TedCo Software Financial Matters Blog

A large component of the work I do with individuals is to gain a clear understanding of their relationship and understanding of money. There is an increasing body of study that looks at the link between how we perceive money and worth and the reality of wealth. Over the next few entries I want to touch on six issues of Behavioral Finance that may be impacting your understanding of money and hindering your financial success. These points are far from the only psychology of money issues, and they are not universal, but they are fairly common issues that most folks will see in their financial life.

Layer it on thick
It seems that most large retailers have some sort of credit card and the vast majority of stores take plastic. If asked I am sure that these stores would say that it is for customer convenience, but there is another reason that retailers accept these proxies for money: the “layering” effect. It is the same reason casinos use chips for gambling. The further the proxy for money is away from “real” money the more psychological distance we feel from the act of spending. Casinos have learned to take advantage of this psych-out. If we laid ten and twenty-dollar bills down on the craps (or roulette, or poker) table it would have a much greater impact in our heads. We see bills and coins as potential items for our life. When we see things that represent food, fuel, and shelter scooped up by the blackjack dealer it scares us a bit. However, colorful plastic chips do not have the same impact, so no money on the table means customers are more willing to part with these plastic proxies for rent money.

You don’t gamble? I bet you still use plenty of proxies for cash. Paying for that Venti Mocha with a Starbucks gift card just doesn’t hurt quite the same way as handing over a fiver. For the real whammy we can now combine online bill pay services with our credit cards. Our employer deposits our earnings directly into a bank account. We then buy a new TV with our Visa card and do not see the bill for a few weeks. When the charge shows up on the credit card statement (delivered electronically) we direct the bank to pay the bill via on-line bill pay. Each layer between cash in our pocket and the purchase makes the loss of the cash a bit more comfortable, and the sale a little easier.

It would be difficult to give up the electronic money world, but this proxy effect can lead us to make poor money decisions. So try to give up the electronics for just one month. For one month convert your paychecks to cash for just a bit so you can see it and feel it. Then, for the whole month pay as many things as possible with cash and use checks for the rest. Odds are your landlord or mortgage company will insist on checks, but your supermarket, gas station, and local Starbucks will be perfectly happy with taking cash. Keep track of where and how you spend your cash. At the end of the month you will be shocked at where you spend your money, and will have found several ways to spend less.

Next week in Financial Psych-Outs Part 2 we’ll tackle “the wealth effect”…

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

It doesn’t take much these days to damage a credit score. Before the recession, late payments and blasting through credit limits would take its toll. But in the past year, Fair Isaac,& Co. the company that developed the algorithm that is the leading determinant of our credit (FICO) scores, made an important change in its formula.

It’s now putting much more emphasis on the size of your balances and how close they are to your total credit limit. It’s a behavior trigger that creditors see as a bigger worry than ever. So the best thing you can do for your credit score is to get your balances down to under half of your credit limit.

Even better, pay them off entirely and use them only when you know you can pay them off at the end of the month. Inactive accounts will ding your credit score, but quick payments can only help.

The latest revision in the FICO system will actually allow a bit of lenience on late payment – something that might affect more than a few consumers with the downturn in the economy. Obviously, this won’t mean that someone can chronically pay late, but once or twice won’t make the same impact as in earlier FICO versions.

Yet credit utilization – the amount of credit you’re actually using relative to your credit limit – is a much bigger deal simply because high balances are still prevalent among consumers. From the lender’s perspective, high balances mixed with a tough economy means a higher risk of default among customers.

So, one more time. What’s a good target utilization rate for all your revolving credit accounts? No more than 50 percent of your credit limit, and if you can get it significantly lower than that over time, that’s a good plan. The lower your credit utilization, the better your score.

What does that mean for ordinary Americans who don’t meet that under-50 percent goal? It means you shouldn’t be applying for new credit or refinancing for awhile, and that includes something as innocuous as a department store charge.

So maybe that means deferring gratification for awhile until you get things under control. But look at it this way – you can use this time as a way to develop more knowledge about credit and be in a better position long-term. Here are some things you need to know:

You’ll need at least a 740 score for the best rates: You’ll often hear that credit scores of 700 and up will get you best customer status with lenders. That’s true, but you need to aim significantly higher. For the lowest rates and best terms, you need to get your credit score above 740 (the top credit score, by the way, is 850), so keep that target in mind.

Budget: If you’ve never reviewed your spending and picked out areas where you can cut, you’ve never done a budget. Start tracking your spending either on paper or with financial planning software (such as DebtDasher) and start pinpointing what spending you can shift over to paying off debt.

Get some advice: Remember that debt is just one part of your overall financial picture. It might not be a bad time to sit down with a financial planner to talk about your debt issues, planning for retirement, your kids’ college education and any other key financial goals.

Monitor your credit reports: Remember that you have the right to get all three of your credit reports — from Experian, TransUnion and Equifax — once a year for free. You can do so by ordering them at AnnualCreditReport.com. Order them individually at different points in the year. That means you’ll get an extended picture of how your credit picture looks because the three bureaus feed each other the latest information. You’ll also be able to clean up errors as you find them — errors can drag down a credit score – and you’ll also keep an eye on identity theft. Oh, and make sure you use the site above and avoid the businesses that use “free credit report” in their title or a singing pirate as their spokesperson. It’s easy. If they ask for your credit card number, don’t do business with them.

Make electronic payments: Electronic bill payment will allow you to save on postage while guaranteeing on-time payment, and the budgeting advice mentioned above will allow you to put a few more bucks toward getting that loan or credit card bill paid off. It’s important to always pay more than the minimum payment on your bill – otherwise your balance will barely move.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

Schedule a holiday budget and credit check: When the triumphant freshman returns home for the holidays, schedule some R&R, home cooking and the first reading ever of their fall budget figures and their first credit reports. Since credit reports can be ordered online, parents and student should sit down with each of the child’s three credit reports from Experian, TransUnion and Equifax and review them for activity and errors. Since everyone is entitled to one free report from each of the agencies each year, go to www.annualcreditreport.com for theirs.

Help them open their first IRA: If your 18-year-old child is earning wages by working part-time at school, at home during breaks or for your own company, have them open a Roth IRA in a growth fund. Make sure they understand this is essential to their future savings so they don’t cash it in. Ask your planner about this.

Discuss identity theft: Personal financial data left on laptop computers, cell phones and other electronic devices can be readily stolen on campus or in a dorm or roommate environment. Tell your son or daughter to keep all paper records in a safe place and introduce passwords to keep all their digital information safe.

Get them networking: Internships and jobs in their chosen field during summer breaks can give your student a head start on their career path. Encourage them to research these opportunities in their freshman year so they’ll be in the front of the line when it’s time to apply.

Handle mistakes carefully: Most kids will make money mistakes in college. If they overdraw a checking account or overdo it with their credit card, make the criticism constructive but firm and always come up with a corrective plan you’ll work on together.

This time of semi-independence can be a great learning time for your children, but it is only semi-independence. Help them through it and the lessons they learn will pay dividends for the rest of their lives.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

The National Center for Public Policy and Higher Education reported last December that college tuition and fees increased 439 percent from 1982 to 2007 while median family income rose 147 percent. The report also noted that student borrowing has almost doubled since 1998.

The most worrisome statement to come from the report? That if current trends continue, our country might be without an affordable higher education system in 25 years.

This is why it’s crucial to train incoming college freshmen in critical personal finance skills. Before you send your child off to school, make sure you cover the following lessons:

It’s never too early to plan: If you think your words won’t hold enough weight – or you need some guidance yourself – consider bringing in an expert such as a Certified Financial Planner™ professional. It’s never too early to deliver the message that how a child manages his money in college will set the stage for how well she manages it in adulthood. A planner can help a child focus on spending and debt issues in college, but it also makes sense to discuss how your student will save for a home and a car. That might force some smart spending, saving and investing decisions while she’s still in school. Once your child gets the message, consider a meeting for yourself.

Focus on credit: It’s one thing for a teenager to use their parents’ credit card while they’re still living at home. It’s quite another when they get their first taste of freedom hundreds of miles away, often without the parents’ knowledge. Parents should opt to co-sign the student’s credit card but keep it in the student’s name. That way, parents will know when financial missteps occur, which will be a strong incentive for the student to keep his credit rating clean for the next four years. Most important: Parents should do whatever it takes to make sure the child doesn’t sign up for any credit cards on campus where they’ll be bombarded with offers.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

Have you ordered your free credit reports yet? The three big credit reporting agencies (TransUnion, Experian, and Equifax) will provide you one free credit report every year. You can order the reports through www.annualcreditreport.com. Consider ordering one report now, then one from another company in four months, and the last company four months after that. That way you can check on your credit report regularly throughout the year for no cost. It is not as effective as a regular credit monitoring service, but it is much less expensive. Also, if you need to make a correction it gives enough time between checks to see those corrections made.

Credit is a tool, a bit like fire. It is really useful, but if it gets out of control it can really hurt you. In addition to checking your report for errors, use the reports to take a look at how you use credit. Are you really using it in a way that helps you? This is more than how you use credit cards. What are you paying interest on and for? Some things just about require borrowing, like a home purchase. Most things don’t, though. It can be hard to avoid borrowing for a big purchase like a car. At a minimum you should have a plan for getting out from that sort of debt as soon as you reasonably can.  An excellent tool for figuring how fast you can pay a debt off early is LoanSpread Loan Calculator.  With LoanSpread, you can enter your loan information (loan amount, number of payments, rate, etc.), select the payment in the grid, and click the Amortize button on the toolbar to see your loan’s amortization schedule.  What’s really useful about the Amortization Schedule in LoanSpread is you can add “prepayments” to the schedule (prepayments are additional payments or “overpayments” you make toward the principal of your loan – typically added to your normal loan payment).  Once you have added your prepayments you can scroll down through the schedule to see how much sooner your loan will be paid off.  For example, if you were to make prepayments (or “overpayments”) of $50 a month on the loan pictured here, the loan would be paid off six and a half months early at a savings of about $47,000.  Plug in different prepayments to see what kind of results you can get for various prepayment amounts at various points in the loan’s life.  You can download and try LoanSpread free by clicking here.

Paying interest for consumables like meals and vacations is just a flat bad idea (there may be exceptions to that rule, but they are exceptional exceptions).  Learn to use and respect credit and it will be a help. Abuse it and you will pay a higher price than just interest.  

Jim Heitman, CFP®, is a writer, speaker, and Certified Financial Planning practitioner in Southern California.

Who would you guess is more likely to quit paying an underwater mortgage, someone with super credit or someone with subprime credit?

The answer may surprise you.

In “Homeowners who ’strategically default’ on loans a growing problem“, writer, Ken Harney, reports on research by Experian and consulting firm Oliver Wyman.

The big surprise is that a person with super-prime credit is statistically more likely to default and walk away from a mortgage that’s underwater than someone with poor credit. This seems counter intuitive.

Read the article to learn more about this unexpected finding …

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” Henry Ford

Do you feel a change on the wind? People of the nation are beginning to understand our banking and monetary system.

You can find it in articles in the New York Times, “When Debtors Decide to Default“, that tell about consumers who can get a credit card company’s attention only after they quit making payments.

You can read about it in Mish’s Global Economic Trend Analysis blog where he writes about “Preemptive Defaults“.

There’s a lot of anger in our society being directed at big banks and credit card companies that were bailed out by the U.S. Government, because they continue to refuse to act reasonably with consumers (aka “taxpayers”) who are paying for the bail out of Wall Street. In fact, Wall Street seems to be rubbing taxpayers noses in it with renewed reports of excessive bonuses.

It’s a crazy financial world, but I think consumers are beginning to look for the points in the system where they do have power and leverage.

Unfortunately, for many consumers, the issue of morality is no longer part of their financial world. By that I mean we should remember that no one has a credit card who didn’t apply for it and agree to the terms … including the terms that stipulate the credit card company can change the terms by increasing the interest rate at will.

Credit card holders agreed to be taken advantage of.

The moral issue is that consumers have agreed to the terms of their credit card accounts.

(Note: if you’ve lost a job and income and cannot afford to make payments, that’s a crisis. Missing payments in a situation like that is unavoidable. Talk to creditors and explain your situation.)

Otherwise, is it right to refuse to do what one has agreed to do? There seems to be two arguments many consumers are hearing in their heads:

The first, “The banks have been bailed out by tax payers. I’m a tax payer. I’ll be paying and my children will be paying and my grandchildren will be paying for this bailout for decades. Therefore, we’re even. I’m paying no more.”

And the second, “I’m a victim of a global crisis. I have no choice. The bank understood the risk they were taking and jacked up the interest rate because of the risk. They knew I couldn’t pay. My refusal to pay is a ’self-fulfilling prophecy’. They got what they wanted.”

Of course, if an individual refuses to pay his or her debts, there are consequences. Credit scores plummet, the bad debt is sold to collection agencies who harrass until paid, etc.

The change on the wind is the number of people who seem to be angry enough at what they perceive to be financial injustice (29% interest rates?) to quit paying en masse. For many, there seems to be only one point of leverage consumers have left in a financial system gone haywire: mass defaults.

You can read about it in the New York Times, Bank of America’s June default rate was at 13.8%. Things do not look good.

The Detroit News ran an article today titled, “Seven tied to mortgage fraud: Paroled killers among those FBI accuses of bogus home sales”. The article describes a fraud scheme perpetrated against a real estate project located on Detroit’s riverfront involving straw buyers.

In the article, Ralph Roberts, an expert on mortgage fraud, says of the paroled prisoners involved in the fraud, “While they were paying their debt to society, their credit was cleansing itself and preparing them to be perfect straw buyers.”

Apparently, doing time may be good for your FICO® score. Though it’s not a recommended way to repair one’s credit!

Nothing is perfect … especially in the world of politics where money buys influence and opposing parties have opposite interests. But, perfect or not, credit card reform is coming.

Martha White, writing for “The Big Money”, has an article that does a good job of summarizing the current state of the reform legislation and the probable outcomes.

Read, “What to expect from credit card reform: Consumer advocates say the proposed legislation falls short in many ways“. Of course, with banks, being bailed out by tax payers, holding all the green, it’s to be expected that politicians are having a hard time siding with consumers.

This week I received a direct mail card from a national cash advance company. Everyone in my neighborhood, maybe even in my town, received it. It was addressed to “Current Resident”. (You may have received one, too.)

The mailer has two side-by-side photos. The first is of a black child in a doctor’s office. The doctor is checking the child’s throat with a tongue depressor. The text above this photo reads, “Needs a prescription.”

The photo beside it is a shot taken in a pharmacy. The pharmacist stands with his arms crossed in front of shelves filled with medications. The text above this second photo reads, “Not covered by your insurance.”

On the reverse side of the mailer is an invitation to “come in today and you can get up to $350 on the spot.” This flyer is from national cash advance chain which has a new office in my town.

The chain is owned by Advance America Cash Advance (AEA on the NYSE), a public corporation. It’s a large, international company. The investor relations information on the Advance America website reports “payday cash advances are small-denomination, unsecured advances that are typically due on the customers next payday.”

So how does a public corporation make money mailing payday loan junk mail?

The parent company, Advance America Cash Advance, offers a “How Much Is a Cash Advance?” calculator on their web site that makes it pretty clear. Simply choose your state, choose a loan amount from the drop down list, and you have your eyes opened.

In Louisiana, the online calculator indicates if someone borrows $100 and pays the $20 Fee (Assuming a 14-day term) the APR is 521.43%.

Who borrows at 521% APR? People who are desperate.

And the mailer I received appeals to desperation. People will do things for their children they wouldn’t do for themselves … like buy medications at 521.43% APR.