Crash Course in Credit, Lesson 3: Good and Bad Debt

Originally published Feb. 25, 2015

Most of us can’t afford to live entirely debt free, but not all debt is the same. While some types of debt can actually be beneficial, others can be dangerous. Before you borrow money, it’s good to know the difference between “good” debt and “bad” debt.

In general, “good” debt will: create value over time, is often tax deductible and is used for a purchase that appreciates in value, or produces more wealth. Any debt that you accrue for things that have no potential to increase in value can be considered “bad” debt.

Mortgages
You probably can’t afford to purchase a home in cash, but that doesn’t mean you can’t own a home. If you plan carefully and only borrow what you can afford to pay back, getting a mortgage to purchase a home can be a great example of “good” debt. Your purchase will likely appreciate, especially if you make any renovations or improvements to the property. Plus, any interest paid may be tax deductible (but you should talk to your tax advisor for details).

Student Loans
People with college degrees or education in a skilled trade tend to make more money in a lifetime than those who stop after high school. A college degree or skilled-trade program is likely to pay for itself within the first few years after you enter the work force. But just like all other debt, it’s important that you don’t borrow more than you really need or student loans can quickly become “bad” debt. Experts recommend borrowing no more than what you expect to make in the first year of employment after graduation.

Business Loans
This is one case where the saying “it takes money to make money” can be true. You need a little capital to start a new business or expand an already successful one. Keep in mind that business loans are only “good” debt if you borrow reasonably and have a clear plan to generate more business or income in the future.

Credit Cards
Credit cards are often used to purchase wants rather than needs, and the ease of use can have debt piling up faster than you realize. How do you know if you’re building up bad debt? One sign is using credit cards for things that won’t appreciate in value, like clothes, food or vacations, without paying off the balance every month. You’re charged interest every month you carry a balance, which means the stuff you bought continues to lose value while the price you paid for it increases.

Car loans
You need a car to get to work and run all of life’s other errands, but you don’t have to go broke getting one. Most new cars depreciate quickly, sometimes as much as 20% in the first year. We’re not saying you should never buy a brand new car but, if you’re not careful, you could end up upside down on your loan—meaning you owe more than your car is actually worth. Whatever you decide to buy, look for a loan with little-to-no interest and pay it off as quickly as you can.

If you’re struggling with too much debt, our friends at GreenPath can help.

You might also be interested in Lesson One and Lesson Two from our Crash Course in Credit.

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Crash Course in Credit, Lesson 2: Common Credit Myths Busted

Does it ever seem like everyone you know has advice or “facts” to share with you about credit? While a lot of it might be helpful, chances are pretty good that at least some of it is false. For part two of our Crash Course in Credit, we rounded up some of the most common credit misconceptions we hear to set the record straight.

You have to have credit to get credit.
While it doesn’t make much sense in the real world to say you can’t get credit if you don’t already have it, it can be significantly harder to get if you have a short (or non-existent) credit history.  Most lenders require borrowers with little or no credit to have a cosigner for any loans, like auto loans or private student loans.  If you don’t want to or can’t find a cosigner, a good way to start building your own credit is a secured credit card, which allows you to make a cash deposit as collateral—a protection for the card company if you fail to make payments.

Checking your credit report damages your credit score.
Checking your credit report does not hurt your score. It’s actually recommended that you check your credit report at least once a year to ensure it doesn’t contain any errors. When you look at your own credit report, it’s called a “soft inquiry.” Soft inquiries can occur without your permission, and are only visible to you. If you’ve ever received a credit card preapproval in the mail, that creditor performed a soft inquiry on your credit.  Hard inquiries, on the other hand, can only happen with your permission. Only hard inquiries affect your credit score because they’re the result of a request to extend credit, like a loan or credit card.

Carrying a balance on a credit card helps your credit score.
As long as you’re making payments on time, carrying a balance doesn’t hurt your credit score, but it doesn’t help it either. The only thing you get from carrying a balance is more interest charged. If you use a credit card, your best bet is to pay the balance on time and in full every month. The on-time payment is a positive mark on your report, and paying in full prevents you from paying any interest. It’s as simple as that.

Delinquent credit accounts fall of your report once they’re paid in full.
While it would be nice if anything potentially damaging to your score would disappear once you fixed it, that’s not the case. Credit relationships generally remain on your report for seven years. So just because you’re paid up with a lender you’d fallen behind with, it doesn’t mean other lenders won’t be able to see that you were once delinquent. The good news is that positive relationships hang around for up to ten years.

Bankruptcy is a good solution if you have too much debt.
While it might seem like a good way to get creditors to stop calling if you’re in over your head, it’s not always the best long term solution. If you file for bankruptcy, you may be relieved of paying all of your debts or just some of them. Debts owed on mortgages, student loans, taxes, alimony or child support are rarely dismissed.

Once you file, credit reporting agencies are required to list bankruptcy on your credit report for seven or 10 years, depending on whether you file chapter 7 or chapter 13. Having bankruptcy on your credit report doesn’t just make it harder to get credit in the future—it might also affect your insurance rates or your ability to get a job or apartment.

Rather than rushing to bankruptcy, you should start by working with a credit counselor, like our friends at GreenPath, who might be able to suggest better options to pay off your debt.

Struggling with your own credit conundrums? Leave us a comment, reach out to us on Facebook or talk to a Financial Services Officer. We’ll make sure you (and your credit score!) are moving in the right direction.

Want to learn more? Check out part one of our series A Crash Course in Credit: The Basics

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Crash Course in Credit: The Basics

You’ve heard people talk about good credit, bad credit, building credit, repairing credit, etc. But unless you have a real understanding of credit itself, you probably don’t know what any of that really means. Asking someone to explain credit can be tough—especially if you already have a student loan or credit card you feel you should know more about.

If you’ve been too afraid to ask about credit, here’s what you should know:

Credit is your ability to get a product or service based on the understanding that payment will be made later. Your credit history tells creditors and lenders how reliable you are to pay it back. The better your credit history, the better your chances are of getting credit.

There are four basic types of credit available:

  1. Revolving credit is credit that is automatically renewed as debts are paid off, like a credit card. They have a maximum credit limit, and you can make charges up to that limit.
  1. Installment credit is issued for a set amount, and you make monthly payments (or installments) of a fixed amount over a period of time until the balance is paid in full. Unlike revolving credit, installment credit doesn’t automatically renew after payments are made. Auto loans, mortgages and student loans are examples of installment credit.
  1. Service credit is any service you receive and pay for with monthly installments—like a cell phone plan, electricity or cable. Not all service accounts are reported on your credit history.
  1. Charge cards operate similarly to credit cards, but you’re usually required to pay the balance in full each month.

Your credit report is the detailed record of your credit history. These reports are compiled by credit bureaus (more on those later) and used by lenders to determine your creditworthiness. It includes personal information, like your address and social security number, in addition to the number and types of accounts you’ve held in good and bad standing. Any negative information will usually stay on your report for about seven years, while bankruptcy filings usually remain on your report for ten.

There are three major credit reporting bureaus in the United States: Equifax, Experian and TransUnion. All three companies collect information about consumers’ bill paying habits, personal details and accounts to build a unique report. The information in each report will probably be similar, but there are usually some small differences.

Your credit score is created with the data from your credit report. This number is one element lenders use to determine your creditworthiness. Fair Isaac Corp. (FICO) produces the most commonly used credit scoring algorithm in the U.S. Scores typically range from 300 to 850.

So what makes up good credit?
Every lender has different standards for what is considered “good” credit, but scores below 629 are generally considered bad, 690 or above is good and anything over 720 is excellent.

Knowing the basics about credit makes it easier to understand why it’s so important that you use credit wisely—late payments, maxed out cards and bankruptcy all tell potential lenders that you can’t necessarily be trusted to pay them back, making it harder to get credit in the future.

While this is a good place to start, there’s still a lot to know about the credit industry. Stay tuned for our upcoming blog on common credit misconceptions.

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[INFOGRAPHIC] Should you refinance your student loans?

Refinancing your student loans is a big decision–it could potentially save you thousands of dollars in interest over time, or make your payments more manageable by extending your repayment period.

But all student loans aren’t created equal. Refinancing federal student loans with a private lender could mean the loss of the borrower protections guaranteed by federal loans.

If you’re struggling to decide if refinancing is right for you, check out the infographic below, then learn more from NerdWallet.

Infographic: should you refinance your student loans?
Via: NerdWallet

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Graduation doesn't mean you'll live with debt forever

How to Quickly Pay Back Your Student Loans

If you’re like most recent college grads, you’re probably dreading the day your student loans go into repayment. We’ve all heard (or lived) the horror stories of grads with $1500/month minimum payments, living in their parents basement until they’re 45 because there’s no money left over.

While those scenarios do exist and are all too real for some people, you don’t have to live under that cloud of student debt forever. With some planning and diligence, you could pay off your debt faster than you think.

Understand your loans.
The terms of your loan could affect your payment schedule. If you have loans with a fixed rate, you’ll likely have a fixed payment. But, your payment could change drastically if you borrowed with an adjustable rate. Knowing if and how your payments will change in advance allows you to create a flexible budget and prepare yourself for rising minimum payments.

Make payments while you’re in school.
This advice is a little late for recent grads, but making interest-only payments while you’re in school can have a huge impact on your post-grad balance. Private and federally unsubsidized loans begin accruing interest when the loan is dispersed. As your loans enter repayment, that interest will most likely be capitalized—meaning it’s added to the principal balance of the loan, and your interest rate will then apply to the new balance. The more interest you pay off while you’re in school means you’ll pay less overall in the future.

Pay more than the minimum.
It may seem obvious, but making extra payments is the fastest way to pay off any loan. Make sure you won’t be penalized for pre-payment, then figure out what works with your budget. Some lenders will automatically apply any extra monies to the next month’s payment, allowing you to essentially pay a month early. So make sure your lender knows you want it anything extra to be applied to the principal and will continue to make monthly installments.

Consolidate—if it works for your situation.
Consolidation—rolling several smaller loans into one big loan with the same servicer, could make it easier to manage your payments. But, be careful combining federal and private loans. Consolidating federal loans with a private lender means you forfeit the buyer protections, like income-based repayment, that comes with them.

Though consolidation will usually leave you with a smaller monthly payment, it might also extend your repayment period. So even if you have a lower interest rate after consolidation, you could end up paying more overall when you factor in the extra time.

If this seems like the plan for you, IH Mississippi Valley Credit Union can help consolidate or refinance your private student loans with features like a low, variable interest rate and zero origination fees. Learn more from our partner, Student Choice.

Enroll in automatic payments.
Enrolling in automatic payments allows your lender to receive payments without requiring you to log in or mail a check each month. Just make sure the correct funds are available in your account before your due date so you aren’t charged overdraft fees. You can still make one-time payments too. So it won’t prevent you from paying a little more when you find yourself with extra cash.

Even better than reducing some stress, some servicers will reduce your interest by a small amount as an incentive to enroll in automatic payments. Check with your lender to see if they offer an incentive—according to FinAid.org, the most common discount is a .25% interest rate reduction.

Everyone’s financial situation is a little different, but the key to paying off any debt is consistency. By making at least the minimum payment each month, you avoid late fees and penalties, putting you much further ahead than if you skip payments.

Need help planning your payback budget? Talk to our financial services team about a free financial checkup.

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There are plenty of bad reasons to buy a house.

Why You Shouldn’t Buy A House

“Renting is just throwing money away.”
“A house is a great investment.”

Sound familiar? Maybe you’re facing pressure from friends or family to make the switch from renter to homeowner. Or, maybe you feel like everyone else is doing it, so you should, too. Maybe it just feels like the logical next step in your path to becoming a Responsible Adult.

But here’s the thing: none of those are good reasons.
There’s only one really good reason you should buy a house: because you’re financially prepared to do so.

We’ve said it before and we’ll say it again. Buying a house is a big deal, and likely the biggest purchase you’ll ever make. You shouldn’t take it lightly and you shouldn’t rush into it. If you’re feeling the pressure but aren’t sure if you’re financially fit for home ownership, there are some things you should know.

Not all investments are good
Your uncle may be convinced otherwise, but a house isn’t always a great investment. Yes, some people make (a lot of) money investing in real estate. But the reality is that most people do not. When you consider market volatility, taxes, interest and depreciation, you may not even get an annual return on that “investment” at all. While time certainly helps level out volatility, not everyone has 30 years to wait for investment to pay off. Unless you’re buying properties for rental income, it’s wiser to think of a home purchase as just that: a home. Not an in investment.

You’re not throwing your money away
Perhaps one of the biggest benefits of renting is the luxury of being able to call your landlord when things go awry. It may take longer than you’d like for the maintenance team to show up, but at least you aren’t footing the bill for that broken furnace.

Are you ready to spend your weekends fixing leaky faucets and doing yard work? Not all houses require extensive maintenance, but some do and almost all of them are bound to need a new roof or water heater or other major repair/replacement during your ownership stint. Experts recommend saving between one and four percent of your home’s value each year to pay for general upkeep and major repairs. If none of that sounds appealing, you may want to keep writing that rent check.

You can’t take it with you
Feel like moving across the country? If you’re renting, your housing situation isn’t likely to prevent you from doing so for very long or cause a major blow to your finances.  You may have to pay a penalty if you leave before your lease is up, but that’s nothing compared to the expenses you could face if your house doesn’t sell.

If you buy a house, you should plan on staying put for at least five to seven years if you plan to break even, ten if you’d like to make a profit. Moving before that could end up costing you money when all is said and done.  If your job requires you to move quickly, you could get stuck in the unfortunate situation of paying rent in your new location on top of your mortgage.

Bottom line: Owning a home is a great thing for some people, when they’re financially and emotionally prepared for the task. But, if you’re buying a home because of peer pressure, societal pressure or any reason other than because you’re financial prepared, you probably shouldn’t.

If you’re not sure if home ownership is right for you, IH Mississippi Valley Credit Union is here to help. Try our online calculators to estimate the costs of owning vs. renting. Or, give one of our Financial Services Officers a call. They’ll give you a financial check-up and put you on the right track to be ready in the future.

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Team of happy college students sitting in the library and communicating. One of them is using laptop. Focus is on woman in the middle.

What you should know about student loans

If you’re like most people, you probably don’t have the funds to pay for college tuition out of pocket. Without student loans, higher education wouldn’t be an option for most students. But just because the majority of students today graduate with debt, it doesn’t mean it’s the right move for everyone. Before you start looking for funding, it’s important to know your options.

First things first, students should max out their free and lower-cost options before turning to private funding. Free options are things like scholarships and grants that don’t have to be paid back. If you still owe after the free money has been used, lower-cost funding like Federal Direct Loans are the next best option. The more expenses covered with these funding sources now means less that’ll have to be paid back later.

Federal vs. Private Loans
If you can’t cover all of your expenses with federal student loans, be smart when you turn to private lenders.  Many private lenders don’t offer borrowers the same protections as federal loans, like deferment, forbearance and specialized repayment plans.

Generally speaking, federal student loans have lower interest rates than private loans. Some private lenders offer loans with variable rates, which could have an initial rate that’s lower than federal options. If you go this route, keep in mind that variable rates change—sometimes drastically. The low rate at signing could skyrocket after graduation. Before you sign anything make sure you’ve researched all your rate options and how they align with your repayment goals.

Co-signers & Credit Checks
Federal student loans don’t require a co-signer or credit check, which is good news for young borrowers with little or no credit. Most private lenders will require a co-signer, usually a parent or family member, who agrees to take responsibility for the loan if the borrower fails to make payments. The upside here is that if your cosigner has really good credit, you could get a lower interest rate.

When it comes to private loans, borrowers should shop around for the best rates—but be careful not to ding your credit in the process. Lenders will pull credit for both the borrower and co-signer to determine the interest rate, so you have about two weeks to comparison shop. After that, every inquiry can temporarily lower your scores.

Borrowing limits
Federal loans usually limit the amount that can be borrowed to the total cost of school, minus any awards (scholarships, grants or work study programs). Depending on the lender, private loans may just have a yearly limit, leaving it up to the borrower to decide how much to take. So it’s important to ask not how much you’re able to borrow, but how much you need to borrow and stop there. You might want a new big screen TV, but you’ll end up paying way more for it in the end.

Repayment
Most student loans have a standard repayment term of 10 years but, with deferments & specialized repayment plans, the average actual repayment is closer to 20 years. Depending on your interest rate, an extra 10 years could mean a lot more money spent overall.

No matter what kind of loans you end up with, federal or private, you’re stuck with them until they’re paid in full. Unlike other debts, student loans aren’t dismissed in bankruptcy. With few exceptions, student loan forgiveness is pretty much limited to death and total and permanent disability.

Need funding to fill your payment gap? IH Mississippi Valley Credit Union offers undergrad, graduate and consolidation student loans that won’t leave you with a mountain of debt. Learn more or apply online at ihmvcu.org/studentloans.

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What to know before you buy your first home

Buying a home is serious business.

If you’re anything like the average first-time home buyer, you probably have ten new questions for every answer you already know. So how do you know if you’re ready to be a homeowner? In addition to saving a down payment and preparing a budget, knowing the answer to a few basic questions is a decent start.

What’s a mortgage?

A mortgage is a loan to finance the purchase of a home. It’s probably the largest debt you’ll ever take on, and is usually more than just a house payment. It’s made of a couple moving parts: collateral, principal, interest, taxes and insurance.

In the case of a mortgage, the house you purchase serves as the collateral, or security for the loan. If you fail to make payments, your lender can seize the home as repayment.

You’ve probably heard the words principal and interest in the context of loans before. The amount you borrow up front is the principal balance of your loan. Typically you’ll make a down payment of at least 20% of the purchase price and borrow the rest. Some lenders will accept a down payment as low as 3.5% of the home’s value for first time buyers. Interest is what your lender charges you to use their money to make the purchase. Together, principal and interest will make up the bulk of your loan.

Like most other purchases you make, you’ll have to pay taxes on your home and the amount you pay will vary depending on where you live.

Before you close on your home, you’ll also have to prove to your lender that you have insurance to protect the house and your belongings in the case of a fire or natural disaster. If you live in a designated flood plain you’ll have to obtain flood insurance, too.

Many borrowers elect to have taxes and insurance rolled into their mortgage payment through an escrow account. This way, they can make small payments every month instead of worrying about a large annual or semi-annual payment.

Do I really need 20% for a down payment?

Not necessarily, but it’s recommended. How much you’re required to put down will depend on your lender and qualifications.

The Federal Housing Administration (FHA) has programs tailored to first time buyers that offer low down payments, low closing costs and easy qualifications. Some states also offer their own assistance programs for first time home buyers.

If your down payment is less than 20%, you’ll have to pay for private mortgage insurance (PMI).

What’s private mortgage insurance (PMI)?

PMI protects your lender if you default on your loan, but you pay the premiums. It’s a requirement for any mortgage loan with a down payment less than 20%. There’s really no benefit for the borrower, so it’s best to avoid it if you can.

If you opt for a lower down payment, you’ll have to make PMI payments until the balance of the loan reaches 78% of the home’s original value.

If you get an FHA loan, you’ll have to pay PMI for the life of the loan, even if you get the balance down to 78% of the original value. The only way to remove PMI from an FHA loan is to refinance.

Should I work with a real estate agent?

Unless you have expert level knowledge about the area you hope to buy in, and know a lot about how to properly price a home and make an offer, you’ll probably benefit from working with a professional.

The listing agent works for the sellers, not buyers. A buyer’s agent will help you get the best price, give you independent advice and may even be able to point you towards listings you wouldn’t know about otherwise.

What’s the difference between preapproval and prequalification?

Prequalification is usually the first step in the mortgage process. You’ll provide your lender with a basic picture of your financial situation including debt, income and assets. In most cases you can do this over the phone or even online. Your lender won’t pull your credit report or take an in-depth look at your ability to finance a home, so you’ll only get a ballpark number of what you might be able to afford based on surface level information. It’s essentially an estimate, and just because you’re prequalified for a certain amount doesn’t mean you’ll be approved for that amount (or even be able to afford it).

Preapproval is the next step. You’ll probably fill out a mortgage application, and your lender will take a hard look at your financial situation—pull your credit, assess debt to income ratios and verify your employment. When it’s all said and done, you’ll be given a specific amount for which your mortgage is approved. You’ll probably also get a written contingent agreement allowing you to shop for homes at or below that dollar amount.

Getting preapproved will save you a lot of time and disappointment by narrowing down your price range before you start looking at homes. You can totally avoid those homes you know you can’t afford, and focus on your real options. You gain advantage when dealing with sellers, too—you’ll be able to make serious offers that aren’t contingent upon obtaining financing. If you’re competing against other buyers for the same home, your bid may be more appealing compared to someone who hasn’t arranged financing.

What are closing costs?

These are the fees associated with the close of any real estate transaction. Closing takes place when the buyer takes position of the home’s title.

How much you pay depends on where you live and what home you buy, but total closing costs are usually around two to five percent of the homes total purchase price. Typically, your lender will give you a Closing Disclosure that outlines any fees a few days before closing.

If you’re still searching for answers, check out our first time home buyer checklist and see where you stand before you get started.

Ready to get moving? Contact our home loan officers today for more information!

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How to Cope with Market Volatility

Recent market swings, brought on by falling oil prices, China’s slowing economy, and political uncertainty have many investors concerned about their retirement savings. Market volatility plays a big role in the performance of investments over time. Consider taking these six steps to minimize its impact on your investments.

Know your long-term goal.
It’s important to develop a long-term, disciplined plan for saving and investing so you can draw from your savings throughout retirement. Think of it as being able to pay yourself each month when regular income from your employer stops.

Stick to your plan.
Nobody can predict when the market will have its best days, so it’s vital to stay the course regardless of market shifts. Steadily investing the same amount on a regular basis lets you take advantage of dollar-cost averaging, avoid the temptation of timing the market and takes the emotion out of investing.

Consider asset allocation.
Asset allocation can be an important investment strategy. Dividing your contributions among stocks, bonds, real estate and cash allows you to balance the risk of your investment if one investment class is performing poorly. The right asset allocation for you depends on a few key things: your comfort level with risk and how much time you have until retirement.

Diversify.
Diversification takes asset allocation a step further by spreading your money into different options within each asset class. This spreads the risk so investment balances may be less affected by short-term market swings.

Rebalance regularly.
Rebalancing should be a part of your action plan. Over time your asset allocation can change as some investments grow more than others. Rebalancing returns your investments to the original allocation, keeping it consistent with your long-term goals.

Monitor your investments.
Once you choose the mix of investments that works with your goals, it’s important to review it periodically. Life is full of unexpected changes that can affect your tolerance for risk or the time horizon for your plan.

A financial professional can review your investments and help make changes to you plan on an ongoing basis, and incorporating these six steps will help you stay on course. Let us know if we can help you meet your long-term investing goals.

Bob Blaze, CFP®

Bob Blaze, CFP®

 

Article by Bob Blaze, CFP®, Financial Advisor
Bob has been helping clients with financial planning for more than 20 years, and a CFP® professional for nearly ten. He currently specializes in personalizing wealth accumulation strategies, Individual Retirement Accounts (IRAs) and retirement plan rollovers.

 

Source: “Coping with Market Volatility.” Principal Fund Distributors. August, 2015.

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