Getting the Debt Monkey off Your Back

Going hand-in-hand with the earlier post, Bankrate.com has an article on getting the proverbial debt-monkey off your back.

Since 2000, Americans' outstanding credit card debt increased 18 percent, according to figures tracked by the Federal Reserve.

During the 1990s, the amount of debt racked up by consumers more than doubled. One survey puts the average credit card balance among low- and middle-income households at $8,650. Collectively, our debt situation continues to worsen over time.

Yikes! If you make $40,000/year gross income, you probably take home $30,000/year or $2,500/month. If you pay the bare 2% minimum that credit cards require you to pay, you'll pay about $170/month, or more than $2,000/year. With a rate of 18%, you'll pay off less than $500 of the balance during the next year. All this is assuming you start off with the average debt of $8,650.

What would it take to pay off that debt in a year? About $795/month. Put that another way, about 1/3 of your take-home pay would go to paying down credit card debt to pay off the average debt of Americans with the average amount of income in one year. Paying the typical minimum of 2% the balance or $10 would take you 611 payments. If you prefer to think of it in years, it would take 51 years.

At a 25% interest rate, not uncommon with credit cards, it would take $850/month to pay that balance in one year. If you pay the 2% minimum on the card, the payments would be about $2,100/year. And guess what? Your balance would actually increase about $100. You'd never pay off the balance paying the minimum.

So, now that you're scared out of your wits, how do you get the debt-monkey off your back? Bankrate has four suggestions, all of which have been discussed before, but should be again.

1. Commit to change
2. Spend less
3. Prepare (and stick to) a budget
4. Pay yourself first

Follow those four steps every month and you'll pay off the credit card much faster than 51 years. Eventually, debt will crush your finances if you let it get out of control. Pay off credit cards every month and you won't have to worry about it.

Save, People!

The headline to this AP article made me cringe. "Savings Rate at Lowest Level Since 1933". What was worse were the details in the article.

The Commerce Department said Monday that consumer spending rose by 0.9 percent in December, more than double the 0.4 percent rise in incomes.

Basically, that means for every $1 in additional income for the average consumer, they spent $2.25 in December. Wow, simply wow. Spending has been outstripping income for a few years now as consumers sucked their home equities dry to buy the biggest SUV they could find. But to have spending outstrip income by more than double, while home re-fis are dropping like a rock due to increased interest rates, means that consumers are coming up with a new way to pay for their spending. I'm guessing we'll see the level of credit card debt boom in December along with this measure of increased spending.

Consumers went on such a binge in December that it pushed the yearly savings rate to -0.5%. The only other times in history that the annual savings rate has been negative were 1932 and 1933, at the height of the Great Depression where a quarter of all Americans were unemployed.

What does all this mean in plain English?

A negative savings rate means that Americans spent all their disposable income, the amount left over after paying taxes, and dipped into their past savings to finance their purchases.

*shudder* This measure includes retirement savings. So, if someone has 3% going into a 401(k) plan, they spent any increase in income *plus* another 3.5% of income in 2005.

There are only two ways to build wealth, save or win the lottery. As Americans we're not saving, so we best win the lottery soon. And there aren't enough lotteries to go around.

Hooray for Pataki!

As an accountant, I'm torn on tax complexity. While it keeps me employed, I am of the belief that taxes should not require an accountant, especially personal income taxes. One of my favorite quotes is from Roth, CPA

A tax practitioner who opposes the devil of tax complexity is a bit like the preacher who struggles against the forces of evil: we fight on the side of the angels, but Satan is good for business.

That being said, some states are much worse than others. Run up to a corporate tax person and whisper "New York" and watch them scream in terror. In New York, a corporate taxpayer has to calculate four different tax bases in order to complete the return. Then, you take the highest of the four bases and pay that. Unless you have tax credits. Then you have to take the tax credits and then recalculate all the tax bases since not all tax credits reduce all the bases.

It's a nightmare that rivals California in complexity (I think the typical corporate tax accountant would just drop dead if you whispered "California"). In Governor Pataki's State of the State, and in his budget proposal for the 2006-2007 Fiscal Year, he has said enough is enough. He would eliminate three of the four tax bases and have New York corporate taxpayers calculate tax solely on net income. Halleujah!

He also has a national trial balloon in his address that will get shot down. He has put in a provision to immediately expense all fixed assets located in New York. This is a GOP pipe dream that they would like to see implemented at the national level. Unfortunately for Gov. Pataki it would be immediately challenged and probably thrown out on Constitutional grounds. You can't discriminate between in-state and out-state business.

It's not often I commend governing types for clear thinking and wherewithal. But in this case it's well deserved. Huzzah Governor Pataki! I hope more Governors take your lead (not to mention Congress).

Beware 'debt elimination' scams

From the "if it sounds too good to be true, it probably is" file, Bankrate has a Q&A on the latest debt elimination scam sweeping the country.

One is that credit card lending is really illegal, so if you stop paying them and they take you to court, you'll win with the secret, and expensive, legal strategy you will be sold. Yours is a variation on that theme -- it's a scam, pure and simple. They probably want a big upfront fee. Don't pay it. A similar scam was circulating three years ago in the mortgage arena, where companies wanted you to believe that by waving their special piece of paper at your lender, you could *poof* make your mortgage disappear. At that time, government agencies issued a flurry of warnings. To quote the U.S. Treasury, such schemes "are worthless" and "using such fictitious instruments with the intent to discharge valid debts may be subject to criminal prosecution."

If you get a solitication about magical ways to eliminate any debt, whether mortgage or credit card, assume it's a scam and walk away. There are only two methods to reducing debt: paying it off or bankruptcy. Anything else is rubbish.

When maxing isn't bad

Well, I maxed out my first credit card last weekend. I know what you’re thinking “That goes against every single rule you and every other know-it-all preach!” Well, it does in a way. But I’m not paying 25% or 15% or even 5% on that balance.

When we purchased our house, we inherited the washer and dryer of the previous owner. They were of unknown age and, frankly, pretty crappy machines. The dryer had started to go down the path of replacement. It would take 3 or 4 cycles to effectively dry clothes and fixing it would cost the same as a new dryer. We decided to go ahead and get the most we could out of the current dryer until an opportunity presented itself to replace it.

Well, that opportunity came in the form of Best Buy’s offer of 36 months zero financing. We could easily pay cash for the washer and dryer that we purchased, but Best Buy’s offer allowed us to make monthly payments and keep the money in our account, where we can earn interest on the amount of the purchase.

Even if we only earn a 3% yearly return on the $1,300 purchase price paid over 36 months (assuming equal payment amounts of $36.11 per month), I figure we will earn $57. Investing that cash in bonds will realize an even better return.

In my mind, this isn’t bad debt. We could easily pay for the washer and dryer in cash, but there was no discount for doing so. This way, we’ve earned interest of $57 that we would not have earned by paying cash. All the while paying no interest on the underlying debt (though, make sure to watch expiration dates so you don’t get hit with back interest of 18% annually). $57 doesn’t seem like much, but it’s a dinner at one of our favorite restaurants with money left over to pay a babysitter.

It still makes me slightly nervous to have one credit account maxed out (though we could probably ask for an increase if we really wanted to). I am conservative with money and don’t like to have large debts. I wouldn’t suggest doing this without the zero financing (making 2% and paying 18% doesn’t make a whole lot of sense), but these offers provide an opportunity to use arbitrage to earn a little extra on purchases that you would make anyway.

It is also not a good idea to max out credit accounts if you plan to borrow money in the near future. The percentage of open credit used is one of the items that make up your credit score and the higher the percentage the lower the score. However, we do not plan to borrow in the next couple of years, so we will have the balance paid off or largely so before we borrow, which will not hurt our credit score.

In a later post, I will discuss why Best Buy is able to offer so many 0% interest offers on their credit cards and how to avoid becoming a casualty of these offers.

The Ins and Outs of the Home Office Deduction

I blogged earlier this week about CNNMoney's suggestion to aggressively take home office deductions whenever possible. I suggested that might not be the best idea because the percentage of the home that is used to take the deduction is disallowed when calculating the capital gains exclusion for home sales.

I was only partially right. You must pay capital gains on any depreciation that you have taken. The rules were changed in 2002 to allow the entire home to be excluded, but still require depreciation recapture (the fancy term for paying tax on deductions already taken). But it gets worse. If you follow CNNMoney's suggestion to take other deductions, such as utilities, even if you don't qualify for the depreciation deduction, you will get quite the surprise when you sell the home.

What if you take other home office deductions and skip the depreciation? Nancy Mathis, an I.R.S. spokeswoman, says that will not help. "Even if you don't take this depreciation, it will be treated as if you did when it comes times for calculating the basis of the home sale and capital gains exclusion."

So, even if you don't take the depreciation deduction you will still pay capital gains as if you did if you claim other home office deductions.

That's why it always pays to talk to a professional if you plan on taking any overly aggressive positions on your tax returns. In this case, you are chancing an audit and chancing having to pay taxes on expenses you didn't even deduct. Doesn't sound like such a hot idea to me.

Four steps to spotless credit

Money Magazine has an article on four steps you can take to improve your credit.

The last section is the most important, how to clean up your credit. The first three sections deal with obtaining a credit report, making sure only "good" credit shows up on your credit report, and protecting your identity.

Everyone that doesn't understand what actually goes into a credit report needs to read this article. It's a short summary of good credit habits that will allow anyone to repair their credit and maintain a good credit score. If yours is below 700, or worse you don't know what it is, check out the article and follow their advice.

Six don't-miss tax breaks?

CNNMoney has an article on six “can’t-miss” tax breaks for 2005 (they should really be doing 2006 so people will look ahead), most of which are changing consumer behavior type breaks or are so targeted that most people won't be able to use them.

I’m not a huge fan of changing consumer behavior in order to capture tax breaks. Usually, the amount of the tax break is not worth the hassle of changing behavior and the documentation required to sustain the break if it is ever looked at.

The sales tax deduction is useless unless you already itemize or made such a large purchase to push you over the standard deduction. The IRS publishes tax tables, that while probably set too low for most people can be relied upon unless you kept every single receipt from 2005 (I don't even do that). You can add a purchase to the tax tables for certain large purchases like cars. But make sure you have documentation because it may cause your return to be kicked out for further review.

The advice on the home office deduction (take every deduction you can) is really not terribly good advice. The problem is that any space that is used as a deduction for a home office is exempt from the capital gains exclusion when the house is sold. So, if you take 10% of your mortgage payment as a home office deduction, when you sell the house 10% of the gain will be immeadiately taxable, even if you have enough capital gains exclusion to cover it. Also, the home office deduction sends a red flag to the IRS. You can expect to be audited if you take such a deduction because there are a lot of people that follow the author's advice and goose the deductions.

The other breaks are fairly targeted. Do many divorcees not living on Wisteria Lane live off of alimony? How many people making under $25,000 contribute to retirement plans? And don't extend if you don't have to. Procrastination should never be the reason for the extension. Get it over with early and enjoy the rest of your year.

Is the Apple too shiny?

One of the stock values that I understand the least is Apple. While I would have loved to have owned a stock that has tripled in each of the last two years, the valuation now simply does not make sense to me.

I'm guessing that the P/E of 54 is due to the growth of the iPod. It's true that sales of the little music player have been growing exponentially, but a P/E of 54 seems to say that will keep happening. The truth is that the growth has to stop slowing because of two reasons. One, there are only so many people willing to pay the current prices for a music player. Two, the "upgrade factor" will slow as features are as less cool.

Of the people I know with iPods, many are on their second or third, upgrading when the screen went color and/or when video was added. The next generation of iPod may only contain an FM tuner as a serious upgrade. While that will likely get me off the bench, I doubt many people will upgrade from earlier iPods just for FM tuning (see the sales of most other music players that already have FM tuning, for instance).

An analyst for the Motley Fool seems to agree with me and he has numbers to prove it! He estimates that Apple is about 30% overvalued unless they can continue to grow at 20% for the next decade. Hard for any company, much less a 30 year old one.

Another possible explanation is the hope that the iPod will spur sales of the Macs to users that would not have considered one previously. The truth is that sales were below Apple's expectations, despite what the financial press may say. The Intel-based Macs may expand the market slightly, but by introducing the replacement for the Powerbook (starting at $2,000) rather than the iBook (starting at $1,000) I think Apple missed an opportunity to make a splash in the sweet spot for laptop sales.

Apple currently has a market cap that exceeds Dell. That's insane, iPod or not.

Never, Ever Take Refund Anticipation Loans

Ah, the time of year when H&R Block and other accountants pray on those that hire them to prepare their returns. Their predatory technique is the Refund Anticipation Loan.

The Refund Anticipation Loan is sold as a "win" for the consumer. You don't have to wait the six weeks to get your tax refund. Woohoo! Right? Wrong.

The interest and fees for them - which can run 30 percent or higher of the loan value

Let's be generous and assume it takes six weeks to get a refund on a filed 1040 (with electronic filing and direct deposit I got mine in two weeks last year). 30% of the loan value for a loan of six weeks results in an annual rate of interest in the range of 250%. Would you accept a "loan" with a 250% annual percentage rate (APR)?

While not as bad as payday loan outlets that prey on the poor (who often have APRs in the 1000% range) the Refund Anticipation Loan is about the worst debt you could have (unless you are H&R Block).

To it's credit, it appears that H&R Block has taken some of the criticism and changed their procedures. Have they stopped offering Refund Anticipation Loans? Well, no. It's a lucrative business after all. They do require all preparers to go though a five-step presentation explaining all options. Have any readers gone through this presentation? How is it actually presented?

Never, ever take a Refund Anticipation Loan. You'd even be way better off to carry credit card debt than take on one of these. And that should tell you how horrible these "loans" are.

Why am I doing this?

The first question you should ask any blogger or website is their motivation for doing the site. Mine is that there is a lot of sharks in the water in the world of personal finance, taxes, and investing (most have a "recognizable" name). I've found only a few sites that actually try to help people rather than try to sell them something.

It didn't shock me that just about every major brokerage house has paid fines because they steered clients money into funds that were bad because the brokerage was paid a higher commission on those funds. It was (and still is) a common practice, which is sad considering most people go to these brokerages not knowing anything. That is why they hire a professional to manage their investments.

And the financial press isn't any better. Every day they exalt Google, Apple, or some other high priced stock. The same way they did during the dot-com boom and bust. Who needs profits when the press talks up your stock like it's worth its weight in gold?

In the world of personal finance, the U.S. is heading for a disaster. I'm not generally an excitable guy, but with personal savings rate being below zero and the crushing amount of debt that Americans are taking on to keep up with the Joneses, people are going to need a smack in the face sooner rather than later.

Taxes are a world to themselves. The sheer amount of crap out there astounds me. From the latest "you don't really have to pay taxes!" scam to misinformation from non-professionals tax blogs that are reliable and aren't above the heads of most people are hard to find.

So who am I to comment? Well, I am a tax professional that is currently studying for my CPA and CFP (Certified Financial Planner). I am someone that is fascinated by markets and investor psychology. I'm also someone that wants to help people, either through involvement in organizations such as the Jaycees or Special Olympics, or through helping a friend maximize tax deductions and learn to budget.

That's not saying this is all flowers and lollipops. This is also a vanity project (like all blogs). I like to write and if I don't find an outlet my boss tends to laugh at my research memos (it's the Irish in me that causes me to use words like I do, I swear!).

I hope that you find what I say interesting, and more importantly, helpful. Please know that I am not going to intentionally mislead you. I am not a shark, and I don't want you to be chum.