Monday, March 26, 2007

Reality 101

This particular entry is probably going to come across as insulting and condescending but if you need this lesson I don't think there's anyway to get around that.

Reality is the way things actually are. Now, oftentimes the way things are have absolutely nothing to do with the way you want them to be. Let me repeat. Oftentimes the way things are have absolutely nothing to do with the way you want them to be.

For example: Some people, for ease of remembering and managing, want to pay all of their bills at one time during the month. There is some appeal to this approach. You're more likely to remember to pay your bills if you only have to remember one due date. However, most of your bills don't come at one time during the month. Yes, some companies allow you to say whether you want your bills due at the beginning, middle, or end of the month, but not all do. And some companies define these dates differently. One company may consider the beginning of the month the 1st of the month, some might consider it the first week of the month. Either way, it is very, very hard to get all your bills sent to you, much less due, at the same time each month.

The problem is, some people won't accept this reality. They think that just because they want all their bills due at one time in a month, they can get away with paying their bills that one time of the month. So that's what they do. They pay all their bills on the same day each month. What ends up happening? At least one bill is late every month. The company starts adding late fees to their bills, and that person ends up paying more each month. The lates start to add up and the company reports the lates to a credit reporting company and the person's credit score gets dinged and goes down. The more lates, the more reports to the credit companies, the lower the score.

Now, this doesn't just affect that individual. Let's say one of the bills paid late due to this system is the person's home loan. Let's say that individual went through a broker to obtain their home loan. Well, four months of late payments later the lender gets fed up because servicing the loan is becoming too time consuming and expensive and they can't sell the loan because no one will buy the loan of a person who can't pay on time. What does the lender do? They call up the broker and demand the broker do something about it. The broker now has to spend money and man-hours trying to get the borrower to do what they're supposed to: pay on time. The borrower, not accepting reality, refuses. Now the lender gets annoyed and forces the broker to buy back the loan. The broker has to come up with the cash to buy that loan. Now they're stuck with a bad loan that they can't sell and that they may not be able to service and they're out what may be vital operating funds. Obviously, this is a relatively extreme case, but it is one that is fast becoming common. One has only to look in any finance publication to see just how bad the housing and loans industry is becoming.

Reality is you have to pay your bills when they're due, regardless of what date that may be so that's what you should do. No matter how much you may not like it. No matter how much it may disrupt your "system." If you have a financial planner/manager and they tell you otherwise, you should consider looking for a different financial manager.

Another common failure to grasp reality is in regards to credit cards. Reality is that just because your credit card has a credit limit of $10,000 it doesn't mean you can afford to spend $10,000 a month. But, apparently people see their credit limit as a statement of financial means or a challenge to be met. It's not. Unless your credit limit is very small, you should very rarely get close to hitting it. Remember the Financial Golden Rule: If you can't afford it, don't buy it. And just because you want it, doesn't mean you can afford it.

So, please, please, keep a firm grasp of reality when considering your financial self. This doesn't mean you can't have or pursue financial dreams. But it does mean you should understand what you may encounter during your endeavors. It means you need to understand that things probably won't go according to your plans. It means that if something happens, even if it isn't what you wanted or doesn't occur at the time you wanted, you still have to deal with it at that time.

Tuesday, January 30, 2007

Organization 101

This is the mantra of Food Network star Alton Brown, but it applies to finances as much as food.
Organization will set you free.

You financial house should not only be in order in the monetary sense, it should be in order in the physical sense. Business receipts and bills don't belong in a pile in a shoe box. When tax time rolls around, you should be able to hand your tax preparer what he or she asks for in less than a minute.

Service providers are not perfect. Banks are not perfect. If something looks off on your gas bill, you should be able to pull up a full year's back bills and compare your usage levels to the bill you are questioning. You should have all of your ATM receipts ready and organized when your bank statement comes in, and you should reconcile your bank statement with your records every month. Many debit card based money thefts start with the theives stealing small amounts and then, if there's no reaction, they drain the account. If you have all your records and you reconcile your statements, you'll be able to catch the small amounts and alert your bank. If you try to reconcile your statement and you can't find your ATM records, you're going off memory, and that allows a lot more to slip through.

For the Small Business Owner
Don't, absolutely positively do not, keep your personal finances in the same place/container as your business finances. At all times, you should be able to pull your business financial paperwork out without touching a single personal bill or receipt. You do not want to be telling an IRS auditor that you included your daughter's ballet lessons as a business expense because you didn't have time to sort your bills.

Now, this doesn't mean you have to be absolutely anal and file everything the second it comes in, but you should have a system. Get an accordian file or a plastic filing case and label each section with a type of bill or statement and once a month or so file your various bills in their appropriate sections. One day sit down for five minutes and mark your calender for the entire year with the day big bills are due, like car and house payments. Put your tax paperwork for each year in one folder, clearly labeled, and keep all the folders together. Put bills to be paid in the same place every time they come in so you get in the habit of looking at the same spot every day to see what's due.

If you want to take it one step further, create a spreadsheet of bills and expenses for each month and record your expenses by category, such as food or utilities, and have a spot to put in your income after tax withholdings. Each month total your expenses to find out what you spent where and if you made enough to cover it. Do this for every month for a year and give yourself an idea of what you spend the most on, how much you save after spending, and where you need to make cuts in your spending. This will give you a good idea of what to budget and what to change for the next year.

Remember, organization will set you free.

Thursday, January 4, 2007

The Financial Golden Rule

I probably should have started with this, but it's better said late than never.

This is the rule upon which good personal financial management is built. Following this rule helps get the rest of your financial house in line.

If you can't afford it, don't buy it.

With a few exceptions, which are really variations on this rule, you should never borrow money to buy stuff. Stuff is not as important as running water. Stuff is not as important as being able to pay your hospital bills if something happens.

If you have to ask yourself whether you should buy a new toy or pay your electricity bill, you should put that toy down. You can't afford it. You should not buy it. If you have a credit card maxed out you need to stop buying non-essential things. Because you can't afford them.

The exceptions to this Financial Golden Rule come in the form of large-item loans: Home mortgages, car loans. Getting a loan to buy a yacht you think you'll use every weekend does not count. If you can afford it, go ahead. If you can't, don't.

The Large-Item Loan
The sad fact of life is that most people in developed areas need a vehicle to get around. Many metropolitan areas are not safe to walk in, the distances are too great to make walking or biking feasible, and public transportation does not meet the everyday needs of a lot of people. So, a car becomes a necessary purchase. Housing is a basic necessity for life. If you are considering a loan to purchase either of these items, the variation on the Financial Golden Rule comes into play: If you can't afford the monthly payments, you can't afford it. And if you can't afford it, don't buy it. Not everyone can afford to pay cash for a car or a house. They can afford to put a, relatively, small amount of money towards the item each month. This is the purpose of a loan. Money now for small repayments plus interest over time.

If you can afford to pay $1200 a month in home loan payments and you have a choice between a home that would cause you to pay $1150 a month and a home that would cause you to pay $1500, you should buy the first home. You can afford $1150 a month. You shouldn't even consider the $1500. What are you going to do about the $300 you can't afford? Get another loan somewhere? It is the height of idiocy to put yourself into debt to pay off debt(the exception being shifting debt to a lower interest rate or more stable program). What about just paying the $1200 you can afford and ignoring the $300? Well, even if your lender allows you to get away with that, you're just hurting yourself in the long run. That's $300 a month that's not going towards paying off principal. That's principal that's still gathering interest. That's principal you're going to have to find a way to pay off when your loan comes due. Let's say the lender does allow you to only pay $1200 a month instead of $1500, but they're going to apply the $1200 a month you send them backwards so that they put $300 to the first month's bill and then apply the rest to the current month's bill. Here's how it would go for the first year.
Month 1: $1200
Month 2: $300(to month 1)/$900(to month 2)
Month 3: $600(to month2)/$600(to month 3)
Month 4:$900(to month 3)/$300(to month 4)
Month 5:$1200(to month 4)/$0 (to month 5)
Month 6:$1200(to month 5)/$0(to month 6)
Month 7:$300(to month 5)/$900(to month 6)
Month 8:$600(to month 6)/$600(to month 7)
Month 9:$900(to month 7)/$300(to month 8)
Month 10:$1200(to month 8)/$0(to month 9)
Month 11:$1200(to month 9)/$0(to month 10)
Month 12:$300(to month 9)/$900 (to month 10)
Not the kind of situation you want to be in.

Remember: If you can't afford it, don't buy it.

Friday, December 29, 2006

Good Credit 101

There are a lot of things that affect your credit score and I won't pretend to know everything that does and how those things change your score. I can list a few things to keep in mind when considering the various things we consider in our life.

1. The more your credit is pulled by companies, the lower your score will be. If you pull your credit as you, which I would recommend once a year just so you know where you stand, it won't affect your score. A company pulling your credit to evaluate you for employment has a small impact. A company pulling your credit to evaluate you for a credit card, mortgage, financing, or a big purchase will have a larger impact.

What does this mean? Keep the number of credit cards you have to as few as possible. I have 2. I might go to 3 for American Express when I start to travel more. Do in-store financing as little as possible. (I'll expand on this issue in another post) Check out mortgage rates and companies before approaching them so you don't end up shopping for a mortgage and having each company pull your credit lower and lower.

2. Pay your bills. And I mean all of them. $2 late fee for a book at the library? They're starting to send those little items out to collection agencies and that means they show up on your credit report. Pay the big ones too. Especially your mortgage. With the number of mortgage fraud cases going up(which I'll expand on in another post) lenders are getting more efficient at their foreclosure processes. A trip to Tahiti for two weeks is not worth losing your home. And, maybe most importantly, PAY YOUR CREDIT CARD BILLS! Even if you can't afford to pay the whole amount(which is a big issue I will expand on in a Credit Cards 101 post) pay as much as you can, NEVER EVER pay just the minimum amount.

3. Pay on time. Late may be better than never, but now is better than later. Don't wait until the last second to mail your check in. Have your check in the mail at least a week before the due date listed. Remember, the postal system takes time. If you can have bill payment automated at no charge, do so. I have Discover, it is my primary card because of the cash back feature. Every bill that I can have charged to my Discover card automatically, I do. Because the automation is handled by the company billing me, the amount taken is always enough and it's always taken on time. Not paying your electrical company for a couple months doesn't just shut off your electricity, it'll probably end up on your credit report.

4. Don't max out your credit limits. This includes Home Equity Lines of Credit(HELOC) as well as credit cards. Stock accounts have margin accounts and those are included too, although for slightly different reasons that I won't cover here. Most credit reports have a 3 line summary of issues with your credit under each credit agency's score. One of them is often "amount of balances relative to credit limits too high" or something similar. If the rest of your credit is fine, this is pretty meaningless, but if your credit is shaky, this is seen as an indicator of poor ability to manage bills.

Remember, your credit score affects many things. Your ability to get a job, a car, a home, a celphone. The lower your score, the harder and more expensive it will be to get these things. So, do what you need to do keep your score up. You may find other parts of your financial life falling into place.