Handling Finances

I’d like to give a quick thanks to Dough Roller for his help with my blog.  I was fighting to add progress bars to my website and he kindly shared some php code that helped me get it working.

As one of my favorite personal finance blogs, his articles are very well-written and well worth reading.

Thanks Dough Roller!

As mortgage lenders rush to revise their lending policies and greatly reduce their financial risk, credit card issuers are losing money(many of whom were bitten by subprime mortgage losses) are also pushing to return to their historically high, profitable margins. In 2007, credit card revenues rose 4% to 25 billion, but profits decreased by 35% largely due to rising delinquencies.

Bank of America recently sent out notices to it’s cardholders that they would be facing interest rate increases of 9% to 27% and apparently didn’t limit the increase to those with poor repayment histories.

Avoid higher rates as you pay off your balance

At a time like this when credit card companies are drastically raising rates, it’s extremely important to read all the fine print they send you. In many cases (as with the recent Bank of America increase) you can opt out of the rate increase if you make all your payments on time and stop making new purchases on the card. It’s vital to opt out in writing, and there are often a list of conditions and details you have to attend to, but if you’re working on paying off your credit card debt and don’t want your rates to double, the few hours it takes to keep rates low might very well be worth the effort!  Also be careful about acting on any information you receive over the phone.  Different representatives can give wildly varying responses to the same question and you should never consider any policy or agreement binding unless you have it in writing.

I’m not alone in considering interest rates in excess of 30% per year to be unethical, but at the same time I don’t see it as pure evil.  We’re seeing the true cost of offering high credit limits to nearly every American regardless of their ability to pay if they run up a tab.  Many industry practices are deplorable (like targeting those who have declared bankruptcy as they have a “taste for debt” and can’t declare bankruptcy again for years) but it’s nice to see the financial institutions getting bitten for their unchecked subprime lending.  Even more people will be harmed by this attempt by the industry to recoup costs and shed as many poor borrowers as possible, but when the dust settles, America will be a bit wiser and credit will be much more restricted for a few years.

The future of ubiquitous consumer credit

The really interesting part of the whole credit-card mess will be to see if anybody learns from recent events.  Eventually the economy will hit another long-term upward trend banks will go back to competing for ever riskier borrowers to try to beat each others’ quarterly profits.  Consumers will have recovered from debt or outlived the 7-year bankruptcy penalties and a new generation will have to learn the dangers of credit card debt all over again.

Even if the government steps in to try to regulate the industry and stop this financial disaster from being repeated, we can be sure that banks will find new, innovative ways to take advantage of consumers.  The real trick will be if we can educate the average American enough that they can make wiser choices about credit and debt in the future.  I’m ever optimistic, but I won’t be holding my breath.

Dave Ramsey, popular speaker, radio host and writer on getting out of debt, encourages his audience to use a debt snowball.  The idea is that as each debt is paid off, the monthly payments that used to be directed toward that debt can be directed toward the next debt in an ever-increasing “snowball” of monthly payments focused on one debt at a time.  In their admirable fight to be free of debt, some snowballers have even turned to “snowflaking” — the frugal search for every possible dollar and each elusive penny to accelerate the repayment of their debt and reduce the monthly interest payments.  For example, Paidtwice recently wrote about how snowflaking isn’t only for attacking debt.  Rocketc at Rocket Finance mentioned snowflaking in a discussion of how he earns interest on monthly credit card balances.  Glblguy at Gather Little by Little brought up snowflaking in an article about gazelle intensity vacations (gazelle intensity is a term used by Dave Ramsey to describe the alert focus it takes to get out of debt).

These bloggers are absolutely right.  Snowflaking can easily increase wealth (not just decrease debt) and it’s a great way to focus on what’s important rather than blowing money at vending machines.  However, snowflaking is highly inefficient — it requires constant focus on priorities, a considerable amount of time thinking about small purchases and requires a strict budget to be really effective.  The vast majority of Americans should not focus on snowflaking, but on throwing huge blocks of ice at their debt or savings.  The vast majority of Americans are not being nickel-and-dimed to death, but are vastly overpaying for houses, cars and televisions.

Ice blocking — some examples.

Okay, so I won’t start using “ice blocking” as a verb, but attacking spending by focusing on the largest expenses first is just good common sense. Because we see gas prices at every other corner in our daily commute, many of us obsess over the price of gas.  We are depressed when gas prices rise and feel victorious when they drop just before we buy.  We’re willing to drive miles out of our way to save $2.00 on a tank of gas at the “cheap” station.  How many of us regularly check to make sure we’re saving 10-15% on fuel by keeping our tires properly inflated?  Even more importantly — how many Americans are buying cars new and taking a huge hit in depreciation while griping about gas prices?  It’s so easy to focus on gas prices when they’re on every road in huge letters in the sky, but saving $2 on gas won’t help your finances if you refuse to save $10,000 by buying your car used!

Similarly, it’s easy to get caught up in sales and spending hours browsing through clearance racks for rock-bottom prices, but it won’t help a bit if you spend $800 on a “reasonably priced” new HD-TV when you could buy a decent used TV for under $100!

We humans are simply hardwired to look at the world in relative terms — when we discuss gas, we compare the price to the last few prices we noticed.  When we buy a new car, we tend to compare the price to all the other new cars rather than taking the time to looking at all the options, calculating the yearly cost of gas and looking at the options in relation to our other financial goals.  There’s nothing we can do about this rational thinking — in fact, one study had people estimate the price of everyday items like keyboards, chocolate and wine after writing down the last two digits of their social security numbers.  It found that those who wrote large numbers (like 80) estimated the prices as 216 to 346 percent higher than those who wrote small numbers (like 22).  Advertisers use this relative thinking against us in sales and cash back bonuses and very successfully manipulate us into paying more while feeling like we saved less.

Some larger expenses that should be researched carefully to avoid washing out coupon-cutting and bargain buying:

• Purchasing a car,
• Shopping for the latest *anything* rather than paying half the price for the last generation,
• Routine medical treatment like flu shots, dental work or physicals.
• Music/movie/book collections where radio and the local library offer the same for free.
• Gym memberships.
• Planning vacations.

That’s not to say that going to Disneyland instead of the Grand Canyon or keeping a DVD collection can’t fit into your budget!  And it certainly doesn’t mean that cutting out vending machines and packing bag lunches is stupid if you do have a gym membership and have the latest, fastest computer!  I just think it’s important to point out that while many frugal bloggers have cut the major fat and moved on to pinching out dollars and cents in their zeal to get out of debt, the average American trying to get out of debt or start saving money needs to start at the top and make the large decisions that come with large savings.  Yes, every little expense adds up over time and small daily cuts can make a huge difference in the long run.  Still, to someone just starting on the road to financial security, making a small number of highly rewarding decisions will be much more effective than fighting to cut back back on daily coffee consumption while spending $200 a month on cable.