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Judy Loy: The Good, Bad, Do's and Dont's of Debt

by on January 08, 2012 1:00 AM

The start of the new year brings in renewals and resolutions for many people.  The top resolutions pertain to getting fit (ever visit a gym in January?), spending more time with family, helping others and getting out of debt.  I also find that many individuals and couples come to me at the start of the year to get their financial house in order. It is a time for improvement and reflection.  What are some top ways that someone can begin to build for a solid present and future financial situation?

Many people have built up too much debt.  There is good debt and bad debt. 

Typically, a mortgage on a house is good debt.  Paying the principal on a mortgage builds equity and the interest can be deductible for tax purposes.  However, in 2008, real estate saw a downturn of unprecedented proportions and many homeowners found themselves ‘underwater.’  This means the debt or mortgage connected to their house was more than the house was worth.   Many people defaulted and walked away.  If you are still in an underwater position on your mortgage and have kept up payments, work with your bank to see if you qualify for the FHA Short Refinance opportunity or if they offer an option.  If your financial situation is dire, see if Home Affordable Modification Program (HAMP) might work.  Your bank would tweak your current mortgage by reducing your interest rate, extend the term of your loan or defer a portion of your mortgage payment.  This can give you some breathing room and allow you to stay in your home. 

If you are the lucky sort (many in State College are) and your mortgage is still in line with your home value, a traditional refinancing may be in order.  Rates are extremely low right now.  A 30-year fixed is currently quoted at 4.269 percent and a 15-year fixed is at 3.4 percent.  Refinancing to lower your monthly payment and pay less in interest over time typically makes sense if you plan on staying in the residence and the percentage interest rate decrease is 1 percent or more. 

The most important thing I can suggest to a homeowner is to set your mortgage so your house is fully paid in retirement.  This decreases the expenses in retirement and means less income is needed during your non-working years.

Credit card debt can be dangerous.  It is typically high interest with high fees if you carry a balance.  The first rule is, don’t carry a balance from one month to the next.  Pay off the entire balance of your credit cards every month. 

If credit card debt has been built up to a level that is beyond a monthly payoff, a plan needs to be set in place to pay back the debt.  Be extremely careful of agencies that offer to ‘help’ pay down or reduce payments. Many are scams.  A do-it-yourself plan is best.  Pay off the highest interest credit rate first.

One way to avoid building up debt is to have an emergency savings account in place.   An emergency account is for exactly what it states: emergencies.  Your car needs a radiator, new brakes ?  Your  roof leaks?  Break into this account rather than pulling out the credit card.  The rule of thumb  for how much cash to set aside is three-to-six months in expenses.  A family or individual with job security can be fairly safe with three months and a person who is less sure of their job should try for six months.  This money is set aside in a cash-equivalent account, savings, money market, etc.  The money needs to be easily accessible in case of an emergency.  Interest rates are extremely low, if not non-existent, on this type of instrument.  Regardless, it is still important to set money aside there as a safety net.

A way to get a handle on your long-term finances is to run a retirement calculator.  This takes a look at your retirement goals and can offer insight into whether you can sustain your standard of living at your chosen retirement date.  A majority of families and individuals have not saved enough for retirement according to recent surveys on the matter and my experience with individuals.

The first place to turn to save more or start saving for retirement is your employer’s retirement plan.  Saving here is essential if the company matches your contribution.  A company match is the equivalent of doubling your money immediately and this advantage cannot be found in other retirement vehicles.  If your company does not match, does not offer a plan or you are not yet eligible for that plan, saving for retirement can still be done through a Traditional IRA or a Roth IRA.  If you qualify, the maximum that can be contributed to these accounts each year is $5,000 (plus an additional $1,000 for those over age 50).  The earlier you start, the better, and better late than never.  Just taking a step to increase, start or max out your retirement plan or IRA contributions can make a world of difference when retirement rolls around. 

Making any positive change financially in the new year is a step in the right direction.  As with exercise or diet, trying to go too far too fast can lead to exhaustion and burnout.  Take small steps and try to make the right moves over time.  If you find it difficult to work through the myriad of options and need direction, work with a professional advisor.  They can help you with your individual finances and work to keep you on track — kind of like a coach.  If you get discouraged, to paraphrase Oliver Wendell Holmes,  “The great thing in this world is not so much where we stand, as in what direction we are going."

Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at [email protected]
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