You know, there was once a time when the picture was a little clearer on this point.
About ten years ago, experts would tell you that all home-related debt was “good” debt, meaning that the near-guaranteed appreciation of property values and the tax deductibility of interest on loans to buy those properties invariably made borrowing a good deal for the consumer.
All other debt? Bad or worse.
But today, you have an interesting situation- people increasingly using the equity in their homes and other real estate properties as personal piggy banks for everything from new kitchens to fancy vacations. There are now gradations of “good” debt within the real estate arena thanks to the home equity issue.
So as you apply the lessons here to your own situation, you really have to think about the old perceptions of debt and how they’ve changed in today’s marketplace.
Debt levels over the past 20 years
Consumer debt is now a staple of American life. What happened? Was it the temptation of credit cards? The move toward more personal management of our assets that we thought gave us permission to take on more risk? Was it the record-breaking appreciation in real estate properties over the past decade that convinced us it was okay to harvest our home equity to pay for the stuff we need-including the bills on other outstanding debt?
It was all this and more. We can talk all day about what created the borrowing addiction that exists in this country, but before individuals can successfully address their debt issues, it makes sense to look at facts about debt and how they can reverse their borrowing practices.
Here are some interesting and perhaps frightening facts about personal debt in this country.
• As tougher bankruptcy legislation went into effect late in the year, one in every 60 U.S. households filed for bankruptcy protection in 2005, bringing total filings for the year to more than two million, a new record, according to the American Bankruptcy Institute.
• According to 2006 statistics from the federal Reserve, 46.3 percent of all families now carry a credit card balance.
Household mortgage debt recorded by the Fed increased by 14.1 percent in 2005; it rose 13.4 percent in 2004, 14.3 percent in 2003 and 11.9 percent in 2002.
• The average American household has an average credit card balance of $8,900.
• According to the Bureau of Economic Analysis, the savings of U.S. households in 2005 totaled a negative $34 billion, or -0.4 percent of total disposable personal income for the year. Although the personal savings rate has trended consistently lower over the last 20 years, 2005 marks the first year since the Great Depression for which the ratio fell below zero.
When ‘good’ mortgage debt goes bad
In 2006, the real estate market was slowing, interest rates were rising and many consumers were stuck with dangerous adjustable-rate debt. In fact, one statistic by Loan Performance, a San Francisco-based mortgage loan research firm-showed that one out of every four new mortgages at the time was an interest-only loan-a loan that delays principal payments for three years or more to guarantee a borrower a lower monthly payment.
Yet no matter what the rate environment or economic situation, individuals have to keep in mind that they have choices, and some of the seemingly risky ones might be the right choices given their financial situation and how they use the loan product. In any event, it’s best to get some advice before you respond to the.se offers. Your tax adviser or financial planner not only can help you understand these options, but he or she can assess your overall financial picture to see what’s right for you in the first place.
Whether they come from your current lender or a late-night infomercial, here’s an overview of several nontraditional. loan options on the market and their potential risks and rewards.
Smart ways to handle credit card debt
It’s a fact-you have credit card debt. So often, we tell ourselves it’s okay to use a credit card because we’ll be earning miles or some other incentive. Stop doing that now.
Here are some good ways to get rid of it.
Go debit. Your bank probably issues debit cards that carry a Visa or MasterCard label, and we say get one, but only because some necessary merchants don’t allow you to use a plain-vanilla ATM card for transactions. But do not start using a branded debit card without making sure you ask your bank to tie your usage strictly to your checking account, and use that card only for debit transactions that require a PIN (your secret access code). And yes, make sure you write every transaction in your checkbook, if you don’t already do so with your ATM card.
As for your real credit cards? Keep one nearby only for emergencies and cut up or lock up the rest.
Make a weekly electronic bill payment on your credit card balance.
You’ve probably noticed that your credit card company allows you to pay by phone or through the Internet. It’s intended to be an option for people who can’t pay until moments before their bill is due. But why not make that option work in your favor? For instance, sign up for the service, and then every Friday or Monday, set aside a specific amount in your checking account that will go toward your monthly balance-pay it ahead of time and you won’t incur interest charges or waste so much as a minute or a stamp.
High balances first. This is not 100 percent true for everyone, but generally, you want to eliminate high-rate debt first and then pay down lower-rate balances as you go. As long as your payments are steady, this is generally the better approach. Also, talk with an adviser first, but you may want to consider rolling higher-interest debt into a lower-rate card (make sure the higher balance won’t raise your rate on that lower-rate card) so you pay less in interest and more in principal.
Watch that HELOC. Many people are tempted to pay off their consumer debt through home equity lines of credit (known as HELOCs). True, in many cases, you’ll be able to write off the interest on your taxes. But if you have a financial calamity, home debt is secured debt, which means a lender could take your house if you start missing payments. Credit card debt doesn’t leave you nearly as vulnerable. Talk to a financial adviser first about the best way to go on this.
Start tracking every penny. You won’t get out of debt until you fix the leaks in your wallet. If you are not presently tracking where your spending is going, then start either by hand or with the help of a computer program like Quicken or Microsoft Money that forces you to plug every time into a category. The results will surprise you, and it’ll make your tax filings easier too. (You might even save money with deductions you didn’t know about.)
WHAT’S A CREDIT CARD EMERGENCY?
A credit card emergency is not an emergency latte fix. Redefine your definition of a financial emergency. It might also help to start thinking again like a kid who might get in trouble for using your parent’s credit card for anything but an emergency-if you ever had to do that. Here’s your new checklist of when it’s okay to use a credit card:
1. Car breakdowns, not scheduled repairs
2. Hotel and rental car payments on trips
3. Out-of-town emergency medical bills
4. The occasional mistake when you don’t bring enough cash to pay for a special dinner out (Note to self: Stop eating out so much).
The exception to all above? If you can fully pay your credit card balance every month. The key is learning to live within your means, not using your credit cards as a constant bridge loan.
Checking your credit report and learning your credit score
There are three companies that create credit reports-Equifax (www.equifax.com), TransUnion (www.transunion.com), and Experian (www.experian.com). These reports are purchased by lenders, employers, landlords, and other service providers that use this information to help them decide whether to approve your application for a loan, credit card, job, or housing, or to offer you a product or service at a particular rate.
Credit reports have produced a particular form of shorthand-the credit score, which we’ll get to below. But you need to monitor your credit report for accuracy since it basically determines so many critical things in your life. It includes when those accounts were opened, and the inactive or closed accounts stay for seven to ten years in your file. It also reports which organizations have requested to view your credit reports.
Credit reports also may record public records such as overdue child support, bankruptcies, liens and, felonies, student loans, overdue taxes, over-due parking tickets, overdue library books (and the list keeps growing) and that’s information that also stays on a credit report for seven years.
Your credit score is a three-digit number representing the credit-worthiness to the individuals and organizations mentioned above. Credit scores determine far more about our lives than we realize. You need to check your credit report every year at staggered dates that are consistent year-to-year. Doing it more often or at different times actually serves to lower your credit score. You can do it for free at a Web site sponsored by credit bureaus: www.annualcreditreport.com. When you receive the report, look it over carefully to check every detail from addresses and employment information to the information on each account listed. Make sure everything is correct, and if it isn’t, follow each credit bureau’s exact instructions for how to put your appeal in writing.