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11/5/08

The Difference Between Good and Bad Debt

There are two different ways to understand the concept of "good" debt. Good debt can be described as either (1) debt that makes you money; or (2) debt that does not count against your debt to credit ratio. An example of debt that makes you money is a real estate loan. Although you are paying a loan, the real estate is appreciating, and you could collect rental income from a real estate property. An example of good debt that does not count against your debt to credit ratio is a school loan. One of the components of a credit score is your debt to credit ratio. If you have more than 30% (meaning that of all your available credit, you owe more than 30% in outstanding balances), your credit score is lowered. Student loans are not calculated into this ratio. Thus, if, for example, you owe $50,000 in school loans and have only $10,000 in available credit card credit of which you owe no money, your debt to credit ratio is still going to be zero, regardless of the fact that you owe $50,000 in school loans.

Now that good debt has been defined and you understand it, the question becomes, what is bad debt? There are many variations on the definition of bad debt, however, the consensus is that bad debt is debt that costs you money. In other words, if you borrow money to purchase something that will never increase, or in fact decreases, in value, you have bad debt. The most common example of bad debt is credit card debt. This is debt that costs you money.

The distinction between these two kinds of debt causes much confusion among people who carry the debt. In you are concerned about "getting out of debt," you need only be concerned about your bad debt. Bad debt is the debt that needs to be paid off in order to relieve any financial pressure you may be feeling. This means, car payments, credit card bills, and other high interest loans for depreciating assets need to be paid off as quickly as possible.

I understand the difficulty that people have with comprehending "good debt." Most people think that owing money is bad regardless of its use. However, if you stop and think about it, there are many things that debt can create. Using the real estate example above, if you take out a loan to buy an investment property, and then rent that house out to another, you are enjoying many benefits: (1) your rental property (assuming you did not overpay) is appreciating; (2) you are taking in a rental income that hopefully pays for the mortgage on the rental property and all other expenses on the property; (3) you are making a property available for another person to live; and (4) you are increasing your net worth. All of these things occurred because you incurred some debt.

Know the differences between the kinds of debt and you will be able to prosper. Get rid of all your bad debt and utilize the good debt to your advantage. A college education, an increased net worth, and additional income streams could be the benefits of good debt. On the other hand, high interest rates, fees, and depreciating assets accompany bad debt. Which would you rather have?

9/4/08

Teens and Car Insurance: Who Should Pay?

Teaching teenagers financial responsibility is vitally important. Good financial lessons at an early age carry over to successful money management when such teenagers become adults. As such, you should educate your teenager about savings, credit, investing, and real estate, to name a few subjects. Doing so will help your teenager avoid common money traps that snare many young adults.

One of the most important financial lessons to teach teenagers is the effort that it takes to earn an honest dollar. As such, if your teenager wants to get a job, you should let him/her to the extent that the same does not interfere with his/her education. Additionally, once your teenager is working, he/she will start to understand that you have to work for things that you want in life. Therefore, if they want to spend there money on something, they will know the effort that is required to obtain the same.

One item that it seems that every teenager wants is a car. As we are all well aware, a car can be a very expensive purchase. Outside of the actual cost of the car, you have to pay for gas, oil changes, insurance, registration, and maintenance. These costs can add up and thus, should you get your teenager a car, he/she should have to pay for some of these expenses. On such expense that a teenager should pay for is insurance.

Having your teenager pay for insurance is good because it will help teach financial responsibility. Additionally, because insurance can be costly for a teenager, he/she will respect the car and thus, take better care of the car that he/she has. Teenagers, like all people, respect things more if they pay for it. Thus, although the cost of the car may be outside of the financial realm of your teenager, the insurance payment is not. As such, your teenager should make this payment.

Insurance can be expensive and as such, if your teenager does not have a job, he/she will not be able to pay for the same. Therefore, making the condition that in order for your teenager to get a car, he/she has to pay the insurance will make your teenager take on the responsibility of getting a job and of maintaining his/her finances in order to pay for the monthly insurance payment.

Teach you teenager financial responsibility by having him/her pay for his/her own car insurance. Doing this will make your teenager respect his/her car more and will help your teenager appreciate the work it takes to earn enough money to pay for such an expense.

8/9/08

Can Applying for Loans Bring Down Your Credit Score?

A credit score has many components. Each component weighs differently on your credit score. For example, having a late payment recorded on your credit report will cause more damage to your credit score than will having too many inquiries on your credit report. However, it is important to know that regardless of what the negative information is, such information will stay on your credit report for many years. As such, you will want to weigh the consequences of the negative impact on your credit score against the advantage of applying for and obtaining a loan.

Applying for a loan can negatively impact your credit score in more than one way. First and foremost, whenever you apply for a loan (whether it is for a house, a car, a student loan, a personal loan, etc.) the bank or lending institution to which you applied is going to run a credit check on you to calculate the risk involved in lending you the money. The riskier you are, the higher your interest rates and/or fees will be. If you are too risky, you will be denied a loan.

When the bank or lending institution conducts a credit report check to calculate the risk level involved, each check is recorded as an "inquiry" on your credit report. Banks and lending institutions look to see how many inquires are on your credit report for a set period of time. If you have "too many" inquiries, this tells the bank or lending institution that you are trying to borrow money and thus, this means that you are acquiring or attempting to acquire a lot of debt. As such, you may not have the money to pay back a loan. Therefore, this makes you a risky loan and you will either have to pay more interest and fees or will be denied outright.

However, even though these inquiries are recorded on your credit report, this does not mean that every one of them negatively affects you credit score. The key is not to get "too many." The exact number that crosses the "too many" threshold is not exact, but to be on the safe side, you should try to keep the inquiries to no more than 3 per year. Remember, every time that you apply for a credit card or any type of loan, an inquiry is recorded on your credit report.

The other way that applying for a loan can damage your credit score is if you are approved for the loan. If you are approved for a loan, it will affect your credit to debt ratio. If you get a loan, this will create more debt. The closer you are to "maxing out" your credit limits, the worse off your credit score will be. The reason for this is because if you have no available credit, banks and lending institutions will be concerned that you have reached your limits and will have trouble paying off your debt. As such, there is a higher chance that you will default and thus, a higher chance that the bank or lending institution will not get paid.

As stated above, because of these negatives, you have to weigh the cost of getting a loan against the benefits of obtaining the same. Make sure you are applying for and receiving a loan for a good purpose (buying a home that you can afford, getting a college education, making a good investment) and are not obtaining a loan for something you do not need.

4/23/08

Actual and Potential Credit Card Usage Fees

Yes, credit cards can have costs. There are two main costs associated with credit cards: (1) interest rates; and (2) annual fees. Interest charges result only from the use of a credit card. Annual fees, on the other hand, are charged regardless of whether or not you actually use your credit card.

You should never have to pay to use credit cards. However, this is the exact effect of an annual fee. An annual fee is a payment by you to the credit card company for the privilege of using that credit card. There are far too many good credit cards out there that do not have an annual fee for you to obtain one with an annual fee. In essence, do not get a card with an annual fee, it is that simple.

In addition to annual fees, credit card companies charge other fees of which you may not be aware. If you are ever late on a payment, there is usually a fee. If you go over your credit limit, there is usually a fee. Know what these fees are and factor them into your decision as to whether to obtain that particular card. It is important to note that almost every credit card will have these fees. Therefore, do not refrain from obtaining a good credit card simply because these fees exist. Should you do so, you will not find a credit card.

Interest rates are another fee charged by credit card companies. First, you should notice that the interest rate is different for credit purchases and cash advances. Cash advances always carry a higher interest rate. Additionally, your monthly payment will not count towards your cash advance balance until your credit purchases balance is paid off. This is because cash advances carry a higher interest rate. Therefore, the longer that your balance remains unpaid, the more money the credit card company makes.
Also, make sure that the interest rate that is advertised is not an "introductory" rate or a "variable" rate. Introductory rates only last a couple of months (at most, one year). After that introductory period, your interest rate resets to the default rate. The default rate is usually a lot higher than the introductory rate. Therefore, be aware of what you are getting yourself into because you do not want to see your interest rate jump over twenty points at the end of your "introductory" period.

Variable rates change with economic conditions. Therefore, you could have a great rate one month and a terrible rate another month. Granted, the rate changes are not dramatic. Therefore, you will not go to bed one night with a 9% interest rate and wake up the next morning with a 20% interest rate. The changes are gradual. However, do not play a guessing game with your credit card interest rate. Get a low fixed rate, and you will be much happier.

Know the costs that are associated with a credit card. By doing this, you will be able to make the best decision possible based on your needs and wants.


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4/1/08

How Long Should You Rent Before You Buy A House?

There are many consideration to make before your should decide to buy a home. A home is an expensive purchase and thus, absent you having a large cash reserve, you are going to have to borrow the money to purchase your home. As such, you are going to have to consider your credit score, your monthly income, your monthly obligations, and the price range of homes that are within your economic range, to name a few. Additionally, depending on the current economic condition, your interest rate for your mortgage is another consideration. You also have to consider you job situation and whether it is likely you will move out of your current city or state. This consideration is important because if you need to sell you home in order to be able to afford to move, the status of the real estate market is going to dictate how quickly you can move.

If you discover that you cannot currently afford to buy a home, your alternative is to rent for the time being. This does not mean that you will never be able to buy a home. Renting for now simply means that due to your current financial or credit situation, you will have to refrain from purchasing a home. If this is your current situation, you may be wondering how long you have to wait until you can buy a home.

The answer to this inquiry depends on all of the factors discussed in the first paragraph. If you can financially afford to buy a home, have the credit in order to qualify for and obtain a loan (should you need a loan), and do not plan on making any long distance moves at any time in the near future, you should be in a position to buy a home. However, even if you are in position to buy a home, depending on where you live, there may not be any homes available for you to buy.

There are many cities and towns that are not expanding or have no room to expand, and as such, the total number of homes in that area remains constant. As such, you may have to wait for an opening or may have to look for a home in another location. Therefore, even though you are ready, willing, and able to purchase a home, the current real estate market may not allow you to do so.

If you can financially afford to do so, you should consider purchasing a home. Even though overcoming the financial and credit obstacles are the hardest burdens to overcome when purchasing a home, the current real estate market may be a factor that prevents your purchase of the same. If this occurs, be patient and maintain your financial and credit situation so that when a home becomes available, you will be able to purchase the same.

3/12/08

Should the Government Regulate the Credit Card Industry?

The truth is, there is no industry that does not have some sort of government control over it. The credit company is no exception. Granted, a large part of the sector does remained "unregulated," however, there is government regulation is some respects. For example, the law states that a credit card cannot be denied based upon discriminatory reasons, credit card companies have to pay taxes and abide by other state and federal financial laws, and if you have a grievance, you can sue a credit card company. All of those examples show that there exists some level of government control over the credit card industry. However, many people believe that the government should regulate who gets a credit card, how many credit cards one should have, the maximum amount of credit one can have, and the maximum interest rate a credit card company can charge. Doing so would effectively cause the government to take over, and not regulate, the credit card industry.

It is important to note that nobody is forced to obtain a credit card. A credit card can be a powerful financial tool, but this does not mean that it is mandatory for a person to get one. Additionally, each individual person makes the decision on how to use or abuse his/her credit card privileges. As such, the credit card company is not to blame when somebody defaults on a payment.

Some argue that the credit card companies raise your credit limit so that you will spend more money. This is absolutely true, but it does not change the fact that each human has free will. Therefore, just because your credit limit is raised does not mean that you have to use the additional amount of available credit.

Another argument pressed by proponents of government regulation is that the interest rate on credit cards is too high because there is no limit on the amount of interest a credit card company can charge. Theoretically, this is true (however, I find it hard to believe that if a credit card company charged a 60% interest rate that lawsuits would not rain down upon that particular credit card company), but once again this argument negates a person's ability to choose. A person does not have to apply for, or accept a credit card offer that charges a high interest rate. Therefore, it is again not the fault of the credit card company if the person applies for and obtains such a card.

The bottom line is that credit cards are a privilege and not a right. As such, there is no need for government regulation as to the practices of credit card companies. Every person has the right to choose the card he/she wants and whether or not he/she wants a credit card in the first place. The answer is to educate people about responsible credit card use. Credit cards, like all privileges, can be abused, and as such, sometimes a person needs to learn a tough lesson before they figure out the proper use of such a privilege. If the government intervenes and "bails out" these people every time they get into trouble, no lesson will have been learned and the irresponsible behavior will continue.

1/14/08

Is the Credit Rating System Fair?

The main reason that the credit rating system is fair is because each person controls his/her own credit rating. Your borrowing and payment habits are what dictate your credit rating. If you abuse your credit, your credit rating reflects the same. However, if you are a responsible credit user, your credit rating will be favorable.

Lenders need a system that can help them determine whether a person is a borrowing risk. By using the current credit rating system, lenders have some kind of barometer for measuring credit risk. Without such a system, obtaining a loan would be extremely difficult because lenders would require, among other things, years of financial records to help determine the potential borrower's creditworthiness. Our current credit rating system conveniently compiles all of a person's financial records and uses them to create a nice, neat number that lenders use to make lending decisions.

The people that complain most about our credit rating system are the people that have low credit scores. These people claim that their low credit scores are somehow not their fault. These people claim that the credit card companies kept sending them more and more credit, and that they just "had" to use this additional credit. Are these people serious? We reap what we sow. It is amazing to me that a person can abuse their credit privileges, and then complain about the penalties that are assessed as a result of their abuse. These complainers are proof that the system is fair and is effectively working. If the credit rating system was unfair, these credit abusers could continue to take advantage of their credit privileges to the detriment of responsible credit users.

Another common complaint that people make is that they have no credit score before they apply for credit. The argument that these people make is that they have never had debt, therefore, they should have a high credit score. How does this make sense? A credit score measures a person's creditworthiness. Therefore, how can one have a credit score without first having credit? This is not a hard concept to understand.

The system is not perfect, but it is fair. I have had my credit score reduced due to negative information being placed in my credit file that was not mine. I had to get the information removed by contacting the credit bureaus. I would be lying if I said that the information was immediately removed. In fact, it took a couple of months to get the information removed. I was not happy, but mistakes happen. If the system was perfect, there would be no complaints.

The point is, the system is as fair as it can be. If you feel that the credit rating system is unfair or unreliable, pay cash for everything. If you cannot afford to pay cash for everything, stop complaining about the system and use the system to your advantage. If you use your credit responsibly, you will have nothing to worry about.


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Pros and Cons of Debt Consolidation

Debt consolidation can offer many great benefits, such as a lower monthly credit card payments, reduced interest rates, the prevention of being assessed late and over-the-limit fees, and faster debt reduction, to name a few. However, there are also some disadvantages that accompany debt consolidation, such as a freeze of your credit using privileges, closed credit accounts, and consolidation fees. Knowing how to weigh the positives against the negatives and becoming completely (or as well informed as possible) informed about consolidation are two important factors you need to consider before making a decision as to whether or not you should consolidate your credit card debt.

The first factor you should consider is the amount of your credit card debt. Many consolidation companies require that you have a minimum of $5,000 worth of credit card debt before you are allowed to participate in the program. Some companies require at least $10,000 worth of debt. The point is, if you have only a relatively small amount of credit card debt you can probably work the problem out by yourself. Additionally, because these debt consolidation companies charge an “administrative” fee every month, the longer it takes you to get out of debt equates to more money for the debt consolidation company. Therefore, they are not willing to help people who are only $1,000 or $2,000 in debt because it is not profitable to the debt consolidation company.

It is true that the debt consolidation company will combine all of your monthly debt payments into one monthly payment that you pay to the debt consolidation company who then distributes the payment to the various credit card companies. Additionally, it is true that the debt consolidation company will work with your creditors to lower the interest rates on your outstanding debt accounts. However, what they do not tell you is that sometimes credit card companies do not change the payment due date for your account. Thus, if your single monthly payment to the debt consolidation company is due on the 5th of the month, but one of your credit accounts is due on the 4th of the month, you may incur a late fee. Make sure that this situation is remedied before you start making payments to the debt consolidation company.

One of the negative aspects of debt consolidation is that your credit score will be lowered because all of your credit card accounts that are in this program will be closed. Closed credit accounts lower a credit score. Additionally, the credit accounts that are the subject of the debt consolidation program will be frozen. As such, you will not be able to use your credit card for any of these accounts. Therefore, you should choose carefully which accounts to consolidate. Do not leave yourself without an emergency (and I emphasize “emergency”) credit card. This does not mean that you keep your credit card for your favorite department store because there is a new clothes line coming in next week. This is not an emergency, and this way of thinking probably got you into the credit debt mess that you are currently facing. I suggest that you consolidate the cards with the highest amount of debt and with the highest interest rate. By doing this, you will be saving the most money.

Do your homework and do some comparative analysis if you are considering debt consolidation. Choose a company that you are comfortable with, that is easy to contact, and that has the lowest, or, if possible, no fee. If you are not comfortable with credit card debt consolidation, try solving the problem yourself. Contact the credit card companies and see if you can negotiate a lower interest rate or monthly payment. The point is, you have to take action to resolve your credit debt situation before it reaches the stage where bankruptcy is your only viable option.


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