Thinking About Money

Today I received a credit offer so sneaky that I just had to write about it. But while sneaky, it’s one you can use to good advantage if you’re clever.

The offer is from Washington Mutual, a bank I generally have a lot of respect for (I even have a home equity line with them). But they too have been caught up in the sub prime loan mess, their stock having dropped from the mid 40′s to about $10/share, and I suppose they’re trying to chase revenue along with every other troubled bank.

The problem is, it’s your revenue they’re after.

Here’s the deal:

0% FIXED APR on Purchases until October 1, 2009 when you Transfer a Balance NOW!

Now, I have to admit, 0% for a year and a half is a nice offer. The catch? You have to do a balance transfer of at least $100 within 90 days of opening the account. This transfer has no fees attached (which is good), but any payments you make will be applied first to the lowest interest balance.

What this means is: if you transfer $1000, then start using your card for purchases, payments you make will be applied first to the finance charges, then to the purchase principal. That $1000 will stay on your card building finance charges until you’ve paid everything else off first. At 9.99%, that’s about $100/year in finance charges.

But here’s a trick that should work (as I read the term sheet). Get the card and do a small balance transfer. Then pay it off completely. After that, you should be able to use the card for purchases at 0% until October 2009. If you save the money to pay off the card, you can effectively earn 3% or more on 18 months worth of purchases – If you spend $500/month and put them on the card that’s a free $200.

But don’t try this unless you are very disciplined and can:

• Save up the cash to pay off the balance in October 09 (earning interest on the balance in the mean time).
• Make every payment on time (if you’re late on this or any other Washington Mutual account, they can raise your interest rate to an astonishing 21.74% over the prime rate – currently 28.24%).

If you have little or no debt and pay off your credit cards in full each month, don’t bother with this film. For everyone else, this film may prove an eye-opener. Though it suffers from “over-the-top” sensationalism in the style of Michael Moore, the basic information is sound.

You’ll learn how various loan instruments such as sub-prime loans, title loans, payday loans, tax refund advances, and rent-to-own, banks and finance companies are able to charge interest rates that you would think would be illegal. Conspiracy theorists will enjoy this as well (not to suggest that there isn’t a conspiracy).

I wish I could tell you that this will help you get out of debt if you are in debt. But it’s a great film for those who aren’t in serious trouble. And for those just starting to get credit (especially college students and recent grads who may be ignorant about credit), this film can save you a lot of grief.

In Debt We Trust: Highly recommended.

As you can probably tell, I’m a big fan of cash rebate cards that have no fees. True, a 1%-3% discount on everything you buy isn’t that big a deal, but when you add in everything from groceries, to gas, to travel, it can easily add up to hundreds of dollars a year. And that’s for the negligible effort of choosing which card to use and paying on time.

So far my main two cards are a Chase card from Amazon (3% on Amazon purchases, 1% on everything else), and a Capital One Visa (2% on groceries & gas, 1% on everything else).

I also have an American Express rebate card by way of Costco, that has a strange tiered system of .25% for the first $2,000, .5% for the next $3,000, and 1.5% for everything over $5000/year. For those of you who are wondering, this card doesn’t start beating a 1% rebate card until you’ve spent $11,000. Not very exciting.

Except that Costco and American Express have sweetened the deal. They have a second card called their “True Rewards card” that not only starts at 1%, but goes to 2% for travel and 3% for eating out. That gets interesting.

So I decided to switch, which brings me to today’s story, an experience that was absolutely astonishing.

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I have a new favorite credit card. A while back I noted the advantages of the Diner’s Club Mastercard for those who rent cars frequently (it offers primary insurance coverage on rentals) – demonstrating that one great feature can be enough in some cases to justify one card over another, even if the card has an annual fee.

Recently I found another card that offers a compelling and unique feature, in this case with the added benefit of no annual fee (in fact, it’s provides cash back). It’s the Capital One “No Hassle Cash” Rewards card.

Not only is the card free, but with a 2% rebate on gas and most groceries and a 1% rebate on all other purchases, it’s one of the most generous of the cash back cards.

But that’s not what got me interested in this card. Nope, the beauty of this card is hidden in the fine print of the disclosure form. It says:

Foreign transaction fee: None.

Once upon a time, credit cards were absolutely the best way to buy things when traveling abroad. Not only did you get the best possible exchange rate, but there were no hidden charges. But card companies in their search for fees couldn’t resist the urge to tamper with a good thing and started slapping on all kinds of fees, not only using retail exchange rates but adding fees – some as high as 4%, on each foreign exchange transaction. Even traveler friendly companies like American Express jumped on the high fee bandwagon.

Capital One is the only bank I know of that continues to use the wholesale conversion rate and charge no additional transaction fees. www.capitalone.com

There’s been lots of dire talk about real estate and rising interest rates, but little practical advice to those facing an increase in mortgage payments (See “Time to Refinance?“). The Housing Bubble doomsayers seem to almost take pleasure at the prospect of vast numbers of foreclosures caused by the inability of people to make their rising payments. Personally, I’d rather contribute to preventing that if possible.

The biggest mistake you can make if you have an adjustable rate mortgage is to ignore the recent rate increases and hope that they won’t matter to you. This head in the sand approach is exactly the wrong way to address the situation. You’re much better off figuring out where you stand and preparing for it – and maybe, just maybe, reducing its impact.

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Over the past couple of days, 2cworth.com has posted a couple of great messages about the monthly mentality – the way marketers try to convince us to make large purchases or take on debt because we can carry the monthly payment.

It’s important to recognize that like so many financial issues, this one is actually more psychology than finance. That nice car is certainly affordable at a few hundred dollars a month. Why not buy that new sofa at only $15/month?

Learning to look at the real price of anything instead of the monthly payment is a good first step, but a better goal is to turn this completely around and look at the total value of small savings.

I have one friend who eats out every other day. Assuming she spends an extra $5 on each meal that she eats out (as compared to preparing the meal at home), what happens if she changes that to every third day? At first glance that saves $300 (60 times fewer eating out at $5 each). but it’s really better. Let’s say she can invest that money at 7%. That makes it $310. And if she’s in the 25% overall tax rate, it actually corresponds to a $387 effective pay increase.

There are all sorts of places one can give oneself a pay raise. For example:

• Drop a premium channel on cable.
• Check out your phone plan to make sure you’re getting the best deal for your needs.
• Increase the deductible on an insurance policy.
• Conserve energy – If you switch 15 100W bulbs used 5 hours per day to 23W fluorescents, at 10cents/kwh you’ll save $210/year – an effective raise of about $270.

It’s actually a simple habit to form – just translate every monthly transaction into its total cost for the year every time you think about it. Once you start thinking about the real cost of payments, and the real benefit of small savings, you may be surprised how easy some financial decisions become.

An ARM can be a huge money saver, or a time bomb. Unfortunately, there are a lot of time bombs out there.

In my previous posting, I focused on interest only mortgages and a couple of readers pointed out the risks of these mortgages – well actually, they pointed out the risks of adjustable rate mortgages, which are a different beast entirely (though they often come in the same package).

There are many variations of adjustable rate mortgages. The worst of them are those that allow for negative amortization – meaning the principal on the loan increases over time because your payments are not sufficient to cover the interest on the loan. These loans are evil and should be avoided in almost all cases (the one exception is a reverse mortgage used by some senior citizens to turn the equity of their home into income).

Adjustable rate mortgages have two separate issues that can magnify to either save you lots of money or cost you lots of money. First, they almost always start out with below market rates (either due to marketing discounts or rates bought down through points) which results in effective interest rate increases early in the life of the loan. Second, they vary with interest rates.

When are adjustable rate mortgages a wise choice?

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A friend of mine just pointed out an article in the San Jose Mercury News pointing out the dangers of interest only and flexible payment loans. Let’s ignore for the moment the question of negative amortization loans (evil! evil! evil!) and just look at interest only loans.

Let’s start by considering a hypothetical example of a $400,000 loan at 7% (not unreasonable numbers for a Silicon Valley condo).

An interest only mortgage payment will be about $2333/month.

A fully amortized 30 year fixed payment will be about $2661/month.

So the interest only mortgage saves you about $328/month.

Over the course of 30 years, for most people it’s a much better deal to have the fully amortized loan – you end up owning your house.

But it’s probably better to look at the loan over 7 years – the average time people own homes.

Because most of your payments during the early years of an amortized loan are interest, how much do you actually save in interest payments over that time?

Less than $6000.

You do end up with considerably more equity in the home: an extra $36,000 over what you would have had with the interest only loan, but that’s mostly because your payment is higher.

In other words, in this timeframe the mortgage is really acting more like a forced savings account.

How good an account is it? Well, for every dollar you pay on principal, you get a return of 7% (in the form of an interest reduction). You’ll be paying tax on it (in the form of a reduced mortgage deduction). Still, not a bad return.

So the real question is: do you have the discipline to save an amount equal to the difference in mortgage payments? In this example, if you have the discipline to save $328/month and the ability to invest it at a better rate than 7% (or obtain a better tax treatment, say by investing in holdings that produce long term capital gains), the interest only loan might be a better choice.

But if you don’t have that discipline, from a long term perspective you’ll probably do better going for a smaller home where you can afford the fully amortized loan. That is, unless property values are growing quickly, in which case you want the most leverage you can get – making the interest only loan a better choice.

But what about the risk?

Well, it depends on whose risk you’re taking about.

A fully amortized loan reduces the risk for your bank. In the event that property values go down, it reduces the chance that you’ll end up owing more than the home is worth and walking away from the loan or declaring bankruptcy. Bad for you, sure. But also bad for the bank.

From your perspective, there are two risks. There’s the risk of what real estate values will do, but that’s much the same regardless of which mortgage you have (you’re so highly leveraged either way that the amount of equity in question remains less than 10% of the loan value even with the amortized loan).

The real risk related to mortgage choice depends again on your own self discipline. If you are saving that extra amount each month, an interest only loan only increases your risk by the amount of risk in that outside investment. If you aren’t saving or investing that extra amount (or more) you aren’t “risking” your long term financial future – you’re just ignoring it.

In the book “Why Smart People Make Big Money Mistakes” (See review) the authors discuss the fact that we don’t count all money the same. In other words – you would think that a dollar is a dollar, but it isn’t.

If you find $20 on the road, you’re much more likely to spend it because it’s “found” money. Same thing with gifts or gambling winnings. We tend to to be much more careful with large purchases than small ones, even though the many small purchases we make can easily exceed the value of the larger purchase.

And then you have credit cards.

In the book, the authors describe an auction, where half the bidders were required to pay cash (they had a day to get the money) and half were required to use credit cards. The average bid of the credit card group was twice that of the cash group.

In other words, we tend to look at plastic money as less valuable than real money – even though it’s actually more expensive (because we’re paying high interest on it).

So I thought I would take some time and share my own experience and philosophy when it comes to credit cards.

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Most people who travel a lot know about the best cards for frequent flyer miles and features like baggage insurance. But for those who rent cars frequently or travel internationally, here’s one of the best kept “secrets” around. Most financial advisors will (rightly) suggest you avoid fee based cards. At $95/year, the Diners Club/Mastercard is one of the most expensive around. But for those who travel it can actually save you money. Here’s the trick:

Most cards today offer car rental coverage, but the coverage they offer is secondary – meaning that they pay after you’ve filed a claim with your insurance company. Diner’s club car rental coverage is primary – which means that they cover the collision damage without any claim on your auto insurance. That not only can simplify the claim process, it can protect you from a rate increase on your own policy.

From their web site:

For most Cardmembers there’s usually no need to file a claim with your own insurance company, so your personal insurance premium won’t be affected. For Cardmembers, the insurance covers physical damage and theft of the vehicle, reasonable loss of use charges, reasonable towing charges, and includes Secondary Personal Effects insurance.

As far as I know, it’s the only card that offers primary collision coverage.

In addition to a typical selection of benefits common among cards (like extended warranty, purchase protection, emergency services, reward program, miles on any airline, etc.), Diner’s club has another bonus for those who travel internationally – free access to an airport lounge in many international airports. If you’ve ever traveled internationally, you know that a few hours in an lounge (with it’s comfortable chairs, free snacks and drinks, computer workstations, etc.) can make a huge difference in comfort on a trip.

While this is certainly not a card for everyone, it’s unique features make it one that should be considered by every road warrior.

www.dinersclub.com