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Buy Ellie Kay's 2005 book The Debt Diet, an easy to follow plan to shed debt and trim spending. |
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Quiz
Top Ten Money Moves Quiz
By Ellie Kay
Author of The Debt Diet
CBNMoney.com
– Consider the following ten statements in light of your own attitudes or actions. Rate each with agree, maybe, or disagree.
1. "I have a large mortgage because all mortgage debt is good debt."
2. "I'll just use a home equity loan to pay off credit card debt."
3. "I'll put it on my credit card."
4. "I need to drive a really nice/new car; it will save on maintenance."
5. "We always get a big tax refund."
6. "I'm going to borrow from my 401(k)/IRA. I'll look into the details later."
7. "I'm not building my 401(k) in this kind of market."
8. "I like/invest in this company because I know them."
9. "I don't want to contribute to a nondeductible IRA because there's no tax benefit."
10. "I should probably refinance, but it really seems like a hassle."
Answers: Top Ten "Money Moves" Quiz
1. "I have a large mortgage because all mortgage debt is good debt."
Disagree
One major reason for debt gain has to do with the "good news/bad news" of recent mortgage rates. According to Economy.com, the annual household liability has grown 24% since the start of 2003—which is ten percentage points more than during the 1991 recession. Part of the increase can be attributed to the increased number of homeowners today—which we all know is "good" debt. It's kind of like the dietary equivalent to having muscle weight instead of fat weight. However, when it comes to finances, at some point the good debt/bad debt logic is going to break down.
For example, the mortgages that many homeowners have today are much larger than they might have had in the past due to lower interest rates. Furthermore, many homeowners have taken advantage of rising home values to use some of their equity to pay off consumer debt such as cars and credit cards.
On one hand, "People have improved their balance sheet because the mix (of debt) is better," said Brian Nottage, Economy.com's director of macroeconomics. "If people are going to rack up debt, better that it's mortgage debt" (Jeanne Sahadi, CNN/Money senior writer, Money.cnn.com, Oct. 7, 2003).
The interest rates on HELOCs (home equity lines of credit) tend to be much lower than credit card interest rates, and the interest is usually tax-deductible. Since the risk of not paying your mortgage means a possible foreclosure, the incentive to pay those debts is greater. But what happens when the rates follow the norm of adjusting upward? If you also have a mortgage rate that is adjustable, it means you could suddenly see your debt load rise significantly, and that means more debt weight than ever before.
If home prices slow down or the companies downsize and individuals lose their jobs, debt-laden consumers could find themselves clamoring to work off their debt load in order to fit into the "size 8 jeans" of that lovely new home or car.
2. "I'll just use a home equity loan to pay off credit card debt."
Disagree
I alluded to this in the previous paragraph, but why, specifically, is this a dumb money move? Lenders love to tout the benefits of using Peter to pay Paul. And when home equity rates are down, it seems like a good move, right? Wrong. According to the Federal Reserve, last year we borrowed $701.5 billion from our home equities, which is up $416.2 billion from 1997. The only way this truly helps is if you completely stop using credit cards to run up those debts—an act of discipline that the average American simply will not do. Therefore, unless you're well above average, it's not a good move. Your debt hole is getting deeper and you don't even realize it because you're able to keep making your mortgage payment and don't see the bottom line of your total debt load.
You want proof? According to Moneycentral.com writer Liz Pulliam Weston (Jan. 28, 2004), "Nearly two-thirds of the people who borrowed against their home equity between 1996 and 1998 to pay off credit cards had run up more card debt within two years, according to a study by Atlanta research firm Britain Associates."
This slowly whittles away the equity you have in your home for use in case of an emergency, such as unemployment, medical expenses, or other financial setbacks.
3. "I'll put it on my credit card."
Disagree
If your credit card works out more than you do, you likely have a debt weight problem. For example, some consumers feel that by using their credit cards for daily purchases they're building airline miles or they have an interest-free loan until the bill comes due. But buying on credit makes it far easier to overspend. Paying cash is a more conscientious decision, no matter how you look at it. The average person is less likely to buy whenever the urge hits if they're constantly forking over twenty dollar bills to pay for purchases. Plus, fees are becoming more and more prevalent (see chapter 4 for ways you're paying more than ever on credit card fees and penalties).
There are two kinds of debt: good debt vs. bad debt. A mortgage is an example of "good" debt, but consumer debt is the bad kind of debt. Your credit card debt may either be in the card or in the mortgage (on a home equity loan)—but the debt is still there, waiting to be erased.
According to CardWeb.com, at the end of 2002, the average family's debt load was $8,940. That's expensive weight to carry around, making the family more at risk for an average of 16.2% APR for most cards. The amazing fact is that the average family has not only one card but sixteen! That typically includes six bank cards, eight retail cards, and two or three debit cards.
If your credit card works out more than you do, you likely have a debt weight problem.
4. "I need to drive a really nice/new car; it will save on maintenance."
Disagree
We are in love with cars. The American fantasy includes a big house, nice cars, and dream vacations. While we might get good interest rates on our home and economize on vacations, it's usually the car craze that loads us down with debt in the end. Auto sales have been at near historical levels in the past five years, and the average consumer has paid more than ever for the privilege of owning a cool car.
According to the Consumer Bankers Association, the average new vehicle loan has increased 5% to $21,779 in 2002. The average used vehicle loan rose 12% to $16,542. The trend toward longer loans means that the average consumer will have a car that will not be paid for in less than 49 months. By the time you trade in the car for a new one, the old car is often worth less than the remaining loan value. Buying a new car every five years, as most Americans do, while still owing on the old one, continues to add debt upon debt.
Is it only car and mortgage debt that is weighing us down? Unfortunately, no. We have smart people making dumb money moves that keep them from paying off debt, even when they have the means to do so.
5. "We always get a big tax refund."
Disagree
The operative word here is big, meaning more than $2,000 or so. If you are getting this much back in a refund, then you are likely over-withholding on your taxes. Some people just like getting that check every year so they can spend it on vacations, luxury items, or paying off an item they bought in anticipation of the refund. Most tax professionals are exasperated with clients who are getting upward of $10,000 in refunds and are happy about it. It's usually best to adjust the W-4 to have less withheld than to have the "forced savings" of a refund. That way, your money makes money throughout the year instead of sitting stagnant, waiting for you to get it back in the form of a refund.
It's wiser to adjust the W-4 to the correct amount and then use that available income to create a direct deposit into a savings plan. You really can trust yourself to save more and let your money make you money throughout the year—not just at tax time.
6. "I'm going to borrow from my 401(k)/IRA. I'll look into the details later."
Disagree
The younger the family, the more likely they are to make a dumb money move without knowing the details (penalties, restrictions, and limitations involved) of their financial decision. Let's say a family takes $50,000 in early distributions (withdrawals, not loans) from a 401(k) and IRA to buy a home because they thought they could do so without penalty. Without knowing the "details," they don't realize they are wrong in their assumption. You can only take a $10,000 distribution from your IRA without penalty if you're a first-time home buyer and even then you'll still owe income tax.
I'm amazed at how many long-term decisions are made as a result of getting casual (and bad) information over a water-cooler conversation! One young family man believed he would only pay a 10% penalty for anything he withdrew over $10,000 from his 401(k) in order to buy a home. Instead, he ended up owing taxes and penalties on the whole amount. It's important to check with your tax professional (hire one, please) before you make major financial decisions. The end result in the case of this young man is that the family got tagged with a $19,000 tax bill because they didn't check the rules and run the numbers.
7. "I'm not building my 401(k) in this kind of market."
Disagree
Don't deprive yourself of a tax-deferred savings plan for the future because the market is down today. Furthermore, you shouldn't deprive yourself of free money if your employer is matching the contributions! Even if the market is down, you don't have to invest your 401(k) in stocks. You could put your money in a low-risk bond or money market fund until the market bounces back.
8. "I like/invest in this company because I know them."
Disagree
Suppose a doctor is fond of investing in a particular pharmaceutical company because he is familiar with their products and services. Is that a good reason to buy their stock? No. Similarly, employees tend to own too much company stock because they're overconfident they'll know when to sell. They feel they'll see the writing on the wall internally. I'll sum up that faulty logic in one word: Enron.
The best advice is still never to invest more than 10% of your portfolio in any one stock and never more than 30% in a particular sector. Even if the company is owned by your mother!
9. "I don't want to contribute to a nondeductible IRA because there's no tax benefit."
Disagree
The individual ends up not investing in any kind of IRA at all, and the future will not fund itself. The money you put into an IRA might not be tax-deductible, but the interest that grows from that fund is still tax-deferred. This means the money can grow faster than it might in one of the taxable accounts, where you'll pay taxes every year on dividends, capital gains, and interest to Uncle Sam and to your home state.
10. "I should probably refinance, but it really seems like a hassle."
Disagree
The only reason you should not refinance isn't because of the hassle, but because of the bottom line. If you crunch the numbers on the amount of time it takes to shop for a loan, fill out the paper work, and project the overall benefit, you'll find it truly could be worth "the hassle." For example, if you can save $3,600 per year with a refi, and the process takes about ten hours, you are making around $360 an hour! This is guaranteed income (and tax-free, I might add) and usually worth the time. Just make sure the numbers add up to your advantage in order to make this a smart money move for you.
Assessing Your Debt Diet Needs
Give yourself one point for each question you answered "agree," two points for each "maybe," and three points for each "disagree."
Financially Fit:
If you scored between 26 and 30, you weren't swayed by any of the gimmicks or tricks found in the suggested money moves, and you are financially fit (not to mention smart).
Mild Problem:
If you scored between 22 and 26, you have a mild debt problem and may want to lose a few pounds to be at top form.
Moderate Problem:
If your score was between 18 and 22, you are susceptible to making some dumb money moves that could keep you in debt for most of your life. You most likely live above your means and have a mounting debt problem. It would be wise to develop a better understanding of debt and begin a path toward the right attitudes and actions that will help you improve your financial status. Savvy?
Mongo Problem:
If you scored less than 18, you clearly have a significant debt problem that will weigh you down and keep you from reaching the finish line of your financial goals. You need to take deliberate, disciplined action to overcome the problem. If you continue down the path you are currently on, you will likely end up in need of the financial equivalent of a gastric bypass: That is bankruptcy and/or no retirement funds or a financial legacy to pass on to your children. But even in your case, there is still hope for your future.
This test is not scientific and it can be subjective. Therefore, please feel free to retest in light of the information found in the answer portion of this chapter. What you want to identify are attitudes and actions that reveal weak areas that require attention—in other words, the necessity of going on a debt diet. Whether you need to lose a few pounds of debt, or a truckload, the good news is that you are reading this book. So take heart! This could very well be the time when you understand where you are, how you got there, and how you can regain your financial health.
Excerpted from:
Debt Diet by Ellie Kay
Copyright © 2005; ISBN 0764200011
Published by Bethany House Publishers
Used by permission. Unauthorized duplication prohibited.
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