2008. Unlike many struggling with debt, my pursuit is not due to excessive spending. My treatment of debt was not perfect, however.

I graduated in January 1998, but by August 2003, I still had about $4,000 left of my undergraduate student loan. In 2003, I decided to pursue a master’s degree in business. 90% of the tuition (and 0% of the additional fees) would be covered by my employer. Rather than having the company pay the university directly, I allowed the school’s financial aid adviser to convince me to open a loan and use my company’s reimbursements to pay back that loan.

With a long-term view, it was a poor decision. I wonder if the university’s financial aid adviser is instructed to suggest the loan even when expenses are reimbursed because the university makes more money with that option.

With a short-term view, it may have been necessary. At the time, I was not earning much money outside of my day job — my blogging activities didn’t begin earning money until 2004 — and my level of expenses dangerously approached my level of income on a regular basis.

Rather than using my reimbursements to repay the loan, I occasionally deposited the checks into my checking or savings account, allowing the loan to grow. If I had skipped the loan option and decided to have the company pay the school directly, I would have had a tough time with my cash flow for a few years but I might have paid off my remaining student loan much quicker.

As I mentioned, this state of being debt-free is likely only temporary. I do not have a mortgage. I’ve been a renter as long as I’ve been living on my own, and I expect I will continue to rent until I make some decisions about where to live in a more permanent state of being. I expect that I will, at some point, own a house and require financing. Perhaps the feeling of euphoria and excitement that seems to be associated with debt elimination will come once I’ve acquired and conquered a mortgage.

Those who have been following Consumerism Commentary may remember that I also had a car loan. In 2004, I purchased a new Honda Civic — the price differential between “new” and “acceptably used” was negligible — and opted to finance most of the purchase. A loan from family helped me stay away from high interest rates and fees. I paid this loan off within three years.

According to the government, for the first time ever, American household debt has decreased since the same figure was measured three months ago. Don’t get too excited. Americans aren’t suddenly becoming more financially secure. Over the past few months, credit has been harder to come by. Thanks to the state of the economy, car loans, mortgages, and other types of financing for large purchases have been less available. But perhaps there are more people like me who used this year’s declining benefit of savings account interest as an opportunity to pay off debt.

Photo credit: mudpig

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Dave Ramsey’s Baby Steps

by Flexo on August 25, 2008

in Financial Advice and Advisers

I’ve done a good job of sharing my disdain for Dave Ramsey’s popularization of a method of getting out of debt that caters to unmotivated individuals, the “Debt Snowball” method. That doesn’t mean I don’t agree with his principles or his intentions. I just think he, as one of the most popular “gurus” in personal finance, has to cater to the masses. It makes sense for him to profess a methodology that is simple reaches people on an emotional level. Real financial planners who work one-on-one with individuals to get out of debt and formulate a lifetime financial plan would be able to supply better options.

Dave Ramsey does offer something I like, his “Baby Steps.” These are seven suggestions that, when followed sequentially, will do wonders for helping people struggling with their finances to take ownership of the money in their life and start moving towards a more prosperous future.

Here are Dave’s suggestions, verbatim:

In general, I like this plan of action. These “baby steps” help someone ease into a pattern of new, financially responsible behavior, with small mini-goals which when taken in full view go a long way to help ensure financial stability.

These “baby steps” are designed to appeal to a large mass of people. This is not advice based on any one individual’s real situation, so it’s fair to apply some customization and perhaps even improvements. Here are a few small criticisms.

Is $1,000 enough or too much for an emergency fund base? Dave Ramsey suggests shoring up a $1,000 cash cushion before beginning to pay off debt. Although $1,000 is a finite number of dollars, its value has a different meaning to different people or to different families. A family with an income of $250,000 a year and $1,000,000 in debt may not consider $1,000 to be much of anything, while a family earning $20,000 per year and $100,000 in debt might find the saving of $1,000 to be a struggle. So what’s a better option? I would suggest that this base savings, what is needed to lay the groundwork before embarking on the great debt reduction journey, should be one months’ expenses, whatever they happen to be. That sets a high enough starting goal.

The “Debt Snowball” method is not so great. Despite its popularity and proven track record with a million dollar business marketing this method, I’d like to see more people give a real try to the Debt Avalanche. They’ll save money and time in the long run if they are intrinsically motivated. I’ve discussed this at length before.

Is it too soon to worry about college funding for children? I’ve heard experts suggest that parents should make sure their retirement is fully funded before worrying about funding education for their children. I don’t think saving 15% of household income, unless begun at a young age, will get most parents to a secure retirement, but that depends on the family’s needs at that later date. There are too many variables to predict that with any accuracy. The reason most experts suggest this is because you can borrow money for college, but you can’t borrow money (as easily or inexpensively) for retirement.

I strongly believe that parents have a responsibility to ensure that the best educational opportunities are available to their children, but with the prices of tuition increasingly well beyond the rate of inflation, I’m not sure how well that philosophy will work in the future.

Why pay off the mortgage early? Dave Ramsey is strongly against holding all forms of debt. Mostly, I agree. If the mortgage rate is low enough, and you have the fortitude, risk tolerance, and availability to invest the funds you would otherwise use to accelerate your mortgage payment in an asset allocation designed with a long-term time horizon, it may make more sense to pay just your minimum to the mortgage. But I won’t stop anyone who wants to pay off their mortgage early, even if they might end up with a lower net worth than if they had invested. The market is unreliable, but when paying off a mortgage early, you’re guaranteed to “earn” the rate of interest you’re being charged. It’s not a precise way of figuring the math, but knowing that you don’t have to pay interest that was originally included in your amortization is good.

Thanks go to Dave Ramsey for popularizing good general advice.

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