JoeTaxpayer

Not a major Faux Pas, but one that can cost you if you are playing the float on zero interest credit card loans.

For those of you not familiar with this, let me start with a description of what I am discussing. Despite the state of the economy and credit crunch we are in, a number of credit card issuers are still offering zero interest cash withdrawals for as long as 12 months, and some with no transfer fees. The no-fee deals make it tempting to borrow the money, put it in a CD, and just pay it back when the zero rate comes to an end. Of course, this is not for everyone. You set yourself up for the risk of a missed payment, (in my case I set up monthly automatic payments on line), or the temptation to spend that money instead of putting it into a CD. For others, the credit line offered isn’t high enough to justify the effort.

Now, to my recent mistake. When you have an outstanding zero interest loan, any new charges are typically incurring the standard interest rate. So, with an outstanding zero interest loan, I forgot that I had this same card set up to charge my eBay account seller fees. I recently had a sale that had a fee of $2.47. So this amount will accrue interest until I pay this card off in January. Now, interest on this tiny charge would normally be about three cents per month, but BOA credit cards have a minimum $1.50 per month finance charge. So the account will be subject to $7.50 in finance charges over these five months or about 1450% when annualized. Not enough to cancel out the interest I earned on this deal, but enough to offer this as a warning. If it’s early in the free year, and you accidentally pull out the wrong card to make a large purchase, you may find you’ve just negated the saving for the whole year’s deal.

(To be clear, I have no issue with BOA, their rules are clear, the $1.50 min finance charge is stated on their agreement as well as on the checks I used to draw the loan. This is just one of the ‘got ya’s to watch out for.)

Joe

written by JOE \\ tags: Credit, credit card, credit card loans, credit cards, Finance, finance charges, interest, interest rate, loan, money, saving

A regular reader of my blog kindly pointed me to an article in Smart Money titled “401(k) Debit Cards Can Put Retirement at Risk” in which we are introduced to a debit-card like product which taps your 401(k) instead of your checking account. Although I wrote back in May’s “401(k) Loan bad for your (financial) health?” that loans were not absolutely bad, it depended on many factors, I think that such easy access is the flip side of the coin, almost certainly a bad thing. There are times I walk the fine line between wanting ‘big brother’ to establish just enough regulations to protect people from their own irresponsibility and wanting no such laws at all, caveat emptor still applying. Here, I’ll make the distinction between a one-time 401(k) loan used to help with the purchase of a first home, bridge the gap of income for an unemployed spouse, or a refinance of credit card debt combined with a change in lifestyle. Of course, paying off the cards with the loan, then charging up the cards again is no better than using a 401(k) debit card in the first place.

As the post title suggests, my feeling on this product is that it gives the consumer just enough rope to hang themselves.
Joe

written by JOE \\ tags: 401(k) loan, Credit, credit card, Finance, income, money, Retirement

Last September I wrote a post titled “Zero Interest Redux” in which I discussed the impact to one’s FICO score and how borrowing large sums off a credit card at zero interest can hurt your score in the short run. In May, I posted “Free FICO Score” about my discovery that WAMU (Washington Mutual) offered free access to your FICO score if you are a credit card holder.

The access to the report has been a bit sporadic. I was able to pull a number in April, but then no access till July when I received my warning email that my score “had changed more than 20 points.” Fair enough. The April score was 746. Since then I pulled one more $30,000 zero interest loan, and put it against my mortgage. The zero interest deal was for 24 months, and we’ll be able to pay it in full when it comes due. I also added a credit card which offered higher airline miles, a CitiBank Amex card, in addition the CitiBank Visa we had. So I went to the WAMU site, and much to my surprise, my score was up to 773. Even so, it offered suggestions as to how to raise it further;

1. The proportion of balances to credit limits on your revolving/charge accounts is too high
Analysis of consumer credit behavior repeatedly finds that owing a substantial balance on revolving/charge accounts (Visa, MasterCard, Discover, American Express, Diners Club, department store cards, etc.) relative to the amount of revolving/charge credit available to you represents increased risk.

2. The time since your most recent account opening is very recent
Research shows that consumers who have recently opened new credit accounts are slightly more likely to miss payments than those who have not. This is not an especially strong risk factor, and therefore usually means a difference of no more than a few points in a consumer’s FICO score.

That first one is interesting, they go on to suggest “Bear in mind that even if you pay off your credit cards in full each and every month, your credit bureau report may show the last billing statement balance on those accounts” Which means that giving up the float (the time from when the bill is cut to the time it’s due) or some portion of it, will help your score further. Let’s look at the math on that. If you are earning (or paying) 5% as the cost of capital, $1000 will cost you $2.75 for a 20 day float. If your credit card bill is $3000 each month, that’s about $8.25/mo to improve your FICO score. To be clear, this suggests that you make a payment before the bill is cut, so whatever you spent over the month does not show as a balance due.

The alternative to this would be to contact the issuing bank and request a credit line increase, or to use multiple cards, keeping the maximum balance on any one card below about 30% of its credit line.

Joe

written by JOE \\ tags: Credit, credit card, credit cards, department store cards, fico, free fico score, interest, irs, loan, Mortgage

I recently read an article on CNN/Money’s website titled “Credit card rewards are a real rip off“. The page starts with a legitimate gripe, “You got burned with frequent flier miles, which were nearly impossible to redeem and hardly worth the hassle, so credit card issuers turned to other kinds of incentives to entice you to charge more.” Now, I’d be hard pressed to argue with that. I typically use the miles to upgrade to first class on longer flights for a more comfortable ride, but rarely have been able to use miles to get the original ticket, too few seats are available per flight, and tend to get booked well in advance.
But CNN goes on to trash other reward programs as well, suggesting that “though rewards do spur consumers to spend more, the study found that confusing rules and restrictions make most reward cards more trouble than they’re worth.” Really? Let me share my card reward experience:
I use Amex Open. It rebates 5% on gas from dollar one. I calculate the rebate at $600+/yr on just that. Same 5% on any office supply store purchases.
A Fidelity Mastercard that gives 2% (they changed to 1.5 for new applicants, but I kept the 2%) into a 529 account. My child is 10 and we will have a full semester of college paid free with the cards rebates. We only charge what we can pay in full each month.
There is responsible credit card use. We prove that. If one will be too tempted and run the card up on purchases they cannot pay in full, they should use cash only. Me, I’ll enjoy the rebates.
Joe

(Well, just when I finished setting up this post, the mail came, and Amex advised me, that due to the high cost of gasoline, they were reducing the gas rebates down to 3% on this card. Still, that’s cash back in my pocket, just no so much.)

written by JOE \\ tags: Amex, CNN, cnn money, Credit, credit card, credit card rewards, gas, money, reward experience

The June Kiplinger’s magazine ran an article, “Raiding your 401(k).*” It advises against borrowing from one’s 401(k) and cites a T. Rowe Price study suggesting that someone borrowing $10,000 for 5 years (at age 35) will be short $145,000 at retirement even after paying back the loan. At 10%, $10,000 would grow to $131,100 in 27 years, that’s just math. Maybe they think this guy will retire at 63, not 62. But he did not take a withdrawal, he took a loan. My 401(k) charges 6.5% for a loan, credited back to the account. This means a 3.5% hit to the return on that borrowed $10,000. The account will come up short about $900 for having had the loan outstanding. Still using the 10% return, the retiree may find he is short nearly $13,000 at age 62, certainly not $145,000. Someone at T Rowe hit the wrong key, and none of my friends at Kiplinger’s catch this?

Think about this, though, the story cannot just end there. I can make the case that what matters is where that $10,000 loan went. Did the person buy a plasma TV and sound system? Or did he pay off all his credit card debt (at 24%) and start fresh? I can add to this - perhaps he was paying $288/mo and would have done so for 5 years to pay off the cards, but now is able to pay only $196 to the 401(k) loan, and use the extra $92 as an addition monthly deposit to his account. He is in the 25% bracket, and deposits a full $123 (which is the gross amount that nets him the $92) to his 401(k) and it’s matched by his employer, dollar for dollar, so at the end of year 1 he has nearly $3000 more in his account which more than makes up for the $350 hit he has from the loan itself. By staying on this path, he’s actually ahead by over $150,000 at retirement time.

As with any example, your mileage may vary. There is just one point I’d like you to take from this post. In finance, there are few absolutes. For every person who uses their 401(k) loan wisely, there may be five who blow the money and run up their credit cards again. But just as I take issue with Dave Ramsey’s statement that ‘responsible use of a credit card does not exist’, I feel that there are wise ways to use loans, 401(k) or otherwise. While I admit that a short article appearing in a magazine cannot cover every possibility, the one missing (and most important question was ignored - what does the borrower do with the money?

Joe

*The article is not yet available on line. As soon as I am aware it’s accessible, I will link to it.

UPDATE - I made an error here. (I prefer to leave the error in tact, above, but add this footnote.) In fact, the article did state “assume contributions stop for the life of the loan, as usually occurs”. This would make the math work, although I still take issue with these assumptions. I plan to revisit this subject in a future post.

written by JOE \\ tags: 401(k), 401(k) loan, credit card, Finance, Inumeracy, kiplinger's magazine, Retirement, saving