Public Service Announcement - Debt

[mbossman2]

Debt - a necessary evil.

Debt - levaraging tomorrow for today

Debt - borrowing for today hoping for a better tomorrow

At some point in your life you will be faced with an expense that, no matter how careful and frugal you are, is either greater than your available cash reserves or drains those cash reserves to an unaccpetable level so you are faced with a choice: either go without or go to the moneylenders and pay them to use their money.

If you have read what I have written in the past, IMO, the bulk of debts are what i term as "bad" debt - something that is an anchor around your life that just drags on you and, if you aren't careful, can sink you.

having said that, lets jump on in:

Good vs Neutral vs Bad debt
"Good" debt is incurred when you are buying something that is worth more tomorrow than it is today. Things in this group are really limited:
Housing and education are the 2 main ones. In both cases, what you are buying today will (or should) bring in more money down the road than the money you are spending today. Taking education as an example: http://www.infoplease.com/ipa/A0883617.html. As you can see, investing $40,000 in earning a bachelor's degree vs a high school diploma increase a worker's median income from $35.7K/yr to $57.2K/yr. Not a bad trade off.

"Neutral" debt. This is actually a misnomer. This is debt that you incur when you must, but avoid whenever you can. things that fall into this category are things like the primary car (main, back and forth to work transportation): things you must have and more than likely cost more cash than you have on hand. You have to have one, so borrow if you must, but once it's paid off, ride that horse until it dies.

"Bad" debt. This debt is really a yoke around your neck. A trap. Bad mojo. Products that fall into this category are: Credit Cards. Don't get me wrong, credit cards, when used wisely, are a wonderful tool, but if used improperly, can saddle and crush you for a long long time.
Now, credit card companies know this and use a lot of lures to get you to use their cards (points, airline miles, "cash" back, low/no teaser interest rates and otherglittery enticements) and those encticements, unless you are very careful, can get you to take your "eye off the ball" and then BAM, you are deeply in the hole. for a r-e-a-l-l-y l-o-n-g t-i-m-e...for example: $5000 balance on a credit card with a 14% interest rate (the national average) and a normal minimum paymentof 3% of the balance would take 189 months (almost 16 years) to pay this off. Suffice it to this kind of debt is NOT a real friendly kind of debt.

How to get a loan
There are many ways of obtaining a loan (mail, in store, in dealer, in bank) but the process really is no difference regardless of where you get the loan:

Application

On here you will indicate:

• Your name
• Address (length of time there, own/rent/live with parents, monthly payment)
• Employment (length of time, job, salary)
• Social Security Number
• Other credit references (bank accounts, other loans, etc)
• Personal references
• the same information for any co-borrower/co-signer
• and, most importantly, your signature attesting the accuracy of the information and granting your permission for the lender to investiage the
  information that you have provided.

it is important that you accurately complete the information (no fudging here) as any "lying" could be construed as fraud (a very very bad thing). In addition, you may be asked to provide a valid government ID to prove you are who you say you are or additional documentation
proving income, employment, account/asset existence and the like, all depending upon the size of the loan, your credit worthiness and the like.

Investigation
Once the lender accepts the application (BTW, a lender CAN NOT refuse to accept a credit application, that is discrimination), they will investigate the information you have given them and evalutate your credit worthiness against a set standard of lending. they will take into account:

• Credit Score (aka FICO score) - this is a calculation than encompasses your income, your payment history, debt load, available credit etc and spits out a number that indicates your likelihood of successfully (on time) repayment of the loan.
• Employment - where you work is less important than how long you have been there and how much you make
• Debt to income ratio - how much do you make, compared to how much do you pay out each month?
• Residence status - own? rent? how long have you been there?
• Other assets
• personal references - this has become less and less used but in some cases CAN make the difference (say the CEO of Ford says you are an OK guy might influence whether Ford Motor Credit will give you a loan or not )

Decision
Once the investigation is complete (and this can be anywhere from 10 seconds - just a FICO check up to weeks - calling and checking every single reference, credit and personal) a decision is made:

Denial

If, for some reason, your credit application is denied, the lender is obligated to advise the applicant as to "why" they were denied and from what source the information was obtained. This, in theory, allows the applicant to review the information and demand corrections to erroneous information so that the loan application can be reconsidered.

Contigent Approval

The lender may extend an approval contingent upon some set of requirements: acceptable collateral, further verification of some information, increased down payment, co-signer/guarantor are common ones. once those requirements are met, a full approval is issued.

Approval

Well, this is what we all hope for...an approval. this means that the loan will go thru. But just getting the loan is only 1 part of the approval. What interest rate you will pay is also part of the approval. Remember back in the investigation and evaluation? Your application is "slotted"
based upon your information (most notably your FICO score) and the interest rate you will be charged is determined. So it pays to have good credit. The better your credit, the lower your interest rate.

Contract
Once the approval is issued, a lending contract is prepared. this can range anywhere from a quick, half page document all the way up to a multipage package with, literally, 50-60-100 pages. it is imperative that you review this document carefully. Make sure that all the blanks are filled in, the information entered is correct and accurate etc. Until they are DO NOT SIGN. Once you sign, you are bound by the terms and conditions included in the paperwork, right or wrong. The longer and more complex the loan documents, the better off you are if you
get an attorney involved (extremely common, and, in fact may be required, for mortgages). Once the documents are completed and signed off
you have yourself a loan.


Types of Debt
There are 2 main kinds of debt that you will encounter and each of these types have different "products", purposes, requirements and costs.
I'll deal with each type in turn:

Unsecured Loans

These loans are granted based upon the credit-worthiness (or strength) of the borrower, there is no collateral securing this debt. The risk is higher for the lender therefor the interest rate tends to be higher than

secured Loans

These loans are granted on both your creditworthiness and the value of the collateral offered to secure the loan. Car loans, house loans etc are secured. The interest rates are, generally, lower than with unsecured loans as the lender can come and sieze the collateral in case of non-payment.

Once the loan is made and loaded into the lender's systems, you are now obligated to pay the loan on time, per the terms and conditions of the loan documents. Please note that even if you don't get a loan booklet or bill or invoice, that does not alter the fact that you are still required to make the payment(s) on time. If you don't make the payments, on time and as agreed, there can be ramifications, The range from:

• Late fees - these can be anywhere from pennies to hundreds of dollars
• Phone calls and letters (think telemarketers are bad? try a bill collector)
• Impact to your credit standing - remember, your credit score influences the the loans and terms you can qualify for.
• Increase in interest rates - especially for credit cards, the default rate is amazingly high
• Loss of collateral - don't make the car payment? you may get a visit from the repo man. after they sell the collateral, you'll still owe on the loan, just less.
• Lawsuit - won't pay voluntarily? The court can enforce the obligation via judgement and wage garnishments

None of the above are really fun options, so it is best to pay on time (I use my bank's on line bill paying service and the loan payments are autommatically deducted from my checking account - whether I remember or not).

That about wraps up this topic.

[perkster]

i underwrite secured loans in the UK so i see people in debt and on verge of losing their homes every day and its mainly credit cards that do it, loans are better (unsecured if possible) if its something you need to borrow for, least that way there is set terms.

[TwoRails]

Nice post, mbossman2... or should it be called an article?!

[MaxRat]

also should be a posting...

If you are considering a loan go to a reputable bank...

NOT a lender or mortgage broker or loan broker...

If you cant get it at a bank you really dont need it and you are being set up for failure...

Preditory lending is on a rampant rate and most are unknowing...

I can tell you 1st hand how they work and just how you lose...I did.

if you are considering credit options talk to a banker...

A good lender will convince not to consolidate all your debt and help you get rid of the ones you dont need at a very low cost...

Besides...if you CANNOT afford to pay your bills now...? how can you afford to consolidate all those bills into one payment plus give the broker a nice fat check for anywhere from $4,000-$50,000 just doesnt make sence does it?

Money is very easy to get...especially if you have less than perfect credit...they know you cannot pay it back and charge a much, much higher rate for it knowing you'll fail...

This is backwards life...if you are money strapped and need cash and have to take a loan you have to pay more for the money than people who really dont need loans and have cash readily available...

The biggest mistake I see people make when buying a house is consolidating all there bills into the payment...like car loans...thats just stupid...

the Lender tells you they'll pay off you car getting you to think it's paid for...but now instead of only paying the interest on what would have been a 3 year loan is now to paying interest on a car for 30years...

Chances are you wont have the car that long....

Anyhow good write...

[LeftyAce]

but now instead of only paying the interest on what would have been a 3 year loan is now to paying interest on a car for 30years.

And that's a very very bad thing with compounded interest. The formula for how much you'll pay by the time you're done is something like (1+interestRate)^NumberOfMonths times Principle. It adds up fast.

[HAL9000]

Originally Posted by perkster i underwrite secured loans in the UK so i see people in debt and on verge of losing their homes every day and its mainly credit cards that do it, loans are better (unsecured if possible) if its something you need to borrow for, least that way there is set terms.

Heck, as it's well known now... I work for MasterCard... and yes, I see the messes that people get themselves in every day. The loyalty programs are great for those that use them properly.. for example.. you put ALL of your monthly expenses, absolutely everything on the credit card and then obviously pay in full at the end of the month. You get a lot of points and rewards in a year that way.

The mistakes come when people purchase things that they can't afford and on top of that, draining all their savings money so all they have is the minimum payment. I hear too many people say, I only need to pay $30 on my $1000 card if it's maxed, but as mbossman pointed out, it takes you a long time to pay back that way. I see people with hundreds and thousands of dollars in interest over the year.

I've made my mistakes, been bankrupt, rebuilt credit at high interest, built up a few debts in my rebuild... but it's all coming down, the plan is in place and working... two lines of credit and one credit card to go. I'm really hoping to have them paid off by this time next year. I still have my VISA card and it's been paid off and clean now for about 4 months and I've lowered the limit to something much more managable as I really don't need the limit that I had. I own my car and it runs well, I don't see the need to run out and buy a new one. The house has a lot of years to go, but property values have been going stupid here, so all is good.

[Kov-Ice]

Originally Posted by HAL9000 The loyalty programs are great for those that use them properly.. for example.. you put ALL of your monthly expenses, absolutely everything on the credit card and then obviously pay in full at the end of the month. You get a lot of points and rewards in a year that way.

This is what we do. I have an amazon credit card, and we make nearly every monthly budgetary purchase with it. If we know we're going to make a big purchase, we have the money saved in advance. The card gets paid in full each month, and we rack up $25 amazon gift certificates left and right!

The key when doing something like this is that the card absolutely must be paid off before the due date every month or else interest is incurred. That would defeat the purpose!

The same holds true for 0% financing offers. It's great to purchase something at 0%, but the full interest accrued is charged to you if the balance on such a card isn't paid in full by the special offer time limit. Just have a payment plan in mind or have the money to pay it off collecting interest for you somewhere until it's needed.

[HAL9000]

RIght... and that is something the majority of people don't realize... if you put $5000 on your credit card.. then at the end of the month can only pay back $4900... you're not paying interest on the remaining $100 owing, you're paying interest on the FULL $5000 until that full $5000 is paid back.

[mbossman2]

there are 2 issues here:

with Kov, most of the promotional finance rates and terms have the provision that if the whole balance is not paid, you get zapped with all the interest, dating back to day one, so if you've got $5000 on the card and the interest rate is 21% you get CREAMED! To the tune of approximately $1100 in interest if it is a 12 month deal.

With HAL, credit cards use an "average daily balance" method of calculation to determine your interest charge. with $5000, a 30 day cycle and a $4900 payment, your average daily balance is $4983 and THAT is what the interest rate is charged. Some lenders are even sneakier and do a 2 billing cycle average daily balance and that can push the ADB even higher.

Remember: debt is, more times than not, something that is not your friend.

[HAL9000]

Not all cards use the average daily balance, ours for instance, do not, it is on the full balance. Either way, you can see interest on $5000 or $4983, it's not going to be your friend either way.

[edfair]

Now if I could only get my children and grandchildren to read the thread.

I can sympathize with those who must live on the edge and applaud those who recognize that it is a losing effort and get off the treadmill.

Good thread.

[thefultonhow]

I have a credit card with what is now an $8200 limit. I never put anywhere near that much on the card, because I don't have the means to pay it off every month if I do. The most I've ever put on the card is around $3000 when I got my Dell Inspiron XPS Gen 2 in 2005, and I paid that off in full at the end of the month because I had enough money to do so. Most months I put on well under $500, because that's all I can afford to pay (luckily, being at college, my room and board are paid for, but even when I was on leave, working full time, and living alone, I only put on around $600-700 a month).

There's only one time I didn't pay the credit card off in full. I bought some stuff on it for my parents, so my mom paid her share before I paid mine. I was lazy and didn't get around to paying until after the due date -- I said, "Oh, it's fine, it won't be a late payment because part of the payment has already been submitted." Yes, that was correct, but it was maddening to see the interest show up on the card for the next couple of months, even though it was only a few dollars.

I use a Citi Dividend Platinum Select (originally co-signed with my mom over three years ago), and it gives 1% back on most purchases, but 5% on gas and groceries. I currently have around $60 sitting there waiting for me to ask for it.

[HAL9000]

That's another topic to bring up.... if you don't need a large credit limit, reduce it to what you need. What happens when you are applying for say a loan or mortgage in the future, that credit card limit is seen as POTENTIAL debt. Sure, your $10k limit may have nothing on it, but at 3% payback, it's a potential $300 per month liability. If you only need $2000, then reduce it to $2000... now your potential debt is only $60 per month.

[MaxRat]

Good tip Hal...

I did not know that...

[telegramsam]

Originally Posted by HAL9000 That's another topic to bring up.... if you don't need a large credit limit, reduce it to what you need. What happens when you are applying for say a loan or mortgage in the future, that credit card limit is seen as POTENTIAL debt. Sure, your $10k limit may have nothing on it, but at 3% payback, it's a potential $300 per month liability. If you only need $2000, then reduce it to $2000... now your potential debt is only $60 per month.

Why in the world would anyone want a credit card? A debit card and savings account with some money in it works very well. You can rent cars and travel with a debit card, and a savings account to borrow money from works MUCH better then a credit card. It's surprising how irresponsible I feel when I don't have my balance goal in there.

I cut up my credit cards 10 years ago and make no car payments. I make lower middle class money, and I'm doing pretty well for myself, I believe. But then again, I don't have that retarded fascination with shiny new objects...

[thefultonhow]

Originally Posted by telegramsam Why in the world would anyone want a credit card? A debit card and savings account with some money in it works very well.

Four reasons:

1. It builds credit so that you can do things like buy a car or a house when you need to do so, and have a lower interest rate on the loan.
2. You don't have to be completely attentive to the exact amount of money you have in your bank account, because you won't have to pay hefty overdraft fees if you go over. As long as you have a general idea of what you're spending, you're okay.
3. With rewards cards, you can get cash back.
4. It's easier to dispute charges, just in case someone randomly charges something to your card (as happened to me last month) or you buy from an untrustworthy store by accident.

Really, as long as you resist the lure of, as you said, shiny new objects, either one will work fine. it's only when you decide to use your card as a loan that there is a problem.

[doctorgonzo]

Don't forget that some credit cards have additional perks, like extending warranties on the products you buy, providing additional insurance for travel or renting a car, etc. You can also have more protection against liability if somebody steals your card.

I'm another person who pays the credit card bill in full each month. Ten years running now, and I've only paid $1.50 in credit card interest in my life (and that was when I first got a credit card and my first $50 purchase, just to do it I guess).

Think about the debt you get into. Lots of people wait until after the fact when they are locked into it. I almost made that mistake not a month ago.

[HAL9000]

Originally Posted by telegramsam Why in the world would anyone want a credit card? A debit card and savings account with some money in it works very well. You can rent cars and travel with a debit card, and a savings account to borrow money from works MUCH better then a credit card. It's surprising how irresponsible I feel when I don't have my balance goal in there. I cut up my credit cards 10 years ago and make no car payments. I make lower middle class money, and I'm doing pretty well for myself, I believe. But then again, I don't have that retarded fascination with shiny new objects...

Where are you renting cars from that they will take a debit card? I can't think of any place in that doesn't want a credit card pre-authorization for the rental... most hotels too. Now if you are talking about something like a Global Payment Mastercard.. yes, those work just like a credit card but are attached to a line of credit or your chequing account and work like a debit card... but like I said.. I've never heard of any car rental that will just use a debit card.

[LeftyAce]

My debit card works just like a credit card (it's MasterCard) except that the money has to be there. Which is a pain when rental car places pre-authorize charges, because the cash has to be in the account. Also, when a store I shopped at had their database hacked into, my bank contacted me to void the card just like a credit card company would.

I guess it depends on the debit plan you've got. And there's no 'overdraft' ability, as thefultonhow said.

[glc]

Enterprise takes debit cards for rentals - they charge $400 on it right away then credit you the balance when you return the car.

If your checking account has overdraft protection, so does your debit card - up to that limit.

[HAL9000]

Hmm... interesting G... Enterprise here won't touch it... CC only.... either way, it still sounds like you're severely limiting yourself.

Lefty, that's exactly what I am referring to with the Global Payment MasterCards that we issue through credit unions where I work.

[telegramsam]

I've rented a few cars with my debit card--like GLC said--you have to have enough in the checking account to survive a $400 reserve. Hotels don't seem to care either way...

I just found that I'm far more disciplined with my spending when it bites my checking and savings balance. Maybe it's just a personal thing. I know I'm far happier without a credit card. I have a mortgage and got a reasonable 30 year fixed rate without too much trouble...

[Floppyman]

Doesn't a Debit card act as a CC anyway when you're not entering the PIN during a purchase?

[glc]

Yes - and mine has a $3000 limit.

[telegramsam]

Originally Posted by Floppyman Doesn't a Debit card act as a CC anyway when you're not entering the PIN during a purchase?

That's what it does at most gas pumps. I've recently been asked for a PIN, but generally the pumps just give you the gas and a receipt, no questions asked.

[alanebro82]

A note on Debit Cards acting like Credit Cards...

Most debit transactions are free for the store you are buying from.
Most credit transactions actually cost the store money. (ie Visa charges Best Buy $x.xx per CC transaction)

So you are actually saving the store money by putting in your pin/running your DC as a true DC.

[mbossman2]

Credit life is like any "life", it has stages and depending upon where you are in that cycle, your options change.

Telegramsam has an excellent point IF you are at the point in your life where you are firmly established credit wise and have developed a significant cash base from which to draw and that is accomplished by budgeting, proper tax withholding strategies and savings strategies for retirement (as well as "regular" life). Once you are there, making sure that you have have sufficient amount of credit references drops off rather dramatically. By this time you have successfully paid (or are paying) your mortgage (usually the ultimate credit reference) and have a bunch of cash, so who cares?

Now, if you are just starting out in your financial life, having a credit card or two where you make charges and pay them off in a timely manner is good for establishing yourself, credit-wise, and this allows you to obtain better interest rates as well as other advantageous offers.

As to using your debit card as a credit card. Yikes! the big difference between the 2 is that a credit card is 'virtual' money. if an error is made, you can quickly and easily use the federally mandated dispute process and you can continue on with your life.

OTOH, with a debit card, you are accessingreal money, so something as simple as going to the gas station and having them slap a $50 or so hold on your account while you pump gas (which usually stays in place for 72 hours or so) could (and has) caused checks to bounce, especially, if you are like many people, you live very close to th edge: paycheck to paycheck, running your account balance down to near zero with each paycheck, have little or no buffer in the account and decline to have overdraft protection. the same thing can happen if a merchant screws up and double charges you for dinner or the six pack you bought or or or.

While yes, the merchant can usually fix it fairly quickly but the inconvenience of explaining it to the bank, explaining it to your creditors (who also got zapped for bounced check fees) and undoing the damage, is far more than the inconvenience of keying in your PIN number, paying cash (a real novel idea and something that darn Visa checkcard commercials seem to belittle) or using a real credit card and having the discipline to pay it off, 100%, each month.

Credit, in its myriad of forms, is a tool and like any tool it can be constructivel or it can be destructive, all depending upon the hand and mind that wields it.

[glc]

Originally Posted by alanebro82 A note on Debit Cards acting like Credit Cards... Most debit transactions are free for the store you are buying from. Most credit transactions actually cost the store money. (ie Visa charges Best Buy $x.xx per CC transaction) So you are actually saving the store money by putting in your pin/running your DC as a true DC.

However, my bank gives me rewards points when I use it as a CC.

[HAL9000]

Originally Posted by mbossman2 Once you are there, making sure that you have have sufficient amount of credit references drops off rather dramatically. By this time you have successfully paid (or are paying) your mortgage (usually the ultimate credit reference) and have a bunch of cash, so who cares?

My mortgage doesn't even report to a credit bureau... the way they look at it here is if you don't have a mortgage, you have rent. Mortgages are relatively easy to obtain here.

Originally Posted by mbossman2 As to using your debit card as a credit card. Yikes! the big difference between the 2 is that a credit card is 'virtual' money. if an error is made, you can quickly and easily use the federally mandated dispute process and you can continue on with your life.

Or better yet, fraud situations... it's not nice to have a lot of your real money stolen and you will feel a lot more violated. Hope you have enough cash to cover yourself as I've seen these situations go into the thousands rather rapidly.

Originally Posted by mbossman2 OTOH, with a debit card, you are accessingreal money, so something as simple as going to the gas station and having them slap a $50 or so hold on your account while you pump gas (which usually stays in place for 72 hours or so) could (and has) caused checks to bounce, especially, if you are like many people, you live very close to th edge: paycheck to paycheck, running your account balance down to near zero with each paycheck, have little or no buffer in the account and decline to have overdraft protection. the same thing can happen if a merchant screws up and double charges you for dinner or the six pack you bought or or or.

Gas station pre-auths here start at $99 and are as high as $175... 5 business days to drop off. If you're travelling by car, that can be a lot of holds on your account.

Originally Posted by mbossman2 While yes, the merchant can usually fix it fairly quickly but the inconvenience of explaining it to the bank, explaining it to your creditors (who also got zapped for bounced check fees) and undoing the damage, is far more than the inconvenience of keying in your PIN number, paying cash (a real novel idea and something that darn Visa checkcard commercials seem to belittle) or using a real credit card and having the discipline to pay it off, 100%, each month.

The other PITA, merchants here have 5 business days to post a refund to fix a screwup. So you're sitting around waiting to see if it shows up. After that you are disputing which can take up to 45 days... again, a long time to tie up real cash.

[telegramsam]

Those are good points, Mbossman...

The reason I hate credit cards so much is because of the absolutely criminal irresponsibility of the lenders. While they really shouldn't be blamed for their clients' irresponsibility, what do they realistically expect from a 20 year old married couple who are GOING to have periods of financial hardship? It's so easy to fall into a habit of using credit cards for gas, groceries, paying cable/cell phone bills, etc... I found all of this out the HARD WAY myself. It was a real struggle to overcome my youthful stupidity and lack of discipline. Again, personal issue. I'm sure a great many young people handle themselves well with a credit card.

Not very long ago, you had to have established GOOD credit in order to get a credit card. That certainly isn't case anymore.

It seems to me that the relaxing of credit standards, the unprecedented debt carried by American families, the free for all with big screens, cars, recreational vehicles and other "stuff" bought on credit is a symptom of big problem--that being an overly inflated sense of entitlement. It seems like our insistence that we deserve to have things we can't afford shows that we're merely spoiled brats, maybe? To elaborate further, we've managed to hand a couple of million jobs to the far east in an effort to reduce the price of all of this crap so that people working in entry level jobs can have 50" DLP's in their living rooms. This all seems like self-destructive behavior to me.