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Deep in Debt? Take These Drastic Steps

pennies We’ve heard a lot of discussion about the toxic assets held by our financial institutions. Here’s what hasn’t been explicitly stated too often – in order for these financial institutions to have toxic assets, many of us must be carrying toxic debt.

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We’ve seen government at all levels, corporations, and yes, individuals borrow more and more money over the past few years. Many people now have this sinking feeling that they will never get out from under it all.

So today we want to talk about what to do if you have that feeling.

The King and Queen of Personal Finance

Cash is king again and credit score is queen. In the coming years, people with cash and a good credit score will have more options, be able to take advantage of more opportunities, and will experience less stress. Isn’t that a nice place to be?

A Timeless Principle Makes a Comeback

It requires discipline. It’s amazing how we can rationalize our purchasing decisions. If I can’t afford to buy it now without credit, why would I think that I can afford to pay for it later along with an exorbitant interest rate?

So we need to pay cash or don’t buy at all. Eliminate purchases on credit, even ones that promise “no interest, no payments” for some period of time. Of course, if you already have the money, and you’re just using their money, and you need the item … really need it … then go ahead and enjoy!

Two Important Financial Moves

Perhaps more so than at any time in our lives, we need to build up our emergency reserves. Financial planners have been saying it all along, for the most part. Many of us weren’t listening. Keep six to twelve months of living expenses in a readily-accessible reserve account just in case you need it.

Pay off almost all of your debt. You may not pay off your mortgage. You may even keep a car loan for a time. Get rid of all other debt; it’s robbing you of your future.

Then you’ll be ready to start looking for the tremendous opportunities that will be available to anyone with cash to invest.

Drastic Steps to Dispose of Toxic Debt

Drastic times call for drastic measures. These steps will not be easy. In fact, they will be uncomfortable at best. However, if you’re feeling overwhelmed by all of your debt, they are necessary.

Sit down and logically determine how quickly you could get out of debt, given the two exceptions we noted above. If it’s more than five years, even after considering the steps we’re about to outline, it’s probably best to seek professional help. Here are the steps:

Sell assets

Look around for anything that you don’t need, never needed, don’t use, or never used. Get rid of it and use the money to build up your cash reserves and/or pay off debt.

Get a second income

Get a part-time job or find a way to make some spare money. Even if it’s only $300, $400, or $500 a month, plowing this money into paying off high-interest debt will pay you bigg dividends in the future. This doesn’t have to be something to do forever, just do it until you get your financial situation shored up.

Cut back on contributions to your retirement plan

We always hesitate to suggest this because you’re robbing your future. Talk to your financial planner before you take this drastic step. But even with an employee match, it may be better to pay off high-cost debt. You may earn 30% by paying off a credit card, for example, and give yourself more room to maneuver through tough times and unexpected events.

Reduce housing costs

With the price of houses down in many markets and the continued lack of buyer demand, now probably isn’t the time to consider downsizing. However, analyze your specific situation because you might be surprised.

Another option might be to rent part of your home. Or find other ways to cut costs on your existing house. For example, property tax assessments will be going out in January. Check your assessment and the price of houses that have sold nearby to see if you can protest the value you’re being charged for.

Cut transportation costs

Could you get by with one less car? Could you take advantage of public transportation? Could you car pool? All of these ways put money in your pocket that can be used to build up cash and pay off debt. 

Stretch your dollars

We’ve covered the bigg ones, but it’s also important to look at all your other discretionary expenses. Many people have already cut back on dining out. Go even further – buy fewer prepared foods and cook meals yourself. Sure it will take more time, but it will save you money that can be used for stockpiling cash and knocking down debt.

Look for your recurring expenses – cable bills, cell phone bills, and everything else. Is there a way to make cuts?

Strive to stretch every penny you can out of every dollar you bring in so you get back on your feet and on track to being a bigg success!

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Next time, we’ll discuss the “must-haves” for your productivity tool kit. Until then, here’s to your bigg success!

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Direct link to The Bigg Success Show audio file:
http://media.libsyn.com/media/biggsuccess/00246-102008.mp3

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Are You Throwing Money Away by Owning Your Home?

toss_moneyWe all know that the three essentials for living are food, clothing, and shelter. We definitely rent our food. Do we rent or own our clothing? Hmmm.

Part of the American dream is to own your own home. And there are good reasons to do so. For instance, a Federal Reserve study[pdf] shows that the average family that owns a home has a net worth of nearly $625,000 while families who rent have a net worth of just a little over $54,000.

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Homeowners on the move

We’ve seen an interesting statistic bantered about, but we haven’t been able to pin down a reliable source. If this statistic is true, American homeowners move once every five years or so, on average.

So we thought we’d consider what that does to the buy vs. rent equation. We’ll use some averages and national statistics to create an example. However, what really matters is your own situation and your local real estate market. Only you, working with your financial advisors, can determine what’s in your best interest.

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marylynn When I was younger, one of my bosses in radio told me that I was just throwing away money by renting. I remember thinking that it made sense. I’d reached an age where maybe I should consider buying. So I did. As often happens in the radio business, less than a year later, I lost my gig. So I had to sell my house to move to a different market. I lost a lot of money by buying. If only I had had a crystal ball!

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Putting buy vs. rent to the test

We created a fictional purchase to see if we would be better off renting or owning a house for five years. We assumed that:

  • We put 20% down (approximately $63,000).
  • We financed the rest with a 30-year mortgage
  • The interest rate would be 6.50%, slightly above the current rate.
  • Our house would appreciate 4% per year, slightly below the recent average.
  • Property taxes would cost us 1% of the value of the home.
  • Insurance would run 0.50% of the value of the home. (Renters and homeowners have to insure the contents. We have the added burden of insuring the building.)
  • Repairs & maintenance would consume 1.50% of the value of the home.

Over the first five years, 83% of our total mortgage payments would go for interest. In other words, for the most part, we’ve traded renting property for renting money. If the interest rate is higher, the portion that would go to interest would also be higher. Of course, the reverse is also true.

During this period, we would pay $2,171 per month as “rental costs” for our home. We call them rental costs because they have no value once they’re paid. They only allow us to keep owning. So if we could rent a similar property for less than this, we would be better off renting instead of buying.

Of course, if we had made a down payment of less than $63,000, our cost would go up because we would be paying even more interest.

Where’s the break-even?

We also looked at how it would take before we would break-even. After all, it costs money to sell a house. We would have to pay commissions to our realtor, closing costs, and the like. We assumed these costs would total 8% of the selling price.

Given our assumptions, we looked at what would happen if we sold after one year. Our house would now be worth $326,560. From that, we would pay $26,125 in selling costs. After a year, our mortgage balance would be $248,392.

So we would be able to take out $52,043 in cash. But remember, we invested $63,000. So we lose about $11,000 if we sell after one year.

But that’s not the whole story …

We haven’t yet considered the opportunity cost of tying up that $63,000 in a house. Because if we didn’t invest it in this house, we could have invested in something else. We assumed we could have earned 6% by investing in some portfolio of financial assets.

That would have returned nearly $3,800. So by buying this house and selling it in a year, we would put ourselves in the hole nearly $15,000.

Even after 2 years, we’d still be about $3,500 behind, given our assumptions. Of course, one of those assumptions is that real estate prices are rising. It’s almost certain they will in the long run, but will they rise in the next year or two? They may not in some markets.

What’s the bottom-line?

We concluded that if we didn’t plan to own a house for at least two years, we’d rather rent. We also saw that the longer our holding period, the better we would do. For instance, in the last five years of the mortgage, only 15% of the mortgage payment would go to interest. It seems like buy-and-hold is rewarded in real estate investing.

How to get around it …

We have two friends who have been able to get around the short-term ownership problem. One of them is in the military, so he moves frequently. He only buys a house that he knows would make a good rental property. If he gets transferred, he hires a local property manager and rents it out. Until he decides where he wants to retire, he plans to hold a number of his houses.

Another friend doubled-down on this strategy. He moved quite frequently as he climbed the corporate ladder. Not only does he own houses in a number of cities, he bought additional rental properties, so he has a diversified portfolio across a number of cities. Now he’s retired living off the rents!

So you can get around the disadvantages of short-term ownership by having an alternative exit strategy!

Next time, we’ll discuss how a toy that you probably played with as a kid can help you manage your time. Until then, here’s to your bigg success!

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9 Questions to Answer Before You Make Extra Mortgage Payments 

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9 Questions to Answer Before You Make Extra Mortgage Payments

Bigg Challenge
One of our listeners, Randy, is considering making paying his mortgage every two weeks instead of every month so he can pay it off faster. He wants to know if this is a good idea..

Bigg Advice
We can’t give you a direct answer, Randy, but we will give you nine questions that will help you determine if you should make the extra payments.

#1 – Do you have any other debt?
Chances are your mortgage is the cheapest debt you’ll ever find, after taxes are considered. So if that’s the case, you should pay off your other debt first.

#2 – Do you have an emergency cash reserve?
The general wisdom among financial planners is that you should have somewhere between three months to a year of living expenses in an account that’s readily available.

#3 – How good is your credit rating?
The better your credit rating, the better chance you have to borrow in the future at a reasonable cost should the need arise. When you make extra payments, you’re essentially investing in an illiquid asset. So if your credit score needs some improvement, work on that first.

#4 – How do you feel about debt?

Some people don’t like having any debt at all. If you’re one of them, and if you’re happy with the answer to the first three questions, then make extra payments!

#5 – What’s your interest rate?
This question gets you ready to determine your best financial move. There are two things you need to know:

  • the interest rate on your mortgage
  • your tax bracket (i.e. how much you’ll pay in taxes on your next dollar of income, that’s called your marginal tax rate).

Multiply your interest rate by (1 – your marginal tax rate) to get your after-tax cost of interest.

#6 – How disciplined are you?

If you’re likely to just spend the extra money if you don’t make extra mortgage payments, then by all means just make extra payments. If you’re disciplined
(or set it up so you don’t have to be), then you’re ready for the next question.

#7 – When do you plan to retire?

In general, the longer you have until you retire, the more aggressive you can be. So if you plan to retire in a relatively short time, lean toward extra payments. If you have a relatively long time before you retire, you’re probably better off investing.

#8 – What could you earn if you didn’t pay off your mortgage early?
You figured out your after-tax interest cost in Question 5. That’s your cost of money. Now you’re going to look at how much you can make from your investments. That’s your projected return. If the return on your portfolio is greater than your cost of money, that’s a sign you shouldn’t make extra payments on your mortgage.

#9 – Will your current portfolio support your desired lifestyle?

If you already have enough money to keep you happy for the rest of your life, why do anything risky? Just pay off your mortgage and reduce your risk even more.

We’ve offered some general advice here. Find a certified financial planner or CPA to help you with your specific situation. 

Want to read more? Here are the
9 questions you should ask before paying off your mortgage
in more detail.

Our bigg quote today comes from Walter Savage Landor:

“We talk on principle, but we act on interest.”

But you shouldn’t pay down your principal unless it’s in your best interest.

Next time, we’ll share a love story with lessons. Until then, here’s to your bigg success!

Subscribe to The Bigg Success Show in iTunes. 

Subscribe to the Bigg Success feed.

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