Posts Tagged ‘interest rates’

When It’s Okay to Carry Debt

Posted on: June 16th, 2010 by

Financial Planning - Rockville, MDFederal Reserve Chairman Ben Bernanke has told Congress that “the federal budget appears to be on an unsustainable path,” but that that the “exceptional increase” in the deficit had been necessary to pull the country out of recession.  That raises a question everyone should consider: When is debt okay and when is it not? After all, everyone has financial rough spots.  The federal government is a good example of what ordinary folks should not do: pile debt upon debt forever, taking out new loans to pay off old ones.

In one of its most dangerous practices, the government uses short-term borrowing to fund long-term obligations.  That seems to work fine when interest rates are very low, because rates are lower on short-term loans than on long-term ones.  But later the borrower may have to take out new loans at higher rates, having passed up the opportunity to lock in a low long-term rate when it was available.

This is what homeowners do when they choose adjustable-rate mortgages over ones with fixed rates, or when they use one credit card to pay off another.  So the first lesson the dysfunctional Federal government teaches us is: don’t finance long-term obligations with short-term loans.  Don’t use an 18% credit card to fund a home addition that will take years to pay off.  If you must borrow for that, take out a home-equity loan.  The rate is likely to be half as much.

What about borrowing in an emergency?  In a real emergency, you can justify almost anything.  A legitimate emergency is a serious illness, or a car problem that will keep you from getting to work, a leaky roof that will ruin your home.  The need for a vacation is NOT an emergency.  Basically, an emergency is something that will seriously undermine your life for years, not something that will put a little damper on your lifestyle.  If necessary, borrow to get basic, essential transportation, not to get luxuries like leather seats and navigation systems.  Of course, the average American is borrowing all the time, using credit cards for everything from gas to groceries to clothes and entertainment.  Credit cards should be used for convenience, so you don’t have to carry cash.  Balances should be paid off in the grace period to avoid interest and other charges.

Dumb Ways You Throw Away Your Money

Posted on: May 9th, 2010 by

Financial Planning - Rockville, MDIts easy for our emotions to take over and force us, or rather convince us to make irrational decisions.  Our money is not exempt from these decisions.  But, you have to remember, from here on out, that you need to only use logic when it comes to finances.  Some people can make a go of it on their own, others employ the assistance of a financial adviser.  One of the biggest mistakes people make is coming to the conclusion that because its on sale, its a good deal.  If you are going stereo shopping and you see two marked at $400, but one is $300 off, which would you buy?  If you use your logic and reasoning, you would buy the one that got a better rating from consumer reports; but if you react like most people, you buy the one that is on sale because its a bargain.  In fact, research has found that people who wouldn’t normally spend that kind of money on a stereo before will buy the discounted stereo based on the fact that it is discounted.  The reality is, $400 is $400, and if you normally wouldn’t spend that kind of money on a stereo in the first place, you shouldn’t do it now.  Before you splurge, evaluate whether the product is worth that in enjoyment.  Also, consider how often you will use the product and if there is a cheaper product of similar quality out there.

The number of people who have money in savings accounts, earning less than 2% I might add, while carrying credit card debt, usually with interest rates above 12%, is mind boggling.  People tend to use what is called “mental accounting” and compartmentalize their funds.  Often people have the money to pay off their entire debt, but choose not to do so because they are afraid to dip into their savings.  The reality is, you are not earning enough interest on your money in savings to justify not paying off your debt.  You are losing money everyday in interest.  If you have the money to pay off your credit card debt and still pay your bills, do it. Worse case scenario, if there is an emergency, use your now zero balance credit cards to help and then pay them off as soon as you can.

Finally, people have begun hoarding money again as a result of the economic climate.  People are so afraid of running out of money, they don’t enjoy the money they have.  If you are legitimately worried about running out of money, you should sit down with a financial planner and work out the math.  Make sure you consider worst case investment scenarios, not just the averages.  That should make you more comfortable about weathering a bad patch in the future.  Then, if you still have more than enough, make a plan that will allow you to enjoy your wealth by either spending the excess or giving it away.  Money, after all, is a means to an end, not the end.  You save it to make you and the people you love calm, comfortable, and happy.  Enjoy it!