Financial Freak Show

Man I’m glad I don’t have to deal with credit card companies any more. Sunday evening I was catching up on my laziness and decided to watch an old episode of Frontline titled the Secret History of the Credit Card. No, I don’t normally make a habit of relaxing to episodes of highly biased news programs from 2004 but I figured you FinancialFreaks might benefit from my pain – so I took one for the team!

The program itself started out by revealing the history of how credit card companies positioned themselves to take advantage of a lack of regulation in some states. They then went on to discuss how the companies then came to exploit the lack of regulation to take care advantage of the consumer/borrower (told you they were biased…but then again so am I).  I’m not going to suck the life out of you with the intricacies if the credit card business here today but I will say the more I pay attention to the business the more I wonder, aside from the stock holders, who is really benefiting from their practices. The one thing I found surprising was how many ex-credit card industry professionals came out to speak against industry practices.  

Now I’m not here to completely bad mouth these guys but it does reinforce to me why I choose to find other options than credit cards. Remember these consumers, including myself, signed up for this ride and if you don’t understand the contract maybe you shouldn’t be so quick to sign on the line. I am personally a share holder in several banks through my mutual funds so I love it that people several million people can’t control themselves almost to the point of bankruptcy then manage to fight their way back through 30% interest rates and late fees then immediately jump back on board for another trip. To that I say….YEEHAW boys! Let’s ride these hogs all the way to retirement on the backs of out of control consumers trying like hell to save the embarrassment of a low credit score! Keep it up suckers, daddy needs a new Maserati!   

So if you have 40-ish minutes of your life you won’t regret spending on the couch and you have an odd fascination with money, business & credit click here: FRONTLINE: Secret History of the Credit Card or even better read my Credit Card Debate page to learn how you don’t have to ever deal with them if you don’t want to.

Last night I received phone call from Military Wife about her Citibank credit card interest rate being raised from 13% to 29% interest. Actually if I remember correctly her exact words were…

the %!<&\# at Citi just jacked my interest rate right after I made the stupid payment

Her call sent Vinny Financio into action and prompted me to snoop around the inter-web a bit. Little did I know I would find out that Citigroup has also started charging annual fees to card holders who don’t put more than a specific amount on their cards, typically $2,400 per year. So let me get this straight…If I use a card you charge me, (I get that) If I don’t use my card you charge me (thats the part I don’t get!).

Okay that’s not really true, I do get it they are charging customers more fees. That’s what they do, that’s what their consumer business model is based on. The part I don’t get is why do they still have customers? You know the saying though…

you can lead an idiot to water but you can’t make him drown himself

It amazes me what people are willing to put up with. Luckily though Military Wife, due to her recent financial progress, was able to close the account and I doubt she was able to contain her ex-Marine Corp potty mouth when she told them what she thought about their new programs. I guess at this point for those that are willing to accept this treatment more power to them. Somebody has to get bent over the bar to keep those bank stocks in my mutual funds afloat for another 30 years. Personally I’ll take my own road on this one.

I was posed a question about using a 401k loan to clean up someone’s financial train wreck. The mess in particular was created by buying a bunch of junk that these people didn’t really have to ability to afford at the time but did have the ability to borrow. Now they’re trying to refinance their home to lower their monthly payments to get a little breathing room. The problem is they’re now a little upside down on the home and the bank wants them to bring some cash to the table before they will allow them to re-fi the house. So they’re considering a 401k loan to make this happen. That is until I laid out to them a little more insight into how these loans work.   

They would be allowed to borrow up to 50% of the vested balance with a maximum of $50,000. That should be okay in their case because they have a balance of near $65,000 and are looking to pull about $28k.

The money in their case would be available at a 6% interest rate. The interest does go back to your account but depending on the market performance this could be a losing deal as far as growth.

The loan sort of turn offs your 401k for a period of time while you work to pay back the balance. Well you don’t turn off the entire 401k but the portion you borrowed is no longer considered part of the balance so no growth will happen to the portion you have taken out of the account.

Here’s the big reason I think 401k loans should be used only as a last resort:

If you leave your company most plans require that the balance be paid back into the account within 60 days. This comes due no matter the circumstances of your departure, if you go “Jerry Maguire” on them and walk out the door with the hot receptionist you’ve got 60 days. If you decide to leave because things get a bit uncomfortable around the office after you’ve been fired, you have 60 days. If you’re unfortunate enough to die, 60 days. If the loan is not repaid within 60 days the remaining balance is considered an early withdrawal and you will have the pleasure of paying income taxes plus a 10% early withdrawal penalty (if you’re under 59-1/2). So for many families you’re looking at a full 30%-40% tax bill due on that money. So if my friends borrow the $28,000 they needed and it blows up in their face they are looking at writing a check for $8,400 to $11,000 conveniently right around the time they lose a job. Talk about crappy timing…oh, and add that to the fact that they had to borrow money so they obviously we’re already in a less than desirable situation before they lost the job! And remeber the IRS doesn’t like to wait around for their money.

So I’m not saying a 401k loan is not an option, in some cases it may be the only option someone has to save a house or avoid a bankruptcy. I just want to throw this out there so everybody knows what road they are heading down before they board the special bus.

What’s your experience with 401k loans? Please share.

Recently I shared my personal goal of reaching the mysterious heights of the Zero Credit Score. I want to take some time to clarify a couple potential issues with reaching that goal and how they will or will not affect my life. For more info on this crazy goal of mine please read Zero Credit Score.

The first objection I always hear is the issue of buying a home. True a high credit score will help in financing a home but there is also a process known as “manual underwriting.” The way they used to do home loans before a number was used to determine your worthiness. In this process they do weird things like confirm you have a real income, confirm you have real bank accounts and that you have money in those accounts, confirm you’ve honored your other financial obligations appropriately (landlord, utility bills, medical debts, etc.). This process is still used today and it’s most often seen with people who are self employed, or others that may have trouble proving their income, or for those that have (get this) low or zero credit scores. So to debunk the myth, no you do not need a good credit score to finance a home. You can qualify for a Fannie-Mae mortgage with a credit score of Zero (if you’re not familiar with Fannie-Mae they are said to have over $800 billion in mortgages – if you can afford your house it’s likely they can afford to lend you the money). True this process can take a bit longer than just running your FICO score for approval but in the end if you’re proven to be credit worthy the rates and terms will be likely be the same. (Note, again, that a low credit score do to you mismanaging your debts is not the same as a zero credit score and will complicate your financing – as it should!)

The second place people argue a zero credit score will work against me is if I’m trying to land a job that requires a security and/or background check. Examples could be banking or financial jobs, some government positions and in some cases military security clearances. Here the credit report can be used as a judge of character or as an indicator of potential risk for the employer. A good credit score is not necessary though for this purpose…sort of. By law, companies are not allowed to pull your credit score though they are allowed to pull your credit report once they have your written permission.  Also, just in case your credit really sucks, due to the Federal Bankruptcy Act a company can use any information found in your credit report except information regarding as past bankruptcy, no matter how recent.

Though I defiantly support the military I don’t see myself needing a high level clearance any time soon so that takes care of that one. As far as a future employer goes I figure if they want to hire me, a credit report that displays an obvious long term track record of financial discipline should be enough to show them they can trust me. I figure if I can’t talk my way through that discussion to the point they understand and appreciate how I handle my finances and my life in general I doubt they’ll like many of the other things I have to say! So I guess at that point I’d have to find an employer that won’t judge me by how much money I don’t borrow and don’t have to pay back every month.

A survey for AmeriCredit for Market Facts asked 1000 consumers the order in which they pay their bills when they know they’re going to be late. The results were good to see (maybe there’s still some comon sense out there.) True most of this seems like common sense but it never hurts to chat about it. You never know when someone might ask you the question.

Here are some of the results: (this shows what they would pay first - last)

1. Mortgage or Rent 79%
2. Car Payment 41%
3. Auto Insurance 39%
4. Credit Cards and/or Cell Phones 38%
5. Cable and/or Satellite Television 32%

The survey results look good to me. If someone is in crisis mode the first thing they need to do is shore up their position as best they so they can hopefully “live to fight another day.” This means taking care of the essentials first. Food, Shelter, Clothing, & Transportation. If these four things are taken care of you can hopefully keep workong to address whatever your other issues are (and we know people got some issues!) Beyond the essentials look to cover your secured debts next. Things next like car payments or other property. Since these debts are secured by liens the lenders may be much faster to attempt a repossession of the property.  Next address your unsecured debts. Things like credit cards, phone bills, cable bills, old medical bills etc. Obviously all these debts need to be addressed but aside from questionable and sometimes illegal collection tactics these folks have little ability to retrieve their money with out taking you to court first. True, you do need to get these thing taken care of but the dentist can’t usually repo your dental work instead he’ll have to slap a lawsuit on you before he can legally take back the fat gold grill in your mouth.

Remember the unsecured debts (especially credit cards ad payday loans) will likely be the first to start yelling since they are in the first loser’s position if you file bankruptcy. They yell loud and they yell often hoping that you’ll become emotional and pay them before you feed your kids.  All the creditors obviously need to be addressed but if you or someone you know finds themselves in a seriously tight spot try to leave emotion (as much as you can anyway) out of the process and address the bills in a way that gives you the most flexibility to keep fighting.

When faced with the issue of my personal debts there was really only one way to fix the problem (I’ll put this in bold so nobody misses it). Pay it down then pay it off! We had to spend less money than were was making and pay as much as we could towards the debts. That’s it, it was really that simple, there were no shortcuts here. We’ll there was one other option….don’t do anything at all and let the bankruptcy courts wipe a majority of the debts away, but we didn’t really like that option. Those who stare their challenges in the face have the chance to overcome and win and those who refuse to face, or even worse avoid them altogether, will often continue to struggle until they are forced to face them. In our case we were forced to face it because it was beginning to put up a fight against us (and every month it was getting closer to defeating us). Well we could have ignored it a bit longer but I knew deep down inside the only place that would ultimately lead me was to a life of financial mediocracy. So in my case it was either face it now or face it forever.

Just about everybody I know has faced the issue of debt at some point. There are countless reasons this issue could be brought to the top of someone’s “Crap you should really clean up in your life” list(s). Some of the common causes of this are a job loss, an illness, divorce, or just plain dumb money habits. Some of these are major changes in their financial situation many consider outside of their control. In my case it was all brought to my attention through a publicly humiliating moment involving my new Cadillac and a nearly empty tank of gas in the middle of the night somewhere in Oregon.

No matter how the issue is brought to your attention the first step is always pretty much the same. You must identify the root cause of the problem. In my case I had been spending more money than I had been bringing in. It was really that simple and there was no room for excuses here; this was all my fault and now it was all my responsibility to myself and to my family to clean up the mess.  Step one was now complete I found the cause of the pain – and once again it was me! Once you’ve identified the problem you need to determine where you stand. This step is pretty easy as well. When dealing with money and numbers everything is factual and absolute – the numbers only lie if you allow them to lie. So here is your chance to be a FinancialFreak and stare into face of what many refuse to. Write down how much you owe and who you owe it to – every damn penny! No shortcuts here.  Now add it all up – this part sucks. Now you know where you stand. Are you disgusted with yourself? I know I was the night I finally sat down and took that step. Now that you know where you stand you can devise a plan to properly address the issue and remember “How you do anything is how you do everything” So don’t try any shortcuts here, just stare it in the face and start fighting to resolve the issue. 

What shortcuts have you taken in the past? How did that work for you? Did you learn any lessons? Please feel free to share so that others may avoid the same fate and/or embarrassment!