Freedom from Student Loans

Credit: ddpavumba

While reading an article recently published in InvestmentNews, I was surprised to learn that 71% of college graduates coming out of school with a bachelor’s degree have student loan debt. I was also surprised to learn that student loan debt has passed credit card debt and is now the largest form of consumer debt after home mortgages. When considering the 71% of college graduates with student loan debt, the average debt is close to $30,000!

I knew student loan debt was a burden for many people, but I’ll be honest, I didn’t have any idea that it impacted nearly three out of four college graduates. I was also a little shocked by the magnitude of the average debt. So, what if you’re like the majority of college graduates out there, and you’ve got some significant student loan debt relative to your current salary weighing you down? What should you do? I’d like to share some thoughts.

If it were me, I’d get a job after college graduation as quickly as I possibly could. Even if it was not my ideal job and was just a short-term opportunity, I’d want some income so that I could hopefully avoid taking on any additional debt and maybe even begin to think about attacking my student loan debt principal. 

If it were me, I’d look into consolidating my student loans (if I had more than one) so that they would be easier to manage. One check per month would feel less overwhelming, and the interest rate on the consolidated loan could even be beneficial.

If it were me, I’d obviously keep making minimum payments on my student loan debt, but I’d set aside a reasonable cash emergency fund, I’d contribute whatever it took to get my employer’s maximum company match to my 401(k) or retirement plan, and I’d pay down any credit card debt I had before attacking my student loan debt principal. My goal would certainly be to get my student loan debt paid off, but I need to make sure I can survive a “rainy day” and go ahead and begin saving for my retirement, as retirement dollars contributed now have a longer time frame to really appreciate than retirement dollars contributed years from now. After I had my rainy day fund built up, my retirement contributions in order, and my credit card debt zeroed out, it would be full-fledged war on my student loan principal until I was able to remove the giant debt stone that had been tied around my neck as I pursued a higher education and a brighter future.

While I’d do everything I could to eliminate my debt burden, I wouldn’t put my life totally on hold. I admire and respect people who are focused on extinguishing their student loan debt as soon as possible, but putting off things such as getting married, renting your own apartment, and buying a reliable car in the name of paying down student loan debt may not be the best life choice. It may be the best financial choice, but it may not be the best life choice. Do whatever you think is best, but I wouldn’t put off taking the next steps in your life and move back in with your parents solely so you can live as inexpensively as possible and pay down your student loan debt as soon as possible.

I understand that some members of my generation aren’t yet interested in my ramblings about investing, insurance, and estate planning because they are still battling their student loans, but that doesn’t mean I can’t help. Get a job, set aside some cash, start contributing to your employer’s retirement plan, and live thriftily so that you can pay off your student loans as soon as reasonably possible, but don’t “postpone” your life. Once you’re free from your student loans, you’ll have a lot more cash flow free up, and you’ll be ready to take flight towards your other financial and life goals.

-Tom

What You Should Do With Your Tax Refund

Credit: David Castillo Dominici

Hopefully, you’ve already started working on your taxes. If you’re a real overachiever, maybe you have already submitted your taxes. With a little luck (or conservative withholding), hopefully you’re expecting a refund. If you are, I’d like to make a few suggestions for what you should do with those funds.

1. Go have some fun. Take 10%, take a couple hundred bucks, take whatever you feel is right and go buy that snowboard, get that new dress, or eat at that new, expensive Italian place everyone is raving about. I’m not your typical financial advisor, and I’m not Scrooge: go take some of your check from Uncle Sam or your home state and enjoy yourself!
2. Pay off your credit cards. There are very few things you can do that help your financial health more than paying off that Visa debt you’ve been carrying around since college. Maybe you’ve been making steady progress in recent months and need a surge to finish the drill? Luckily, if you’re getting a refund, the Department of the Treasury could be about to provide that cash surge.
3. Boost your cash / rainy day fund. If you’re working, I’d advise you to have three to six months’ worth of living expenses in cash. If you’re retired, I’d propose one to three years’ worth of living expenses, just to make sure you’re in good shape and can sleep comfortably. If you just checked your account balance and it isn’t at my suggested threshold, take advantage of this unbudgeted (and maybe even unexpected) cash inflow.
4. Put a little towards your long-term debt. An extra mortgage payment every year can sometimes cut five or six years off a thirty-year mortgage! If you’ve got an outstanding car loan or student loan, go ahead and consider putting some of your refund there. Seeing people debt-free or working towards being debt-free makes me happy, and it usually makes them happy as well!
5. Make an IRA contribution (or a bigger IRA contribution). If you’re 49 or younger and have earned at least $5,500, you can contribute $5,500. If you’re 50 or older and you have earned at least $6,500, you can contribute $6,500. Now it’s important to note that $5,500 (and $6,500) is the limit, not the requirement! Every dollar saved towards retirement gets you one step closer to that recliner, newspaper, and having your wife bring you your slippers – wait, strike that last part!

Getting a tax refund is a great feeling and as I mentioned in #1, you should do something fun with part of the money. Don’t just throw it all away on a March Madness bet, a golf weekend, or a shopping spree!

 

Many people, myself included, sometimes view a tax refund as money you were never expecting to have. On some levels, that may be true, but it can also be said that a tax refund is money you should have never agreed to loan the government in the first place! When you look at a tax refund that way, I’d suggest you look at options #2 though #5 and decide for yourself what you should do with your tax refund.

 

-Tom

Dealing with Debt

Credit: Stuart Miles

One of the most common questions I receive is about paying down debt. If you only have one debt, be it a student loan, a car loan, or a home loan, it’s pretty easy: make the monthly payments and pay a little extra when you can until you don’t owe any more. Paying off that loan will remove a recurring, fixed expense from your monthly cash flow, eliminate your interest expense, and free up some more cash for you to save or invest. However, if you have multiple debts, things can get a little more interesting…

Let’s say you have a car loan for $15,000 at a 4.5% interest rate and a $200,000 mortgage at 4.75%. What should you do? Any financial advisor with any sense at all would encourage you to make the minimum payments on both of your personal liabilities at the very least, but if you ask some of the great financial minds out there which debt you should focus on beyond your minimum payments should you have a little extra cash lying around, you would probably start hearing conflicting answers. What I mean, is that from a longer-term point of view, you should always attack the debt with the higher (or highest) interest rate to maximize your net worth, but from a shorter-term point of view, you should probably go ahead and pay off the smaller (or smallest) debt to lower your fixed expenses a little bit and take some pressure off your cash flow. Every case is different, but if the interest rates of the two debts you are trying to decide between paying more towards are very close AND the amount owed on one of them is significantly smaller than the other one, I’d usually recommend you go ahead and eliminate the smaller debt. The interest rate savings you are giving up are most likely minimal compared to the satisfaction you will feel and progress you will see by eliminating a debt.

Credit card debt is often another matter entirely. Let’s say you have six credit cards with balances on them that you can’t pay off at the end of the month. What do you do? First, read this blog more often, and unless you find yourself in a really, really bad situation, don’t ever rack up a credit card bill you can’t completely pay off at the end of the month! Just say no! Seriously though, what should you do? I’d get a sheet of notebook paper and write down the name of each credit card, the balance you have worked up, the interest rate you will be charged, the minimum payment due, and the maximum credit limit of each card. Make a nice little chart if you like. Either way, I’d advise you to make minimum payments on all of them and then go after whichever credit card has the highest interest rate regardless of the balance you owe. Credit card interest rates have teeth and fangs, so when we’re talking 15% to 25% interest rates or higher, you should really focus on stopping the “interest rate bleeding” as quickly as you can. One other thing probably worth mentioning is that if you have some credit left on some of the cards with lower interest rates, you could potentially take advantage of that remaining credit and try to pay down (or pay off) some of the cards with higher interest rates if your particular credit card(s) will allow you to do so. It’s a creative approach, and you’d need to be careful, but it could work and save you some interest. If you actually resort to this tactic, don’t just pat yourself on the back: go get a pair of scissors and cut that paid-off credit card down its back!

Everyone with debt is in a different financial position with different cash flows and different assets at their disposal, so my proposed debt reduction strategy is not always the same. Whatever path I advise, or more importantly, whatever path you choose to take, I encourage you to take that “freed-up” cash you have every time you pay off a debt and go ahead and put it towards paying down your next debt. This practice is often referred to as a “snowball,” and if you hold true to this strategy, you can really pick up some momentum towards becoming debt-free. 

Almost everyone has debt or has had debt. Please don’t hesitate to let me know if I can help you come up with a plan tailored to deal with your debt.

-Tom

A New Car! ...or Not?

Credit: M - Pics

You can acquire a car in lots of different ways. Some people buy with cash, some people buy with credit cards, some people buy with the help of an auto loan, some people lease, and some people even steal. Not many of us will ever be fortunate enough to win a game show and just walk away with a car. So, one of my wife’s friends asked what’s the best way to acquire a personal mode of transportation? Well, it depends - on your lifestyle and time frame, on your available assets, and on your “craftiness” at the dealership or car lot. Let’s take a look at how to best get that sweet ride.

Do you have to have the latest and greatest vehicle out there? Do you want to have a new car every 3 or 4 years once that new smell wears off? Are you just looking for a reliable form of transportation for the next decade?  As long as you are financially capable, these lifestyle preferences are neither right nor wrong, but you should at least consider their financial implications.

• Leasing: If changing cars frequently is important to you, then you should consider leasing due to the lower monthly payments and lower probable maintenance costs, but you should also recognize that you will always have a car payment.
• Buying: If you are planning on keeping the car for most of its life or paying towards owning something is important to you, then you should consider buying a car.
• Buying Used: A used car will have a lower price, will depreciate in value at a slower rate, and will have less expensive auto insurance, but it could potentially have more maintenance costs since you would have a limited warranty at best and cannot know what the car has actually been though.
• Buying New: A new car will have a higher price, will start depreciating in value quickly, and will have more expensive auto insurance. A new car will come with a longer term warranty, and like buying a used car, you will eventually own it.

Assuming your car lasts, buying your vehicle eventually means no monthly payments; just gas and maintenance expenses and the ability to sell something you own. Still don’t know whether to lease, buy-used, or buy-new? Let’s consider a car’s true cost and then your available assets.

A car does not cost what the vibrant-colored numerals say on the windshield, and it does not cost what the seller or dealer initially tells you it will. A car will actually cost you the sticker price plus sales tax (probably 5-8%), plus the price of any options or add-ons you may have agreed to, plus the interest you pay over time if you do not buy the car outright. You also will now have to acquire additional auto insurance, pay for gasoline, and be able to afford regular and unplanned maintenance. Now that’s too many variables for me to give you a useful numerical example, but the bottom line is, you need to estimate all the initial and monthly costs of a new car and look at your monthly cash flow and savings. If you see that the new expenses will cause your monthly cash flow to become negative or your current assets to start declining, you need to look at a less expensive new car, consider used cars, or consider leasing. You can save up and get that car you have always wanted next time, without straining or destroying your financial health this time!

Finally, assuming you have decided to buy a car, used or new, here are a few tips on how to get the best deal:

• Do some research and know what kind of car you want before you go shopping.
• Know what options and upgrades are available and what you want before you go shopping. Do not waiver on your decision when you start shopping.
• Do some research and know how much the Manufacturer’s Suggested Retail Price (MSRP) is. This empowers you when the seller is telling you what a good deal you are getting.
• Check your credit score and ensure that the reports are accurate before you go shopping.
• Go to your bank and consider getting pre-approved for a car loan. This gives you an idea of how expensive of a car you can afford, what your monthly payments would be, and what your interest rate would be. This not only helps you decide how best to acquire a vehicle, but it also acts as a safety net and point of reference when negotiating financing with the seller. You hold the cards. See if the seller can beat or match your bank’s offer.
• Plan when you shop. The end of the year when new models are arriving, the end of the month when sales quotas may not have been met, and even rainy days when no one else is buying a car are supposedly the best times to get a deal.

I hope this helps. Happy shopping!

-Tom

To Refinance or Not to Refinance, That is the Question

Credit: jscreationzs

One of the most common questions I get from clients is whether or not they should refinance an outstanding mortgage. As is the case with most financial advice, it depends. It depends on how much lower the potential rate is than the current rate, it depends on what type of mortgages or lending instruments we are talking about, and it depends on fees and closing costs. Let me quickly walk you through the decision-making process as I would a client.

The first items I would want to know from a client are their current interest rate and the rate of the potential new mortgage. If the difference between the two interest rates is not more than one percent, the conversation will usually stop there. This is because any small monthly payment benefit you might receive from that refinance flyer you got in the mail will most always be immediately negated by administrative fees and closing costs that you must pay. In addition, anyone who has been through a closing knows that the whole process is usually a stressful hassle with a cost in sweat and tears in addition to dollars.

The second items I would want to know from a client are what type of mortgage they are currently in and what type of mortgage they would be potentially refinancing into. Basically I would be checking to make sure the client is not thinking about refinancing into another 30-year mortgage when they are already 10 or 20 years into their current 30-year mortgage. The lower interest rate of the refinanced mortgage would not matter because the overall costs would be increasing due to the longer period of interest rate compounding. In English, 3.5% over 30 years is not necessarily better than 4% over 15 years. I would then take the opportunity to talk to the client about how comfortable they are with increasing their monthly payments. Refinancing into a shorter term mortgage is sometimes more beneficial than even the lower interest rate. This is because a 15-year mortgage roughly requires a monthly payment of only 25% more than a 30-year mortgage and allows you to build up equity in your home twice as fast!

Based on the client’s responses, I would then raise a few other questions such as:

- How is your credit now since the last time you got a mortgage? If it has gotten worse, refinancing probably does not make sense. You’re not going to get as favorable terms as you did the first time!

- How much equity do you have in your home? If you have to borrow more than 80% of the value of your home, you’re not going to be getting the best rates. You should probably wait until you have finally reached that 20% down threshold, and then consider refinancing.

- What are your closing costs? I’ve mentioned this already, but you really do need the specifics before you refinance because many items, such as recording fees, title fees, appraisal fees, attorney fees, points, and transfer taxes, could come into play. These one-time payments alone can make your decision for you about whether or not it is a good idea to refinance.

With interest rates at historical lows over recent years, refinancing has been very popular. Refinancing has been a very good financial strategy and has helped many of my clients, but you can actually make things worse for yourself and cost yourself more money in the long run if you do not consider things carefully.

-Tom

A Rate of Return You Can Actually Count On

Credit: Stuart Miles

I find it quite funny how many people I come in contact with think that financial advisors know what the stock market is going to do. I find all the people that claim they know what the stock market is going to do to be even funnier.  I would know what the stock market is going to do if I could only get a copy of the Wall Street Journal a day early. Even the best of the best stock-pickers are only making very educated guesses.

What I can tell you is that in the long run, the stock market is going to grow and go up because it always has. I can give you a bucket of frequently successful investment strategies to try. I can even tell you statistically that over long periods of time the stock market goes up an average of about 8% a year, but I can’t give you specifics.

In spite of acknowledging my crystal ball shortcomings and all the market fluctuations in recent years, I have good news. Today, I can tell you something you can do that will give you a rate of return you can actually count on. 

Do you have a school loan, car loan, furniture loan, or a mortgage? If you do, I can almost guarantee your rate of return; your interest rate.

Frequently people are focused on owning more houses, more property, more jewelry, and more cars. They want more cash and more possessions; essentially more assets. It is a relatively simple concept, but paying off debt (lowering your liabilities) is just as good to your financial position as putting it in the bank or investing it. At times, it can even be better.

Let’s say you have $100. You have three options: 1) Put it in the bank, 2) Put it in the stock market, or 3) Pay off your student loans.

1.       If you took option 1 and put it in the bank, in one year you would have earned approximately $0.50 because interest rates are so low (per Bankrate.com, Interest Checking Yield is currently .50%).

2.       If you took option 2 and put it in the stock market, in one year you would have something. As I stated earlier, neither I nor anyone else can tell you what you will have. It is my belief that the market is slowly recovering, but there are some more peaks and valleys to be seen over the next few years. So, let’s say you get ½ of that average long term return we talked about earlier (1/2 x 8% = 4%). That would mean you would have earned approximately $4.00.

3.       If you took option 3 and put that $100 towards your student loans, you would have saved yourself $6.80 because the current interest rate for student loans is 6.8% (per direct.ed.gov). You saved $6.80 because if you had not paid that $100 towards your loan, you would owe $6.80 more at the end of the year than you did at the beginning of the year.

So I ask you, would you rather make $0.50, $4.00, or save $6.80? Of course you and I would take the $6.80. However, there is that risk that the stock market might do better than we thought and earn more than that $4.00 or even our $6.80 we saved. All that being said, with so much international and market uncertainty, you should at least consider the value of going with a rate of return you can actually count on and use any extra cash you may have sitting around to pay towards any of your liabilities that have a relatively high interest rate.

-Tom