Debt Strategy Myth: Pay extra on your mortgage

There's once piece of financial advices that always causes me to wonder, "huh?" So many personal finance advice experts always say that you should pay extra or even double on your monthly mortgage payment with the intent of paying it down faster.

I never understand this advice for two reasons. First, if you are struggling with debt, your mortgage is likely to be the lowest interest loan that you have. Your efforts would be better allocated toward eliminating high-interest debt. And second, the interest that you pay on your mortgage loan is tax-deductible. The interest on credit cards and car loans are not tax-deductible.

Ron LoSasso, mortgage consultant at Coors Credit Union, put it like this: "I am not a fan of prepaying the home loan as once that is made the only way to get that money back is to refinance the loan, obtain a home equity line of credit or sell the house."

This is an excellent point. On average most people sell their house 7-10 years. The time spent in a house increases as we get older, but generally speaking we like to move around. There are probably dozens of better ways to use that cash.

Maybe this debt strategy myth of that paying more on your mortgage is a might make sense for somebody, but in my opinion this MYTH is BUSTED.

Debt—it’s Not My Fault. It’s In My Genes

Isn’t it nice when we don’t have to take responsibility for our behavior? It’s especially comforting when some scientific study proves what we’ve thought all along—that we have no control over our actions.

Jan-Emmanuel De Neve, of the London School of Economics, and James Fowler, of the University of California, San Diego conducted a study on the correlation between genes and human behavior. During this time they have connected the gene known as MAOA with financial decision making. Okay to be fair we can’t put all the blame on this gene. Human behavior is much more complex than that. However, the MAOA gene encodes an enzyme that degrades neurotransmitters in parts of the brain that regulate impulsiveness and cognitive ability. Some people have versions of the gene that are less efficient than others. That low-efficiency have been linked to impulsivity, and addictive behavior—things that aren't so good for your finances.

To further connect the MAOA gene to debt the researchers looked at a genetic database of more than 2,500 U.S. 18- to 26-year-olds who have been tracked since high school in the National Longitudinal Study of Adolescent Health, which looks at the health-related behavior of young people and follows them into adulthood. They found that the group with low-efficiency MAOA reported a higher incidence of credit card debt.

So there you have it, blame it on the genes. Not so fast. The results of the study have yet to be replicated and nearly half of the 2,500 people had the low-efficiency MAOA. And if we assume that this is representative sample of the entire U.S. population than about 1 of every 2 of us have the same low-efficiency. It’s true that a lot of us carry debt, but there is still much to learn about nature vs. nuture. So I’d say it’s a rather big dose of denial to claim that debt is out of our control.

Lease-Back or Repurchase Scams Prey on Desperate Homeowners

Scammers just love to kick people when they are down. The Lease-Back or Repurchase scam has been hot for awhile and people are still falling for it. In this case the potential victims are homeowners who are delinquent in mortgage payments.

The scammer promises to pay off your delinquent mortgage, repair your credit and possibly pay off credit cards and other debt. However, in order to do this, you must “temporarily” sign your deed over to a “third party” investor. You are told that once your credit is repaired you’ll “have the option” to buy back your home. Plus, you can stay in the house. You’ll just be renting, this is supposed to help you build credit also.

The trouble is once you have signed away your rights in your property, you may not be able to repurchase the property later, even if you can and want to. Once you become the renter you might realize that conditions have been set that make it impossible for you to back your home. Often this includes ridiculous time-limits and an exorbitantly high buy-back price. Your rent could be raised unreasonably and You could also be evicted by the investor owner. Typically, after the deed is signed away, the property changes hands numerous times. The scammer may have taken a new mortgage out on your home for hundreds of thousands of dollars more than your mortgage, making it impossible for you to buy back your home. Or your home may be sold and you could be tossed out.

Be careful, when things get tough the first thing you should do is consult a company that you trust—like your credit union or mortgage holder. There are legitimate programs to help homeowners who are having difficulty making payments.

Even if you are not facing foreclosure, but want to reduce your mortgage payments, or improve your debt situation, your credit union may be able to help. It doesn’t hurt to ask the credit union to review your situation; in fact there isn’t even a charge for this service. And improving your financial outlook is nothing to be embarrassed about—it’s a smart thing to do.

How long do need to be employed to qualify for a home loan?

The quick answer to this reader question is that it is preferred to have at least 2 years employment history. But getting a mortgage isn’t quite that cut and dry.

As we all know lenders have been hit hard with blame for the recession. They’ve been required to be more stringent in lending and have become much more cautious. Your income history is one of the best measures they’ve got to ensure that you’ll be able to make your monthly payments, though it still a risk on the lenders part.

Before mortgage lenders can grant you a loan, they of course would like to make sure you can repay them. They’ll need to know:

• your credit history
• your gross income each month
• the amount of money you plan to use as a down payment

The Debt-to-Income Ratio Explained
A big part of the lender’s concern is your debt-to-income ratio. There are two calculations used to determine this number:

Front-End Ratio
This calculation determines how much of your pretax income will go towards your monthly mortgage payment. The mortgage payment figure includes interest, principle, taxes, and insurance and typically should not go over 28% of your gross monthly income.

Annual Salary x 0.28 / 12 (months of the year) = Maximum Housing Expense

Back-End Ratio
This calculation determines the amount of your total gross income that will go to pay all of your other obligations, including the mortgage, other loans, child support, credit card bills, and any other monthly debts. The figure should not exceed more than 36% of your gross income.

Annual Salary x 0.36 / 12 (months of the year) = Maximum Allowable Debt-to-income Ratio

Different lenders will have different requirements for the debt-to-income ratio. For instance, conventional loans — typically a conventional loan from a bank or other mortgage lender — will require no more than 26% to 28% of month gross income for housing costs and not more than 33% to 36% of monthly housing plus debt costs. With an FHA loan, the housing costs should not exceed 29% of the monthly gross income and 41% of the monthly gross income.

And it’s not impossible for self-employed people to get a loan. You’ll just need to show not only that you were gainfully employed, but also what your net income was compared to business expenses. Self-employed people will also need to show a profit-loss statement. If you don’t keep good records of legitimate business expenses, don’t have your taxes professionally prepared, and guesstimate your profits and losses, the loan process could come to a halt very quickly for you.

Who Gets the Debt? (or Financial Lesson #2 from the King of Pop)

Everybody knows that Michael Jackson leaves a legacy of debt, which has left some people wondering why there is so much hoopla about who is entitled to his estate. Actually, it's not about debt at all. MJ was responsible for creating the debt and even in death it's still his.

Debt cannot be passed on to heirs--only assets are passed on. However, assets can be depleted to pay off debt. Whatever is left over is distributed to heirs, even spouses.

But let me tell you about my personal experience. My parents divorced when I was a teen and my father remarried. He'd always been meticulously financially responsible. He built his own business, owned his house outright and had several rental properties. Then at a early age he suffered from Alzheimer's disease. His new wife new nothing about money, but was too proud to let anyone know. The business quickly failed. She couldn't manage the properties. So they were stuck. She let the health insurance laps because she couldn't afford it and so my father's health rapidly deteriorated. All the properties including the business began to fall apart. One-by-one she sold the rentals, but not the business. She took a reverse mortgage on their home. She stopped paying for oil (east coast heating). Eventually my father died. After the funeral his wife disappeared. She walked away from the house and everything.

For years while this was going on I never heard from my father or his wife. I had been living in Colorado for many years and they were in Pennsylvania. They never answered the phone, didn't return messages or letters. I assumed that his wife wanted me out of their lives. I did learn about his death and attended his funeral.

So none of my father's bills were paid--not even the funeral. Nothing was left to me or my siblings in the will, because my dad's wife wanted it that way. But creditors still contacted me. The funeral home gently wondered if I could pay the bill or at least part of it. Nursing homes that occasionally cared for my father also asked. And now, three years later I'm getting calls from a lawyer regarding my dad's house. Most of the queries are small. No government agencies, would ever think to contact me.

I am not obligated for any of my father's debts, but that doesn't mean his creditors can't ask, ever so gently. That's okay since I know to say, "No Way."

5 Dieting Tips That Apply to Debt Management

I've said before that the words "diet" and "budget" are nasty, negative labels that equal Catholic school guilt. But like it or not there are part of our vernacular. Most of us fuss, worry or think about each of these during different times in our lives. The other day it occurred to me that they are actually quite similar. In fact, you can look at almost any diet tip and apply it to budgeting or vice versa. Here are 5 that I quickly came up with:

1. (diet) Take off the weight slowly for long-term success (budget) Controlling debt can be a slow business

Sure some people brag about dropping 20 pounds in 3 days, but we all know that that's not true for most of us. Likewise, if you've accumulated debt you could shrink it by rolling it into a lower interest rate loan, but that's just smoke and mirrors. It's a good move, but don't fool yourself into thinking you've got control of the situation. Lowering your interest rates should always be your goal, but you've still got to work at keeping down the debt.

2. (diet) Exercise is essential for weight loss—(budget) You need to work a little to reduce debt

Just like there is no magic pill that will make you healthy and slim, there is no overnight cure for debt. You'll need to work at lowering your interest rates, consistently paying down the debt and resisting incurring new debt.

3. (diet) Stay focused on being healthy, not on becoming thin—(budget) Stay focused on building wealth, not eliminating debt

Remember to keep your long-term goal in focus. You probably want to be thinner because you want to be more attractive, but being healthier is the ultimate in beauty. And your not trying to just get rid of some debt, your goal is to build enough wealth that will enable you to live as you would like.

4. (diet) Find out why you overeat—(budget) Find out why you overspend.

Some people eat for comfort, some spend for comfort, but your debt accumulation may not be that straight forward. Maybe you've run into medical expenses or some other emergency. What have you learned from this experience? By analyzing your spending you'll see that maybe you need to aim for a larger emergency fund or curb your enthusiasm for the latest techno gizmos.

5. (diet) Weight loss support: join a weight management group—(budget) Don’t be secretive about your debt management goals.

Usually when you are on a diet everyone that you know knows about the diet. It's easier that way. When they see you reaching for the donut they'll stop you. They'll also comment on how great you're looking. Debt management, however, isn't typically the same. We wear our weight out in public, but hide our debt like a dark secret. If you're serious about paying down your debt, come out of the closet. You need the support. Without it you'll find yourself trying to fake it when friends suggest a fancy dinner and a night at the clubs. Friends who know your goals will support you. They'll understand if you only order an appetizer at the restaurant. They'll get if you'd rather go for hike than to the ballgame. And they'll be there to congratulate you when you've hit your milestones.

The common denominator in dieting and budgeting is that you need to make lifestyle changes in order to be successful. So even though I don't like those words there is just no ignoring them.

New Rules: Saving vs. Debt

The new rule on whether you should pay off debt vs. building savings is that there are no rules. I know I've been following the rule of pay down debt before adding to savings and I've touted the benefits of this strategy: debt costs more long term, savings accumulate slower. But all bets are off in this economy.

Suzy Orman just released an update to her 2009 Action Plan, and I've got to agree with her on this. Suzy says, "If you do not have a stash of cash and you have been using all your extra money to pay down your credit card debt and they keep closing your cards down- what are you going to live on if you lose your job? Chances are you may not have any available credit limit to use to rely on since the cards are reducing those limits, you will not be able to get a new card since you are now not employed. So to help you in the event you lose your job my advice is to pay just the minimum required on your credit cards every month, and then use every extra penny you have to build your emergency savings fund."

Make your goal to have 8 months of living expenses in an emergency fund. As long as you continue to make minimum payments on your credit cards your credit score should be fine. That is unless the card company doesn't reduce your limit or close down your card, which they are less likely to do as long as you pay the minimum. But don't be tempted to use the cards for charges that are not emergencies. And only then if you don't have other funds to cover the event.

If you already have a substantial emergency fund in place, keep paying down that debt. These are unusual times and it's important to be prepared for the worst while remaining flexible to changing your strategies.

How to pay down credit card debt in 2 years

Credit cards are confusing. What seemed like a good safety net at one time can turn into a death trap. That's because so many cards have complicated APR calculations or clauses that can bump your rate just because you were late on an unrelated credit payment. Ugh!! There are so many ways they can get you.

To get the credit monkey off your back you've got to take a practical approach. But what's that? There's tons of advice out there, but here's the best way--really--to get out of the problem.

Pull out your highest interest rate card and throw money at it. Don't even look at the balance, you're only object is to get out of sufficating interest rates. Anything you can afford to pay above the minimum, do it. Look at this example.

Let's just say for example you've got a high-interest card with a $10,000 balance.
Here are few payment strategies:

Paying the Minimum Payments
Interest rate: 26.99%
Balance: $10,000
Min payment: $345
Time to payoff At minimum payment: 22yrs, 2 months
Interest paid: $16,344.45

Double the Minimum
Interest rate: 26.99%
Balance: $10,000
Min payment: $690
Time to payoff At minimum payment: 1yr, 6 months
Interest paid: $1,910.52

How much more do you need to pay?
Experts advice to pay 2-3 times the minimum but really any significant amount above the minimum will help. Let's play with the numbers from the example above. You've already seen what affect a double payment has, what about something less...

Paying just $150 over the minium for a total of $495
Time to payoff At minimum payment: 2yrs, 3 months
Interest paid: $3,127.87

It might seem a little odd not to go for the lowest balance card first. You could do that, if you want, but you're more likely to be paying out more interest that way. And if you don't believe these outrageous examples? You can plug in your own crazy credit card balances into this calculator from CNN Money. Be sure to click on the full strategy detail to see how your payments should go.

When Paying More Pays Off

Here's a case where paying more than what is asked is in your best interest.

Take a look at your credit card bill. There's a spot that says minimum payment due. That's all their asking you to pay. And compared to your total bill it's pretty small. IGNORE THAT.

Instead pay as much as you can--hopefully the entire balance. The minimum payment covers the interest owed and only a small portion of the balance. When you pay just the minimum balance you keep racking up future interest. That's how credit card companies earn money and how you get deeper and deeper in debt.

Paying in full will save you from debt and interest. But if you can't afford to pay the entire bill then just paying more than the minimum would save you a bundle.

photo by redjar

Parting with just one more $20 can keep you afloat.

Look at this example:

If I charged $1,000 on a 12% interest card.

My minimum would be around $40.

At that rate I would pay $289.07 interest and it would take me 74 months to pay it off.

If I payed a little more, say $20 more (that's $60 to save you from the math).

I would pay $183.24 in interest and it would take 53 months to pay off.

I'd save $105.83 and 21 months of debt. Not bad.

To calculate your own payments use this calculator from Bankrate.com.

My Darkest Money Secret

If I were able I’d turn this screen black as I tell you of my dark secret. It happened back when my husband and I first moved to Colorado. Blah, blah one bad financial decision led to another and another and another until finally we were deep in debt. So deep that we avoided answering our phone. We were using credit cards to buy basic food.

Then we got hungry and we’d had enough. We wanted a house. So we turned to a credit counseling service. Eight months later our debt was under control and we bought a home.

Remember—Nobody can erase bad credit. Don’t ever believe otherwise. A good service can get you back on track, but it’s up to you to commit to keep it going. Be careful there are many shysters out there. Ask question and choose carefully.

What are their credentials? Look for accreditation from organizations such as the National Foundation for Credit Counseling, the Association of Independent Consumer Credit Counseling Agencies, Council on Accreditation and the International Organization for Standardization. Also ask about their counselor’s certification and ongoing training.

Are there any complaints? Check with the BBB and the State Attorney General’s office.

What services do they offer? Choose an agency that offers a variety of services—not just debt consolidation. If the counselor recommends a debt management plan without having conducted an interview, something’s wrong.

What’s expected? Be sure to read through the agreement and review the terms and conditions. Agreements should be written and include the counselor’s name, agency name, address, contact information, total costs (including payment details), timing, expected results, and any guarantees.

How much will this cost? Debt management programs are regulated by state law and typically run up to $40 per month. A reputable agency will let will explain all fees before you share any personal information.

There was a point when I never believed we could turn things around. Fortunately we chose wisely and today we’ve got a top credit score and food in the fridge.