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Archive for April, 2007

The Ice Fisherman & Finances

April 30th, 2007 at 11:55 pm

A friend just sent me a video clip. It showed an ice fisherman sitting alone on the lake with a pole in his hand. In the background, you could hear the wind whistling over the frozen lake. The pole dipped a few times as the man began to reel in a fish. Suddenly, a huge shark broke the surface and ate the man. Naturally I was caught unawares and surprised by the shark. It was funny.

But sometimes our finances work the same way. We think that we're fishing for something small. Even think that we've got it hooked. Only the truth is that we're about to be swallowed by something much bigger than we are.

I wonder if that's not true with some folks who took out mortgages with low teaser rates that were to be adjusted in a few years. They thought that they were just getting a good low rate on their mortgage and that they had found a way to buy a home that they couldn't really afford. Unfortunately, now that the rate is about to be adjusted, some of them will be swallowed up and lose their home and credit rating.

Some surprises can't be predicted. Our ice fisherman's encounter with the shark for instance. But some, like the mortgages with sharply escalating rates, can be predicted. And, unless you like being eaten, it's probably wise not to go fishing in that pond. It's too late for some people now. Hopefully, others can learn from their mistakes.

Repaying Charged-Off Debts

April 23rd, 2007 at 05:11 am

I am curious as to whether or not charge-offs can continue to accrue interest. I was always told "no" but today an attorney for one of those "third party collectors" told me "yes." I had already paid $900 into the charged-off debt and then that collector dropped us after I confronted them about some shady practices. They withdrew funds without my authorization and a new law firm picked it up and tacked on another $1500 above what I'd already paid! The first law firm didn't charge interest, but this one is. Any information you can offer would be most appreciated! -- Jennifer

Sounds like Jennifer is in a tough spot. To make the best of the situation, she's going to need to learn a little about what a "charge-off" really is, how collections work and whether the lender can charge interest on the debt.

When Jennifer borrowed money from a company, she created an expectation of future income when the debt was repaid. That's an asset of the corporation.

When a company "charges-off" a loan, they're saying that they don't believe that they'll ever be able to collect the debt. So they "write-off" the asset. It's an accounting entry that reduces their profits and taxes.

They'll also report the charge-off to the credit rating agencies. That makes it more difficult for Jennifer to borrow money later. An overdue debt can be shown on your credit report for 7 years after the account became delinquent.

But, that's just the accounting aspect. What happens to the debt in the "real" world?

Just because a debt has been charged-off does not mean that Jennifer still doesn't owe the money (plus interest and penalties). What she owes depends on the original loan agreement, state law concerning the Statute of Limitations (SoL) and the federal law governing collections.

The original terms from the loan still apply. All that fine print that no one reads becomes important now. Generally, it gives the lender quite a bit of latitude to charge interest and penalties.

Next Jennifer needs to find out the statute of limitations (SoL) on her debt. In most cases, it's between 3 and 6 years. State law and the type of debt will determine the SoL. The SoL says that after a certain period of time that the debtor is no longer legally required to pay a debt.

There are actions that Jennifer could take that would restart the clock on the SoL. Making a payment, signing an agreement to pay or even admitting that the debt is valid could be enough to stop or reset the SoL clock to zero.

She'll need to do a little research to learn the SoL in her state. Her phone book should have a number for the state's information operator. They should be able to point her to the state agency that can explain the law.

Two notes about SoL. Even though the SoL says that a debt doesn't have to be repaid, it's not illegal to attempt to collect it. And, if the lender gets a judgement against the borrower, there's no SoL on the judgement.

Jennifer also needs to know a little bit about collection agencies. Some work for a percentage of any money that they're able to collect. Others buy a group of bad loans for pennies on the dollar. Then they keep everything collected. Since they own the loan, they're also allowed to re-sell it to another collection agency. That could explain why Jennifer has heard from more than one agency. They're also sometimes affiliated with law firms so that they sound more important.

Whoever owns the loan, original lender or collection agency, is allowed to keep charging interest and penalties per the original loan agreement and applicable laws.

Anyone trying to collect the loan is supposed to obey the federal Fair Debt Collection Practices Act. But, as you'd expect, some will bend or even break the collection rules.

It's no surprise that they tapped into Jennifer's bank account. She might have given permission without realizing it. They will also try to garnish her wages or put a lien against any property that she owns. There are, however, laws that keep them from just taking anything they find.

If Jennifer does agree to settle the debt by paying a portion of it, she needs to get a release from the agency saying that the balance of the debt is forgiven. She should look for the words "payment in full."

Once a debt as been reported as written-off, paying it will not wipe away the bad comment in her credit report. It will look better, but only slightly. It's possible that the original lender may agree to remove the item if a partial payment is made. But, only the original lender may do that. Not an outside collection agency.

Hopefully, Jennifer will be able to close this unfortunate episode and never have to revisit the issue again.

Auto Lease Nightmare

April 16th, 2007 at 05:09 am

Can You Help Out This Reader?

Auto Lease Nightmare

I was not thinking clearly when I signed a three-year auto lease back in October 2006. I knew what I could afford and somehow I was talked into payments that were beyond my budget. Now I'm stuck with a lease and payments that are killing me.

I've talked to the dealership to see what my options are and was pretty much told that there is nothing I or they can do. How can I offload this car and get something more affordable without ruining my credit?
-- K .

Saving Strategies

April 12th, 2007 at 06:21 pm

Do you have any advice for a teenager with a steady job who would like her savings to grow. I have paid for my college education without taking out student loans. I contribute to an RRSP and I carefully keep track of all my income and expenses. I am not sure what to do with my savings. I set aside 10% of my income, but it is currently in a basic savings account because I don't know what to do with it. I was wondering what the best investment strategy would be for someone of my age. Any help you could give me would be great! -- Anita

Wow! Anita sure is off to a good start. Contrary to what a lot of people think, the young adult years are often the easiest time to save money. They often see their income grow faster than their financial responsibilities. That gives them an excellent opportunity to save.

Anita has already started down that path. So what's the best place for her to park the 10% of her salary that's she's saving? The answer to Anita's question has less to do with her age than what she plans on doing with that savings. The decision making process is the same for any age. The first thing Anita needs to do is to decide what she's saving for.

Why is that true? Her use will determine how quickly she might need it. And, that urgency will affect her investment choice.

Let's look at two simple rules of investing. First, you earn a higher return by assuming more risk. For instance, stocks are riskier than savings accounts.

The Journal of Financial Planning cites studies that show the real rate of return for the S&P 500 (stocks) from 1950 to 1999 was 10.3%. At the time this was written, a short term CD (6 months to a year) would pay about 4.0% and a five-year CD closer to 4.5%. An interest bearing checking account earns 1.0% while money market funds are about 2.8%.

So the earnings difference can be significant. To illustrate, suppose that Anita puts away $1,000 each year for the next 50 years (ages 20 to 70). If she earns 2% on the money, at the end of that time, it will be worth $89,000. But, if it earns 10%, it will grow to $1.4 million. Quite a difference!

That means we need to learn about the second rule of investing: risk can be minimized. Either by diversification or through a longer time frame.

Diversification is a fancy word that means owning more than one stock. If all of your money is in one company and the stock goes down 50%, you have a disaster. But, if you spread your money among 10 different stocks and one drops 50%, you've only lost 5% of your investment. Not nearly as bad. In fact, it's possible that one or more of the other stocks could go up and offset the loser.

The longer time frame reduces risk much the same way. The stock market does have bad years. Sometimes even two or three in a row. But, for the last 100 years, if you took any 10-year period, the return was positive. So you might have lost money in one year. But if you could afford to wait awhile to sell, you would have gotten the losses back. Combined, time and diversification allows Anita to get the higher returns without increasing her risk.

Now let's apply all of this to Anita's situation. We'll assume some life events. The first reason that she might need to access her nest egg is for an unexpected bill (think auto repair). For that she needs money that's accessible immediately. Like in a savings or checking account.

Once she's saved more than enough to cover immediate needs, she's ready for a second investment account. Suppose Anita is also planning on buying a new car or making a down payment on a home in two or three years. Savings earmarked for those purposes would earn more if they were put into CDs.

Longer term, Anita will want to save for her retirement. She already has an RRSP account. For our U.S. readers, an RRSP (Registered Retirement Savings Plan) is a Canadian account very similar to an IRA. A mutual fund investing in stocks would be an appropriate selection here.

Anita is off to a fine start. All she needs to do is to decide why she's saving, how much she needs for that purpose, and then select the type of investment that matches her goal. At the rate she's going, in a few short years, she'll be giving others advice on how to accumulate money!

Can't Afford My Friend

April 9th, 2007 at 08:17 pm

Can You Help This Reader? This is what she writes:

My "Can't Afford" Friend

I have a friend who works full time (I work part time and make half the income that she does) who just doesn't seem to understand that I can't do the things that she does. She is having a holiday from her job soon for two weeks, and when I went to see her a few days ago, she asked me what "we" are doing for her holiday.

I have to work and told her so, but she knows that I work mornings and she wants to do things in the afternoon. Everything that she wants to do involves money, which I simply don't have. I have some bills to pay at the moment, and I am trying very hard to keep on top of my bills and pay off the debts that I have.

I simply don't have the money to travel around and visit places with her. She won't pay for me and I wouldn't ask her to anyway. She wants me to take her places and go on trips with her, but I simply don't have those resources. She lives with family as do I, but she doesn't pay board or have a car. My car is acting up too and I need to save money to get it fixed.

How do I explain to her that I simply can't keep up with her social life and let her know that my expenses are more important than running her around without her getting offended?

Has anyone had a problem with someone like this?

She told me that she doesn't want to sit at home on her holidays and I know that she expects me to run around after her as I have stupidly done in the past. If you or any of your readers have some advice, I would be grateful.

Finances Are Like A Screwdriver

April 9th, 2007 at 08:32 am

Had an interesting experience last weekend. I was with a friend and he pulled out an old toolbox. In the toolbox was a pretty good-sized screwdriver. The shaft was badly rusted. The toolbox had probably been sitting on a boat for quite some time. My friend is a boater and loves to go out into the gulf.

I looked at the screwdriver for awhile. It was one of those sold by Sears with a clear plastic handle. I noticed that the shaft that was within the handle was also badly rusted. But the handle looked and felt just fine.

It occurred to me that people's finances are similar to that screwdriver. Some people have openly rusty finances. They're struggling and pretty much everyone knows it.

But others had a slick plastic shell. They look good. But, if you can see into their situation, you'd find a rusty shaft. There may be a new, expensive car in the driveway, but the last two payments were late.

If you had a file or a grinder, you could put a nice new head on the screwdriver. But, chances are that it'll just be thrown away and replaced. After all, screwdrivers aren't that expensive.

But it's pretty hard to throw away and replace your finances. Yes, you can go bankrupt, but that's not an easy road.

So my hope is that your finances aren't a rusty shaft. Or, if you have a bit of rust, it's just a little surface rust that can be sanded away before it does any serious damage.

Credit Score Repair

April 4th, 2007 at 05:16 am

My husband was out of work for two years. We were forced to live off credit cards, so we have five cards that are close to their limits, along with a mortgage and a car payment. Despite our circumstances, only a couple of credit card payments were late over that time, but our rates skyrocketed while our credit score dropped dramatically even though I had had a nearly perfect credit score before. My husband now has a job and our income has increased. What is the best way to get our financial life back on track? Does income count in calculating credit score or in assigning credit card rates? Is there something we can do besides paying off as much as we can as quickly as possible? --Stephanie

Stephanie is smart to want to boost her credit score. That score is quickly becoming a very important number for all your financial affairs.

Let's start by examining her current situation. We'll begin with something called the FICO score. It's named after Fair Isaac, the company that calculates and provides credit scores. The score is a number between 300 and 850. A higher score is better. It attempts to predict how likely you are to be able to pay your debts.

Lenders use the score to determine whether to approve your loan and how much interest to charge you. Others use the score to see how financially responsible you are. Insurance companies, employers and landlords are among those using your credit score in determining whether they want to do business with you.

Stephanie admits that during her husband's unemployment they had a few late bills. And that the interest rates on their credit cards jumped. That's common. In fact, you should expect that a late payment on one will have an effect on all your cards.

According to Fair Isaac, negative information can include "overdue debt from collection agencies, and public record information...including bankruptcies, foreclosures, tax liens, garnishments, legal suits and judgments." Fortunately, for Stephanie, only a couple of payments were late and they stayed current on the mortgage and car payments.

So what's the best way for them to improve their credit score? Fair Isaac will not say how they're calculated. But some general information is known. Stephanie's income is not part of the score. In fact, the scoring company does not know her income.

Some companies claim that say they can raise your score immediately. Don't trust them. Repairing your credit score is not an overnight event. It takes time to improve it.

If information is accurate, you cannot remove it. For instance, a late payment will remain on your report for seven years. That might seem like a long time, but it becomes less significant as you continue to make timely payments. Recent late payments hurt more. The number of late payments counts, too.

Fair Isaac says that about 35% of the score is based on your payment history. So it is important for Stephanie to make all of her payments on time.

If Stephanie is creative, it might occur to her to close the accounts that were late. But, a closed account will still show up on your credit report. You can't "erase" a late payment by closing the account.

Stephanie is right that reducing her loan balances is important. An additional 30% of her credit score is based on the amount of outstanding debt. Ideally, her card balances would be 25% or less of the installment credit available to her.

Do not open up new credit card accounts in hopes of creating new, unused credit to lower the ratio. That would actually work against her by raising the amount of unused credit and by lowering the average time that the accounts have been open.

Stephanie has already limited the number of accounts carrying a balance to five. It is believed that your score will drop if you have an unpaid balance on more than 6 or 8 accounts.

It would probably also be a good idea for Stephanie to check her credit report for errors. Actually, that's a good idea for everyone. At least once or twice a year. Tests show that one in four credit scores have a significant error. Get a free credit report at annualcreditreport.com or call 1-877-322-8228.

Stephanie and her husband are fortunate. They've survived a tough financial situation. Although some damage has been done, their credit score will rebound in time. The key now is to avoid any 'quick fixes' or missed payments that would make things worse. Simply following good money management practices like paying down her credit card balances is the best thing that she can do.

Pay off Mortgage First or Invest?

April 3rd, 2007 at 07:39 am

I'm 35 years old and have the option to pay off my mortgage and be totally debt free. After paying off my mortgage, I'd still have approximately $68,000 to invest for retirement. I'm really confused about whether it will be best for me to pay off my mortgage or invest all of the extra money ($98,000) instead. My financial advisor and professor from a Personal Finance class I just completed are telling me it's not in my best interest to pay off my mortgage because I will no longer have the tax benefits. Some financial experts say you should pay off your mortgage as soon as possible. I'd really like to hear your opinion on this subject. -- Julie M.

Good question! And, a common one, too. When you have some extra money, is it wise to pay down the mortgage or is an investment a better choice? Let's begin by understanding the mortgage interest deduction and then work on a framework for comparing options.

Interest paid on a mortgage for your home is generally deductible on your federal income taxes. To use the mortgage deduction, you must file an itemized 1040, be legally liable for the loan, and the debt must be "secured" by the home.

The IRS defines home mortgage interest this way in publication 936: "any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan."

There are some limits to the mortgage deduction. We won't get into the formula here, but in most cases, it won't be a problem as long as the money borrowed was used to buy or improve your home.

The biggest problem with the mortgage deduction is that many people use the standard deduction. In 2004, it was $4,850 if you were single or married filing separately. Filing married on a joint return? You got $9,700.

The rules for what's eligible for deductions are beyond the scope of this article. The safest way to figure out your status is to see what you did on last year's and expect to do on next year's tax returns. The biggest items are typically state/local income taxes, property taxes, medical costs and charitable contributions. Before making any decision, see how your specific tax situation would play out.

One way to look at the mortgage interest deduction is that you're paying someone $1 in interest to get 25 cents back in tax savings. That's what would happen if Julie were in the 25% tax bracket. I suspect that most of us would be willing to give Julie a quarter for every dollar that she gave us. The point is that the interest deduction by itself probably isn't a good reason to have a home mortgage.

Now for Julie's choice. Can she get a better return by putting $30,000 into paying off her mortgage or by investing it for her retirement? We'll need to do a little math so hang on tight! And, we're going to simplify just a little. But, that's ok. This decision doesn't require three decimal places.

What does Julie's mortgage really cost her? If her mortgage were 6% and her tax rate were 25%, she'd pay $1,800 interest during the year (.06 x $30,000). But, that $1,800 in interest would be worth $450 reduction in taxes if she itemized ($1,800 x .25 tax rate). So the true cost of borrowing the money is really $1,350 ($1,800 - $450). That works out to an interest rate of 4.5% ($1,350 / $30,000).

Everybody still with me? Ok, next Julie can calculate what she'd earn by investing the money elsewhere. If Julie were to invest the money, she'd earn the investment return minus the tax rate.

Julie could invest in a lot of different things. And, they have different potential rates of risk and return. We won't get into that today. Let's simply assume that Julie found an investment that she thinks will earn 7%. In the first year, she'd earn 7% minus the amount paid in taxes. So she'd see $2,100 ($30,000 x .07) minus $525 ($2,100 x .25) or $1,575. Or a rate of 5.25% ($1,575 / $30,000).

In this particular case, Julie mentions investing for her retirement. If she's able to use a tax-sheltered account, it's possible that she won't have to pay taxes on the investment earnings for years.

So given these assumptions, the investment looks better. Remember though that predicting future investment returns, tax rates and the ability to use mortgage interest deductibility aren't precise.

Julie also needs to be aware of any biases that her investment advisers have. We're not saying anyone is dishonest, but it is easier for mortgage and investment advisers to see the benefits of taking out a mortgage and investing the money in other places. Julie shouldn't ignore what they say, but she should be aware of the context of the advice.

Finally, there's an emotional side to be considered. Some people feel more comfortable without debt. They sleep well knowing that no one can take their home. Others have a more adventuresome nature and like the thought of picking investments and earning a higher return.

If Julie takes the time to work through her choices and how she feels about them, she's likely to make a decision that she won't regret later.

Frugal Community

April 2nd, 2007 at 04:13 am

Wow! Today I get to do something that I've been waiting for years to do. I get to tell you that we have created forums for The Dollar Stretcher site.

I've always wanted a place where it was easier for our readers to contribute and connect. Part of our DNA around here is that everyone is an expert on something. And, that if you take the 100k+ readers of the ezine and add that to the 100k+ visitors to the website each week, you'll find someone who can answer just about any financial question/problem that there is. It's just a matter of getting the question and the answer together.

"Can You Help This Reader" was our first attempt at harnessing our combined wisdom. And, it's been a favorite since our first issue back in 1996. We came close to starting a forum back in 1999, but we didn't have the staffing to do the job properly so we gave up the attempt.

That all just changed recently. Many of you know Pat Veretto. She was responsible for the frugal living pages at about.com.
I always admired her work. Well, to make a long introduction short, about a month ago Pat joined us with her main function
being helping to make The Dollar Stretcher Community a great place for you to ask questions and trade ideas about frugal living and money. We haven't given her a title yet. Perhaps you have a suggestion. If so, you can send it by
mail to pat@stretcher.com. Or maybe you just want to say hello. I'm sure that she'll be glad to hear from you in either case.

I'll admit that we still have some work to do on the forums. The layout isn't exactly what we want. And, we'll need to add sponsors so we can afford to pay for it. But, if you don't mind the fact that we're still moving the furniture around, we'd be happy to have you visit. You'll find The Dollar Stretcher Community at community.stretcher.com Oh, and let Pat or I know what you think. We've always relied on our readers to share their ideas for improvements. No plans to
stop now!