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Monthly Archives: September 2009

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Achieve More: Give it All You’ve Got

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Contemplating the ways of personal finance, I thought I’d bring our readers a few meandering thoughts on the topic.

It has been said that half of life is just showing up. While I can see some merit to the argument that at least being physically present gets you somewhere, it certainly doesn’t get you far enough.

For example, showing up at the gym is good for the ego, but unless you are giving it your all, you’re still unlikely to reach your goals.

For kids, my thought is that it is better to be fully present only some of the time, than around all of the time but never really engaged.

The same goes for money. You can go through the motions of budgeting, watching what you spend, even investing, and still your heart may not be in it.

If you are wondering why the change you seek is illusive, ask yourself what more you can do. I bet you there is something.

My challenge to you. If it means something you, if you really have a serious desire for change or achievement, put your all into it. Make your energy count. Don’t just do it, but do it well.

Let’s face it, that sounds great in theory, but there are times when you will stray from your ever so ambitions goals. Just as in meditation, when your attention wanders, bring focus back to the present.

Remember what gets you excited about exercising, spending time with the people in your life, or saving for a specific goal.

Leave just showing up to your cube mate. If you really want to get ahead, give it all you’ve got and be present in each moment.

Cheers,

Miel

Student Loans and the Ability to Obtain Credit

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I always considered student loan debt to be good debt. Well, not exactly “good”, but in a different class of debt; one that was judged more favorably than credit card debt. I thought this was especially true for someone around my age (25), considering around 2/3 of students graduating from a four-year college have at least some student loan debt. I reasoned that these facts would be taken into account when a loan, credit card or mortgage application was being considered, but apparently that isn’t always the case.

Recently I was visiting a friend of mine when the discussion of money came up. As we stood in his kitchen and drank our beer, he told me about his desire to obtain a credit card. He had one years ago but closed the account after not using it for some period of time. But he wanted to build his credit rating a bit and possibly take advantage of a rewards program, so he had applied for a standard credit card at his bank and was summarily rejected.

This came as a bit of a surprised to the both of us; we work in the same industry and I know generally how much he makes. I also spend enough time around him to know that he doesn’t blow a lot of money. He lives well within his means so I was curious as to why he was rejected.

After speaking to his bank’s credit underwriters, he told me that the reason given for his rejection was “a high student loan balance”. His student loan balance is high (around $50,000) but at the same time he has a higher than average salary for where he lives and no debt other than the student loans. I found his rejection very strange.

It looks like my friend is the victim of poor timing more than anything else. When FICO is determining a credit score, they lump debt into two categories: installment and revolving. Examples of installment-based debt include car loan, mortgages and student loan debt, while credit card debt is considered revolving.

In the past, installment debt was looked upon more favorably than revolving debt, to the point where having high installment debt wouldn’t necessarily be a show-stopper when applying for a line of revolving credit – in most cases it would take a high installment debt balance (or more specifically, a high debt-to-income ratio) plus other negative marks such as late payments or a high debit-to-credit ratio on any revolving credit lines.

However, with the current credit tightening still an issue, a lot of banks who experienced a liquidity crisis in 2008 are reluctant to loan money to all but ideal borrowers. In some cases, banks are choosing to shore up their cash reserves instead of lending that money out (which runs contrary to the intent of the bank bailouts, but that’s a separate issue).

Unfortunately, it looks like my friend just went to the wrong bank at the wrong time, and given the choice between lending to an individual with little to no student loan debt, or to my friend who has a higher than average student loan balance, an institution that is still smarting from the credit crisis is going to go with the individual who has the fewest risk factors, even if other applicants would typically be described as “low risk”.

What my friend’s situation shows is that first of all, there is no such thing as “good debt” and secondly, it illustrates how deep of an impact our financial crisis has had. A couple years ago lenders would have been throwing thousands of dollars of credit at my friend. But now, even as some prognosticators have declared the end of the recession in sight, lending institutions, the backbone of our economy, are still a little bit more anxious to lend out money than they have been in the past. It can be validly debated on either side whether that’s a good thing or not, but nonetheless, it is certainly a change from only a few years ago and will affect the ability for people to get a loan and utilize that credit.
In my next post I’ll discuss credit ratings a bit more. I’ll talk about some common misconceptions as well as details regarding what actually goes into coming up with a score.
-Michael

Credit Card "Convenience" Checks

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Does your credit card issuer send you the blank “convenience checks” along with your statement? If so, do you use them or just throw them away?

Well, you are probably better off just ripping them up and putting them in the trash.

Here are some problems with “convenience checks”.

1) Hidden Costs. If you deposit a convenience check into your credit card into your checking account, but have exceeded the cash advance limit then you could be charged an overdraft fee. In addition, if you use this type of check to pay a bill – then discover the retailer doesn’t accept them, you could be subject to a returned check fee.

2) Less Protection. The Fair Credit Billing Act guarantees credit card purchasers some protections. For example the FCBA allows refunds for defective merchandise and the chance to dispute bogus charges on your account. However, when you use a convenience check, you don’t have any of this. If something goes wrong you’re out of luck.

3) No bonus points. A lot of people get credit cards to harvest the reward points. However, if you use the (in)convenience checks, you don’t get any reward points. No miles, no cash back, no free gasoline, no COSTCO membership. Nothing.

4) Fees and High Interest Rates. Typically the card companies charge you far more than what you’d pay your non-convenience check balance. The exact amount varies, but its often twice as much as a regular balance. For example if your regular card charges you 11%, then the interest rate on the check could be 22% or higher.

In addition, you’ll likely get stuck with a 2 to 5% fee on the check you write. So, if you write a convenience check for $300, you could get stiffed with a fee of 6 to 15 bucks.

5) Repayment restrictions. Check this out. Some card issuers mandate that you can only pay back your convenience check after you have discharged the balance on your card first. Okay, so for example if you are carrying a balance of $5,000 on your card, you’ve got to dump that before dealing with the convenience check funds. This of course is a problem because you’ll likely rack up a lot of interest by the time the card balance is paid off. Naturally, this is buried in the fine print.

Finally, Congress’s recent enactment of the Credit Cardholders’ Bill of Rights Act of 2009 (Credit CARD Act) means that many card companies are increasing interest rates and imposing new fees before the law limits their ability to do so. In this type of environment look for convenience check fees to be even higher and repayment restrictions even tougher.

Best,

James

Roth versus Traditional IRAs

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Traditional IRAs are great, but they do have some restrictions that make them less palatable to the common investor. An alternative to the Traditional IRA is the Roth IRA, which, while still a retirement account that shares many common properties with the Traditional IRA that we’re all familiar with, has some advantages that make it an attractive investment vehicle.
History
The Roth IRA is named after the former Delaware Senator William Roth. Senator Roth worked intensively on the Taxpayer Relief Act of 1997, which went into effect beginning in 1998. The Taxpayer Relief Act of 1997 was born out of the House Republican’s “Contract with America” which was vetoed by then-President Bill Clinton in 1995. After being signed into law, loopholes in the Roth IRA specification were quickly identified: an individual was allowed to convert a Traditional IRA to a Roth IRA, then make withdraws from the Roth IRA immediately, thus avoiding the 10% penalty associated with taking an early withdraw from a Traditional IRA. These loopholes were closed legislatively in 1998, and the Roth IRA that is in the current U.S. tax code has been largely unchanged since then.
Tax Structure
So what differentiates a Roth IRA from a Traditional IRA? What really separates a Roth IRA from other types of retirement investments is how it is structured from a tax standpoint. A Traditional IRA’s qualified contributions are tax-deductible, unlike contributions made to a Roth IRA. With a Traditional IRA, anyone making any amount of money is allowed to make a contribution to their IRA, allowing them to defer paying taxes on the earnings resulting from their investments. However, not all contributions from all income groups are tax-deductible. Both IRAs use what is referred to as the Modified Adjusted Gross Income, which is a fairly complicated value that is dependent on the context from which it is invoked, but generally speaking, it is your gross yearly income minus any deductions for which you qualify. With a Traditional IRA, you must first meet the minimum Modified Adjusted Gross Income (MAGI) limit, which means you must have taxable, non-investment, income. If you do not meet that requirement, then your deductible contributions are limited to be equal to your non-investment income for that year. Assuming you meet the minimum MAGI requirements, your filing status determines how much of your contributions are tax-deductible. If you’re married filing jointly or a qualified widow then you can take the maximum deduction up to a MAGI of $85,000 and you can continue to take a percentage of the maximum deduction until your MAGI exceeds $105,000. If you’re married filing separately, then you the maximum deduction limit is $0 and the maximum MAGI that you’re allowed to still take a deduction is $10,000. If you’re single or head of household, then the maximum deduction limit is a MAGI $53,000 and the deduction upper limit is a MAGI of $63,000. You’ll notice from looking at those values that the MAGI appears to be kind of low, especially for those with married filing separately status. It’s also worth noting that these values are valid if you are already covered by a qualified plan through your employer. If you are not, then then you can take a full deduction at any income level.
Roth IRAs don’t have tax-deductible contributions, but they do have a limit on what income levels can contribute. Roth IRAs are a bit more accommodating than Traditional IRAs for a wider range of income levels. They were originally developed to help the middle class save for retirement, and their income eligibility requirements reflect that goal.

Roth IRAs have the same minimum MAGI limit requirement that Traditional IRAs have, and they have different eligibility requirements based on your MAGI. If you’re a single filer you’re eligible to make a full contribution if you have up to $105,000 MAGI, or up to $120,000 for a partial contribution. Joint filers are restricted to having $166,000 and $176,000 MAGI for the maximum and partial contribution requirements, respectively. Those filing as married filing separately have limits of $0 and $10,000.

Additionally, Traditional IRAs and Roth IRAs have a maximum amount that you’re allowed to contributed per year. If under 50 years old, you are only allowed to contributed a maximum of $5,000 total spread across whatever IRAs you’re eligible for (meaning you can’t contribute $5,000 to a Roth IRA and then $5,000 to a Traditional IRA; the sum total of all contributions to all IRAs must be less than $5,000). If you’re over 50 years old, then you can increase that amount by $1,000.
Advantages
The biggest advantage of using a Roth IRA is its withdraw policies. Any contribution to a Roth IRA can be withdrawn penalty-free as long as the withdraw occurs at least five years after the initial investment, even if that initial investment was a roll-over from a Traditional IRA. Conversely, withdraws from Traditional IRAs are subject to income tax and are also subject to a 10% penalty if made before you turn 59 1/2 years old. Additionally, there are a number of penalty-free exceptions that include paying for: education expenses, medical expenses and the purchase of your first home, among others. Withdraws are not included in your yearly gross income, as they have already been taxed, whereas Traditional IRA distributions are taxed.
Regardless of which investment vehicle you favor, there are going to be advantages and disadvantages. The tax implications and withdraw policies make Roth IRAs an attractive retirement investment, and if you’re eligible you should definitely look into opening one. They can be a great vehicle to both build and conserve your wealth. As with any investment, if you are unsure about whether you qualify or if a Roth IRA is a good fit for your particular financial situation, you should consult a professional financial advisor whom you trust. If you want to do some additional research on your own, you can go here.
-Michael
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