Free 10-Week eCourse: Stop Living Paycheck-to-Paycheck
Financially Poor is offering a Free 10-Week eCourse to get your financial life together!
They will send you a new challenge every week, for 10 weeks and you will learn to:
- Control your money instead of having it control you
- Plug leaks in your spending
- Make a budget for your situation
- Eliminate your debt load
- Put your savings to work
- Protect yourself from the unintentional
The real reason you can’t get a loan
This is the real reason the banks aren’t lending. You’ve heard it in the news; the banks were bailed out with taxpayer dollars but they’re not approving loans for mortgages, auto loans or small business loans. Why is this happening if they have all this extra cash on hand to lend out?
The first thing that I thought of was that even though they were bailed out, the economic health of the people who want loans is poor. Just like the government has gone into debt while spending borrowed money, U.S. citizens have also gone into debt to finance their lifestyles. The reason that the economic collapse happened in the first place was because people who couldn’t afford to buy houses were taking out mortgages they couldn’t afford. And now, after the collapse, we expect the banks to make the same mistakes again? That would be foolish!
The second thing I thought of was that even if the people who wanted loans had perfect credit, the current economic conditions may not have justified lending money to anyone – even those with excellent credit - because in a time of layoffs, 10% unemployment and 20% underemployment, plus uncertainty in the market with new business-killing government regulations looming, and no job security, anyone’s ability to repay a loan is questionable.
While those two reasons make absolute sense to me, and to most who consider them, there is another reason that helps fully explain why no one can get a loan. Peter Schiff from Euro Pacific Capital explains the debt maturity problem.
Like the government, financial institutions took advantage of cheap money. Banks were able to lend money at low interest rates in the past several years because they were able to get that money at even lower rates. But just like your auto loan, or mortgage, there is a date that banks must repay their loan in full. Debt maturities are the lowest they have been in 30 years. Banks have been borrowing money with short maturities – meaning, short-term loans for banks – so because of this, they have been offering ARMs (adjustable rate mortgages) with a short-term fixed rate period with a low interest rate for 5 years or so, which then adjusts up or down to whatever the current rates are at the short-term fixed rate’s maturity date, and that is where a lot of people have been hurt, with drastically increasing rates on mortgages they were barely able to pay in the first place.
Now, this isn’t entirely the bank’s fault – people should always do their research before entering into a financial obligation. It isn’t the bank’s job to make us do the right thing for ourselves. If you’re buying a house, you should know the difference between a fixed rate mortgage (in which the interest rate stays the same for the entire length of the mortgage period) and an adjustable rate mortgage. A lot of people didn’t do their due diligence before taking on ARMs and they should have taken a fixed rate mortgage instead.
Back to the current situation: The lowest short-term debt maturity rates in 30 years. This is why even people with great credit can’t get approved for mortgages. Short-term rates for banks are expiring over the next few years and even though rates are low right now, they could skyrocket when the maturity dates expire. Banks who lend at low rates now could be stuck holding 30-year fixed-rate mortgages locked into low rates, when higher rates (expected to come in the near future) could generate more revenue for them if they wait a little longer to start approving loans again. Its good for business but its bad for those who need financing right now.
We need to inform ourselves. The more we know, the better prepared we are when we need financing.
Rule of thumb when taking on debt
There’s good debt and there’s bad debt. You only want to take on good debt – which is investment debt that creates something of value, for example: student loans, home mortgages and business loans. These debts are tax deductible and they help you produce more wealth in the long run.
Bad debt is used to buy things that will lose value – like using a credit card to pay for things like clothing or other disposable or durable goods. Every month that you don’t pay the credit card bill in full, the credit card company adds interest to your debt and you end up spending a lot more for your purchase than you originally intended.
Rule of thumb: If you’re going to buy something that doesn’t go up in value, and you can’t afford to pay cash for it, then you can’t afford it, and you shouldn’t buy it.
How to get a perfect credit score
More Americans’ credit score dip to new lows: 1 in 4 Americans have credit scores below 599, marking them as poor risks to lenders, making it impossible for them to get credit cards, auto loans and mortgages under new tighter lending standards.
Because they relied so heavily on credit for their spending in the past several years, their new restricted access to credit will make our economic recovery even that more difficult.
How do you avoid this? Do what credit score perfectionists do:
- Make payments on time (and make a long history of this, starting now)
- Don’t max out your credit lines (leave room for emergency purchases)
- Hold onto old credit accounts (don’t just close out old credit cards you don’t use – they help build your credit history)
- Shop around for the best interest rate when taking out an auto loan or mortgage (multiple soft credit inquiries by institutions that must pre-approve you have little to no impact on your credit score), however
- Don’t go opening up multiple new credit accounts all at once (don’t just open new credit card accounts to “stock up” your credit history – only open accounts when it makes sense to do so)
Only 13% of people have credit scores of 800 or higher. What do these people have in common? They have:
- 4 to 6 credit card accounts
- No late payments in 7 years
- At least 1 installment (auto or mortgage) loan with excellent payment history
- An average of 10 years credit history per account (and some accounts with 20 years of good history)
- Few credit inquiries (less than 3 in 6 months)
- No bankruptcies, foreclosure, charge-offs or collections
- Debt of less than 35% of their credit limits on each account
Follow this strategy and you should begin to build great credit or repair bad credit on your own. It takes time but it is worth it, plus you’ll form good credit habits in the process, which will benefit you for the rest of your life!
How to grow your money when you’re in debt
Assuming you have already put aside 3-6 months of living expenses into an “emergency” fund, in case you lose your job or have an unexpected need for cash, you are going to want to start saving money for your future. (Get started on that emergency fund).
You’re where you should be: you want to grow your money and you’re educating yourself about saving for the future.
But if you’re in debt, saving is not your first priority. First you need to pay off your debt, then save for retirement. Why?
If you’re in debt and you’re saving your money you may as well flush that money down the toilet. Debt usually accumulates faster than savings:
- Pay off debt first if: The interest payment you’re paying on your debt is higher (i.e., 21.99% APR on your credit card debt) than the interest rate you can earn by saving your money (i.e., 0.81% APR on your savings account).
- Save money while paying off your debt if: You can save money with an interest rate that is higher than the interest rate on your debt.
Money Tip: Look at the interest rate you’re paying on your debt, then look at the rate on your savings account. Wherever you have a higher interest rate, that is where your money should go first.
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