Only if it makes sense for you

Roger Schlesinger
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Posted: Jan 22, 2007 9:33 AM

Everyone wants to know how to handle their finances and whether or not there is a pat answer. The pat answer is simple; it's getting there that is the tough part. The answer is only if it makes sense for you, and you are the one who has to make the judgment call. I certainly can tell you if it makes sense or not, but you are the one who has to make the call as the consequences are yours not mine. You may decide to abdicate the decision, but you can't escape the consequences so you might as well make the call yourself. It is up to me to show you the best way to analyze the situation and to show you the pros and cons of any plan.

You have a house, a mortgage and most likely a home equity line of credit (Heloc), some credit cards, a car payment and who knows what else. If you have been in this situation for a while and it isn't getting any better, then doing the same thing you have been doing isn't going to help. So why not take a different look at the problem? You may begin to recognize the beginnings of a solution. With that type of background, the sheer willingness to take a look at another approach may be enough to shed some much needed light on your situation. Once you grasp the basics, the rest is easy. There are two approaches to the problem. One of them is more analytical and the other more practical. Both should give you guidance and if you can allow yourself to work with both of them, you will do very well for yourself. The first is a comparison of the numbers which I consider the practical look and the other is the analytical approach which s a comparison of the "blended life rate" versus the rates on the solutions. We will examine both and then turn the exercise over to you to help you make a decision for your future.

Let's take a look at the numbers. Take all of your debt and add up the monthly payments for the various instruments. Then take all of your debt and add that up. Now you know what you owe and how much you are paying on a monthly basis. Assuming you owe $300,000 and have total monthly payment sf $2400, you can begin to check alternative ways to save money. You could take a 30 year fixed and pay about $1825 a month or a 15 year fixed and pay a little over $2500 a month. You can take a fixed rate for the first and second mortgages and a short term second for the credit cards and other shorter term obligations. There are many ways to structure a program including doing nothing. I don't recommend doing nothing as I'm guessing that is the one solution, or lack thereof, you have probably already tried and that, in itself, is the whole reason why you're here to begin with.

The analytical look is a method of arriving at an interest rate on your entire financial life. That means blending all the interest rates you have, with a weighted average, and seeing what that blended rate is. Once you know, then you can understand what type of interest rate you need to better your financial position. To discover your blended rate, take each debt and multiply it by its interest rate. That will give you the annual interest payment on each debt. Then add up all the annual payments and divide them by the total debt you currently have, and this will give you your blended rate. You will find that student loans have a very low interest rate followed by your mortgage, auto payment and second mortgage or Heloc. Then it starts to get out of hand with your credit cards and some installment debt.

Remember that your blended rate is what it is. If you were thinking that your rate would be in the 7% range. and you have a fair amount of credit card debt, $40,000 or more, you might find that your blended rate is closer to 9%.

Now you have the tools to improve your financial being dramatically. You know how much money it costs you to maintain your current financial situation, and you also know what blended interest you are paying. This information may lead you to taking a shorter term loan on your house for the entire outstanding debt because you may readily see that it could save you 2 or 3% in interest even though it isn't saving you very much in actual payments. On the other hand, you might take a longer loan because it is saving you a good amount on a monthly basis, and although the rate is higher than the shorter term loan, it is still considerably lower than your current blended rate.

At this point people will write and tell me you can't get out of debt by borrowing. I am not an advocating "new borrowings" in general but am simply showing you how to manage your current debt in a more advantageous way. I am showing you how to take a shorter loan and pay it off quicker and as a result, saving you a large amount of money in the long run. In other words, I'm showing you how to trade your high interest debt in for a lower interest obligation. Managing your money through a better financial plan without basically increasing your balance is not borrowing to get rid of debt--it is using financial tools to better your life.

Before I finish, I must bring up reserves, or savings, once again. I wrote a column on July 18, 2006 "What Reserves?" that everyone should read . You cannot improve your financial life without reserves because the first unplanned occurrence will send you right back to the credit cards for an answer to the problem. Everyone should have a minimum of six months mortgage payments in the bank, but ideally, they should have six months expenses in the bank. Ultimately, you really need one year's income in the bank to be totally prepared in the event of a personal emergency or some sort of natural disaster. While at that point, an event of that nature might set you back a bit, with the proper preparation, it would not have the power to finish you off financially.

This column is about you and only you can decide whether it is appropriate for you. "Only if it makes sense for you" means that each financial plan should be tailored to the individual: your plan may not be appropriate for someone else and vice versa. I wish you luck with your plan, and better than that, I wish you financial success from this point forward.