Credit, Credit Cards, Mortgages and other debt

Credit is necessity today…you cannot rent a car to reserve a hotel without a credit card. The trick is staying out of debt. There are three rules when it comes to credit cards: 1) Charge only what you can pay in full each month. 2) Make sure your credit card works for you (i.e. rewards) 3) Do not have a card that charges an annual fee. Make sure that you get a credit card that doesn’t have nay annual fee and one that rewards you. Then be sure that you never charge more than you can afford to pay in full each month. When the bill arrives each month pay it in full.

Some examples of credit cards that reward you:

American Express has several reward programs. If you obtain your card in combination with a Costco membership, you can earn cash back rebates and avoid paying an annual fee to American Express. American Express also offers other programs like the Starwood preferred guest program and other reward programs.

Discover Card lets you earn a cash back rebate on your annual purchases each year.

Visa and MasterCard probably offer the largest variety of rewards and mileage programs. You can find airline mileage rewards, gas rewards, store rewards, and so on. Find a rewards program credit card and then use that card for everything to maximize your potential rewards.

Just remember never charge more than you can pay in full each month.

A word about mortgage debt. Several types of mortgages have become popular over the last few years that in book fall into the “bad” category of debt. Here are my top two offenders: Adjustable 100% interest only loans and debt consolidation loans. There are very few circumstances when a 100% interest only loan makes sense (and I cannot think of any examples). For most people, they take out an adjustable 100% interest only loan when they want to purchase a home that they cannot really afford. They are hopeful that their income will increase and/or the value of the home the purchased will increase rapidly. In some areas of the country, housing prices have risen rapidly in other areas giving a false sense that prices will always rise (prices have remained somewhat flat in other areas of the country). When interest rates start to adjust upward and it is almost certain that they will, how will those who have adjustable rate mortgages that they can barely afford now be able to keep up? If luck has it, prices will have increased and they can sell their house and pay off the debt. Remember that with 100% financing, you have no equity in the property, so, when you go to sell, the price has to be high enough to cover the costs associated with the sale. Costs associated with selling a house include commission (typically 6% of the sales price) and closing costs 2-3% of the sales price.

If you are looking to buy a house and have discovered that prices are so high that you cannot really afford the payments, you may be better off renting and investing a set amount of money each month in another investment vehicle like a mutual fund. I have a friend you was looking a purchasing a small house for $350,000, she didn’t have any money to put down (she had enough cash to cover the closing costs) so, she was going to take out a 100% mortgage. Her payment for principle and interest would have been a little over $2000 per month, plus property taxes of $250 this doesn’t include homeowners insurance, repairs or maintenance. In her case, she decided that the tax break and future return would not make up for the costs since she wasn’t sure how long she would be in the area. (If you plan on being in an area for less than two years, it usually makes more sense to rent). She ended up renting a nicer house a few blocks from her office for $1200 per month and is investing $1000 per month in an S&P fund.

Debt consolidation loans… There are some circumstances when taking out a home equity loan make sense. For example, to renovate or remodel your home, purchase another home, etc. However, it does not make sense to take the equity out of your home to payoff credit cards or purchase a car or to take a vacation… Think about it do you really want to be paying for an outfit you purchased last month twenty years from now? How about paying for that meal 10 years from now? That trip to Las Vegas 15 years later? Think about it….

Before you swear off credit altogether, lets talk about your credit score….that magic number banks use to determine your credit worthiness…Credit scoring can be good and bad…the decision to extend credit is based on your score not on whether or not the lender likes you. Scoring can be bad if your number is low even though your credit is good. Your score is based upon a variety of factors like how much credit you have available, how much you owe, how long you have had credit, if you pay your bills on time, number of inquiries that have been made by creditors extending credit, etc. you can check out the website for more information on how your credit score is calculated and what you can do to increase it.

I recommend that you check you credit on a regular basis (mistakes happen). There are three major credit reporting agencies:

Equifax: (800) 685-1111

Experian (formerly TRW): (888) 397-3742

TransUnion: (800) 888-4213,

All three companies offer credit monitoring programs which can be helpful in notifying you when there has been a change in your credit report. If you subscribe to this type of service, it can help you detect identity theft in the unfortunate event someone steals your identity. Even if you don’t subscribe to a credit monitoring service, you should check your credit regularly (at least one each year).

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  2. Credit, Credit Cards, Mortgages and other debt