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A New Era...Types of Debt and Loans

Now we are digesting all of this. As a nation, we are moving out of recession and into a new economic era. We are adjusting to the new benefits, rules, and programs that came out of that mountain of legislation. As consumers, we are learning to take advantage of the new programs while learning to live without the easy money that used to be all around us. That's not so bad -- the money really wasn't that easy after all.

In the following pages, I'll take you through all that is new about managing debt in the United States, circa 2010 and beyond. We'll discuss every unique type of debt, from credit cards to mortgages, in great detail. I'll show you where the traps are hidden and where the great new opportunities lie.

For starters, here is a quick overview of the major types of debts that most Americans deal with, along with the recent changes and trends in each area.

  • Mortgages. The biggest and most important debt for most Americans, mortgages have changed dramatically, and changed again. Now we are in an era when mortgages are moving back to more traditional forms -- plain-vanilla, 30-year fixed-rate mortgages dominate the marketplace. There are still some variable-rate mortgages.

Mortgages are secured loans -- they are backed by the property on which they are written.

There are two new government-backed programs for mortgage holders who are in trouble. One allows homeowners to refinance their homes, even if the homes are worth less than their loans. A second one encourages mortgage lenders to modify mortgages for troubled borrowers by lowering interest rates and payments.

  • Home equity lines of credit (HELOCs). These lines of credit are backed by your home, and give you a lot of control over your money. You can use them to fund renovations, buy cars, pay bills, and more, and repay them on your own schedule, as long as you are making monthly minimum payments as big as your monthly interest costs. Disciplined homeowners can really make their HELOCs work for them by using the equity accelerator technique described later in this book. You can use a HELOC to burn your mortgage faster than you ever thought possible.

Bankers tend to like home equity lines, too; they don't typically resell them, so the loans stay in bank portfolios, producing cash. There are still many HELOCs on the market, and competition from lenders wanting to place HELOCs with homeowners.

  • Reverse mortgages. These products put money in the hands of elderly homeowners in exchange for repayment when the home is sold. They used to be prohibitively expensive, and they still can carry some high fees, but they have been improving. They work best in very specialized situations. An older person who is not well and doesn't want to leave home can use a reverse mortgage to pay for care. A reverse mortgage typically reduces the amount of equity that heirs inherit.
  • Credit cards. It's almost impossible to live without credit cards now, but they have gotten more complicated than ever. Consumers who carry credit card debt balances -- about half of all cardholders -- are at the mercy of card issuers that have been jacking up rates and fees as aggressively and unconscionably as I've seen in my decades-long career.

New government rules slated to go into effect in 2010 will limit issuers' ability to retroactively raise rates and trap consumers into late payment charges. Many in the industry say issuers will stop offering generous cash-back deals and start charging annual fees. Those moves may make it harder for the half of consumers who pay off their bills every month to really profit from credit card use, but there is still enough competition in that space to make me think you'll have some good choices for a while.

  • Car loans. The typical car loan has gotten longer and costlier over the years, but troubled automakers are making amends with price cuts that may outweigh the zero percent financing offers that used to rule. Washington has been offering its own incentives; in 2009 it offered a sales tax credit to car buyers. Congress also enacted a "cash for clunkers" incentive for car buyers who turn in old, gas-guzzling cars. Lease deals, which used to be prohibitively expensive, now sometimes rival car loans as a less expensive way to buy a car.
  • Installment loans. When stores offer no-interest-for-a-year deals, or agree to finance your TV, computer, or new living room furniture, that's an installment loan. They can be pretty pricey, and rarely are the best way to pay for a purchase. The no-interest promotions have largely dried up; those that remain usually are carefully constructed to trap the borrower into paying interest. You have to monitor them very carefully. Some medical offices are now offering their own installment loans, usually for high-priced procedures that
    insurance doesn't cover, such as LASIK eye surgery or cosmetic surgery.
  • Student loans. The way in which families pay for college is shifting dramatically. That's a good thing. In the late 1990s and early 2000s, increased dependence on costly private loans put some graduates into so much debt they had to give up on favored careers and grad school. Now the federal government is the direct, primary lender for a much larger share of student loans, and rates have come down. There's a host of new repayment plans that offer great leniency to students who graduate and enter low-paying public service careers.
  • Retirement plan and life insurance loans. You can borrow money from yourself. Many companies allow workers to borrow against their own 401(k) accounts; in those cases the interest you pay back is paid into your own account. Most advisers do not recommend this strategy; it removes money from an account you should allow to grow until you retire. But this can actually be a reasonable place to borrow money in an emergency; it costs less than some other forms of debt.

Cash-value life insurance policies also allow account holders to borrow their own money back. This, too, can be a reasonable way to meet emergency expenses or even pay for college or other big costs, especially if you no longer need the full life insurance death benefit.

Other Kinds of Loans

There are a couple of other categories not discussed in this book -- payday loans and tax refund anticipation loans, for example. I do not consider either legitimate enough to include in a book about debt mastery; you can't be the master of a sleazy product that preys on the poorest in society and charges fees and rates that can approach 500 percent on an annual basis. Just avoid them both; that's all there is to say about them.

I also haven't discussed margin loans in this book. Those are funds that investors borrow to pay for bets they make on stocks, bonds, and commodities. They are very risky indeed, and best left for an investment book and not a debt book.

But except for those examples, the earlier list includes all of the types of loans and debt that most Americans contend with. Each has its advantages and disadvantages, its own pitfalls and rewards.

You may use them all at different times of your life. To truly master them, to take the greatest advantage of each type of loan, to snag the lowest rates, to keep your payments manageable, and to get yourself completely free of debt when you need to be, you'll have to be both disciplined and determined. But first, you'll have to start at the beginning, by figuring out exactly where you stand.

For a more detailed account of how credit became a worldwide obsession that took control of our lives and what can be done, by you and by the government, to help regain our independence from the heavy burden of debt, you must read Master Your Debt by Jordan E. Goodman with Bill Westrom.

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