The “Perfect Storm” and some REALLY STUPID financial decisions... By Christina Mae Olson, CFP®
It seems that every new scheme created in the financial world is designed to be a truly bad choice for investors. The trouble is that we don’t know just how bad the scheme is until it’s too late. In hind sight it seems just ludicrous that so many hundreds of thousands would end up in foreclosure or in bankruptcy on deals that were too good to be true. How could so many people make so many bad decisions at the same time? Bad decisions were made by banks, mortgage lenders, home owners, investors and well… all of us. We are in the middle of an economic perfect storm no thanks to these senseless decisions.
We thought it was pure genius when new-fangled so-called “adjustable rate” mortgages were invented. People could buy a bigger house for their money since the entry interest rate was so low. Living for the moment, as Americans do so well, worked just fine until mortgage interest rates adjusted upward. Then, there was the “no-fee-refi” in which a homeowner could refinance their mortgage with no money down. There always was a cost, however, and the “fees” in these “no-fee” deals were actually financed into the new mortgage. What about NINA’s? These are no-income/no asset verification mortgages? These were great for would be homeowners who were unemployed or had something to hide from mortgage underwriters. Oh, give me a break. What reputable lender would accept an application for a mortgage without knowing how the applicant was going to pay back the money? And, who among us thinks it’s smart to take on a mortgage if you don’t have a job or any way to pay back the money? Apparently, several million of us. If we LGBT’s are 10% of the population then at least several hundred thousand of us made these decisions. In 2006 – roughly 300,000 borrowers foreclosed on their mortgages. In August, 2008 – just one month – 300,000 borrowers went into foreclosure. What were we thinking?
What to do? Save, save, save. When the economy is in trouble – the best advice is to save. Don’t take out any new loans. Pay off the loans you already have. Don’t charge more on your credit cards than you can pay off in full every month. Build up your emergency fund (at least 6 months of ready cash). Live beneath your means. If you can’t pay cash for it then you just can’t afford to buy it!! Period.
I’m a big fan of saving for retirement in a 401(k) plan. These are great long term savings vehicles. 401(k) contributions are tax-deductible. Your taxable income is reduced each year by the amount of money you defer into your 401(k). If you defer $416/check into your 401(k) or $10,000 per year – this could mean a tax break of $3000! Now, this is a good deal. You save $10,000 but it only takes $7000 to do it (because of the $3000 tax break). Taxes will be paid, however, whenever you take out your money. The smallest tax hit will come after age 59 ½. If you take the money out before that age then you’ll not only pay income tax on it – you will also pay a hefty 10% penalty tax on the withdrawal!
Beware, however, of the new option 401(k) account holders have to access their money – before retirement. What new 401(k) scheme is upon us? The 401(k) debit card. This debit card makes it very easy to withdraw funds from your 401(k). There are some “approved” reasons for withdrawals. You can escape the penalty tax on withdrawals if you die (?), become disabled, or quit and move it to another 401(k) plan. Some employers also allow “hardship” withdrawals from 401(k) plans. What qualifies is up to your employer (within IRS guidelines) but usually includes medical emergencies, paying for college tuition and the purchase of a house. What??? Oh yes – buying a house is considered a “hardship.” If you take money out of your 401(k) for an approved reason – you will have to pay income tax on the withdrawal. You will not, however, have to pay the 10% early withdrawal penalty.
You can also “loan” money from your 401(k). This is where the 401(k) debit card comes in. The debit card makes getting at your money so easy. No paperwork, no separate approval for each withdrawal. The debit card makes it too easy. It’s also very costly. Fees are charged for every transaction. Interest accumulates on the outstanding “loan” amount. Oh, and if you don’t pay back this loan per pretty strict rules – you will end up paying an extra 10% penalty anyway. This money is meant for your retirement and not for anything else! My belief is that you should never ever touch the money in your 401(k). Well, OK, maybe if you die you can have it. Not for any other reason except to fund your retirement. Don’t do it. Don’t ever take money out of your retirement accounts.
If you want to buy a house – save for the down payment in a separate account. Save at least 20% of the purchase price. Do not borrow more than 80% of the value of the house. Borrow from a reputable lender only after going through their approval/underwriting process. Do not pay higher interest rates because you are a “high risk” borrower. Wait until you are a “good risk” borrower. If you cannot purchase the house this way – then you cannot afford to buy the house. Period.
Chris Olson is a certified financial planner™ with a fee-only practice. You can reach her at CMOney@centurytel.net or (608)-525-9818.