From Debt to Wealth on $10 a Day
(MONEY Magazine) – HOW WOULD YOU LIKE TO BE FREE OF CREDIT-CARD DEBT? To have a financial cushion to fall back on? To know you have the skills to save and invest for any goal—and to guarantee your financial future?
You can get there on $10 a day. If that sounds like very little—well, it is. But it could be the key to your future.
Let's say you're the average American. You have a decent job, but you also have $8,000 in high-rate credit-card debt and no savings to speak of. You may not believe that $10 a day can dig you out of that hole. But it can—and in less time than you may think.
If you apply that $10 a day against your $8,000 credit-card debt (assuming an interest rate of 16%), you can pay it off in three years. Then you can put that $10 a day into a money-market account, and in another two years you'll have a fat emergency cushion—more than $8,000.
Once you've built up your emergency fund, you can start investing your $10 a day in a tax-deferred account, like an IRA, so the money will grow more quickly. If you earn the 10.7% a year that the S&P 500 has returned since the 1920s, in 10 years you'll have accumulated $24,000; in 25 years, you'll have more than $250,000—all on $10 a day.
But first you need to know how to free up that $10 a day—and how to put it to work for you. Success stories like William and Melanie Behrends (see page 97) say this Pay It Down plan is like a good diet—simple to follow, and easy to stick to—and once you make progress, you'll be inspired to do even more.
DID YOU EVER SEE THE MOVIE DAVE? In it Kevin Kline plays a lookalike for the President of the United States, who takes over the job when the real President has a stroke while fooling around with his secretary. (Yes, it's a comedy.)
In one scene Dave is faced with shutting down a day-care center for underprivileged kids—unless he can find some wiggle room in the government's budget. So he brings his hometown C.P.A. (played by Charles Grodin) to the White House, and they sit around the kitchen table at midnight, chowing down and figuring out where they can make cuts. They get creative. And they succeed.
And that's precisely what you need to do.
Before we dive in, though, you need to be willing to make some hard choices about spending money on particular items. Let's take your cell phone as an example. If you're like many people, you've come to rely very heavily on it. You may have started using it for convenience, or only in emergencies, but over the past few years it's become the easiest and best way to reach you. You can't imagine giving it up. Or can you? Analysts say the average cell phone bill is $53 a month. That's $636 a year. Could you give it up—or use it substantially less often—if that was what you needed to do to come up with your $10 a day? How about your high-speed Internet access? Or your second car? Or that second dinner out each week? These are hard questions. And no one can answer them for you.
We'll address these issues in an order designed to cause you the least amount of pain, one that will ask you to give up the fewest number of things in life that you enjoy. As we go through these steps, keep a running total of the amount you've saved in the worksheet on page 100.
Change your withholding
Did you get a tax refund last year? Do you seem to get one every year? You may love the thought of getting a nice fat check to brighten up each winter, but you should not be giving Uncle Sam an interest-free loan (if the shoe were on the other foot, the government wouldn't give one to you). It's your money, and you should be getting any gains from investing it. Unless you're positive that you would save your refund, you're better off applying it toward your debt throughout the year with automatic monthly payments.
To help you estimate how much you'd benefit from increasing the number of deductions on your W-4 form, the Internal Revenue Service offers an interactive withholding allowance calculator at the agency's website (irs.gov).
Reduce your credit-card rates
If you're in debt, many of your biggest regular expenses are borrowing costs—mortgage, home-equity loan or line of credit, car loan, student-loan and credit-card payments.
Let's start with your credit card. Lately we've enjoyed some of the lowest interest rates in history (although the interest-rate hikes since June signal a change in the tide). At the same time, our homes have appreciated in value quite rapidly. This combination of factors has allowed us to refinance our home mortgages or take out home-equity lines of credit and use some of that appreciated equity to pay down those high-rate cards.
In theory, that sounds really good: You pull money out of your home that you agree to pay back over the next 30 years at a very attractive rate. The interest is deductible to boot. Your personal balance sheet and your cash flow improve dramatically.
In practice, what happens to many people who borrow against their homes to pay down high-rate credit-card debt is that they charge their credit cards right back up again. That means they're even more strapped than they were before. And because they've turned an unsecured debt (those credit-card bills) into secured debt (a bigger mortgage or home-equity loan), they've put their homes on the line.
Unless your situation is dire, there are better ways to bring down your monthly interest payments to Visa or MasterCard.
Cutting the interest rate on your credit-card debt is really a matter of doing one of two things: either reducing the rates on your current cards or transferring your balances to cheaper cards. In order to do either, you need to know where you stand.
Start by laying all your cards out on the table and listing the APR (annual percentage rate, or interest rate) you're paying on each. Note whether those rates are fixed or variable. Next, gather all the pre-approved offers you've received in the mail. Have a rough idea of how valuable a customer you've been: how long you have had the card, how much you charge a month or year, how much interest they're earning each year on your business and whether you pay on time. Knowing if your credit score is above 720 is also smart. (You can get your credit reports and your score at myfico.com; $12.95 for one and $38.95 for those from all three reporting agencies.) At a score of 720 or above, you should be able to borrow at the best rates, so you can use a score at that level to support your case for a better deal from a card issuer.
When you've got everything together, call your card's toll-free customer service number. Say you're considering an offer from another company and ask for a lower rate. If the rep says she's not authorized to do that, be persistent. If she says she can't do anything because your credit card is at a fixed interest rate, say, "A fixed interest rate only means that my rate doesn't vary with fluctuations in the prime rate. In fact, the bank can raise it on my account at any time by just giving me 15 days' written notice. And the bank can—if it chooses—lower the rate today." If that doesn't work, ask for the supervisor. In fact, even if you get a substantial cut from the first person, speak to a supervisor to see if you can do any better. The person on the front line will be authorized to reduce your rate by a preset amount at best.
The next step: Threaten to close your account. Let me be clear—you don't want to close your account. It won't do good things to your credit score. But if the bank believes that you're willing to close your account—and you've been a profitable customer—you stand a better chance of getting what you want. And if the rep calls your bluff ? Say, "I guess I'll have to think about it."
Always keep a record of whom you spoke to, when and what was said. If the rate cut or fee waiver that you were promised doesn't materialize, you'll need a paper trail.
If you're not successful in reducing your interest rate over the phone, it's time to transfer your balance. There are two places to find good offers: in your mailbox (the average person gets five credit-card solicitations a month) and at websites like bankrate.com, cardweb.com and money.com.
HERE'S WHAT TO CONSIDER
• The rate. Balance-transfer offers often come with low teaser rates for the first six or 12 months. Remember that the rate after the teaser expires is at least as important. • The fine print. Balance transfers often incur different interest rates than new purchases. Cash advances sometimes have a third rate. It's important to understand that "pre-approved" may not mean you'll get the rate in large print. • The fees. Some issuers charge a fee for balance transfers.
Heads up! Now that you've worked so hard to reduce your credit-card interest rate, you need to know that there's only one way to keep it down: Pay on time. Late-payment fees have soared to an average $35 a pop, but more than that, a single late payment to your credit-card company can trigger an interest-rate hike to as high as 29%. Many major card companies now consider a payment late if it arrives after 2 p.m. on the date it is due.
For a ballpark estimate of your savings, multiply your minimum payment by your old rate, then by your new one.
Refinance your mortgage
Rates are headed up, not down, but you should still consider a refi if interest rates have fallen since you took out your loan, even by just a half to three-quarters of a point, or your credit score has improved by 25 points or more; if you've paid down enough of your mortgage to turn a jumbo loan (in 2004 more than $333,700 for a single-family house) into a conforming loan; or if your situation is so dire that you need to think about stretching out the term of your loan even if you don't get a better rate. The farther along you are into your mortgage, the more you can lower your payments with a refi.
So how do you proceed? Call your current lender and ask about a "streamlined refi" with less paperwork, fewer administrative hassles and substantially lower costs. If you can't get your lender to play ball, shop around.
There is no single source for the best rates on a mortgage these days. Check local lenders, online lenders, and mortgage brokers to see whether any of them can give you a rate that makes the deal worth doing. If you find a rate that works for you, lock it in. Rates can move as much as half a point from week to week.
Consolidate your student loans
You have a single opportunity to roll all your federal student loans into one at a rate that's at or near a historic low and to lock in that rate. (The rates change each year on July 1.)
If you got all of your loans through a single lender, you must consolidate with that lender, but if you used more than one source, you can shop around. (To see what's available, type "student-loan consolidation" into any browser.)
You're not shopping based on interest rate. The rate you'll receive will be the same at all lenders. What you're looking for is a future rate discount for good behavior (borrowers who have at least $10,000 in debt generally qualify for a discount of 1% if the first 48 monthly payments are on time) and a discount for having monthly payments directly debited from your bank account (usually one-quarter of 1%). If you consolidate while you're still in the six-month grace period after completing school, you get an extra 0.6 point break on the interest rate, but you have to start repayment on the consolidated loan immediately.
Note that consolidating is not the best move for all borrowers. If you have an older loan and you've qualified for discounts by making 24 or 48 on-time payments, consolidating may mean swapping back to a higher rate than you already have. Also, if you have Perkins loans, you should check to see whether, by consolidating, you'll lose the chance to put your loan on hold (or to have the government pay the interest) if you take certain public-sector jobs or go back to school.
Lenders say that borrowers who consolidate their student loans tend to lower their monthly payments by $150 on average. To get an exact number, run your loans through the calculator at loanconsolidation.ed.gov.
Refinance your car loan
Refinancing your car loan is much easier than refinancing your mortgage. There's no appraisal process, and the fees—if any—are minimal. (You may have to pay $5 to $10 to your state's department of motor vehicles to get a new car title.)
Can you benefit? Yes, if you didn't shop well in the first place; if you still owe at least $7,500 on a car that's less than five years old; if your car is not worth less than the amount you owe (if it is, you're said to be upside down); or if your credit has improved since you bought the car.
To refi, pull a value out of the Kelley Blue Book on the Web at kbb.com to be sure you're not in the dread upside-down category. Then shop around. Head to money.com or bankrate.com, where a nifty search engine can pinpoint the best rates in your area. If you belong to a credit union, call it as well. (Credit unions have made a specialty of car loans and offer lower-than-average rates. To join one, go to cuna.org for a list of institutions.) When you find what you think is the best rate for you, don't hesitate—just go for it. There's very little downside. The one thing you don't want to do is extend the term of your loan. Most lenders will happily match the term on your loan, even if it's between their normal terms of 36, 48 and 60 months. To figure your savings, just subtract your new monthly payment from your old one.
Get rid of mortgage insurance
Mortgage insurance (sometimes called PMI, for private mortgage insurance) can be quite expensive—from $16 a month to $50 a month on every $100,000 you borrow—and it's not optional. You have to carry mortgage insurance if you put down less than 20% when you buy a house. The way it works for loans made after July 1998 is that your lender must cancel your mortgage insurance once you've accrued equity in your home of 22%.
The wrinkle comes when the value of your home appreciates rapidly, as it's done in many parts of the country over the past few years. All of that appreciation belongs to you, not the lender, and it may boost your ownership stake above the 20% mark. When that happens, you should try to get rid of your mortgage insurance.
As long as you've made two full years of payments, your first move is to ask your lender to let you drop the insurance. You'll have to have your house appraised, which will probably cost you about $350. If you plan on staying in the house (and not refinancing) for more months than it would take you to get that back, it makes sense to proceed. But first you'll want a good indication that you're right about the value of your home, so check the sale prices of comparable homes in your neighborhood, visit a website like Domania.com or call a realtor to learn what your house would list for.
Your lender may decline your appraisal or require a second one. But if you have a very large mortgage and hefty PMI premiums—say, a $500,000 mortgage and a monthly PMI bill of $250—you can recoup your appraisal costs in a matter of months.
There is another option: a refi. When you refinance, your house is appraised. That seals the value. As long as you borrow less than about 80% of the value of your home, you'll need no insurance on the new mortgage.
But is it worth doing? It's a cost-benefit question, like all refis: How do the refinancing costs stack up against your monthly savings on PMI? How long will it take for this transaction to pay off? Will you be in the house long enough to benefit? Again, you're most likely to come out ahead if you have a jumbo mortgage and high PMI premiums.
6. FOUND MONEY: $_______/MONTH
You're probably feeling pretty good. Now you need to use that money to pay your bills and rack up savings. The best way to accomplish this: automatic transfers through online banking. (For more, see "Take Charge" on page 82.) Once you've found your $10 a day, it couldn't be easier.
How did you do?
Enter the numbers from the previous pages to get a sense of how you're doing. At $100 a month you're one-third of the way. At $200 you're over the halfway hump. At $300 and change you're there.