Archives For Debt

Choosing the most adequate credit card for your needs has never been an easy task, given the large number of options available and the difficulty understanding the exact terms and conditions of each product. In the current climate of economic uncertainty, making the right decision is more important than ever, so as to avoid getting into further financial difficulties.

To help consumers with that decision, we have listed the four main points to consider when choosing a credit card.

1- Consider your spending habits

This is a basic element to consider, as overlooking this point could result in being stuck with the wrong credit card. It is essential to have a clear idea of the amount of money that you will be charging to your credit card every month. Determining this point will prevent you from choosing a credit card that has the right level of spending limits.

2- Take into account your previous credit history

Having a less-than-perfect credit history does not mean you cannot have access to a credit card. In fact, there are cards specifically designed for consumers in these circumstances. If this is your case, choose a credit card with the lowest standard interest rate possible (although APR rates in these particular cards tend to stand at 30 – 40 per cent), or go for a “bottom-up card”, which allows you to gradually increase your credit limit.

Alternatively, consumers who already have an existing debt may benefit from 0 per cent credit card deals, which allow them to transfer balances from other cards at no extra cost.

3- Low APR rates are not always the best deal

Some consumers are attracted by cards that advertise a low standard interest rate. However, and depending on your individual situation, these cards may not be the best option. Consumers who are able to pay their balance in full every month will not benefit from low APR rates and should not choose a credit card solely on that basis. Additionally, beware of the expression “typical APR rates”, as this means that rates can be modified (and increased) depending on your particular circumstances.

4- What if you can’t pay?

Due to unexpected events, there is a possibility that you might be late paying your monthly balance or that you exceed your credit limit. Credit card providers charge a fee in these cases, so it is important to go for the provider with the lowest fees. Also, ensure that the advertised APR rate will not increase in the event of late payment.

There are thousands and thousands of people out there living lives of quiet, screaming desperation who work long, hard hours, at jobs they hate, to enable them to buy things they don’t need to impress people they don’t like.

– Nigel Marsh

Buying Things to Impress People

       The Christian Financial Alliance was created to help readers. The idea is this: Create a panel of biblical finance gurus – people who take seriously the call to teach the Bible accurately with grace and truth. Once a month, we post a question with a response from our panel to provide you with well-rounded, sound, biblical advice. For more on the Christian Financial Alliance (or to join our team) click here.

Name one spiritual reason to get out of debt.

       “When you’re in debt it can become a barrier to your relationship with Christ. As Matthew 6:24 says, “No one can serve two masters. Either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve both God and Money.” When you have a large amount of debt it can cause money to become your master, at the detriment of your walk with Christ.” –

       “Because it’s wise to do so. Every time the Bible talks about debt, it does so as a warning or in a negative light – debt is never presented in a positive manner. The Bible’s wisdom says to avoid debt and the soundness of that advice has been proven time and time again.” –

       “While debt itself is not evil, it can be a sign pointing to a deeper problem in our lives. The typical person in thousands of dollars of credit card debt gets there by being focused on consumerism and materialism rather than pursuing God’s kingdom first. (That’s not always the case, but it is very common.) So a good spiritual reason to get out of debt is to break that cycle of buy, buy, buy and free yourself from valuing your life based on your possessions. For many people, getting out of debt can be a first step to passionately pursuing God’s kingdom.” –

       “Self-control is a fruit of the Spirit (Gal. 5:23). Avoiding and getting out of debt requires self-control (to say the least!). Therefore, I think we learn a lot about this fruit when we start steering away from debt.” –

       “Debt can hinder our ability to hear God’s call on our life. We can have so many bills to pay that if God calls us to some type of work that pays less that what we’re currently making we may think we have a fuzzy connection. Living free from the bondage of debt frees us to hear and respond to whatever He calls us to.” –

       “Wonderful opportunities to serve the Lord are jeopardized when debt obligations demand our constant attention. It’s awfully hard to purchase airline tickets and the supplies needed to go on a missions trip when monthly payments for the Visa and line of credit consume most or all of our income above the basic necessities. Imagine how great it would be to hear of a need for help and be able to pay cash – not only to visit that country to work – but to generously give to the individuals who stay there serving the Lord when we return home! Financial freedom from debt not only releases us from repayment bondage but it allows us to answer God’s calling when asked to serve Him.” –

       For more on the Christian Financial Alliance (or to join our team) click here.

       Readers, what would your answer be? What’s a spiritual reason to get out of debt? What did you think of the responses? Share your thoughts in the comments below!

Rent or Buy - Your Choice!       I recently had a friend comment that renting is “throwing away money”. This is a common misconception because home ownership has been touted as the best path to building wealth and a great decision for everyone. But the truth is that renting isn’t really as bad as some would have you think. In fact, it can be the best choice for many people – it all depends on your situation.

       But specifically, I want to look at the idea that paying rent is just throwing away money. The unspoken assumption in that idea is that once you buy a home you’re no longer throwing away money. This simply isn’t true. Here are five ways you throw away money when you buy a home.

1. Mortgage Interest

       Assuming you get a mortgage when you buy a house, like most everybody does, you’re going to have mortgage payments to make. Part of those payments will go toward the principal (what you paid for the house minus your down payment) and part will go toward interest.

       The part of your mortgage payment that goes toward interest is just as much “throwing away money” as rent payments are. It’s money you’ll never get back and does nothing to improve your net worth. And on an average 30 year mortgage, it’s going to take you about 16 years before you’re paying more toward your principal than you are toward interest.

       Granted, this isn’t as big of an issue later in your mortgage and it doesn’t matter at all once it’s paid off. But don’t underestimate just how much money you’re going to be throwing away on mortgage interest – especially at the beginning.

       And while we’re on the topic of mortgage interest, let me just add that the mortgage interest tax deduction isn’t as good as you think

2. Homeowner’s Insurance

       Homeowner’s insurance can cost anywhere from about $600 a year to $1,200 a year or more. By comparison, my renter’s insurance policy costs about $110 per year and it’s some pretty good coverage. So you’re looking at an additional $500 to $1,100 or more in insurance premiums because you’re covering the entire value of the home. (Renter’s insurance is mostly just for liability and contents of the home.)

       Part of the money that’s “thrown away” in rent goes toward the insurance coverage the landlord buys for the home. So make sure you take this into account when comparing the difference between renting and owning.

3. Property Taxes

       Own a home? Be ready for your property taxes, which can be anywhere from 0.25% of the value of your home up to 3% or more. The national average was around 1% the last time I looked. So for a $150,000 to $200,000 home, you’re talking $1,500 to $2,000 a year in property taxes.

       Renters don’t pay separate property taxes on the home they’re renting. Those taxes come out of the rent they pay, but renters never see a separate bill for property taxes owed.

       And no, you can’t refuse to pay your property taxes. Do so and you can say goodbye to your home.

4. Home Maintenance and Repairs

       As a homeowner, you’re completely responsible for all maintenance and repairs on your home. These costs are going to vary quite a bit based on each situation, but I’d say a reasonable estimate would be about 1-2% of your home’s value each year. So for our $150,000 to $200,000 home, we’re talking about another $1,500 to $4,000 a year in costs. Maybe you could get away with less, but you’re looking at a minimum of $500 to $1,000 per year.

       Renters? Yeah, they don’t have to deal with these costs. They’re the responsibility of the landlord. And while you could have a landlord that doesn’t take care of the property, it’s pretty easy to move somewhere else. Which brings me to…

5. Higher Costs for Moving

       Moving tends to be much more of a hassle for homeowners than renters. It can take some time to sell a home – time you may or may not have before you need to move or start paying on your next mortgage. On top of that, you’ve got costs associated with selling that come out of your final price (commissions, inspections, and sometimes closing costs if you’re in a real hurry). Some of these costs can be reduced by doing it yourself (for sell by owner) but then you’re looking at more time and effort on your part (and you’ll still want to get a real estate attorney).

       Renters have it pretty easy here. Assuming you’re at the end of your lease, it’s no big deal to find another place and move. And if you’re not at the end of your lease, it’s probably going to cost you less to break the lease than it would cost a homeowner to sell their house.

Repeat after me: “Renting is not always throwing away money.”

       It should be clear that there are plenty of ways to throw away money if you own a home – enough ways to make it worse than renting. That’s the case for me, at least, and that’s why I plan to rent for quite a while longer. I’d need a phenomenal deal to make buying a better choice than renting at this point. And it may be the case for you as well. The least you could do is take some time to play with a rent vs. buy calculator and see how the numbers work out for you.

       I should add that I didn’t even discuss the fact that many people tend to overbuy when they become homeowners. And did I mention the desire to remodel, upgrade, paint, redecorate, landscape, and on and on and on? Home ownership isn’t quite the great financial asset many make it out to be.

(photo credit: Phil Sexton on Flickr)

This post was included in the Carnival of Personal Finance.

This post was included in the Festival of Frugality.

That's a big snowball...       Dave Ramsey is well-known as a proponent of the “debt snowball” method. And because of his popularity, many personal finance writers tend to recommend that strategy for figuring out how to pay off your debts (with some exceptions). The idea is that you pay off your debts in order of the smallest balance first. As a debt is paid off, you tack on the payments you were making on previous debts to the next one in line.

       The problem is that many people (including Dave) tend to recommend this as the best strategy for everyone. And they have good reason – because you get a few quick wins at the beginning, many people tend to stay motivated enough to pay off the rest of their debts. The theory is that psychology wins out over mathematics. But the flaw here is that not everyone is psychologically motivated in the same way.

Not Everyone Needs Quick Wins to Stay Motivated

       The assumption behind recommending the debt snowball as a blanket strategy for debt payoff is that most everybody needs some quick wins in order to stick with something. And I agree that this is true for the most part. People tend to give up easily on a goal if they don’t see progress. The debt snowball method sidesteps that problem by giving you some apparent progress very quickly.

       But not everyone is motivated by quick wins. Some people, like me, want to know that they are making the right decision mathematically. That is, they want to do something because it’s the best way – not just because it feels good. When it comes to paying off debts, the debt snowball method is mathematically inferior to paying off your loans in order of highest interest rates first (the debt avalanche method, as some have called it). Even Dave Ramsey concedes that the debt snowball is not mathematically best. Assuming you stick with it all the way through, highest interest rate first is always the fastest and cheapest (least amount of interest paid) method for paying off your debts.

       Let me give you a quick example. Assume you have the following debts:

  • Debt 1: $2,000 – 13.00% interest rate – $60 minimum payment
  • Debt 2: $5,000 – 20.00% interest rate – $150 minimum payment
  • Debt 3: $10,000 – 4.00% interest rate – $100 minimum payment
  • Debt 4: $17,000 – 16.00% interest rate – $510 minimum payment

       This seems like a reasonable mix if Debts 1 & 4 are credit cards, Debt 2 is a store credit card (after the promotional period expired…), and Debt 3 is a student loan. Assuming you continue paying only the minimum payments, it’ll take you 10 years and 2 months to pay off all this debt.

       Now let’s say you have an extra $300/month to put toward paying off your debts. If you use the debt snowball method, you’ll pay them off in the order I listed them (1, 2, 3, then 4). It’ll take you 3 years and 1 month to do and you’ll pay a total of $6,990 in interest.

       But if you pay off the highest interest rate debts first (debt avalanche), it will take you 3 years even and you’ll pay a total of $5,996 in interest. You’ll get out of debt one month quicker than the debt snowball method AND pay almost $1,000 less in interest! That’s enough motivation for me, and I’m sure there are others who would prefer it as well.

If You Need Quick Wins, You Can Still Use the Highest Interest Rate First Method!

       Proponents of the debt snowball method insist on its psychological boost as being key to its success and popularity. It’s the only reason to push it harder than the smart method (highest interest rate first). But it’s not a very good reason because it’s not exclusive to the debt snowball method.

       If you need quick wins to motivate yourself but you don’t want to follow a mathematically inferior method (that is, a stupid method), then you can create your own psychological motivation by setting milestones for yourself. Plan to celebrate when you’ve paid off $500 in debt, $1,000, $2,500, $5,000, and so on. Recognizing your progress and celebrating it can give you a boost and help you keep going without paying more interest than necessary.

Another Problem with the Debt Snowball

       Personally, I think the debt snowball method tries to cover over a deeper problem inside that needs to be dealt with. If you can’t control your emotions enough to make a smart, rational decision in your finances, you risk falling into the same traps that got you into debt in the first place.

       The debt snowball doesn’t force you to deal with this issue until later if ever. Even it’s gradual benefits (quick wins first followed by a slower pace to the finish) can be replicated by combining the highest interest rate method with personal milestones. So even its psychological benefits are limited.

Most of All, I’d Rather You Be Successful than Right

       Although I would never personally use the debt snowball method, I would rather you use it than not if that’s what you need to successfully pay off your debts. If you can’t sufficiently motivate yourself with personal milestones so you’ll stick to the highest interest rate first method, then you might not follow through with it. And even though it’s mathematically the best method, it’s not going to be very good if you don’t finish.

       What I’m trying to say is that the highest interest rate first method isn’t the best for everyone either. And even though I don’t know why not everyone can use it, I’m willing to admit that it may be better to use something else. I’ve even suggested that you might want to pay off your debts in order of highest stress level first. The best method for you is whatever gets you to your goal – being debt free.

       But it is important to realize that you’re paying more and taking longer if you use any method besides highest interest rate first. That fact is enough to make the debt snowball method absolutely wrong for some people because they want to know they’re making the best, most rational choice (even if they’ve made mistakes in the past). So don’t assume that the debt snowball is the best method for everyone just because it works for Dave Ramsey, or some of his “followers”, or even you. It’s all going to depend on each person’s particular psychological makeup.

(photo credit: kamshots on Flickr)

       The personal finance world is filled with stupid rules of thumb that just don’t work when you want the right answer. Sure, they’re easy and simple. But the problem is that they ignore crucial bits of information that are absolutely essential to determining the right choice for you. One of these stupid rules is the idea that you can afford a mortgage that is 2.5 or 3 times your annual income. Here’s why this is just plain dumb.

A. H. Allyn Mansion by cliff1066TM on Flickr

It Ignores Interest Rates

       This one ought be be obvious. This 2.5 or 3 times your income rule of thumb completely ignores the fact that interest rates have a large effect on your payments.

       To keep our example simple, let’s imagine that Bob makes $50,000/year. This rule of thumb says that Bob can afford a $125,000-$150,000 mortgage. We’ll go with $150,000. Today, the rate on a 30 year mortgage is about 4.5%. At this interest rate, Bob would pay $760/month or $9,120/year – about 18% of his gross annual income.

       Rewind to just a couple years ago when rates were 6% and Bob would be paying $899/month or $10,778/year – about 21% of his gross income. Go back to the 2000s when rates were around 8% and Bob would be looking at $1,100/month or $13,200/year – about 26% of his gross income.

       Now, these all sound affordable for Bob but keep in mind that I’m only talking about principal and interest here. I didn’t include taxes and insurance, which could easily put him over the limit in that last example. So one major problem with the 2.5 or 3 times your income rule is that it cannot and does not account for changes in interest rates.

It Ignores the Time Period

       I assumed in the first example that Bob was getting a 30 year mortgage, but this rule of thumb doesn’t really say how long the term should be for your mortgage. I assumed 30 years because it’s the most common and it’s probably what people who spread this stupid rule are thinking. But look at what a difference it makes to go to a shorter time period.

       Using $150,000 as our mortgage amount and 4.5% as the interest rate, we saw that Bob would pay $760/month for a 30 year mortgage. Keep everything the same but change that to a 15 year mortgage with 4% interest (since rates are lower for 15 year mortgages) and Bob will be paying about $1,110/month. So he’s gone from paying about 18% of his gross income to almost 27% simply by choosing a different term for the mortgage.

       This rule of thumb doesn’t help us determine if we can afford a 30 year mortgage or a 15 year mortgage. There’s no distinction at all. That’s strike two!

It Ignores the Rest of Your Situation

       Finally, this stupid rule of thumb completely ignores the rest of your situation on a number of levels. Let’s look at them:

  • Taxes & Insurance – As I showed you before, Bob was getting close to pushing the limits on his income just with his principal and interest payments. What if real estate taxes are high in his area? What if insurance is expensive because he lives in a hurricane zone (or for some other reason)? This rule fails again.
  • Down Payment – What if Bob puts less than 20% down on his mortgage? Well, he’ll have to pay for private mortgage insurance (PMI). Bump up that payment a little bit more now. Oh wait, that doesn’t seem to matter in this rule of thumb.
  • Debt – What if Bob is up to his eyeballs in debt and on the verge of bankruptcy? This 3 times your income rule is absolutely ludicrous in that case, but it doesn’t seem to come with that caveat.

       These are just a few other areas where this rule proves to be absolutely stupid. I’m sure you can think of many more. The point is that simply multiplying your income by 3 to figure out how big of a mortgage you can afford is short-sighted, unwise, and just plain dumb.

The Solution

       There are other rules for figuring out how much of a mortgage you can afford. There’s the 28/36 rule, the 29/41 rule, the 4 times your income rule, the 5 times your income rule, and so on. Now I have to admit that the 28/36 rule is a little better than these “x” times your income rules. But it still ignores a lot about your personal situation.

       By now, the solution ought to be obvious to you. The best way to figure out how much of a mortgage you can afford is to look at your situation and your budget and work backward from there. If you blindly follow the conventional rules, you completely ignore the important factors that can help you make the best choice for you. You also fall into the trap of allowing society, culture, media, or businesses (banks and real estate agents, in this case) determine what your life should look like and how you should spend your money.

       Think for yourself. Work out the math on your own. (It’s not much more than addition, subtraction, and a little multiplication.) Figure out what you need and want. Then determine what fits in to your situation.

What Do You Think?

       What do you think about financial rules of thumb? Why do we like them? What are some rules of thumb you’ve heard that you’d like me to write about? Share your thoughts in the comments below!

       This is the final article in a ten part series on how to get out of debt. If you haven’t already, you should check out the previous articles:

Step 10 – Don’t Get Trapped Again!

       You’ve finally paid off the debts that have been dragging you down. You’ve topped off your emergency fund so you don’t have to rely on credit cards when things go wrong. You feel like you can rest easy. But your journey isn’t quite over.

       It’s taken a lot of work to get here. The last thing you want to do is go back to the patterns that got you into debt in the first place! I’ll be the first to congratulate you for reaching your goal, but the true measure of your success will be your ability to continue using the skills you’ve learned in this process. If you get back into overspending and not preparing for emergencies, you’ll have to do this all over again. I don’t think you want to go there.

       So to make sure you don’t get trapped by debt again, let’s take a few moments to consider what you’ll need to do to retain this success. My hope is that the process of paying off your debt has changed your habits so that you’ll maintain them for the rest of your life. But you’ll have to keep your eyes open so you never fall into the pits of debt again.

  • Limit Your Use of Debt – Debt can be useful for some situations, but using a credit card because you don’t have the money isn’t one of them. Limit your use of debt so that you only consider it as an option when it is wise. Buying a home, getting an education, or starting/expanding a business can be good reasons for using debt (but not always). There may be times when debt appears to be your only option, but make sure it’s your choice of last resort and that you absolutely need whatever it is you’re paying for.

  • Continue to Track and Optimize Your Spending – The single best way to make sure you prevent overspending is to keep an eye on what you’re spending and review it regularly. The simple action of tracking your spending will naturally lead you to spend less because you’re consciously thinking about every dollar that leaves your hands. You can also use the information you collect to find the areas where you can cut back on things that aren’t important to you.

  • Look for Ways to Earn More – If you’ve been in debt for a while, it’s likely you’re a bit behind on saving for retirement and other financial goals. To catch up you not only need to decrease your spending but you also need to increase your earnings. Combining those strategies will leave you with the money you need to save and reach your goals. Advance your career, earn some money on the side, or start your own business – there are many ways to increase your income.

  • Keep Your Emergency Fund Stocked Up – If you have to use your emergency fund, be sure to replenish those savings as soon as possible so you’ll be ready for the next Murphy’s Law event. Also, don’t look at that money as your “spend on anything” fund. It’s there for a purpose. Only use it for that purpose!

  • Have a Plan and Save for the Future – You got into debt because you didn’t have a plan. Fail to make a plan now and you’ll probably end up in debt again. Make a plan, choose your goals, and figure out how you’ll get there. Save for those goals so you won’t be tempted to use debt on a whim.

  • Learn to Find Contentment – Finally, seek contentment in all things. Comparing ourselves to others, wanting what “they” have, and not being happy with our situation all lead us to living beyond our means. And living beyond our means leads to debt. Discover what’s truly important in your life, eliminate what isn’t, and set your own standards for success and happiness rather than letting others do it for you.

       That’s it for this series! As I mentioned in the last part of this series, my plan is to combine these ten steps with some valuable resources to help make getting out of debt achievable and easier. Make sure you’ve signed up for free updates to Provident Planning so you don’t miss out when I release this invaluable package! If you’ve signed up for free updates, you’ll be sure to see it as soon as it’s available.

       Have you gotten out of debt and stayed out of debt? How did you do it? What has been key to your success? Let me know in the comments below!