Master Your Debt
Slash Your Monthly Payments and Become Debt Free
By Jordan E. Goodman Bill Westrom
John Wiley & Sons
Copyright © 2010
John Wiley & Sons, Ltd
All right reserved.
ISBN: 978-0-470-48424-1
Chapter One
How Did We Get Here?
And Where Are We?
We haven't ever been here before. The debt landscape has
changed dramatically and irrevocably, and the ways in which we
borrowed, spent, and repaid debts before are relics of the past.
The cash-back credit card offers that used to crowd our mailboxes
have dried up.
There's no such thing as a "No down payment? No problem!"
mortgage.
Those tempting teaser rates are long gone, replaced by "gotcha"
interest costs so high you'd think the Mob was involved.
It's sometimes impossible to borrow money at any price-for
college, a car, or a home renovation. And you need to submit a credit
card at the front desk before a doctor will even see you now.
It may seem like credit has dried up altogether, just when you
need it the most.
What hasn't disappeared is the debt. American consumers are on
the hook for close to $3 trillion, not counting their mortgages,
according to the Federal Reserve. The average credit card holder
is juggling almost $11,000 in debt on close to 13 cards. Roughly one
of every three homeowners is underwater, meaning that they owe
more on their homes than the homes are worth.
And paybacks are rough. As banks and other lenders began
pulling back on credit, they tightened terms and squeezed indebted
consumers. Interest rates skyrocketed, and so did minimum monthly
payments on everything from credit cards to mortgages.
Middle-class people who were barely making it aren't making it
anymore. Those in the worst situations are trapped in houses they
can't afford to pay for and are unable to sell. Others are selling
homes at bargain-basement prices and downsizing. Or sending their
kids to community colleges instead of the private colleges they were
aiming for. Or working nights and weekends and skipping lunch to
make the payments on their MasterCard and Visa bills.
And yet, all is far from lost. If there were no good news, there
would be no reason for this book. I'd just crawl back into bed and call
it a day-or a decade.
But there
is good news. In the first place, the dialing back of debt
in the United States was necessary. As a society, we got overextended.
Now, there's a renewed feeling of responsibility in the air as banks
and consumers ratchet back to a more sustainable and stable way of
doing business. The federal government has stepped in, over and
over again, to tighten standards of behavior for creditors and to
protect the borrowing public. There are more ways to protect your
home, your family, and your credit score than there were a year or
two ago.
And, as has always happened in U.S. economic history, the
marketplace is adapting to the new era with new products and
services for consumers. Some of them are shoddy, or worse. But
many offer new and innovative ways to manage debt.
That's why we're here. With the right information and the right
techniques, you can take charge of your debts, blow them away, and
prosper. You can negotiate with your credit card issuer, rework your
mortgage, and improve your credit score so you qualify for the
lowest-cost, best deals out there.
You can pay off your mortgage years-and thousands of dollars-early.
You can still find credit card issuers that pay you back. You can
get more cash out of your child's first-choice school that you don't
have to pay back.
I will show you how.
But first, it's instructive to see how we got here.
A Long Time Coming
Americans have had a long love affair with debt, but it really rose to
prominence in the 1980s and 1990s. The deregulation of financial
institutions meant that there were many more lenders competing for
borrowers and that they faced fewer rules about their interest rates
and practices.
More debt became securitized-bundled up and resold to investors.
Mortgage-backed securities were the most common of these
arrangements, and they resulted in mortgage-backed mutual funds
for investors and a big, steady stream of cash for mortgage lenders. As
everything from auto loans to credit cards got securitized, that meant
more money coming back to banks and other issuers so they could
quickly turn around and lend it to new borrowers. This also served to
separate the lenders from the ultimate holders of the debt: Banks
that issued mortgages weren't holding on to them; they were selling
them off as fast as they could issue them.
At the same time, the credit scoring business was growing up.
This gave lenders quick numerical answers to their questions about
the creditworthiness of customers. Instead of poring over credit
reports for hours, they could get a score in moments that would
qualify a borrower as a good prospect.
Here's what happened when all of that came together: Lenders
that issued mortgages, car loans, student loans, and even credit card
accounts were able to make money fast by qualifying a borrower,
collecting a fee (or, more typically, a lot of fees), and then selling the
loan off to someone else. The lenders didn't even really care whether
the borrower made good on the loan; they only cared about the
borrower looking good enough to qualify in the first place.
As interest rates fell in the 1990s, refinancing became another
popular way for lenders to make money, over and over again, from
the same homeowners. They encouraged people to do cash-out
refinance deals-borrow against the swelling equity in their homes
to pay off other debts, improve their homes, send their kids to
college, and do anything else that struck their fancy.
By 2005, the country was in the midst of a housing bubble, and
would-be homeowners were told they should do whatever it took to
buy a house before it was too late and they couldn't afford it any
more. Some lenders simply allowed themselves to be pressured by
brokers, real estate agents, homeowners, and their own bosses to
make more and more loans. But some particularly unethical predatory
lenders went out of their way to push cash-out refinance deals on
unqualified, unsuspecting, and naive (often elderly) homeowners
who gave up good, small, inexpensive loans for subprime deals that
turned out to be disasters.
The creative folks in the mortgage and real estate industries did
what they could to invent new mortgages that would allow more and
more borrowers to qualify. There were new mortgages that required
no down payment and no demonstrable income from borrowers.
They started with teaser rates, tiny monthly payments and a feeling of
euphoria. But they held deadly traps, like interest rates that reset at
levels that doubled and tripled monthly payments, and amortization
schedules calculated so that the balance of the loans grew over time
instead of shrinking.
While that was happening, everything from college to cars was
becoming less and less affordable. College costs were rising precipitously,
and neither household income nor government aid programs
were growing quite as fast. Lenders rushed into that void, too-creating
a student loan industry that was predatory in its own way. At
its worst, it was found to be kicking money back to schools that were
recommending costly private loans to students who had been told
that no price was too high for a good education. Those loans carried
an implicit college seal of approval that made students and their
parents think they were good deals.
As cars became unaffordable, dealers and manufacturers cooked
up auto loans that stretched longer than the useful lives of the sport
utility vehicles they were paying for. It became possible to get a seven-year
car loan, and it was not unusual for car owners to trade in their
cars before their loans were paid off. They were adding the balances
of their old loans to their new car loans.
Credit cards became as common as head colds, and issuers who
could now qualify borrowers and process payments for pennies went
crazy promoting the cards. Every store and affinity group, from
sports clubs to hamburger joints, had its own card. To encourage
consumers to use the cards for even the tiniest pack-of-gum type
purchases, issuers started promoting the cards with big cash-back
bonuses for money charged at gas stations, convenience stores, and
groceries. Then they started piling on the fees. Issuers that used to
depend on interest income and fees from merchants discovered they
could really cash in if they charged consumers for being late, for
going over their credit limits, for getting cash advances, and for
anything else they could think of.
Borrowers did their part, buying into more and more debt for
any and every reason, and thinking it was all okay. By 2006, the
United States had a negative savings rate for the entire year. That
means-and it bears repeating-that as a nation, on average, all
Americans were spending more than they made, borrowing to make
up the difference. Consumer debt quintupled between 1980 and
2001, and then practically doubled again to $2.6 trillion in 2008.
Pop! It had to happen. The credit spree that had taken decades
to build came to a crashing halt in 2007. It started when the lowest
tier of mortgage borrowers-those folks who'd been talked into
crazy mortgages-stopped being able to keep up with the rising
monthly payments. The investors who held big portfolios of weak
loans didn't have the cash to float new loans. The bankers stopped
making money. Housing prices started to fall, and people weren't
able to refinance, pull money out of their homes, or even get new
loans for new homes. Prices fell further. The banks, worried about
where the next shoe was going to drop, started pulling back on
consumer debt. They cut credit lines on home equity lines and
on credit cards. Consumers lost their borrowing ability and their
breathing room. Stocks got slammed, and it all started spiraling
downward. Joblessness, bankruptcies, delinquencies, and interest
rates were on the rise, and spirits, paychecks, and economic activity
dropped.
The government stepped in, on almost a dozen different occasions.
In the fall of 2007, President George W. Bush created the Hope
Now Alliance, a union of mortgage investors (including giants
Fannie Mae and Freddie Mac), the Federal Housing Administration,
mortgage lenders, and trade groups. The group was to provide free
counseling and voluntary workout assistance to troubled borrowers.
In September 2007, Congress passed, and President Bush signed, the
College Cost Reduction and Access Act, which cut interest rates on
federal college loans and eased repayment options for struggling
graduates.
Early in 2008, Congress enacted the Economic Stimulus Act of
2008, legislation that put an additional $600 into the hands of most
taxpayers quickly. That wasn't enough, though, to address the systemic
problems that worsened throughout the year. In July 2008,
under President Bush, Congress passed the Housing and Economic
Recovery Act of 2008, designed to ease credit in the mortgage markets
and make more cash available to support refinance loans for subprime
borrowers. The Higher Education Opportunity Act was passed
by Congress and signed by President Bush in the summer of 2008. In
February 2009, President Barack Obama and Congress approved the
American Recovery and Reinvestment Act of 2009. This was a grab
bag of provisions, including money for students, car buyers, and
homeowners. In March 2009, the Obama administration unveiled a
comprehensive mortgage relief plan called "Making Home Affordable."
In subsequent months, it refined and amended that program.
Later in 2009, Congress passed, and President Obama signed, a
comprehensive credit card reform bill.
A New Era
Now we are digesting all of this. As a nation, we are moving out of
recession and into a new economic era. We are adjusting to the new
benefits, rules, and programs that came out of that mountain of
legislation. As consumers, we are learning to take advantage of the
new programs while learning to live without the easy money that used
to be all around us. That's not so bad-the money really wasn't that
easy after all.
In the following pages, I'll take you through all that is new about
managing debt in the United States, circa 2010 and beyond. We'll
discuss every unique type of debt, from credit cards to mortgages, in
great detail. I'll show you where the traps are hidden and where the
great new opportunities lie.
For starters, here is a quick overview of the major types of debts
that most Americans deal with, along with the recent changes and
trends in each area.
Mortgages. The biggest and most important debt for most
Americans, mortgages have changed dramatically, and
changed again. Now we are in an era when mortgages are
moving back to more traditional forms-plain-vanilla, 30-year
fixed-rate mortgages dominate the marketplace. There are still
some variable-rate mortgages.
Mortgages are secured loans-they are backed by the
property on which they are written.
There are two new government-backed programs for mortgage
holders who are in trouble. One allows homeowners to
refinance their homes, even if the homes are worth less than
their loans. A second one encourages mortgage lenders to
modify mortgages for troubled borrowers by lowering interest
rates and payments.
Home equity lines of credit (HELOCs). These lines of credit
are backed by your home, and give you a lot of control over
your money. You can use them to fund renovations, buy cars,
pay bills, and more, and repay them on your own schedule, as
long as you are making monthly minimum payments as big as
your monthly interest costs. Disciplined homeowners can
really make their HELOCs work for them by using the equity
accelerator technique described later in this book. You can
use a HELOC to burn your mortgage faster than you ever
thought possible.
Bankers tend to like home equity lines, too; they don't
typically resell them, so the loans stay in bank portfolios, producing
cash flow. There are still many HELOCs on the market,
and competition from lenders wanting to place HELOCs with
homeowners.
Reverse mortgages. These products put money in the hands of
elderly homeowners in exchange for repayment when the
home is sold. They used to be prohibitively expensive, and
they still can carry some high fees, but they have been improving.
They work best in very specialized situations. An older
person who is not well and doesn't want to leave home can use
a reverse mortgage to pay for care. A reverse mortgage typically
reduces the amount of equity that heirs inherit.
Credit cards. It's almost impossible to live without credit
cards now, but they have gotten more complicated than
ever. Consumers who carry credit card debt balances-about
half of all cardholders-are at the mercy of card issuers that
have been jacking up rates and fees as aggressively and unconscionably
as I've seen in my decades-long career.
New government rules slated to go into effect in 2010 will
limit issuers' ability to retroactively raise rates and trap consumers
into late payment charges. Many in the industry say
issuers will stop offering generous cash-back deals and start
charging annual fees. Those moves may make it harder for the
half of consumers who pay off their bills every month to really
profit from credit card use, but there is still enough competition
in that space to make me think you'll have some good
choices for a while.
Car loans. The typical car loan has gotten longer and costlier
over the years, but troubled automakers are making amends
with price cuts that may outweigh the zero percent financing
offers that used to rule. Washington has been offering its own
incentives; in 2009 it offered a sales tax credit to car buyers.
Congress also enacted a "cash for clunkers" incentive for car
buyers who turn in old, gas-guzzling cars. Lease deals, which
used to be prohibitively expensive, now sometimes rival car
loans as a less expensive way to buy a car.
(Continues...)
Excerpted from Master Your Debt
by Jordan E. Goodman Bill Westrom
Copyright © 2010 by John Wiley & Sons, Ltd.
Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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