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#FPW: Escaping Debt Darkness – Part 3

Written by Richard Rosso | May, 17, 2017
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Credit card debt has morphed into a bona fide monster. 

Federal Reserve data on revolving debt as of April 2017, reflects how out of control the beast is.

Credit card debt has reached the $1 trillion mark, an increase of 6.2% over last year and at levels we haven’t witnessed since early 2009. The average monthly credit card balance is roughly $9,600 for those who don’t pay their balances in full.

The history of plastic is exclusively an American story; the origins are humble and good-intentioned enough.

The first bank card was named “Charg-It.” John Biggins a banker from Brooklyn, New York introduced it in 1946 as a method to create customer loyalty and convenience. Users were obligated to maintain an account at his bank and the card was only to be used for purchases from local merchants.

When Diner’s Club was introduced in the early 1950s, it was a charge card – the bill had to be paid in full every month. The American Express card, also a charge card, made its debut in the late 1950s.

In 1959, the method in which many consumers use credit cards today was introduced. Card holders were then able to maintain ongoing balances and charged an interest rate for the courtesy.

The revolving credit card balance method was born.

Today, credit cards are used for various reasons – convenience, cash back, travel reward points and the most unfortunate, to meet ongoing living expenses in the face of structural wage stagnation.

Ongoing credit card balances can weaken financial security. When you consider how anemically low interest rates are today, it seems downright criminal to charge users on average 15 percent interest compounded to infinity.

If you’re only making minimum monthly payments it’s going to take many years to exit this debt cavern. Frankly, there’s a solid chance of dying in the dark.

Let me be the light.

Here’s what to do. Each move is a step closer to an exit, and freedom.

Prioritize it: Treat the card with the highest balance as the greatest obstacle between you and escape. Do everything possible, think outside the box, to focus on the most onerous card first. Suspend contributions to retirement plans temporarily, cut expenses and target financial resources to battle this monster.

Consolidate it: Consider consolidating debt to one card with the most attractive balance transfer terms however, understand fees you may pay front for the privilege. The best cards will have attractive fees and a long-term 0 percent interest charge. A list is available at www.creditcards.com. Understand that the best cards require an excellent credit history. Also, don’t use consolidation as an excuse to begin racking up the debt again. The new card

should be considered a balance-transfer passport to eventual freedom, exclusively. That means no new purchases.

Pay it (aggressively): I’m going to let you slide if you have six-month’s worth of living expenses in an account that maintains emergency reserves, even though I generally recommend two years set aside. If you maintain a cash coffer in excess of six months sitting in a money market, checking or savings account and believe your job is secure, then go ahead and use the money to pay down or eliminate credit card debt.

Negotiate it: If you’re a long-standing customer with a solid track record of timely payments, then call your credit card issuers and attempt to negotiate lower rates. A good customer with a strong payment history is valuable these days, so use it to your advantage. Mention how you’ve received attractive credit offers but would like to stay where you are. Be professional, confident and odds are good that you’ll wind up with a deal.

Keep in mind a new credit scoring model is expected in the fall of this year. VantageScore is an innovative, predictive scoring model that’s giving the popular FICO® or “Fair Isaacs Corporation” score we are familiar with, a run for the money by claiming that it can assign scores to more than 30 million people in comparison to traditional models.

VantageScore, founded in 2006, will roll out VantageScore 4.0, a new model that excludes liens, civil judgments and medical collections (after six months of past due). The score will consider consumer behavior or a long-term relationship with credit. 

As opposed to a single snapshot, the algorithm examines how a consumer’s credit balance changes over time or the trend in the data. Naturally, the timely payment of bills remains crucial to a respectable score. However, your credit utilization ratio takes priority which means credit card balances need to remain low compared to credit maximums available.

We all know those people who heed “no trespass” signs and avoid the credit card debt cave altogether. If you’ve never ventured in, you’re probably never going to. Or at the least, there’s a clear direction to an exit.

So, how can credit cards be used to your advantage?

If you can’t beat ‘em, join ‘em (smartly):  If you must maintain ongoing credit card balances, create a rule, a boundary that can’t be breached to limit or monitor usage. For example, an effective rule is to keep balances at 5% or less of annual gross income.

Investigate cash back or rewards cards that suit your spending or travel preferences. The web hub www.comparecards.com does a respectable job with comparisons of reward cards.

My personal favorite is the Discover It® Cashback Match™ card. No annual fee with a dollar-for-dollar match of all rewards earned at the end of the first year, automatically as well as a 0% APR on purchases and balance transfers for the first 14 months.

There are bonus 5% cashback rewards (up to a quarterly maximum of $1,500), for specifically designated spending and product categories that change on a regular basis.

Cash back earned won’t expire as long as the account is open and in good standing. Accumulated rewards can be redeemed by making charitable contributions – a unique feature.

Card holders can receive a free FICO® credit score online, too.

Thinking of applying? Keep in mind you’ll require exemplary credit to receive this card.

Maintain the card with the longest credit history. The long-term, ongoing management of credit is an important addition to +790 credit score. It’s a track record of good habits.

There are people in our midst I call credit card hoarders. They feel better possessing a stack of major and department store plastic. I would winnow the number down to the three you use the most and close the rest.

Department store cards tend to have the most usurious of rates. Unfortunately, they also tend to hold the longest payment histories. It’s ok to maintain retail store plastic as long as balances are paid in full each payment cycle.

Mortgage Debt – Four Walls, a Roof and Perhaps a Mortgage That’s Dangerous to Financial Wellness:

Mortgage debt, if not reined in, is another channel in the cave of liabilities, although people are generally surprised by that revelation. Indeed, you can wander too far into the mortgage debt labyrinth and have a difficult time making it out.

Yes, real estate ownership can backfire, especially if a primary residence is wholesale classified as a wise “investment.”  And what I mean by investment, is a vehicle that increases in value over time and sold at a profit. Just because a house may comprise a significant portfolio of net worth, doesn’t make it a great investment. It makes it one of the largest purchases of your life. That’s true. However, investment? Well, that depends.

Per 2011 Census data, the median net worth for married couples age 65 and older is $284,790. Of this total, $192,532 is home equity which comprises two-thirds of total wealth.

Housing prices generally increase by the widely-accepted rate of consumer inflation or roughly 2 percent a year. Depending on location, price, duration of ownership, supply and demand, there’s no assurance that a house will increase in value.

For example, per Zillow, the Bureau of Labor Statistics and The Economist periodical’s interactive housing price chart, from Q1 1980 to Q2 2016, Houston housing prices decreased 17% in real terms (adjusted for inflation). From Q1 2006 to Q2 2016, Houston housing prices increased by 8.5%.

See? Everything exists in cycles – Human lives, stock prices, housing values.

A home purchase is more than a financial decision. The emotional impact is significant as a house is usually connected to major life events that cannot be discounted. Marriage, children, living, dying. Housing connects to who we are as Americans. However, emotions can blind consumers and lead them astray into long-term debt trouble. “House-poor” can be a stressful reality for unwary homebuyers.

What steps can be taken to be smart with mortgage debt?

Be choosy. Due to low inventory, it’s currently a seller’s market in several pockets of the country. However, mortgage rates should cooperate and remain low by historic standards for longer than expected. Keep a level head: It’s all about location when it comes to prospering in real estate.

Purchasing a tract home in a non-descript development with a catchy name should be considered a place to live and raise a family, not an investment. Quality neighborhoods with good schools and convenient to urban work locations are consistently popular. Quirky, eclectic, or artsy havens can work too although they may not be your preference.

Don’t listen to your realtor, well listen selectively. I have a realtor. She’s the best at what she does. However, she is not privy to my entire financial situation or my philosophy on mortgage debt, therefore she may recommend more house and mortgage than I’m emotionally willing to absorb. So, before you take the step to work with a real estate professional, create a personal mortgage-debt threshold as a first step and stick to it!

There’s that rule you’ve heard about how much to spend on an engagement ring based on three months’ salary. I’ve created a threshold that’s worked for me and clients for years. Feel free to enhance it to relate to your personal situation.

       House Mortgage = 2X Gross Salary

It’s simple. To the point. It gets to the heart of my comfort factor. It separates emotion from the decision.

For example, per the boundary, if you earn $50,000 a year, a mortgage obligation should not exceed $100,000. To be clear, this isn’t the house purchase price, it’s the mortgage or debt on the property. For most, it’s going to mean a reset of expectations, a greater down payment or a smaller abode. I would stray from the rule at great risk to your long-term financial health.

If you can’t stay for ten, wait until then. You don’t know how long I’ve waited to see that in print! If you’re not planning to stay in a home for at least ten years, hold off until you’re prepared to do so.

Flipping a primary residence can be a financially perilous tactic. Preparing to stay put longer than average can reduce risk of losing money when you decide to sell. You’ll be less susceptible to fall prey to lowball offers. There will be a greater chance of weathering through a dismal real estate cycle, too. 

Keep a vigilant eye out for refinancing opportunities. I know. Rates can only go higher. Not so fast. I’ve been hearing for years how low rates must be locked in just to experience yet another period of lower rates. Heck, it may not happen, but odds are at good that another refinancing window will open; remain vigilant and check rates every quarter for possible refinancing opportunities.

Match the duration on a mortgage to your period of ownership. It’s overwhelmingly popular to take on a 30-year fixed mortgage, when in practice it may not be the best debt obligation for your needs. Frankly, the odds of remaining in a residence for 30 years is rare. According to data from the National Association of Homebuilders, an average buyer stays in a home for 13 years so a 30-year mortgage may not be an optimal choice.

Choosing the proper mortgage requires a realistic assessment of how long you may reside in a home, the cash flow needs of your household and the opportunity cost of utilizing financial resources to make

mortgage payments as opposed to funding investments, retirement or college savings vehicles, or paying off high interest obligations like credit cards.

Consider an ARM or adjustable-rate mortgage. How can that be right? Why would you as a financial professional even suggest such a thing? I’ve been an advocate for ARMs since 2009 and if a lower mortgage payment is a priority, then a plain vanilla fixed-rate obligation may not be the best alternative. The media generally bellows how ARMs are dangerous. A mortgage provider will rarely if at all, bring up the topic. It’s like a strain of financial leprosy to discuss ARMs. It requires a discussion, planning, overcoming preconceived notions. So, why would a broker even bother? Too much trouble. Just go with what’s comfortable.

Yes, there were types of ARMs like “option” ARMs that did indeed crush homeowners but that was during the financial crisis. A hybrid adjustable-rate mortgage maintains a fixed rate for a set period like 5, 7 or 10 years. After that period, the rate can adjust higher. Indeed, that is a risk however it comes down to how long you plan to stay in a residence and household cash flow requirements.

If the plan is to plant yourself for three decades in the same house, which is incredibly rare, then knock yourself out. Stick with the traditional 30-year fixed. Otherwise, keep an open mind and explore ARMs. Have your mortgage professional run the numbers. You may be surprised.

Even the most diligent of financial stewards can find themselves lost in a debt cave. 

All is not hopeless.

Through the dark can shine the brightest light of valuable lessons.

These painful episodes are rarely forgotten; long after the escape, memories linger.

Thankfully, all debt caves have exits or may be avoided altogether.

If you heed the signs.

There always exists a way out.

2017/05/17

Richard Rosso, MS, CFP, CIMA

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Richard Rosso is the Head of Financial Planning for Clarity Financial. He is also a contributing editor to the “Real Investment Advice” website and published author of “Random Thoughts Of A Money Muse.”  Follow Richard on Twitter.

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