Spending Less Saving More
IN THIS PART …
Find out how to cope with and reduce debt.
Review strategies for reducing your spending.
Understand how to slash your taxes using the new tax laws.
Dealing with Debt
Accumulating bad debt (consumer debt) by buying things like new living room furniture or a new car that you really can’t afford is like living on a diet of sugar and caffeine: a quick fix with little nutritional value. Borrowing on your credit card to afford an extravagant vacation is detrimental to your long-term financial health.
When you use debt for investing in your future, I call it good debt. Borrowing money to pay for an education, to buy real estate, or to invest in a small business is like eating a well-balanced and healthy diet. That’s not to say that you can’t get yourself into trouble when using good debt. Just as you can gorge yourself on too much good food, you can develop financial indigestion from too much good debt.
In this chapter, I mainly help you battle the pervasive problem of consumer debt. Getting rid of your bad debts may be even more difficult than giving up the junk foods you love. But in the long run, you’ll be glad you did; you’ll be financially healthier and emotionally happier. And after you get rid of your high-cost consumer debts, make sure you practice the best way to avoid future credit problems: Don’t borrow with bad debt.
Before you decide which debt reduction strategies make sense for you, you must first consider your overall financial situation and assess your alternatives. (I discuss strategies for reducing your current spending — which help you free up more cash to pay down your debts — in the next chapter.)
Using Savings to Reduce Your Consumer Debt
Many people build a mental brick wall between their savings and investment accounts and their consumer debt accounts. By failing to view their finances holistically, they simply fall into the habit of looking at these accounts individually. The thought of putting a door in that big brick wall doesn’t occur to them. This section helps you see how your savings can be used to lower your consumer debt.
If you have the savings to pay off consumer debt, like high-interest credit-card and auto loans, consider doing so. (Make sure you pay off the loans with the highest interest rates first.) Sure, you diminish your savings, but you also reduce your debts. Although your savings and investments may be earning decent returns, the interest you’re paying on your consumer debts is likely higher.
Paying off consumer loans on a credit card at, say, 12 percent is like finding an investment with a guaranteed return of 12 percent — tax-free. You would actually need to find an investment that yielded even more — around 18 percent — to net 12 percent after paying taxes on those investment returns in order to justify not paying off your 12 percent loans. The higher your tax bracket , the higher the return you need on your investments to justify keeping high-interest consumer debt.
Even if you think that you’re an investing genius and you can earn more on your investments, swallow your ego and pay down your consumer debts anyway. In order to chase that higher potential return from investments, you need to take substantial risk. You may earn more investing in that hot stock tip or that bargain real estate, but you probably won’t. If you use your savings to pay down consumer debts, be careful to leave yourself enough of an emergency cushion. You want to be in a position to withstand an unexpected large expense or temporary loss of income. On the other hand, if you use savings to pay down credit-card debt, you can run your credit-card balances back up in a financial pinch (unless your card gets canceled), or you can turn to a family member or wealthy friend for a low-interest
Finding the funds to pay down consumer debts
Have you ever reached into the pocket of an old jacket and found a rolled-up $20 bill you forgot you had? Stumbling across some forgotten funds is always a pleasant experience. But before you root through all your closets in search of stray cash to help you pay down that nagging credit-card debt, check out some of these financial jacket pockets you may have overlooked:
Borrow against your cash value life insurance policy. If you did business with a life insurance agent, she probably sold you a cash value policy because it pays high commissions to insurance agents. Or perhaps your parents bought one of these policies for you when you were a child. Borrow against the cash value to pay down your debts. (Note: You may want to consider discontinuing your cash value policy altogether and simply withdraw the cash balance
Sell investments held outside of retirement accounts. Maybe you have some shares of stock or a Treasury bond gathering dust in your safety deposit box. Consider cashing in these investments to pay down your consumer loans. Just be sure to consider the tax consequences of selling these investments. If possible, sell investments that won’t generate a big tax bill.
Tap the equity in your home. If you’re a homeowner, you may be able to tap in to your home’s equity, which is the difference between the property’s market value and the outstanding loan balance. You can generally borrow against real estate at a lower interest rate and get a tax deduction, subject to interest deduction limitations. However, you must take care to ensure that you don’t overborrow on your home and risk losing it to foreclosure.
Borrow against your employer’s retirement account. Check with your employer’s benefits department to see whether you can borrow against your retirement account balance. The interest rate is usually reasonable. Be careful, though — if you leave or lose your job, you may have to repay the loan within 60 days. Also recognize that you’ll miss out on investment returns on the money borrowed.
Lean on family. They know you, love you, realize your shortcomings, and probably won’t be as cold-hearted as some bankers. Money borrowed from family members can have strings attached, of course. Treating the obligation seriously is important. To avoid misunderstandings, write up a simple agreement listing the terms and conditions of the loan. Unless your family members are the worst bankers I know, you’ll probably get a fair interest rate, and your family will have the satisfaction of helping you out. Just don’t forget to pay them back.
Decreasing Debt When You Lack Savings
If you lack savings to throw at your consumer debts, not surprisingly, you have some work to do. If you’re currently spending all your income (and more!), you need to figure out how you can decrease your spending for lots of great ideas) and/or increase your income. In the meantime, you need to slow the growth of your debt.
Reducing your credit card’s interest rate
Different credit cards charge different interest rates. So why pay 14, 16, or 18 percent (or more) when you can pay less? The credit-card business is highly competitive. Until you get your debt paid off, slow the growth of your debt by reducing the interest rate you’re paying. Here are sound ways to do that:
Apply for a lower-rate credit card. If you’re earning a decent income, you’re not too burdened with debt, and you have a clean credit record, qualifying for lower-rate cards is relatively painless. Some persistence (and cleanup work) may be required if you have income and debt problems or nicks in your credit report. After you’re approved for a new, lower-interest-rate card, you can simply transfer your outstanding balance from your higher-rate card.
CreditCards.com’s website (www.creditcards.com) carries information on low-interest-rate and no-annual-fee cards (among others, including secured cards).
Call the bank(s) that issued your current high-interest-rate credit card(s) and say that you want to cancel your card(s) because you found a competitor that offers no annual fee and a lower interest rate. Your bank may choose to match the terms of the “competitor” rather than lose you as a customer. But be careful with this strategy and consider just paying off or transferring the balance. Canceling the credit card, especially if it’s one you’ve had for a number of years, may lower your credit score in the short-term.
While you’re paying down your credit-card balance(s), stop making new charges on cards that have outstanding balances. Many people don’t realize that interest starts to accumulate immediately when they carry a balance. You have no grace period — the 20 or so days you normally have to pay your balance in full without incurring interest charges — if you carry a credit-card balance from month to month.
If you have a tendency to live beyond your means by buying on credit, get rid of the culprit — the credit card (and other consumer credit). To kick the habit, a smoker needs to toss all the cigarettes, and an alcoholic needs to get rid of all the booze. Cut up all your credit cards and call the card issuers to cancel your accounts. And when you buy consumer items such as cars and furniture, do not apply for the E-Z credit.
The world worked fine back in the years B.C. (Before Credit). Think about it: Just a couple generations ago, credit cards didn’t even exist. People paid with cash and checks — imagine that! You can function without buying anything on a credit card. In certain cases, you may need a card as collateral — such as when renting a car. When you bring back the rental car, however, you can pay with cash or a check. Leave the card at home in the back of your sock drawer or freezer, and pull (or thaw) it out only for the occasional car rental.
If you can trust yourself, keep a separate credit card only for new purchases that you know you can absolutely pay in full each month. No one needs three, five, or ten credit cards! You can live with one (and actually none), given the wide acceptance of most cards.
Retailers such as department stores and gas stations just love to issue cards. Not only do these cards charge outrageously high interest rates, but they’re also not widely accepted like Visa and MasterCard. Virtually all retailers accept Visa and MasterCard. More credit lines mean more temptation to spend what you can’t afford.
If you decide to keep one widely accepted credit card instead of getting rid of them all, be careful. You may be tempted to let debt accumulate and roll over for a month or two, starting up the whole horrible process of running up your consumer debt again. Rather than keeping one credit card, consider getting a debit card.
Discovering debit cards: The best of both worlds
Credit cards are the main reason today’s consumers are buying more than they can afford. So logic says that one way you can keep your spending in check is to stop using your credit cards. But in a society that’s used to the widely accepted Visa and MasterCard plastic for purchases, changing habits is hard. And you may be legitimately concerned that carrying your checkbook or cash can be a hassle or can be costly if you’re mugged.
Debit cards truly offer the best of both worlds. The beauty of the debit card is that it offers you the convenience of making purchases with a piece of plastic without the temptation or ability to run up credit-card debt. Debit cards keep you from spending money you don’t have and help you live within your means.
A debit card looks just like a credit card with either the Visa or MasterCard logo. The big difference between debit cards and credit cards is that, as with checks, debit card purchase amounts are deducted electronically from your checking account within days. (Bank ATM cards are also debit cards; however, if they lack a Visa or MasterCard logo, they’re accepted by far fewer merchants.)
If you switch to a debit card and you keep your checking account balance low and don’t ordinarily balance your checkbook, you may need to start balancing it. Otherwise, you may face charges for overdrawing your account.
Here are some other differences between debit and credit cards:
If you pay your credit-card bill in full and on time each month, your credit card gives you free use of the money you owe until it’s time to pay the bill. Debit cards take the money out of your checking account almost immediately.
Credit cards make it easier for you to dispute charges for problematic merchandise through the issuing bank. Most banks allow you to dispute charges for up to 60 days after purchase and will credit the disputed amount to your account pending resolution. Most debit cards offer a much shorter window, typically less than one week, for making disputes.
Because moving your checking account can be a hassle, see whether your current bank offers Visa or MasterCard debit cards. If your bank doesn’t offer one, shop among the major banks in your area, which are likely to offer the cards. Because such cards come with checking accounts, make sure you do some comparison shopping among the different account features and fees.
A number of investment firms offer Visa or MasterCard debit cards with their asset management accounts. Not only can these investment firm “checking accounts” help you break the credit-card overspending habit, but they may also get you thinking about saving and investing your money. One drawback of these accounts is that most of them require higher minimum initial investment amounts. Among brokerages with competitive investment offerings and prices are TD Ameritrade (phone 800-934-4448; website www.tdameritrade.com), Vanguard (phone 800-992-8327; website www.vanguard.com), and T. Rowe Price (phone 800-537-1936; website www.troweprice.com).
It will be interesting to read one of our quick article on Funding Kids Educational Expenses