Tuesday, June 22, 2010

Time to Reduce Your Debt

Here's my latest minyanville.com column:

Savings Rates Dismal, But Good Time to Borrow Money
By John Wasik

Right now, your motivation should be to repair your household balance sheet by saving. But you may have to borrow to get back on track.

I was shopping around for a decent rate for my daughter's savings account last week. Slim pickings.

I'd have a better chance of getting a deal on a car than finding a decent savings yield. You're lucky to find something yielding 1% now.

When you subtract taxes and inflation, your real return is negative on most saving vehicles these days. Here's a sampling of last week's average savings yields, courtesy of www.bankrate.com:

* Money-Market Account: 0.78%

* Checking Account with Interest: 0.56%

* One-Year CD: 1.37%

You're almost a chump for even trying to save money, although saving is what we need to do after the worst financial crisis since the Great Depression.

It's palpable anger time. Why should we give the banks our hard-earned money -- after a massive $12 trillion bailout -- when they reward us with such awful savings rates? After all, the banks are paying almost nothing for the money they borrow from the Federal Reserve. They get to use our cash to lend it out at a tidy profit while we scrounge to make 1% on our savings.

This sounds counterintuitive, but your motivation now should be to repair your household balance sheet -- just as the banks are doing. You may have to borrow to get back on track.

While savings yields may be dismal, it's an incredibly good time to borrow money. I refinanced late last year into a 30-year fixed-rate loan at 4.9%. I think that was a lower rate than my parents paid in 1955 when they bought their first home. Mortgage rates are even lower now.

Even if you're shopping for a new or second home, mortgage rates are still appealing: 4.8% for a 30-year fixed and 4.18% for a 15-year loan. Even a home-equity loan could be considered for debt consolidation.

Need a new car? Not only are dealers offering myriad incentives, the average rate for a three-year auto loan is about 6.6%.

I'm not suggesting that you go into debt for the sake of buying something you think you need. I still advocate saving money every month rather than going into debt for a car you don't need or a home you can't afford.

My own rule is that you're not getting ahead unless you're saving. A new car and home don't matter if you don't have a cushion for the future.

Think like the banks. They’re fixing their balance sheets courtesy of, well, us. Taxpayers and regulators ensured their survival so that the global financial system would survive.

While I certainly don't believe everything is "fixed" -- the housing market is still a train wreck in many places -- savings should be part of your repair strategy. The guidelines are simple:

1. You should be saving at least 10% of your salary for retirement. Even more is better because medical expenses will be higher in the future.

2. You need at least six months' salary set aside in savings for emergencies and unemployment. Jobs are slowly trickling back yet some industries will still be shrinking.

3. Save for college and any other big-ticket items (cars, second homes, boats, etc.)

4. Any money you gain from refinancing or reducing credit-card bills should be plowed into a rainy-day fund.

5. Check and clean up your credit record. Don't spend up to the limit on your credit-card accounts. That will lower your credit score. Correct any errors in your file. Pre-qualify for any new loan you're considering before you sign the purchase contract (with a homebuyer or auto dealer).

Those who save are buying themselves rather precious: A bit of financial security. It won't stop markets from collapsing, politicians from overspending, or reduce the national debt. Yet it will ensure that you won't be a chump when the next crisis comes around.

John F. Wasik is author of The Cul-de-Sac Syndrome: Turning Around the Unsustainable American Dream.


Smoon said...

Thanks, John. That was both calming and motivating at the same time! I think I might actually be able to derive some pleasure from saving these days.

officerjohn said...

Nice article, John. I've been a big fan of your books, own many and read even more. My comment: Why can't tax breaks create as much incentive or more for savings than borrowing?