a foolproof way to turn $1 a day into $67,815? It doesn't take a lot of
money or time or personal sacrifice. There's no magic, no multilevel marketing
and no salesman will call at your door.
it's the simplest and most-proven way to get richer, and if you extend
this concept to other parts of your life, you could end up with an enviable
retirement nest egg.
all you have to do is take your pocket change at the end of the day
and drop it in a jar. If you can do that, and you put away about $1
a day, that's just $7 a week. At the end of the month, you'll have about
is money in your pocket, you've already paid taxes on it in the form
of withholding from your paycheck. (If you're self-employed, that's
not true, but we'll ignore that to keep things simple.) Every month,
deposit your savings in a Roth IRA account, where it can grow tax-free
and -- more important -- be withdrawn tax-free in the future.
a paltry $30 a month going to do for you? Growing tax-free for 30 years,
with a 10% annual return, your investment account will be worth $67,815.
Not bad for pocket change, but that's just the beginning.
some other ideas for saving a few bucks here and there that can add
up to big dollars over time.
| Trim your expenses to save more
vs. dining out once a month
trips to car wash
rental vs. movie monthly
coffee instead of cappuccino on weekdays
If you can knock this $123 out of your
monthly budget, at 10% it will grow to $278,040 in 30 years. You've practically
financed your retirement with just a few small sacrifices.
want to see for yourself how small savings can multiply over time, spend
a little time playing with MSN
Money's Savings Calculator. You'll see that if you can add in some
big-ticket savings, it takes just $443 a month to make yourself a millionaire.
a couple of ways to do it:
Often, the same people who bemoan the fact that they can't save are driving
around in a new car and making monthly payments on a 48-, 60- or 72-month
loan. But you'll be amazed by how much you can save by buying a used car.
You put $6,000 down to buy a new car worth $26,000. You finance $20,000
at 9% interest for 60 months. Your monthly payments are $415.16. Total
interest costs are $4,910, making the total cost of the car nearly $31,000.
a paltry $30 a month going to do for you? Growing tax-free for 30 years,
with a 10% annual return, your investment account will be worth $67,815.
Not bad for pocket change, but that's just the beginning.
example: You pay $6,000 cash for a good used car. Invest that same $415.06
a month for the same 60 months with an average 9% rate of return. At
the end of 60 months you would have roughly $29,000 in your investment
account after paying taxes of about $6,300 on your long-term capital
gains. (The exact amount would vary depending on factors such as whether
your investments paid dividends.) Even if you subtract the cost of whatever
additional repair costs you may have for your older car, you still come
out way ahead.
Buying on credit is a convenient way to pay too much for everything
you buy. Consider the costs: Say you spent $1,000 on clothing, using
a credit card charging 18% interest, and you make the minimum monthly
payment to pay off the balance. It would take you almost six-and-a-half
years to erase the debt, and your $1,000 wardrobe would actually cost
you more than $1,650.
you'd rather buy some furniture. Buy $2,000 worth of furnishings with
a credit card charging 18.5% interest and consider the consequences
if you pay off the balance by making minimum monthly payments. It will
take more than 11 years to repay the debt. By the time the loan is paid
off, you will have spent an extra $1,934 in interest alone -- almost
the actual cost of the furniture.
most things in life, when it comes to saving money, it pays to sweat
the small stuff. And when you're done with that, go after the big stuff
By R Jenkins (MSN.com)
The Three-Day Cancellation Rule
considering applying for a personal loan and using your home to guarantee
repayment, you should know that a federal credit law gives you three
days to reconsider a signed credit agreement and cancel the deal without
penalty. Your "right to rescind" or "right to cancel"
is guaranteed by the Truth In Lending Act. You can rescind for any reason
but only if you are using your principal residence—whether it
is a condominium, mobile home, or house boat—as collateral, not
a vacation or second home.
right to rescind, you have until midnight of the third business day
to cancel the credit transaction. Day one begins after all three of
the following occur:
sign the credit contract;
receive a Truth in Lending disclosure form containing certain key information
about the credit contract, including the annual percentage rate; finance
charge; amount financed; and payment schedule; and...
receive two copies of a Truth in Lending notice explaining your right
purposes, business days include Saturdays but not Sundays or legal public
holidays. For example, if the events listed above take place on a Friday,
you have until midnight on the next Tuesday to rescind.
this waiting period, activity related to the contract cannot take place.
The creditor may not deliver the money for the loan. If you’re
dealing with a home improvement loan, the contractor may not deliver
any materials or start work.
decide to rescind, you must notify the creditor in writing. You may
not rescind by telephone or in a face-to-face conversation with the
creditor. Your written notice must be mailed, filed for telegraphic
transmission, or delivered if by other written means, before midnight
of the third business day.
cancel the contract, the security interest in your home is also cancelled,
and you are not liable for any amount, including the finance charge.
The creditor has 20 days to return all money or property you paid as
part of the transaction and release any security interest in your home.
If you received money or property from the creditor, you may retain
it until the creditor shows that your home is no longer being used as
collateral and returns any money you have paid. Then, you must offer
to return the creditor’s money or property. If the creditor does
not claim the money or property within 20 days, you may keep it.
have a bona fide personal financial emergency—such as damage to
your home from a storm or other natural disaster—the law allows
you to waive your right to rescind and eliminate the three-day period.
To waive your right, you must give the creditor your own written statement
describing the emergency and stating that you are waiving your right
to rescind. The statement must be dated and signed by you and anyone
else who shares in ownership of the home. But remember: if you waive
your right to rescind, you must go ahead with the transaction.
to rescind does not apply in all situations when you are using your
home for collateral. Among the exceptions are:
you apply for a loan to buy or build your principal residence;
- when you refinance your loan with the same creditor who holds your
loan and you don’t borrow any additional funds; or
- when a state agency is the creditor for a loan.
situations, you may have other cancellation rights under state or local
Promising Debt Relief May Be Offering Bankruptcy
got you down? You're not alone. Consumer debt is at an all-time high.
What's more, record numbers of consumers-nearly 1.5 million in 2001-are
filing for bankruptcy. Whether your debt dilemma is the result of an
illness, unemployment, or simply overspending, it can seem overwhelming.
In your effort to get solvent, be on the alert for advertisements that
offer seemingly quick fixes.
ads pitch the promise of debt relief, they rarely say relief may be
spelled b-a-n-k-r-u-p-t-c-y. And although bankruptcy is one option to
deal with financial problems, it's generally considered the option of
last resort. The reason: its long-term negative impact on your creditworthiness.
A bankruptcy stays on your credit report for 10 years, and can hinder
your ability to get credit, a job, insurance, or even a place to live.
Trade Commission (FTC) cautions consumers to read between the lines
when faced with ads in newspapers, magazines or even telephone directories
your bills into one monthly payment without borrowing."
credit harassment, foreclosures, repossessions, tax levies and garnishments,"
out your debts! Consolidate your bills! How? By using the protection
and assistance provided by federal law. For once, let the law work for
find out later that such phrases often involve bankruptcy proceedings,
which can hurt your credit and cost you attorneys' fees.
having trouble paying your bills, consider these possibilities before
considering filing for bankruptcy:
your creditors. They may be willing to work out a modified payment plan.
a credit counseling service. These organizations work with you and your
creditors to develop debt repayment plans. Such plans require you to
deposit money each month with the counseling service. The service then
pays your creditors. Some nonprofit organizations charge little or nothing
for their services.
consider a second mortgage or home equity line of credit. While these
loans may allow you to consolidate your debt, they also require your
home as collateral.
of these options is possible, bankruptcy may be the likely alternative.
There are two primary types of personal bankruptcy: Chapter 13 and Chapter
7. Each must be filed in federal bankruptcy court. The current filing
fees are $185 for Chapter 13 and $200 for Chapter 7. Attorney fees are
additional and can vary widely. The consequences of bankruptcy are significant
and require careful consideration.
13 allows you, if you have a regular income and limited debt, to keep
property, such as a mortgaged house or car, that you otherwise might
lose. In Chapter 13, the court approves a repayment plan that allows
you to pay off a default during a period of three to five years, rather
than surrender any property.
7, known as straight bankruptcy, involves liquidating all assets that
are not exempt. Exempt property may include cars, work-related tools
and basic household furnishings. Some property may be sold by a court-appointed
official-a trustee-or turned over to creditors. You can receive a discharge
of your debts under Chapter 7 only once every six years.
of bankruptcy may get rid of unsecured debts and stop foreclosures,
repossessions, garnishments, utility shut-offs, and debt collection
activities. Both also provide exemptions that allow you to keep certain
assets, although exemption amounts vary. Personal bankruptcy usually
does not erase child support, alimony, fines, taxes, and some student
loan obligations. Also, unless you have an acceptable plan to catch
up on your debt under Chapter 13, bankruptcy usually does not allow
you to keep property when your creditor has an unpaid mortgage or lien
Produced in cooperation with the American Financial Services Association
Ways to Save Money
may lower the price of a round trip air fare by as much as two-thirds
by making certain your trip includes a Saturday evening stay over,
and by purchasing the ticket in advance.
make certain you have a cheap fare, even if you use a travel agent,
contact all the airlines that fly where you want to go and ask what
the lowest fare to your destination is.
flexible, if possible. Consider using lowfare carriers or alternative
airports and keep an eye out for fare wars.
car rental rates can vary greatly, shop around for the best basic
rates. Ask about any additional charges (extra driver, gas, drop-off
fees) and special offers.
car companies offer various insurance and waiver options. Check
with your automobile insurance agent and credit card company in
advance to avoid duplicating any coverage you may already have.
can save thousands of dollars over the lifetime of a car by selecting
a model that combines a low purchase price with low financing, insurance,
gasoline, maintenance, and repair costs. Ask your local librarian
for new car guides that contain this information.
selected a model, you can save hundreds of dollars by comparison
shopping. Call at least five dealers for price quotes and let each
know that you are calling others.
there is no "cooling off" period on new car sales. Once
you have signed a contract, you are obligated to buy the car.
buying any used car:
the seller's asking price with the average retail price in a
"bluebook" or other guide to car prices found at many
libraries, banks, and credit unions.
a mechanic you trust check the car, especially if the car is
sold "as is."
purchasing a used car from an individual you know and trust. They
are more likely than other sellers to charge a lower price and point
out any problems with the car.
decide to lease a car just because the payments are lower than on
a traditional auto loan. The leasing payments may be lower because
you don't own the car at the end of the lease.
a car is very complicated. When shopping, consider the price of
the car (known as the capitalized cost), your trade-in allowance,
any down payment, monthly payments, various fees (excess mileage,
excess "wear and tear," end-of- lease), and the cost of
buying the car at the end of the lease. Keys to Vehicle Leasing:
A Consumer Guide, published by the Federal Reserve Board and Federal
Trade Commission, is a valuable source of information about auto
can save hundreds of dollars a year by comparing prices at different
stations, pumping gas yourself, and using the lowest-octane called
for in your owner's manual.
can save up to $100 a year on gas by keeping your engine tuned and
your tires inflated to their proper pressure.
lose billions of dollars each year on unneeded or poorly done car
repairs. The most important step that you can take to save money
on these repairs is to find a skilled, honest mechanic. Before you
need repairs, look for a mechanic who:
certified and well established;
done good work for someone you know; and
well about repair options and costs.
can save several hundred dollars a year by purchasing auto insurance
from a licensed, low-price insurer. Call your state insurance department
for a publication showing typical prices charged by different companies.
Then call at least four of the lowest-priced, licensed insurers
to learn what they would charge you for the same coverage.
to your agent or insurer about raising your deductibles on collision
and comprehensive coverages to at least $500 or, if you have an
old car, dropping these coverages altogether. Taking these steps
can save you hundreds of dollars a year.
certain that your new policy is in effect before dropping your old
can save several hundred dollars a year on homeowner insurance and
up to $50 a year on renter insurance by purchasing insurance from
a low-price, licensed insurer. Ask your state insurance department
for a publication showing typical prices charged by different licensed
companies. Then call at least four of the lowest priced insurers
to learn what they would charge you. If such a publication is not
available, it is even more important to call at least four insurers
for price quotes.
certain you purchase enough coverage to replace the house and its
contents. "Replacement" on the house means rebuilding
to its current condition.
certain your new policy is in effect before dropping your old one.
you want insurance protection only, and not a savings and investment
product, buy a term life insurance policy.
you want to buy a whole life, universal life, or other cash value
policy, plan to hold it for at least 15 years. Canceling these policies
after only a few years can more than double your life insurance
your public library for information about the financial soundness
of insurance companies and the prices they charge. The July 1998
issue of Consumer Reports is a valuable source of information about
a number of insurers.
can save more than $100 a year in fees by selecting a checking account
with a low (or no) minimum balance requirement that you can, and
do, meet. Request a list of these and other fees that are charged
on these accounts.
institutions often will drop or lower checking fees if paychecks
are directly deposited by your employer. Direct deposit offers the
additional advantages of convenience, security, and immediate access
to your money.
and Investment Products
opening a savings or investment account with a bank or other financial
institution, find out whether the account is insured by the federal
government (FDIC or NCUA). An increasing number of products offered
by these institutions, including mutual stock funds and annuities,
are not insured.
earn the highest return on savings (annual percentage yield) with
little or no risk, consider certificates of deposit (CDs) and treasury
bills or notes.
you select a type of savings or investment product, compare rates
and fees offered by different institutions. These rates can vary
a lot and, over time, can significantly affect interest earnings.
can save as much as a thousand dollars or more each year in lower
credit card interest charges by paying off your entire bill each
you are unable to pay off a large balance, pay as much as you can
and switch to a credit card with a low annual percentage rate (APR).
For a modest fee, RAM Research Corp. (800-344-7714) will send you
a list of low-rate cards. You can obtain a list of low-rate cards
by accessing "www.ramresearch.com"
on the Internet.
can reduce credit card fees, which may add up to more than $100
a year, by getting rid of all but one or two cards, and by avoiding
late payment and over-the-credit limit fees.
you have significant savings earning a low interest rate, consider
making a large down payment or even paying for the car in cash.
This could save you as much as several thousand dollars in finance
can save as much as hundreds of dollars in finance charges by shopping
for the cheapest loan. Contact several banks, your credit union,
and the auto manufacturer's own finance company.
your monthly payment may be higher, you can save tens of thousands
of dollars in interest charges by shopping for the shortest-term
mortgage you can afford. On a $100,000 fixed-rate loan at 8% annual
percentage rate (APR), for example, you will pay $90,000 less in
interest on a l 5-year mortgage than on a 30-year mortgage.
can save thousands of dollars in interest charges by shopping for
the lowest-rate mortgage with the fewest points. On a 15-year, $100,000
fixed-rate mortgage, just lowering the APR from 8.5% to 8.0% can
save you more than $5,000 in interest charges. On this mortgage,
paying two points instead of three would save you an additional
your local newspaper does not periodically run mortgage rate surveys,
call at least six lenders for information about their rates (APRs),
points, and fees. Then ask an accountant to compute precisely how
much each mortgage option will cost and its tax implications.
aware that the interest rate on most adjustable rate mortgage loans
(ARMs) can vary a great deal over the lifetime of the mortgage.
An increase of several percentage points might raise payments by
hundreds of dollars per month.
refinancing your mortgage if you can get a rate that is at least
one percentage point lower than your existing mortgage rate and
plan to keep the new mortgage for several years or more. Ask an
accountant to calculate precisely how much your new mortgage (including
up-front fees) will cost and whether, in the long run, it will cost
less than your current mortgage.
cautious in taking out home equity loans. These loans reduce the
equity that you have built up in your home. If you are unable to
make payments, you could lose your home.
home equity loans offered by at least four banking institutions.
In comparing these loans, consider not only the annual percentage
rate (APR) but also points, closing costs, other fees, and the index
for any variable rate changes.
can often negotiate a lower sale price by employing a buyer broker
who works for you not the seller. If the buyer broker or the broker's
firm also lists properties, there may be a conflict of interest,
so ask them to tell you if they are showing you a property that
they have listed.
not purchase any house until it has been examined by a home inspector
that you selected.
a Place to Live
not limit your rental housing search to classified ads or referrals
from friends and acquaintances. Select buildings where you would
like to live and contact their building manager or owner to see
if anything is available.
that signing a lease probably obligates you to make all monthly
payments for the term of the agreement.
repairs often cost thousands of dollars and are the subject of frequent
complaints. Select from among several well established, licensed
contractors who have submitted written, fixed-price bids for the
not sign any contract that requires full payment before satisfactory
completion of the work.
Consumer Reports, available in most public libraries, for information
about specific brands and how to evaluate them, including energy
use. There are often great price and quality differences among brands.
you've selected a brand, check the phone book to learn what stores
carry this brand, then call at least four of these stores for the
prices of specific models. After each store has given you a quote,
ask if that's the lowest price they can offer you. This comparison
shopping can save you as much as $100 or more.
save as much as hundreds of dollars a year on electricity, make
certain that any new appliances you purchase, especially air conditioners
and furnaces, are energy-efficient. Information on the energy efficiency
of major appliances is found on Energy Guide Labels required by
in load management programs and off-hour rate programs offered by
your electric utility may save you up to $100 a year in electricity
costs. Call your electric utility for information about these cost-saving
home energy audit can identify ways to save up to hundreds of dollars
a year on home heating (and air conditioning). Ask your electric
or gas utility if they can do this audit for free or for a reasonable
charge. If they cannot, ask them to refer you to a qualified professional.
with your phone company to see whether a flat rate or measured service
plan will save you the most money.
will usually save money by buying your phones instead of leasing
your local phone bill to see if you have optional services that
you don't really need or use. Each option you drop could save you
$40 or more each year.
Distance Telephone Service
distance calls made during evenings, at night, or on weekends can
cost significantly less than weekday calls.
you make more than a few long distance calls each month, consider
subscribing to a calling plan. Call several long distance companies
to see which one has the least expensive plan for the calls you
possible, dial your long distance calls directly. Using the operator
to complete a call can cost you an extra $6.
Purchased at Markets
can save hundreds of dollars a year by shopping at the lower-priced
food stores. Convenience stores often charge the highest prices.
will spend less on food if you shop with a list.
can save hundreds of dollars a year by comparing price-per-ounce
or other unit prices on shelf labels. Stock up on those items with
low per-unit costs.
brand name drugs are usually much more expensive than their generic
equivalents, ask your physician and pharmacist for generic drugs
pharmacies may charge widely different prices for the same medicine,
call several. When taking a drug for a long time, also consider
calling mail-order pharmacies, which often charge lower prices.
your wishes known about your funeral, memorial, or burial arrangements
in writing. Be cautious about prepaying because there may be risks
information about the least costly options, which could save you
several thousand dollars, contact a local memorial society, which
is usually listed in the Yellow Pages under funeral services.
selecting a funeral home, call several and ask for prices of specific
goods and services, or visit them to obtain an itemized price list.
You are entitled to this information by law and, by using it to
comparison shop, you can save hundreds of dollars.
to squeezing my flabby money habits into that new skin-tight budget.
Oh brother! Wearing this thing is a bit painful. Here's how I did it.
Creating a budget after 36 years of living without one is like finding
that perfect pair of jeans. You try them on in the store, and you cannot
believe how great those jeans make you look. Then you take 'em home,
wash 'em a few times. Suddenly they're a little too snug -- or your
butt is a little too ample -- and you?re trying to squeeze yourself
into a pair of pants (and a budget) that doesn't fit or feel that great.
you know that even though your jeans will never again achieve the Britney-like
perfection they had in the store, they will loosen up. And the good
news I bring to you, my financial pal, is that so does the budget. Or
at least you get more comfortable. But there is that period when you?re
squirming around, feeling like you gotta wriggle into something that's
two sizes too small. Here's how I did it.
The basic concept behind my budget is to establish a few big categories
for tracking my spending, rather than fret over every penny. The most
important goal is to limit committed spending (e.g. rent or mortgage,
insurance, taxes, kids' music lessons, pet food, car payments) to 60%
of your gross income. Then you divide the remaining 40% into four chunks:
10% to retirement; 10% to long-term and emergency savings; 10% for irregular
expenses; 10% for fun money.
hate counting pennies, I love dividing my money into chunks that are
big enough to keep things simple, yet also allow for growth, change
and expecting the unexpected. The trouble was learning to live within
that svelte 60%.
I'm a freelance writer, I do have some regular writing assignments (like
this one), so about 70% of my income is fairly steady from month to
month. The rest comes in the form of big checks for longer articles
that I get five or six times a year. Mind you, I also have to pay a
big tax bill once every quarter. So the top priority for me was to translate
this vague notion of 60% into real numbers.
For the sake of argument and to preserve some tiny shred of financial
privacy for myself, let's fantasize that I make about $75,000 a year.
I don't, but, A) this is roughly the median income range for the readers
of most personal finance magazines, and, B) it's close enough so that
the exercise actually worked for me. Multiplying $75,000 by 60% and
dividing the result by 12 leaves me with $3,750 per month for my committed
that my regular assignments provide about $4,400 per month that I can
count on. That's more than enough for my committed expenses -- including
taxes -- but I also need my fun money every month. Please note: fun,
or what I call Doing Stuff With Friends, should not be part of the 60%.
You take that out of your 10% fun category. Taking 10% of $75,000 and
dividing by 12, I get $625 per month for fun -- or roughly $150 per
retirement and irregular savings and debt repayment from those big irregular
checks. The one thing I have to be careful about is to set aside money
each month to pay my taxes when they're due. (If you get a regular paycheck,
taxes have already been withheld, of course.)
to live with the numbers
This was weird for me. Living on a budget means living within certain
limitations. I like to think of myself as a limitless kind of gal.
where knowing the numbers comes in handy. You can't argue with them.
If I want to spend more than $150 a week socializing (which in New York
is painfully easy to do), I lose out in another category, like paying
down debt (which is what I'm using the 10% long-term savings category
In my last
column, I used the Spending analyzer on my MSN Money account and realized
that I was taking out an insane amount of money in ATM withdrawals.
That left me wondering where it all went.
using my debit card for more purchases and soon figured out that the
source of trouble for me is the fun category: hanging out, eating out,
meeting for drinks, coffee, lunch. Clearly I'm having WAY more fun than
I can technically afford.
the point of a budget, isn't it? It holds up a mirror to all those unsightly
blemishes you'd rather not see. And you might be surprised by what you
do see when you start looking. I don't need to break myself of an expensive
shoe habit, but the Doing Stuff With Friends category is breaking the
bank! The other night I met one friend for a drink, and then we joined
other friends for dinner. I spent $50, one third of my fun budget, in
one night, without batting an eye.
gotta stop. And it has. I've started cooking more, eating out less and
inviting friends over to hang out at home -- home being noticeably cheaper
than most Manhattan restaurants. (And I make a mean shrimp scampi.)
rears its ugly head
But your budget is never safe. It's constantly under siege by the temptations
of the world.
an almost-irresistible opportunity to rent a room in a year-round country
house. When you don't own a vacation home, renting a room in a shared
house with friends is the perfect way to survive New York City life.
Plus, this one was cheap (relatively speaking) at about $270 a month.
had these moments. You waltz across something you want badly -- a new
coat, a new car, a vacation. You know it's not going to break the bank.
It might even be a deal.
the benign influence of Spending Delusion #1, "I have to buy it
because it's so cheap," you justify spending money you don't have.
find a way to make it work. I realized, facing the painful, gut-wrenching
reality of my budget, that I simply don't earn enough to justify spending
a measly $270 a month extra on anything. Period. So I could let the
getaway house get away -- or I could get creative and make room in the
60% I've set aside for committed expenses.
is to finagle a little extra money. As a freelancer I can do that --
you can too, by working overtime, say, or having a massive garage sale.
That helps, but it?s not going to pay a regular rent bill.
editor had an idea (because really, he does want me to succeed at this,
if only because it makes him look good). He pointed out that by depositing
the 10% of my income designated for retirement (that's about $7,500)
into a SEP-IRA (that's a 401(k) for the self-employed), I'd reduce my
taxes by $870 a year, or $70 a month.
is, can I cut $200 a month worth of fat from my 60%? That would mean
cutting $50 a week from somewhere. That's going to take a little more
a week is about $10 a day. Surely I can cut $10 a day in order to have
a room in a house in the country. But realistically speaking, that's
going to take some time, and I'll have to keep you posted.
not all, folks
I wish it were. But as I've discovered, these are the skills you need
to live sensibly with money. It's slow. It's like trying to tighten
up your flabby gut at the gym. I have to break myself of old habits
and create new ones -- and be disciplined. Did I want that lovely butcher-block
kitchen cart I saw at Crate & Barrel for $249? Yes. Did I instead
go to a junk shop and buy a modest $25 steel cabinet on which I can
put my plastic cutting board? You betcha.
you, if I can figure this out, ANYONE CAN.
challenge will be setting up a financial system for making sure my retirement
money goes where it's supposed to and that I put the savings for irregular
expenses in a place where it won't accidentally get mixed in with the
dining-out money. Because, trust me, if you are new to this, you don't
want to leave anything up to chance. Because chances are, you'll just
spend it. And we're not doing that anymore, are we?
By MP Dunleavey
WHEN TO BORROW--AND WHY
has a bigger impact on your wealth than almost any other decision you
make. So what's a good reason to borrow? To buy a house, sure, but not
about when and why to borrow have a bigger impact on your overall wealth
than almost any other decision you make. Yet few of us think about it
in those grand terms. Instead, we think of solving an immediate problem
or fulfilling an immediate need -- or desire.
in this piecemeal way about your finances can be devastating to your
wealth. It's like shooting yourself in the foot before you run a race.
By borrowing money and paying interest, you’re decreasing your
overall wealth to accomplish a goal or acquire an asset. If what you
acquire is a wasting asset -- something that declines in value -- you
put yourself further behind in the game of realizing long-term goals.
is based on a theory called the utility theory, which assumes that each
person's goal is to maximize his wealth. To do that, the rational person
examines each financial decision to see how it will impact his wealth
over the long term and then makes the choice that will increase his
that's the way it should be. But it's a long shot from the way it is.
"Every one of these assumptions is wrong," says Daniel Kahneman,
a psychology professor at Princeton University and a leading figure
in a new discipline called behavioral finance. "People take a short-term
view and they compartmentalize things rather than looking at them in
a grand way."
like Kahneman argue that we think in terms of mental accounts. For example,
we mentally put our 401(k) plan into one account and consider whether
that account is ahead or behind for the year. Our home is another account.
Emergencies, and loans, are another matter altogether.
should be saved for rare occasions
Of course, there are times when you must borrow. But they are probably
fewer than you think. You should never borrow for a wasting asset. That
includes clothes, furnishings, entertainment, vacations and dinners
you pay only the minimum balance on your cards, you could be paying
for that dinner 30 years after you digested it," says Marc Eisenson,
author of the best-seller, "The Banker's Secret," and a staunch
opponent of any kind of debt.
cards require a minimum payment of 2% to 3% of the balance, Eisenson
says. That means you’re required to pay only $100 to $150 a month
on a balance of $5,000. "Most people assume you are better off
with the one that requires $100," Eisenson says. "But with
that one, you are paying so little in principal that you could be paying
for 30 yearsand end up sending in $10,000 to $15,000 in interest for
the $5,000 you borrowed.”
a $100 dinner could cost you $300 by the time you've paid it off. But
the after-tax cost is much higher. "People forget they have to
earn a lot more because they have to pay taxes," Eisenson says.
"So you really have to earn $450 to have $300 left over for that
meal. That's why so many people are caught living paycheck to paycheck."
a good reason to borrow then? Perhaps the best reason is to buy a home.
A home mortgage is one of the few loans that still provides a tax deduction
for interest. That makes the real cost of a home mortgage less than
that for other debt.
you pay on a home of up to $1 million in value is tax-deductible. So
if you’re in the 30% marginal tax bracket, the government pays
30% of your interest. That means if you pay $15,000 a year in mortgage
interest, the real cost to you is just $10,500.
at it another way, if you pay 8% on your loan, the after-tax cost is
70% of that, or a 5.6% interest rate. You might also build in an inflation
factor. Inflation is a great boon to debtors because they acquire an
asset in today's dollars and pay it off in tomorrow's.
the low inflation we have today, you could reduce your real interest
rate for a home loan. If inflation is 2%, perhaps we could say your
real cost of borrowing for your home is 5.6% minus 2 percentage points
or 3.6%. Taking inflation directly off the interest rate is hardly a
mathematically rigorous method of measuring your cost. Ideally, you
would look at cash flows and so forth. But it gives you an idea of what
it costs you to borrow.
your own home provides psychological as well as financial benefits.
That's why many financial planners urge clients to "go for it"
when they find a home they love.
consumer, according to some experts, would take out a loan only for
a home -- and perhaps a second home -- to capture the tax break. Everything
else would come from his emergency fund or from short-term or long-term
model consumer sets short-term and long-term goals, sets aside money
to realize them and, in fact, operates under the utility theory that
many economists have abandoned to increase his overall wealth. If you
fall short of the model, aim for it.
By R Jenkins
ways to protect yourself in a credit crunch
Rising debt, delinquencies, tapped-out equity: ominous signs of a
credit system that is seriously out of whack. Here's your best insurance
against the day when dollars are scarce and credit is tight.
First it was the stock market bubble. Then the housing bubble. Now
concern is growing about what may, in fact, be the ultimate bubble:
have piled on so much debt in the last decade that some economists
are worrying about the possible fallout if consumers, already living
on the edge, are pushed over by rising unemployment.
a growing number of layoffs leads to widespread loan defaults, consumer
bankruptcies and deflation, you’ve got a grim scenario indeed. Not
only does credit become much harder to obtain, but it's more expensive,
because the dollars you use to pay back your debt would be worth more
in the future than they are today.
This concept is a little hard for those of us raised after the Depression
to grasp. After all, we’ve always paid back debt with cheaper money.
Thanks to inflation, dollars repaid in the future are worth less than
dollars borrowed today.
how it works: Let's say the annual rate of inflation is 2% and you
take out a loan at 7%. Your loan's real interest rate, adjusted for
inflation, is just 5%. If instead you have deflation of 2%, the cost
of a 7% loan in real terms jumps to 9%.
the macroeconomic level, more costly and less available credit reduces
the funds consumers have available to spend, undercutting one of the
economy's major pillars of strength over the past few years. Jim Jubak
describes the potential impact on investors in “Get ready for the
consumer credit crunch.”
So how real is the consumer debt bubble? It’s hard to appreciate how
much credit inundated the economy in the 1990s until you look at the
numbers. Here’s just a sample:
amount of outstanding credit card debt rose from $173 billion in
1990 to $608 billion in 2001, according to Cardweb.com. Adjusted
for inflation, that’s a rise of 160%.
During the same period, average credit card debt rose from $2,985
per card-carrying household to $8,367.
Home equity lending rose sharply from $461 billion of outstanding
debt in 1990 to more than $1 trillion last year. Adjusted for inflation,
that's a 60% increase.
Household debt burdens have risen to near record highs. Ten years
ago, 12.47% of the average household’s disposable income went to
pay consumer and mortgage debt, according to the Federal Reserve.
This year, the figure is up to 14.05%.
debt loads aren’t necessarily a concern if they’re accompanied by
growing assets and rising incomes, as they were for most of the 1990s.
But now we’re seeing signs that easy credit is taking its toll:
Foreclosures have reached the highest level in at least 30 years,
according to the Mortgage Bankers Association of America. The latest
figures, showing 0.4% of homes in foreclosure, are especially disturbing
because foreclosures don’t usually rise in a hot real estate market,
when most homeowners can sell their homes quickly. This indicates
that a rising number of homeowners may owe more on their homes than
the houses are worth.
Bankruptcies keep hitting record highs, with 1.5 million filings
in the 12 months ending March 30, 2002.
Credit card delinquency rates have risen 30% in the past year, with
3.88% of credit card accounts past due.
The average homeowner’s equity represents just 55% of the home’s
value -- down significantly from the 67% level typical of the 1960s,
1970s and 1980s. Again, this is as home prices are rising -- indicating
that people are draining the equity out of their homes at an alarming
rate, leaving less as a cushion in case of emergency or declining
some cases, lenders seem to be responding by gradually tightening,
being slightly less willing to extend new credit. Those zero-percent
balance transfer offers are getting a little harder to find, and their
terms are generally shorter -- two to three months instead of six
months to a year, for example.
credit card lenders are raising rates on people who make only minimum
payments each month or who max out their credit cards. Both behaviors
are seen as a sign the consumer may be headed toward bankruptcy.
regulators are also cracking down on banks that loan money to less-creditworthy
borrowers, known in lending circles as the subprime market. That means
those customers may be facing higher interest rates, lower credit
limits and more trouble getting loans.
ways to protect yourself
In the worst-case scenario, a rising number of defaults and delinquencies
could cause lenders or regulators to slam the brakes on credit. As
the cost of credit rises and its availability diminishes, bankruptcies,
defaults and delinquencies could rise still further -- thereby fueling
higher costs and perhaps even tighter credit.
one really knows the chances of a real credit crunch occurring. As
a consumer, though, you can protect yourself from the potential fall-out
in the following ways:
and maintain a good credit. People with good credit histories
and high credit scores (typically FICO scores over 720) will generally
get the best deals, regardless of the overall credit environment.
People with poor credit may see much of the easy lending terms of
the last few years disappear.
Don’t overextend. Maxing out your credit cards and borrowing
every nickel a mortgage lender will give you are rarely good strategies.
They’re particularly bad ideas in rough economic times.
down your debt. Again, this is always good advice, but
especially so when the cost of credit could be on the rise. Start
with nondeductible consumer debt, like your credit cards, and then
move on to auto and personal loans (assuming you won’t face onerous
prepayment penalties). Mortgage debt is generally cheap, and tax
deductible besides, but it still makes sense to at least pay down
your home equity loans. The more home equity you leave untouched,
the more of a cushion you have in case of emergency.