Does ‘good’ debt really exist?
Some experts say the recession has changed how debt should be viewed
By Marcia Frellick
Does “good” debt exist anymore? Financial experts differ, but many say that in today’s economy, it’s time to reconsider how we look at some common types of debt.
Traditional thinking separates debt into “good” and “bad.” Mortgages and student loans have been considered good debt because they have fairly low interest rates and hold the promise of a substantial long-term payoff. Auto loans and credit card debt usually rate a bad debt label.
But with unemployment hovering around 9 percent, housing prices falling nationwide and the average cost for a four-year private education soaring to an average of just more than $37,000 a year, according to the College Board, does good debt really exist anymore?
Noted personal finance author David Bach says no. The recession, he says, taught us that “all debt is bad if you can’t pay it off.”
“With many Americans today, almost 30 to 50 percent of their paycheck is going just to interest payments,” says Bach, whose latest book is “Debt Free For Life.” “Often it’s more than that. There’s been a real awakening that debt is bad.”
Others say good debt still exists, that buying a house is still a sound investment over the long haul, and borrowing for a college education is a good risk — if you keep borrowing down and study for a profession that can pay it off.
Here are some ways the debate shakes out:
Cars and credit cards
In terms of bad debt, financial experts agree that a large amount of auto loan debt is hard to justify. If you have to have a car to get a job, then get a cheap car, but borrow as little as possible. Borrowing money at high interest to pay for a depreciating asset just doesn’t make financial sense, they say. But there is more debate on credit card debt.
Jordan Goodman, author of “Master Your Debt,” warns against it. “If you’re paying 18 or 25 or 29 percent, it’s hard to imagine what you’d invest in that would pay you more than 29 percent reliably,” he says. “And, of course, it’s not (tax) deductible.”
But Lita Epstein, author of “The Complete Idiot’s Guide to Improving Your Credit Score,” says credit card debt isn’t all bad if it helps you establish a solid credit history that will help you with big purchases later: “Generally, you get your best credit score when you use 10 to 20 percent of your credit limit,” she says. “That shows any creditor who’s considering you that you know how to manage your credit wisely, you know how to pay your bills on time and you’re not going to get yourself in over your head.”
Robert Pagliarini, president of Pacifica Wealth Advisors in Los Angeles, says credit card debt is good if it will make you money. Period. He gave an example of buying a piano on credit so that you may give piano lessons.
“Why wait four years to save up and buy the piano, when you can buy it on credit now and make some money? This is what businesses do. They borrow money … so they can invest it into research, into assets so they can make more money. That’s what individuals need to do.”
Student loans: Good debt or bad debt?
Student loans are good debt, even as costs escalate, if you can expect to make a salary when you graduate that will allow you to pay off the debt within a few years, says Carol Roth, business strategist and author of “The Entrepreneur Equation.” In today’s economy, that may mean only taking on the debt only if you are entering a high-paying field or finding a less expensive college that will make the math work, she says.
You also have to consider that a college education pays off in other ways, she says. “There’s a value to having an education, to learn and to be a well-rounded person but only you can assign what that value is, based on your own circumstances.”
Personal finance columnist and author Liz Weston says there’s a rough dividing line between good student loan debt and bad: “Don’t borrow more than you can make in the first year of your career,” she says.
Pagliarini says student loans are still a good bet financially, even in a time of high unemployment.
“The research shows that the more education you get, the more you’re going to make long term,” he says.
He notes the national unemployment rate is an average and doesn’t fully illustrate the difference in unemployment among different education levels. “When you look at the people with bachelor’s degrees and above, that number just about drops in half.” In fact, Bureau of Labor Statistics numbers for February 2011 show unemployment rates for people with a high school diploma and no college to be 9.5 percent; it’s 4.3 percent for people with bachelor’s degrees and above.
Goodman says he agrees that on average people with college educations make more than people without. But the risk for making that choice has gotten too high, he says.
“People are taking on huge debt and, in the case of student loans, they’re not forgivable even in bankruptcy. The two debts you can’t get rid of are taxes and student loans.”
That debt burden is exactly what concerns Thomas Alexander, Finance Department chair at Northwood University in Midland, Mich. He says paying for a college education with student loans is no longer a good risk unless you’re entering high-paying fields, such as medicine, engineering or accounting.
“If someone is getting a degree in sociology or history — the chances of landing anything that would give them a high return is pretty small,” he says.
He says college is not for everyone and the better payoff may be skipping college and going into a trade.
“If you take a student who does not go to college and becomes a plumber or electrician — those guys are going to make more money than 75 percent of the college graduates, but we’ve made the feeling in this country that that is beneath them.”
Mortgages vs. renting
Goodman says taking on a mortgage is not a way to build wealth as it has been in the past.
“Home prices are falling — probably will continue to fall — and 25 percent of the population is underwater (the house is worth less than the amount of the loan). Home deductions [for interest] are overrated. You get a deduction at your tax bracket, so if your tax bracket is 25 percent, you’re still paying 75 cents on the dollar. If you’re not being bailed out by home-price appreciation, this may not be a good deal.”
Roth says it’s all about the math. She gives an example of buying a $275,000 home purchased with 25 percent down and taking out a 30-year mortgage at 4.5 percent. It will cost you $68,750 today to buy that home (that’s the 25 percent down), and you will pay out more than $376,000 over 30 years. Even if the home doesn’t appreciate in value, you will have an asset worth $275,000 at the end of 30 years. Rent at $1,500 a month over 30 years would be $540,000 and that would be without inevitable rent increases. There would also be no asset at the end.
That makes the beginnings of a case for why a mortgage is a good idea over the long haul, she says. “But you also have to ask yourself some questions,” she says, “such as what are you doing with the difference in money you spend on the mortgage (only $1,045 vs. $1,500 in rent)? That money may also be able to be invested. Do you have property taxes? That creates more costs. Do you have assessments? How much is maintenance on your home? Is homeowner’s insurance more than renter’s insurance?”
Answering those questions will help you make up your own mind about what qualifies as good debt.
Regardless of where financial experts stand on what’s good debt and bad debt, all agree working to pay it off as quickly as possible is a good idea.
“One thing that never backfires is paying down your debt,” Bach says. “It is the safest, simplest investment you can make.”
Year-End Auto Deals Slimmer, but Bargains Still Abound
Car prices and incentives tend to follow the curve of the economy. In the darkest days of late 2008 through early 2009, consumers brave enough to buy a new vehicle scored some incredible deals. Now, as the country appears to be on the mend and auto sales have risen in recent months, the discounts aren’t quite as deep. But that’s not to say buyers can’t still find bargains as 2009 comes to a close.
According to Automedia.com’s “New Car Deals — A Guide to Year-End Deals and Rebates and Incentives,” dealers are still eager to clear out their remaining 2009 inventory and start selling new models as they try to secure their year-end bonuses.
Biggest Deals on 2009 Models
As soon as the ball drops to ring in the New Year, 2009 cars will be slapped with the stigma of being last year’s model. So it’s typical for manufacturers and dealers to sweeten their deals in December. However, some reports say that this summer’s Cash for Clunkers program wiped out much of the country’s 2009 inventory, which could make it harder to find the vehicle you want.
Here’s a sampling of some of the season’s hottest offers for 2009s. If you can be flexible on color and options, you could save thousands.
Year-End Incentives on 2009 Models
Make Model Promotion
Chevrolet 2009 Impala $3,500 cash back
OR
0.0% APR for up to 72 mos.
Dodge 2009 Ram 1500 $3,500 cash back
OR
0.0-2.9% APR for up to 72 mos.
GMC 2009 Acadia $2,500 cash back
OR
0.0% APR for up to 72 mos.
Ford 2009 Expedition $2,000 cash back
OR
0.0% APR for up to 60 mos.
Nissan 2009 Altima $1,750 cash back
OR
0.0% APR for up to 60 mos.
Volkswagen 2009 Passat 0.0% APR for up to 60 mos.
Attention Car Owners – Do You Need a Reality Check?
This is a guest post from Joe Plemon from Plemon Financial Coaching who authors the blog Personal Finance by the Book.
“Geraldine”, a sassy lady portrayed by the late Flip Wilson, answered her husband thusly when he demanded an explanation for yet another new dress: “The Devil made me do it! I was walking down the street minding my own business when he snuck up behind me and pushed me into that dress store. He MADE me try on! Then he pulled a gun on me and forced me to buy it and sign your name to a check.”
Geraldine’s humor is timeless because so many of us can relate to it. For example, have you ever bought a new car and then wondered what possessed you to do it? I doubt if it was the devil, but the devil’s first cousin, car fever, will have the same results.
Do you currently own a car you wish you had never bought? Are you asking yourself if you should try to sell it or just live with it? This post is designed to help you think through this dilemma.
Start by asking yourself these questions:
How much do I owe on it?
If you paid cash, then you are probably not facing a financial crisis necessitating the sale of the car. If you simply don’t like the car, then take your time, sell it and pay cash for another one. If you are in debt, move on to question two.
How big a burden is this car on my budget?
If one hiccup in your life will cause you to start missing payments, then you need to amputate this car before that hiccup occurs. Even if you are easily making your payments, you still might be deceived into thinking all is well. Long term debt on a depreciating asset such as a car is a formula for staying perpetually in car debt. To break that cycle, you need to get the car paid off in 24 months or less and then keep driving it while you save cash for your next car. If you are on track to do so, then keep the car and enjoy it. If not, you should seriously consider getting rid of it.
If I am seriously considering selling, how do I go about it?
Knowledge is power. First, you need to learn if you are upside down (owe more than the car is worth). Check http://www.kbb.com/ to learn the private party value* of your car. If this value is less than what you owe, you are upside down. *(Use private party value because you are money ahead selling the car yourself).
But how does this work? Here is an example: You owe $22,000 on your “Geraldine” car and you could sell it for $18,000 (private party sale on http://www.kbb.com), thus putting you $4,000 upside down. If you decided to buy a $3,000 car (we will call the “beater”), your new debt would be $3,000 plus $4,000 = $7,000. You are still upside down, but you have eliminated $15,000 of debt.
How do I go about selling a car I am upside down on?
Unless you have an extra $4,000 available, you will need to borrow it in order to get the title released. So where do you borrow the money from?
Start by checking with the title holder. You have done your homework, so explain your rationale. In effect, you are asking for an unsecured loan on your upside down amount. Most lenders are not thrilled by this, but explain that this same amount of the current loan is already unsecured and you are simply asking that they move this amount from a more expensive car to a less expensive car.
If the title holder balks, don’t give up. Try your credit union or your home town bank, explaining that you will be moving your business to them. If you simply can’t find financing, consider other options such as selling stuff (Craigs List or Ebay or yard sales) or temporarily working a part time job.
REALITY CHECK: Are you ready to get your Geraldine car out of your life? Good! Doing so will not only be a huge relief, but will teach you to never again succumb to car fever. Still, you need to go into this decision with both eyes open, so the following pros and cons will help you preview the reality of your decision:
The Good
◦LESS DEBT. You have just reduced your total debt by $15,000!
◦OUT OF DEBT QUICKER: From our example, with an 8% loan and monthly payments of $400, your Geraldine car will be paid for in 5 years and 9 months. Your “beater”, on the other hand, will be paid off in only 19 months.
◦STAY OUT OF DEBT: Once the beater is paid off, you could save $4,800 toward another car by making payments to yourself for one year. Assuming your beater would bring $2,000, you could upgrade to a $6,800 paid for car. Had you stuck with your Geraldine car, it would have depreciated to about $12,000 by now and you would still owe $13,300 on it.
◦PEACE: You will know that you have taken the steps to undo that Geraldine decision. This is a great feeling.
The Reality Check
◦INCONVENIENCE: Selling your car and buying another is a hassle.
◦A DOWNGRADED DRIVE: Face it: your Geraldine car is nicer than a beater will be. Be prepared for it.
◦LESS DEPENDABILITY: No doubt your beater will have some issues. You need to be realistic in assuming that it will not be as dependable as a newer car.
◦MORE MAINTENANCE: With less dependability comes more maintenance.
◦FRIENDS WON’T UNDERSTAND: Reality? Yes. Negative? Not really. Just be prepared for it.
One Final Reality Check
You may not be able to arrange the necessary financing. Why? Either your credit score is not adequate or you are too far upside down. Should this be your scenario, you will need to strategically pay down all other debt in order to free up enough cash flow to make huge car payments. Keep the car until it is paid off or you will be swimming in car debt for years to come.
Your Car is Making You Poor And What You Can Do About It
This country has an obsession over cars. It sort of makes sense considering how most of our cities are laid out and the desire for suburban living basically requires almost everyone to not only own a vehicle, but to spend a considerable amount of time in it while going from place to place.
While just having a car isn’t a bad thing, most people don’t fully realize how much of their wealth is getting flushed down the drain while owning a car. They are expensive, depreciate in value rapidly, you have to regularly fill them with gas, and insure them. That really starts to add up.
A Typical Cost Breakdown
So, just how much is that car costing you? Let’s take a look at a typical vehicle and scenario that would fit almost any middle class American household. We’re going to use a new Toyota Camry and these sell for anywhere from about $20,000 – $30,000 depending on features and your location. So, we’ll shoot for something right in the middle of the pack and assume for this example that someone finds one for $25,000. And let’s not forget about sales tax since that’s going to apply to most people as well. 6% is a fairly common state sales tax rate so if we tack that on to the price of the car we have a total sale price of $26,500.
It really doesn’t matter what kind of car we’re talking about or even whether it’s new or used. What’s important is the actual price paid.
Financing
Now let’s talk financing. Most people don’t pay cash for their new car and will typically finance it for somewhere between 3 and 5 years. In addition, most people don’t put a significant down payment down or will trade in their old car. For the sake of this example we’ll assume that we’re putting $5,000 down or getting $5,000 for a trade. That means we’re left financing $21,500, and let’s shoot for a 48 month loan. Rates on this type of loan right now are averaging around 7% so we’ll go with that. That ends up adding $3,200 in interest payments over the life of the loan and a monthly payment of about $512.
Insurance
Insurance is going to vary depending on a lot of different factors. The deductible you choose, your driving record, age, state, and so on. So the best we can do is ballpark an average rate for this type of car. Just keep in mind that you may be paying quite a bit more or even less depending on your situation. Running some quotes and looking online the annual insurance premium on about a $25,000 sedan will cost roughly $1,200 a year or $100 a month.
Gasoline
Every car needs gas, and gas can be expensive. Luckily for this example we have a car that gets decent gas mileage and it’s rated for roughly 20 mpg city and 31 mpg highway. We’ll average it out and assume an overall mpg of 25. The average person drives 12,000 miles each year. Obviously, your own driving habits may differ. But at $3.00 a gallon that would mean you spend $1,440 a year or $120 a month on gas.
Maintenance
Cars need a little TLC and you will need to spend a little money to keep it running its best. The most common maintenance item is the oil change. At a quick lube place you can expect to pay around $30 for an oil change and you’ll likely need 3 of them a year. You’ll also probably need a few other odds and ends like new wiper blades, car washes, etc. So we’ll allocate another $50 a year to cover those miscellaneous expenses. Regular maintenance costs are going to be around $140 a year and you can probably expect to pay about $100 or so on annual vehicle registration. Just to keep things simple, we’ll call these miscellaneous expenses $20 a month.
Total Monthly Breakdown:
Car Payment = $512
Insurance = $100
Gas = $120
Maintenance = $20
Total = $752
It’s amazing how fast that adds up, isn’t it? We’re talking $750 a month just to drive a middle of the road sedan. And that’s with a 20% down payment, a good credit score that gets you a decent interest rate, and a clean driving record that keeps your insurance premiums down. Just imagine if you can’t get a rate for 7%, don’t put any money down, or your insurance premiums are nearly double because of a few tickets on your driving record. You could easily be approaching $1,000 a month. If you earn $40,000 a year you’re spending nearly 25% of your gross income on a vehicle that only decreases in value each year that you own it.
Multiple Vehicles and Luxury Cars
In that example we just used a modest no-frills sedan and look at the true cost with that. Now, think about needing two of these cars because you’re married and you both work. Now you’re making a mortgage size payment just to have something to drive you around.
And what if you’re driving a luxury car or SUV that comes in at $40,000 or more? You can expect your total monthly costs for just one car to easily exceed $1,200. If you need two of these more expensive vehicles you better be prepared to shell out close to $3,000 a month.
Car Costs vs. Saving
I help people with their finances every day. That’s my job. That means I usually have to spend some time digging into a person’s finances to help uncover problem areas or opportunities. If there is one thing that I see more than anything, it’s people who are spending more on their vehicles than what they are saving for retirement or otherwise. Without fail, whenever someone says they don’t have any extra money to put into their retirement account or into a savings account, you can almost always count on significant car costs when digging through their monthly expenses. Whether it’s $300 a month or $700 a month, they can make those payments each month yet can’t scrape together $100 to put into a savings account or their retirement account.
Here’s a rule of thumb: if your total car costs exceed what you’re able to save, you have more vehicle than you can afford. That means if you’re paying $500 a month to keep your car on the road yet can’t come up with $500 each month to stick in your savings or retirement account, you’re in trouble. You will never build the wealth you want by throwing more money away on a vehicle than you can save or invest. That money you apply to a car payment, gas, insurance and everything else doesn’t come back. You do not make money and it is not an investment.
At the same time if you can afford to spend $1,000 a month on your vehicle and still save $1,000 a month, that’s great. Sure, you could still save more money if you cut down your car costs, but at least you are matching every dollar that goes out and putting it into something that is an asset and an investment. At the bare minimum that is how you need to look at it. You have to at least be saving as much as you’re spending.
How to Make Sure Your Car Doesn’t Make You Poor
As you can see a car can make you poor pretty fast. The costs add up and if you’re spending more money on a mode of transportation than what you’re setting aside for the future it’s going to take a long time to build wealth. Unfortunately, most of us need a car. That’s just the reality of it all. But you can take some steps to make sure that you’re keeping your car costs as low as possible so that you can focus on building wealth, not just maintaining a vehicle year after year.
Used vs. New
It goes without saying, but a used car is going to save you money. Remember, cars depreciate in value, often as much as 20% each year. If you can buy a used car even just a year old you could save thousands of dollars which translates to less interest when financing and a lower monthly payment.
If you are looking at a new car, that’s fine too as long as you plan on owning the car for a long time. When you get into trouble is when you keep buying a new car every 3 or 4 years without paying off the first one, or just barely paying it off before buying a new one. This creates a vicious cycle of constantly spending more than you need to. A new car can be a good deal if you know that you’re going to keep it well beyond the financing terms.
Size Matters
The larger the vehicle, the more it costs. Smaller cars are generally cheaper than full size cars, and cars are usually cheaper than trucks or SUVs. So, only buy as much car as you really need. Your situation and driving needs will dictate what kind of vehicle you need, but don’t go overboard.
As you increase in vehicle size and price, you’ll also typically get increased insurance premiums and fewer miles per gallon as well. So, there is more to size than just the initial cost. The higher costs often trickle down to all other areas and it will really start to add up fast.
Consider Depreciation and Maintenance
Not all vehicles are created equal. Some cars will hold their value over time better than others, and some cars have notorious maintenance issues. Do your research before buying your next car and don’t just buy something because it looks good in the commercials. You can not only save some headaches down the road by picking a reliable car, but if it retains its value you will take less of a hit when it comes time to sell.
Finance Wisely
If you need to finance your car purchase, be smart about it. Yes, you can keep your monthly payment low by stretching out the loan to 5 or 6 years, but you aren’t doing yourself any favors. All you’re doing is paying more interest on something that continues to decline in value. Would you borrow money at 7% interest just so you could invest it in a stock that was guaranteed to drop in value by 15% each year? Of course not, but that’s what you’re doing when you finance a car purchase. We know that the value of the car is going to go down each year, so the sooner you can pay it off and the less interest you pay, the more you ultimately save.
You Are in the Driver’s Seat
It’s up to you to decide how you want to spend your money. A vehicle may be a necessity, but it doesn’t have to negatively impact your financial future. If you aren’t careful, a vehicle can erode your wealth faster than anything else, but with some smart decisions you can make sure that it doesn’t.
Be smart about your vehicle costs. It might be nice to drive around in something a little fancy but is it worth the negative impact it may have on your long-term financial goals? That’s for you to decide.
Source: GenxFinancing
Your Credit Score
What is a credit score?
A credit score is a number that lenders, landlords and prospective employers use to predict how an individual will handle obligations like repaying a loan or paying rent on time.
How is my credit score used?
When you apply for credit, the lender uses your FICO score to measure risk in deciding whether to approve the application, what interest rate to charge and the credit limit. Later on, the lender may look at your FICO score again to decide whether to increase or decrease your credit limit.
Potential employers may use your FICO score to evaluate you as an employee. Many landlords consider your credit score to decide whether to rent to you and how big your security deposit will be.
What determines my FICO credit score?
Your FICO score is based on bill-paying history, debt profile, and other statistical information. For particular groups, like people who have not been using credit long, the importance of these categories may be somewhat different.
* 35% of your score is based on your payment history. Making payments on time is extremely important to your credit score. One expert cited that the average score of a consumer that pays their bills on time 100% of the time is 706. Just one percent of difference in that statistic, 99%, lowered that average score to 658.
* 30% is based on your amounts owed in proportion to your total credit limit, or your credit utilization ratio. A good rule is to keep your balances under 30% of your credit limit.
* 15% is based on the length of your credit history. This is something that can only improve with time, so a recent college grad with a limited credit history will have to be patient to see their score improve. Experts recommend keeping your first credit card open, even if it has a high interest rate, and using it enough to avoid cancellation by the card issuer.
* 10% is based on new credit as a gauge of whether or not your credit is expanding. Opening new accounts gradually over time will increase your credit score, provided you pay your bills on time. However, applying for too much credit at once can hurt your score.
* 10% is based on the types of credit you use. Utilizing credit cards, mortgages and car loans can help your score.
What affects my credit score and what doesn’t?
All of the things that affect your credit score show up on your credit report. Payment history, percentage of credit used (amounts owed), length of credit history, new credit, and the diversity of your credit, all appear in your credit report.
Checking your own credit report does NOT lower your score. On the other hand, when you apply for credit and the creditor reviews your credit report, that is called a “hard inquiry” and may lower your score.
How can I get my credit score?
You can get your credit score from any of the three credit reporting agencies, Equifax.com, Experian.com, and Transunion.com, you may have to enroll in and pay for a subscription service in order to see your score.
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