Episode 16
In this episode of Getting Money Right, we’re continuing to answer some of the most common money questions from our listeners.  Knowing the answers to some of these questions can help you tackle some of the challenging financial decisions you might face in the future with greater a chance of success.

Show Notes:
 

1. Unique Terms on my credit report - what do they all mean?

  • Default - A failure to make a loan or debt payment when due. Usually, an account is considered to be “in default” after being delinquent for several consecutive 30-day billing cycles.
  • Charge-off - The balance on a credit obligation that a lender no longer expects to be repaid and writes off as a bad debt.
  • Collection - An attempt to recover a past-due amount by a credit agency or collections department.
  • Settled in Full vs Paid in Full - Paid in full means you paid the entire loan amount in full while settled in full means you negotiated the amount and paid a portion of the loan.
  • Delinquent - A failure to deliver even the minimum payment on a loan or debt payment on or before the time agreed. Accounts are often referred to as 30, 60, 90 or 120 days delinquent because most lenders have monthly payment cycles.
  • Installment debt - Debt to be paid at regular times over a specified period. Examples of installment debt include most mortgage and auto loans.
  • Bankruptcy - A proceeding in U.S. Bankruptcy Court that may legally release a person from repaying debts owed. Credit reports normally include bankruptcies for up to 10 years.
  • Discharge - Granted by the court to release a debtor from most of his debts that were included in a bankruptcy. Any debts not included in the bankruptcy – alimony, child support, liability for willful and malicious conduct and certain student loans – cannot be discharged.
  • Foreclosure - A property has been foreclosed (house).
  • Check with each credit bureau for a glossary of terms and how to read your credit report.

 

2. What should I do if my auto loan is upside down?

  • Vehicles depreciate very fast in the first year or two - $2,000 or more immediately.
  • A $30,000 vehicle will $7,400 in the first year.
    • $600 a month lost, while the payment is about $550.
    • $100 of the payment is going to interest if you have a 5% interest rate.
    • That means that you’re actually not paying off the car as fast as it goes down in value.
    • That’s how you get upside down on a car loan.
    • After 1yr, you owe about $24,500, but it’s only worth $22,500 - upside down $2,000. You’d have to pay the dealer at least $2,000 to take back the car you just bought from them a year ago.
    • The problem gets bigger if you buy a more expensive vehicle, or something that is rare and unique so not many buyers are looking to buy it, so it’s harder to sell and the depreciation is even higher.
    • Imagine you buy a $45,000 truck, it could easily depreciate by at least $10,000 the first year, leaving you with big payments and no easy way to sell the vehicle and get out from under it.
  • General rule of thumb is to not have more than 35-45% of your household income wrapped up in vehicles (depreciating assets). So, if the family earns:
    • $40K * 35% = $14,000 vehicle
    • $50K * 35% = $17,500 vehicle
    • $60K * 35% = $21,000 vehicle
    • $70K * 35% = $24,500 vehicle
    • $80K * 35% = $28,000 vehicle

 

3. Should I use my 401(k) or other retirement funds to pay off debts?

  • 4 reasons to never borrow from a 401(k)
    • You’ll miss out on the earning your investments would have generated.
      • No, you paying yourself back with 4% interest is not a good idea because it’s nowhere near what you would gain if you left it in.
      • Fail to pay and A $10,000 loan taken 20 years before retirement if not paid back could cost you as much as $57,000.  That 10K at a 10% interest compounded over 20 years would grow to $67,000.
    • You’ll pay tax twice on the money you borrow and the interest you pay
      • First, when you pay it back (after-tax money)
      • Second, when you take it out at retirement.  
      • IRS cannot distinguish between pre-tax (your normal contribution) and after-tax (your loan repayment) money, so you’ll pay taxes on that money twice.
    • If you default on the loan you’ll get a large tax bill.  It will be considered income so you’ll get taxed at your income tax rate and if you’re under the 59 ½ the withdrawal will be considered an early distribution, which will add another 10% penalty.
    • Leave your employer and you’ll need to pay the loan back in full within 60 days.  Doesn’t matter if you left voluntarily, were fired, or the company failed.
  • Exception: you can’t pay your bills and have to file bankruptcy or default on a loan.
    • You should do whatever you can, get a second job, sell stuff, and spend less before you cash out your retirement account.
    • Assets should be minimized and not be a lifestyle.

 

RESOURCES

Budget Forms and Tutorials
Spending Guidelines
Envelope System Video