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Tuesday, 13 October 2009

The 4-Letter Word that Brought Down Wall Street

By Dayana Yochim Dayana Yochim

Do you know the No. 1 rule of finance? Of course you do: Don't spend what you don't have.

That silly little rule is one that the Wall Street suits thought fit to ignore. Given how that strategy played out, I think it's pretty safe to state with certainty that borrowing money to buy stuff you can't afford doesn't always work out so well.

Or, even more simply: Too much leverage is bad.

Leverage is actually a four-letter word: d-e-b-t
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.

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. (Never mind what happens if you introduced mortgage-backed securities into the equation.)

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. In fact, one phone call could save you $756.

Don't be shy: Call customer service and ask for a lower interest rate, particularly if yours is more than 15% (which is about the average rate these days). 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.

A cautionary note here: Credit rules are getting tighter every minute, so you must be realistic about the true health of your credit file. Still, 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. Play by the rules -- all the rules -- to win the balance-transfer game.

A final note: I caution against opening new lines of credit or doing anything that could jeopardize your credit score 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.

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