Debt. For most of us it is a fact of modern life and getting away from it is not only hard, it requires a massive amount of discipline as everything all around us is telling us to incur more debt for a better, more wonderful life. Just by taking our that little piece of recycled plastic, my God, Jennifer Garner will smile. Hard to resist and hey, all debt is the same right? Not by a long shot.
Today let's take a look at some of the different kinds of debt we can squirm our way into.
Credit Cards: little bits of recycled plastic printed up to look most impressive are the easiest to use. Now, do not get a credit card mixed up with a debit card. A debit card is a piece of recycled plastic that instantly takes money out of your bank account, while a credit card waits to the end of the month to bill. Some have grace periods, pay it all now and no interest. Some have really insidious interest. I know of one, no interest for a set period of time. Cool, we all like a free loan, but if you miss the set payoff date by so much as a penny, 36% interest, compounded of course, retro active to the inception of the date of transaction. That could come to hundreds of dollars. Compound interest is simply the bank charging you interest on the interest. Example, the credit card has a payment of $25 dollars. The interest is $25 dollars. The card holder pays the $25. It goes to $10 dollars to principal, what the item was bought for, and $15 to interest. That remaining $10 gets added to the purchase price and the bank charges you interest on the $10. Yes, minimum payments are a trap.
Now, if you default on your credit card payments, the bank sends an army of lawyers after you and thanks to Bush 43, we can no longer declare bankruptcy and clear the debt, nope, you are going to have to pay it one way or the other so please be careful with these things.
Now lets take a look at mortgages. A mortgage is nothing but a long loan placed against an asset such as a house. Watch what the contracts say. There are mortgages where the payment is X dollars/month and at the end of the time period, usually 15 or 30 years, the loan is paid off. Then there is the balloon payment, at the end of the contract period a huge lump sum is due all at once. This could be half the mortgage value. Then there is the adjustable rate mortgage. The buyer is lured in with a low rate and after a set amount of time the interest rate is readjusted and it could be enough to cause forfeiture. Forfeiture simply means the bank takes your asset and no, they do not give you back the money already paid toward the asset.
Then we have a collateral loan. The difference with a mortgage is this loan is usually smaller and the asset put up as collateral for the loan is not necessarily what the loan is being used for. Say you need a loan of $1,000 to pay a surprise bill, lets say a mistake on income tax. You go to the bank and put up the truck you just paid off as security for the loan. Dangerous play. If you default on the $1,000 loan, the bank gets to take you $20,000 truck. Fair? Not at all, but the rules are written by the banks.
Auto loans are a lot like mortgages only with a car and for a shorter period of time. What to look out for? I have read there are 100 month loans out there. 100 months is almost eight and a half years. That is a long time to have car payments.
Now, what if you take a loan out against securities? Securities are nothing but a fancy way of saying stocks, bonds, CDs and other financial interments written on paper, hence the term "holding paper". You need a loan. The bank is happy to give you one because you own 1,000 shares of stock in ABC Corporation and they are selling for $100 each giving your portfolio, simply the aggregate of your asset holdings, for the company of $100,000. Cool. You get the loan for $100,000. The next day the stock drops 25%. Your ABC Corp. stocks are now only worthy $75,000. Your phone rings with the banker saying the words, "margin call". What that means is you now have to cough up $25,000 to give to the banker, usually, by end of business today. Sorry, no default here, they will take everything and anything until they get the required money or assets totaling the $25,000. What happens if tomorrow the stock falls again? This could put you in a box in a back alley in short order.
Sometimes debt has to be used and it can be a good tool when it is needed, but please, please when you use debt, go in with your eyes open and know what you are getting into so some bank does not wind up owning everything you have worked for all your life.
Thanks,
Hardlo