You’ve heard all the financial truisms, and while many have a kernel of truth, some axioms should get the ax
You’ve probably heard them all, from anciefnt admonishments against any borrowing, to modern urban legends such as “you have to carry a balance to build credit.”
So while some money rules should be taken with a grain of salt, others just need to be thrown out with the trash.
“A lot of times there’s that kernel of truth in there,” says Bill Druliner, financial counselor and group manager for GreenPath Debt Solutions. “Or it’s true in some situations and not in all in others.”
Check out these five rules you might want to start breaking:
Rule 1: Pay off your mortgage as soon as you can.
“Sometimes it’s true, many times it’s not true,” says Wayne Bogosian, president of the PFE Group, and co-author of “The Complete Idiot’s Guide to 401(k) Plans.” “It all depends on the interest rate you’re paying.” If you have a relatively low interest rate around 3.5 percent, “after taxes, it’s closer to 2.5 or 2 percent,” he says. “That’s pretty cheap money.”
So if you were to take that “extra” money you’re thinking of putting toward the mortgage, and invest it into your 401(k), could you get better than the rate you’re paying on your home loan? “In most cases, yes,” says Bogosian. “Use the money to build wealth.”
“Paying down the mortgage doesn’t lower your monthly payment,” he says. “It takes a highly liquid asset — cash — and converts it into a highly illiquid asset — home equity.”
“Once you bury your cash inside the equity in your house, the only way you can get it is to take out a home equity loan,” says Bogosian. “And the bank’s going to charge you to get at it.”
His advice: If you have maxed out your 401(k) contributions or need to build an emergency fund, put the extra cash into a Roth IRA. That way, you have an easy tax-efficient way to save for that rainy day, and if it goes unused, it goes toward building your wealth.
“Most people we’ve met don’t have enough cash in their emergency fund, anyway,” he says.
Rule 2: Don’t charge if you can pay cash.
“That’s not necessarily true, particularly if you can get a benefit from using your credit card,” says Bogosian. “If you are the person who is morally committed to not paying interest, go ahead and use that card for everything. You will get points or cash back or both. The caveat here: When that credit card bill comes due, you pay it.”
“You’ve got to know what you’re doing,” says Bogosian. “If you forget along the way, you’re in trouble.”
If you are the person who is morally committed to not paying interest, go ahead and use that card for everything.
Wayne Bogosian, co-author, 'The Complete Idiot's Guide to 401(k) Plans'
For most of us, that means the money is already in the bank. But if you’re in an iffy financial situation (waiting on a bonus check that might not come, in a shaky job situation), you might want to either use cash or spend only what you already have.
Related to the “never use cash” rule is the “pay off the balance every month” corollary. But there are a few lucky souls for whom this might not apply.
The exception is if you have one of those no-interest credit cards or loans, says Bogosian.
He recently took out a 12-month, no-interest loan for $5,000. For 11 1/2 months, Bogosian will leave the repayment cash in an interest-bearing account.
When it comes due, “I’ll write them a check for $5,000 and keep the interest,” he says.
Rule 3: College kids need to build credit to get a job.
Not necessarily. “It really depends on the individual,” says Doug Borkowski, director of Iowa State University’s Financial Counseling Clinic.
A couple of years ago, an Iowa State student got a credit card with an $8,200 limit to build credit. She applied for a second one with the same bank. “By the time I saw her four months later, she had $16,000 worth of credit card debt,” says Borkowski.
Another student he saw came in with $52,000 in credit card debt as a senior. The student’s biggest expense? Meals for friends.
A lot of personal financial textbooks insist students must get a credit card to build credit in order to get a job, because an increasing number of employers check your credit.
While building credit is important for other reasons, “As far as what I hear from employers, that’s not necessarily true.” No credit is vastly different from bad credit, he says. And while good credit’s a plus, “they would rather be dealing with someone who didn’t screw up and has baggage.”
One test Borkowski recommends: Look at how you’ve managed your debit card.
Do you overdraft? Do you run out of money before you run out of month? Spend on wants versus needs?
Bottom line: You have the same amount of money, whether you pay by cash or credit card. If you can’t manage a debit card, you’re probably not ready for a credit card.
Rule 4: There’s a set percentage you should spend on items, such as home, car, food, or entertainment.
Big fallacy, says Druliner. It’s “my personal pet peeve,” he says.
Guidelines and rules of thumb are fun water-cooler conversation, but they wrongly assume that everyone is the same, with the identical tastes and similar lifestyles and money goals.
“It really depends what your goals are, and what’s important to you,” says Druliner.
“Those percentages, if you don’t take them as gospel truth, can be OK,” he says. “But you have to look at what’s important to you in your situation and what you value.”
In the same way that some people will fill their homes with ultra-modern furniture and bright colors, while others prefer classic pieces or a background of neutrals. Neither is “right” or “wrong.” But each expresses the person living there.
Some folks may decide to live with friends and split the rent so that they can devote their cash elsewhere. Others may live frugally, putting money toward homeownership or a trip abroad.
The healthy take-away from spending guidelines: It’s fine to be aware of the rules of thumb. That way, breaking away from those money norms is a conscious decision. You’re actively directing your money toward those things that are important to you, rather than passively spending until it’s mysteriously gone.
Rule 5: To build credit, you have to carry a balance.
Totally wrong! But this is one urban legend that Durliner hears frequently, especially from people who are getting secured cards to build or rebuild their credit.
Getting a secured card can help you establish or re-establish credit by helping you compile a record of good behavior: using the card, getting bills and paying them on time. But you shouldn’t carry a balance if your aim is to build good credit.
Carrying a balance is bad for your credit rating. Instead, he recommends, use the card for small purchases “and pay it in full every month.”
“You don’t have to pay interest to rebuild your credit,” Durliner says.
First, if you’re rebuilding bad credit, make sure you’re addressing the mistakes that damaged your credit in the first place..
Then, if you want a secured card, shop the fees carefully before you apply, says Durliner. Often, the best deals are with a local bank or credit union. But you’ll usually have to approach them. Conversely, the companies that are soliciting you uninvited with flashy offers may be more expensive once you do the math, he says.
Says Durliner, “Sometimes the best deal is the one that’s not as noisy and in-your-face.”