There are generally two schools of thought when it comes to paying down debt: pay off the highest balances first and pay off the balances with the highest interest rates first.  But neither of these methods addresses the true issue on their own, which is minimizing interest payments in order to pay down the principal balances more quickly and eliminate the debt. That’s why I prefer to combine the two theories into one comprehensive method that reduces the debt while also minimizing the amount of interest that will be charged along the way.

Looking at the situation strictly from a balance standpoint or an interest rate standpoint does not tell the whole story.  If you have several debt obligations, you will be better served to look at the interest being charged on your statement for a more accurate view of your situation.  The interest you pay should be the determining factor in which obligations get paid first. Take the following rough examples of debt obligations:

1. Principal balance of $10,000; interest rate of 1%
    
2. Principal balance of $6,000; interest rate of 10%
    
3. Principal balance of $2,000; interest rate of 16%

Assuming either of the more common debt-reduction methods were used, some people would pay the highest balance or the highest interest rate first.  However, while those methods would work toward paying down some of the debt, the second obligation, although significantly lower in dollar value than the highest obligation and lower in interest rate than the highest value would end up costing the most in interest during that time.  That is why you need to take a different approach and analyze each of your debt obligations to see which is costing you the most in interest, which in turn will lead to a longer amount of time and resources to eliminate, especially if you are only paying the minimum required payment.

The issue gets even more complicated if you are looking at interest rates alone, specifically on credit cards, because many times there are purchases with different interest rates attached on the same card.  In addition, as time goes on the rate on a particular card can fluctuate so as to increase or even decrease after your debt-reduction plan has begun.  That makes the strategy of looking at interest summary even more important.  It looks at the bottom line figure of how much interest you are paying on each obligation as a whole. This way, you are seeing the total impact of the outstanding debt plus the applicable interest rate being charged on those outstanding balances, not just the balance or rate on their own.

It may involve a bit more work than simply saying “I will pay off the highest balances first” or “I will pay the balances with the highest interest rates first”, but in the end you will save quite a bit of money in interest charges, and even more time since the interest will not compound and continually increase the balances owed as quickly.  You may need to re-evaluate your strategy every few months or so just to make sure that your payments are having the most positive impact on your debt situation, but it will certainly be worth it once you start to see a noticeable change in your situation.

What do you think would work best for your situation: knowing that a debt is completely eliminated first or knowing that you are paying down your debt while ensuring that a minimal amount of interest is being added on top of it?  Or, do you have a totally different approach to tackling debt?

This article, A (Slightly) Different Approach to Paying Down Debt was originally published by DollarVersity, and may have been used without the owner's permission.

Credit is always a hot-button issue. There are many pundits who fault credit issuers for charging late fees and high interest rates while also blaming them for consumers getting into debt.  These people believe that credit is evil, the bane of society, the cause of all that is wrong with the county, etc. While I am being a bit sarcastic in that last statement, it’s not far from the truth.  It’s true that there are some people who have a real addiction to shopping, but that’s a totally different animal. I strongly believe that the credit issuers are not totally at fault, and that every person who has ever found themselves in debt needs to take a good long look at the person in the mirror and claim responsibility for where they are.   

I have written before that financial competency, like many other things, begins at home.  Parents need to teach their children the value of money from a young age.  Like drugs, smoking, drinking, sex, etc. if you ignore the subject children will be forced to learn about credit from sources that are not necessarily interested in their best interests.  Taking the time and teaching children both the benefits as well as pitfalls of credit, they will be much better prepared to handle it in the future.  One such way would be to teach them how to do their due diligence by using all available research materials such as a credit cards guide.

Another thing I have noticed over the years is that people like to shift blame, and avoid any accountability for their own actions.  I always ask clients who are in debt whether or not they were forced into abusing their credit; if they had a gun to their head to live outside their means, or if life as they knew it was going to end if they didn’t go out and max out their credit lines.  The point is that each and every purchase was a choice.  The choice to purchase a fully loaded Mercedes because everyone else they know had one, the decision to take on a mortgage that would leave them struggling to pay the rest of their monthly bills, the choice to buy a Gucci purse because of the status is brings. Everything we do is by choice. Nobody is forced into making any of the purchases that put them in debt; there are no guns being held to consumers’ heads.  Then, when they start falling behind with the creditors, the fingers point every which way except toward the one person that is truly to blame–themselves.

Let’s face it, none of us would ever loan out money interest-free, and with an unlimited payback period to a complete stranger.  Essentially that is what credit issuers do, although the terms are based upon one’s credit worthiness.  Those who have shown a lack of worthiness are charged high interest rates–although admittedly some rates are unnecessarily high–and late fees for not making the minimum payments in the agreed-upon time frame.  We are not talking about surprise fees or charges, either. Upon issuance, lines of credit are accompanied by terms and conditions.  If someone chooses to ignore the disclosures which state the repayment terms, interest rates, fees, and credit limits they have no one else to blame but themselves.

While I do believe that there needs to be more transparency when it comes to any type of credit provider, I am a strong believer in personal accountability.  I also believe that this type of situation is a byproduct of the nation’s propensity to spend as opposed to save, and the desire to live above one’s means.  All in all, while credit issuers should bear part of the blame for the credit and debt problems facing the country, ultimately the brunt of the blame belongs placed on the individuals who misuse their ability to borrow.

Agree with me.  Disagree with me.  Try to convince me that I’m wrong and that people shouldn’t be expected to act responsibly with their credit.  Explain to me how it’s plausible to place all of the blame on the “evil empire” that is the credit card industry and not the users’s fault.

This article, Are Credit Issuers to Blame For the Nation’s Problems? was originally published by DollarVersity, and may have been used without the owner's permission.

I’ve been reading on various blogs where people leave comments preaching that everyone should avoid using credit.  I have also noticed several titles in the bookstores as well, such as “The Last Book on…You’ll Ever Need” or “The Only Book on…You’ll Ever have to Read”, “The …% Solution”.  To be honest, none of it makes any kind of sense.  Finances, and therefore financial advice is not like a baseball hat that is “one size fits all”.  No, it needs to be tailored to fit each person as an individual, and to conform to their individual goals and situations.

Now there are some basic principles that can be used as blanket statements, such as save for an emergency, pay bills when they are due, live within your means, etc. but telling people in general to avoid using credit at all costs, or that they need to save 20% of their net pay is just irresponsible.  Along the same lines, it is simply wrong to say that all people just starting out should have a 100% exposure to stocks, while a person already in retirement should switch to a 100% bond portfolio (simplistic ideas, but they illustrate the point).

Ideally, what should happen is that there should be an interview process in which the person dispensing the advice gets an overall sense of the seeker’s situation, regardless of whether it is retirement or college planning, debt reduction, bankruptcy avoidance, etc. finding out what led them to where they are now as well as where they want to be in the future.  Then, and only then can someone truly give informed and targeted advice.  No two situations are exactly identical, as people have differing levels of need, as well as differing levels of knowledge.  It is not as simple as saying “everyone should….” because of these differences and the necessity to recognize and understand the uniqueness of each situation.

Of course, not everyone is a financial advisor, planner, etc. who need to follow ethical guidelines and codes of conduct, but there is still a need to be responsible when giving advice.  One cannot advise others on a certain diet before you discover their religion or any medical conditions related to food that could affect their ability to maintain such a plan.  Nor would anyone give driving directions to a tourist before ascertaining whether or not the recipient is interested in getting to their desired destination in a speedy manner or if would like to make stops at certain points of interest.  The same holds true for financial advice.  No matter who is dispensing the advice, certain facts need to be reveled in order to get those in need where they would like to be.  That cannot be accomplished by making blanket generalizations and incorporating personal beliefs blindly.  It simply is not right nor is it in the best interest of the people in need.

Have you ever sought out advice from any books or websites?  Do you find it just a little curious that people think one method is the solution for everyone’s problems?

This article, Financial Advice Is Not A One Size Fits All Proposition was originally published by DollarVersity, and may have been used without the owner's permission.

Anyone who knows me knows that I am a huge proponent of the ideas that: a) credit, when used properly can be a tremendous financial tool and b) people (and companies) would be best served learning to take responsibility for their own actions and the resulting consequences. That being said, I am a little tired of the consumers taking all of the heat for the mess that they are in.  Yes, I have said it myself that people need to be held accountable for where they end up, but at the same time, the companies that seduce them and make it too tempting for some of these people to resist getting in over their heads to “live the dream” need to bear some of the brunt of the backlash.  Not all of the blame mind you, since everyone has the ability to make their own decisions of course, but both parties need to take responsibility.  The following is my line of questioning for the credit industry as I wonder where they come up with some of their practices.

Dear credit provider,

In light of the housing and credit crises of the past few years, I am left wondering about some of your practices in regard to the way you choose how to extend credit lines and how you deem certain applicants to be worthy of receiving a line of credit.  In the past, I have been a very big proponent of using credit as a financial tool, and of people taking responsibility for their financial situation, not blaming credit providers.  While I haven’t necessarily changed my views entirely, I have begun to question whether or not the credit industry deserves the support it has been receiving from not only myself, but others as well.

Seeing as there are so many homeowners in foreclosure proceedings or facing the inevitable event of being foreclosed upon, one has to wonder how you chose the recipients of the funds you lend and the mortgages you underwrite.  Did you not think that anyone who needed 100% percent financing or more–up to 125% in some instances as I have seen–was going to struggle keeping their loan repayments current, or even being able to make the payments at all? How about those people who were so risky that they were required to accept double-digit interest rates in order to secure a loan while standard rates were no where near such figures?  And what about the potential home buyers whose mortgage payments figured to be more than half (or even a greater percentage) of their gross incomes, let alone home much of their net income it would consume considering net income is a much more accurate figure to use?  All of these situations were contributing factors to both the housing and credit problems facing the American public, yet seem to be almost entirely born out of short-term vision, with a blind eye toward the long-term effects of such deals.

I am also curious about how you go about choosing who you market your products and services to such as credit cards. Is it simply sending out pre-approval letters to anyone whose name appears on a purchased marketing list?  It’s pretty interesting how many people report receiving pre-approval letters in the names of children (particularly babies), family pets, and even the deceased!  I mean, really, do you verify any of the information you purchase from data collection firms say, by doing credit checks or some other verification method?  Perhaps if the focus were to shift from the quantity of pre-approvals you can send out to the quality of the recipients, the risk involved in extending credit to these people would be reduced significantly.  By shifting that focus, maybe, just maybe, you would be able to bring about a rebirth of credit as a beneficial tool rather than an abused and overused component of the financial landscape.

Speaking of credit cards, perhaps you can also enlighten me as to why it is that you would simply increase a card holder’s credit limit out of the blue.  Actually, how do you even come up with credit card limits to begin with?  Wouldn’t it make more sense to start cardholders off with a reasonably low credit line, thereby putting the onus on the card holder to prove their creditworthiness and make them ask for an increase should the so desire?  I cannot even begin to recall the number of times I have read or heard about people in financial distress who said that they got deeper in the red because of the additional credit that was extended to them unrequested, and which they used simply because it was there.  Why not follow this strategy to avoid such further stories, and save yourself quite a bit of trouble all while leaving no one for the credit abusers to point fingers at other than themselves?  I mean, seriously, how are you going to get paid from people who don’t have the money to pay?  Even if you only expect to collect a fraction of the outstanding debts, a fraction of $0 (which is what many troubled people have) is still $0.

As I have stated, I am a staunch supporter of credit as a financial tool, but you are making it difficult to continually defend you from all of the detractors.  Most businesses find it beneficial to be consumer-friendly and provide value to their customers, but in recent years you have only shown a propensity for greed and disregard for the consumers.  All that has been displayed is an interest in increasing profits and padding your bottom line, no matter what the end result of your reckless actions may be or who gets stepped on in the process, as long as you benefit.  Hopefully, you have seen the error of our ways and are prepared to start putting the consumers first, considering that without people to borrow money, you would be out of business.

Thank you for your time and I hope you have learned a valuable lesson from all of this, as I know many individuals have.

This article, An Open Letter To The Credit Industry was originally published by DollarVersity, and may have been used without the owner's permission.

“Don’t Sweat The Small Stuff…And It’s All Small Stuff” was a book written in 1996 by Richard Carlson, Ph.D which became sort of a phenomenon.  It was written about how people allow little things to cause stress and take joy out of their lives, and some other mumbo jumbo psychological double-speak. Sure, that’s all fine and dandy in theory: ignore the small things, concentrate on things that make you happy, and you’ll be stress free and floating on clouds all of the time.  There’s one big problem with the whole premise of the book, it’s title, and the movement that came with it…if you ignore the small stuff, it usually becomes a monster before you know it.  This is particularly true in the world of personal finance.

Don’t believe me?  Think it’s a good idea to not sweat the little things?  Let’s look at how thinking like this can affect you in a variety of ways:

Credit Scores

Let’s say you don’t sweat the small stuff.  As you go about your merry little way, you get a bill from your credit card company.  You made a purchase of $2.00 in gas just to have some activity on the card so it won’t be terminated and have any impact on your credit report.  It’s only $2.00, so you toss it aside and forget about it.  A few months later you get a letter from a collection agency, but you don’t owe anyone anything, or so you think.  You read the letter and think to yourself, “Oh yeah, that $2.00 bill I got.  I thought I paid it.” It was so small that you not only didn’t sweat it, but you completely forgot about it and now have a nice big problem on your hands: a black mark on your credit report, and a hit to your credit scores.  

All of that because of something so small that it wasn’t worth sweating.  Never mind the fact that it was also so small that it would have only taken all of about 3 minutes to pay the bill, and never have to think about it again.

Bankruptcy

Let’s say you don’t sweat the small stuff.  You go out and shop, dine out, leave lights on when you’re not around, you know little things that don’t require sweating.  As time goes on you start to notice that you are coming up short when it is time to pay the bills.  Oh well, it’s only a few dollars here and there, not such a big deal.  Any normal person would raise the question of why there is a shortfall, but not you, because you don’t sweat the small stuff so you let it slide.  As the weeks roll on by, the deficit keeps getting greater and greater and by now, it’s too late; the bills are past dues, and what you can afford to pay is barely the minimums on any revolving debt.  Next stop, bankruptcy!

Simply taking a few minutes to draw up even the crudest of budgets would have exposed the problem, and action could have been taken to correct it or at least to plan a correction.  All it takes is a minuscule things so small that it isn’t even worth sweating to snowball into a giant problem for you.

Health

Let’s say you don’t sweat the small stuff.  It’s winter and you live up north; one day you start sniffling. No problem, it’s natural for that time of the year in that particular location.  After a few days, you start coughing, nothing terrible but coughing nonetheless. Springtime comes around, and you still have that nagging little cough that isn’t so terrible, but just won’t go away.  Anyone with any sense would have gone to the doctor already, but not you, nooooo you don’t sweat the small stuff so a little cough isn’t going to worry you.  A few more days go by, and you start to have trouble breathing normally and your chest feels heavy.  Then one day later, you don’t wake up.  The grim reaper has come-a-calling.

You know, it’s too bad because a simple regimen of rest, fluids and Tylenol could have cleared u the pneumonia that killed you.  But that would only have been diagnosed if you had gone to the doctor when it was still early, but you didn’t think it was worth the bother, and now, it really doesn’t matter to you because you’re dead!

Yes, these examples are super-simplistic and yes, even a little outlandish, but you know what?  Stuff like this does happen more often than people realize.  The point isn’t to tell a believable story, but to make you all open your eyes to the fact that often times it is the little things in life that end up creating the most stress and the biggest problems.  No matter what some book may talk about or some random dude may preach, the facts are the facts:

If you choose not to sweat the small stuff, don’t be shocked when it turns into the big, ugly, troublesome stuff down the road!

This article, You Better Sweat The Small Stuff Before It Is Too Late was originally published by DollarVersity, and may have been used without the owner's permission.