There are plenty of lessons to be gleaned from our current economic turmoil. One of the most important ones is so simple that evidently all the Wall Street suits thought it beneath them. The silly little rule they ignored? Leverage is bad. In other words, borrowing money to buy stuff you can't afford doesn't always work out so well.
Sound familiar? Of course it does. Most of us have a wallet full of leverage opportunities -- credit cards. Still, while leverage might be the American way, it should not be yours.
Leverage is a four-letter word: debt
I never get tired of this magic trick, in which I turn less than $20 a week into more than $12,000 in debilitating debt. (Apologies if you've heard this spiel before.)
Consider the difference between setting aside $75 a month versus coming up $75 short and patching over the difference with a credit card. Over five years, that monthly $75 in savings amounts to $4,500 if you simply stuff your loose money into a coffee can. But $75 of debt each month, if you let it go untouched, turns into a $7,600 pair of financial cement galoshes -- including $3,100 in interest debt alone, if you assume an 18% interest rate.
Tah-dah: Borrowing money to patch over a weekly shortfall of less than $20, versus setting aside that money in a non-interest-bearing account, amounts to a $12,100 difference over five years.
Got debt? Use the good kind of leverage
Your story needn't have the same tragic ending as it did for overly leveraged investment banks. The time to right your overspent wrongs is now.
If you are a good customer (meaning, you haven't had any late payments or other blunders in the past nine to 12 months), then you, my friend, may have some leverage -- the good kind -- with your lender.
Don't be shy: Call customer service and ask for a lower interest rate, particularly if yours is more than 14%. Seriously, ask. Lenders are very willing to talk turkey if that means keeping a customer from moving a balance over to a competitor's card. More than half the people who call their credit card customer service departments are successful in reducing their annual interest rates by an average of one-third.
If your debt can be paid off in a matter of months, even better -- that means you can settle for a short-term rate reduction. You want to shoot for something in the 6% to 11% range. But don't be discouraged if you don't get it, because you have another trick up your sleeve ...
Swap your debt for more affordable debt
If your balances will take awhile longer to exorcise, then there are a lot of offers out there for 0% to 5% balance-transfer deals. (Check out indexcreditcards.com for current balance-transfer offers.) In these days of tighter credit restrictions, the debt transfer two-step is best performed by those with a decent credit track record.
If that describes you, then moving your balance from your current card to a new lower-rate one is as easy as mailing a balance-transfer check with your statement.
Sounds easy, right? It is. But it's not simple. There are a lot of "gotchas" in the balance-transfer process, including fees, transfer limits, and other zingers that can turn a great deal into an awful one after one misstep. (See the related links below for more guidance.)
Mostly, though, you want to make sure you don't inadvertently sabotage that great balance-transfer deal. That means (lecture alert!):
- Put no new charges on the card (those charges -- usually subject to a higher interest rate -- will be the last ones your payments will touch).
- Pay all bills on time (lenders regularly check your credit report).
- Tattoo the deal's end date onto your forehead.
- Give the bank no reason whatsoever to change the terms of your contract.
I also caution against opening new lines of credit if you plan to get a loan (car, mortgage, refinance) in the next six months or so. Opening new lines of credit can raise red flags on your credit report. You can do better than the money pros by avoiding the kind of behavior that puts your finances in jeopardy.
More de-leveraging advice: