By Mary Hunt
I’m going to guess you’ve made a financial mistake or two in your life. Who hasn’t? For some of us, it was more than an occasional late fee or random urge to overspend that brought us to our financial knees. But I’m not talking about the kind of blunders that got us into trouble—we could list those in our sleep. Instead, I want to focus on the mistakes people make while they’re working their way back to financial health. Whether you’re recovering from a season of unemployment or from a financial mess you created on your own, avoid these goofs and you’ll get where you want to go much faster.
1. Not Saving
You’ve heard this plenty, and here it comes again: Jump to the front of the line— ahead of your creditors—when you divvy up your paycheck. Get over feeling guilty about keeping money for yourself. You need a fat emergency fund, and the only way to build it is to pay yourself first! Stuff happens, and if you’re not financially prepared for those emergencies, you’ll keep falling back into debt.
You’ll need enough in your fund to pay all your bills for at least six months. But don’t let that big number discourage you. Start by saving enough to live on for two weeks, then up it to one month, and so on until you reach goal.
Solution: Put your savings on autopilot—you won’t miss what you don’t see. Commit to saving 10 percent of every paycheck. If you can’t start there, start with 2 percent. Then in a few weeks, change it to 5 percent, then 7 and so forth until you reach at least 10 percent.
2. Paying for College
If you must make a choice between adequately funding your own retirement and paying for your kids’ college education, put retirement first. Contributing to college funds, going into debt by cosigning for student loans or taking out a home equity loan to cover tuition before you’ve taken care of your own future are huge blunders. The best gift you can give your kids is to make sure you won’t become a financial burden to them in your sunset years.
Solution: Kids have far more options for funding their college education than you have for your retirement. They’ve got scholarships, grants, financial aid, student loans, work-study programs and the not-to-be-forgotten method of working their way through college. Once your own future is secure and you’re out of debt, that’s when you’re in a position to help pay for education. Use the free Retirement Calculator at MoneyCentral.MSN.com/Retire/Planner.aspx to determine how much you need to be setting aside for retirement each month.
3. Too Much House
Add up your shelter costs (monthly mortgage payment plus taxes and insurance). Your total shouldn’t exceed 28 to 33 percent of your gross income—and that’s only if you don’t have a lot of other debt. Biting off more house than you can chew leaves you wide open to foreclosure and bankruptcy.
Solution: Don’t let a commissioned professional talk you into buying the most house you can qualify for. Do your own research and run your own numbers to determine how much house you can afford. You need a 20 percent down payment and a 30-year fixed-rate loan, with monthly payments that can easily fit within 28 to 33 percent of your current gross household income. If you’re over your head in a house you can’t afford, maybe it’s time to sell. If you’ve fallen behind or fear you may soon, but you owe more than the house is currently worth, call your lender immediately. You may be able to enter into a short sale (the lender agrees to settle your debt for the sale price that you can get for the house now, and forgives the balance you owe). Or speak with a HUD-approved housing counselor to find out about other options, such as loan modification (the lender agrees to adjust the terms of your loan so you can afford to keep living in your home).
4. Refinancing a Fixed-Rate Mortgage
With mortgage rates at a 50- year low, it’s tempting to refinance to get a lower monthly payment. But before you do that, ask yourself this: Can you take the difference between the payment you have now and the lower payment and use it to repay all your refinancing costs within 24 months?
Let’s do the math. The average closing cost is 2.5 to 5 percent on a $150,000 loan ($3,750 to $7,500), but the percentage normally goes down as the loan increases. Divide the amount you’ll save each month into the closing cost. If the result is more than 24, you’ll be making a big mistake by refinancing.
Even worse, refinancing with this lower monthly payment will “reset the clock,” putting you back on a 30- year payback schedule. Your goal should be to pay off the home so you own it free and clear before you retire If you’re 10 years from paying off your home and you refinance to get a lower monthly payment— but end up with a new 30-year term—you’ll be making those new “lower” payments for an additional 20 years! If the payment is, say, $2,000, you’ll end up paying an additional $480,000 just because you refinanced and reset the clock.
Solution: If you did the math earlier and it worked out in your favor, go ahead and refinance—but keep making the original, larger mortgage payments you’ve been making all along. Now, that lower payment will make an authentic, financially wise difference. You’ve managed to outsmart that reset clock and the extra interest that comes with it.
5. Paying Off the Mortgage Too Soon
Paying extra on your mortgage each month is laudable, but not if you time it badly. Your mortgage should be the last debt you pay off. Why? First, its interest rate is a lot lower than the interest you’re paying on your other debts (credit cards, student loans). Second, mortgage interest on your primary residence is tax-deductible. While you’re in debt having that deduction helps to ease the pain by lowering your tax bill.
Solution: Once you’ve built up a fat emergency fund and all of your high-interest, unsecured debts are paid in full—only then should you consider putting money toward paying off your mortgage.
6. Investing in the Wrong Thing
If there’s one thing we’ve learned over the past year, it’s that money invested in the stock market is at risk. You could lose it! Don’t jeopardize any of your hard-earned money while you’re carrying high-interest, unsecured debt. Instead, invest in your debt—it’s a much smarter move. Let me explain: If you have a $2,000 credit card balance at 14.5 percent interest, you’re paying $290 per year in interest, or $24.16 per month. Instead of taking a $2,000 gamble on the stock market, put it toward reducing your credit card debt Now each month, rather than paying that $24.16 interest to the credit card company, you get to keep it.
Solution: As long as you’re carrying unsecured debt, do everything you can to pay it down each month. You’ll get a return equal to the amount of interest you would have paid to the credit card company.
7. Debt Consolidation
Sounds great, doesn’t it? Get a new low-interest loan to pay off all your high-interest debts! But more often than not, that’s a big faux pas. Low-rate consolidation loans are typically tied to something of value like your home’s equity. Bad enough, but here’s the real problem: The financially immature person gets that equity loan and then keeps using those credit cards. In no time, the balances creep back to the limit. And that means double the trouble.
Solution: Forget about consolidating old debt into new debt. Instead, get serious about cutting your spending so you can pay off the debts you have as quickly as possible. If you have a good payment history, call the creditor and ask for a lower interest rate. You never know— you just might get it!
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