Monday, June 26, 2006

11 common financial misadventures

Based on an article from CNNMoney, with added commentary and numbers by the Finance Wonk. Also check out the new live news feeds!

Most readers here are probably aware of most of these but the details are interesting and I've added some numbers to impress your friends at parties.

Interest-free financing

You really want a new high-efficiency front-loading washing machine, but the $1,200 price tag is hard to swallow. Don't worry, says the salesman, the store offers interest-free financing for 18 months. Deal?

NO DEAL! Paying the minimum every month (usually 4 percent of the balance) will never clear your debt within the interest-free window. And when that promotional period is up, you're typically socked with interest that was actually accruing during those 18 months, at a rate as high as 20 percent.

If that happens, you could end up paying more than $755 in interest before you've paid off the machine. You might be tempted to game the system - to put $1,200 in a high-yield savings account for 17 months and 29 days, pay off the balance and pocket the interest. But that'd net you only about $75. Besides, no matter how you play it, borrowing from a finance company can really hurt your credit score.

Open bank account, get bonus

The bank down the street is handing out a free portable DVD player to anyone who opens a new checking account. Deal?

DEAL IF...you're okay with the terms of the account. These types of splashy promotions are designed to lure customers away from other banks, and often you have to keep a minimum balance or pay a certain number of bills a month online.

But be sure to keep up your end of the agreement, or else the bank could charge your account for the retail cost of the gift. It's also worth noting that the bank reports the value of the bonus to the IRS as taxable interest income.

What's more, the taxable value the bank reports on your gift is often higher than the "street price" you would be willing to pay for the gift. You can pay more in taxes on the gift than you would be willing to spend to buy one.

Extended warranty

Your new PC is just a few mouse clicks and $700 away. Like most desktop computers, it comes with a limited one-year warranty. But for another $190, you can extend the coverage to four years. Deal?

NO DEAL! There's a reason extended warranties are highly profitable for manufacturers: Buyers seldom cash in. PCs, and consumer electronics in general, are very reliable these days.

"If you take care of your equipment, you really don't need a warranty," says technology analyst Rob Enderle of the Enderle Group.

Besides, four years is an eternity in the computer world. If your PC breaks down in three years, you'll want a newer, faster machine by then, not a replacement. Save the $190 for a down payment on your future upgrade.

One of the few places extended warranties make sense is on the older cathode ray type big-screen TVs. Those tend to have 2-3 service calls in a 4 year span and you tend to keep a big TV at least that long if it keeps working.

Cheap stock trades

Eager to take charge of your investments, you're intrigued by an ad for an online brokerage account: $4 trades! Deal?

NO DEAL! To get the low rate, you may have to make 10 or more trades a month, which will run you at least $480 a year. Worse, your investment performance is likely to suffer. Studies show that the most active traders underperform their less manic peers.

You're better off paying a more pedestrian $12 a trade and keeping your inner Jim Cramer in check. In other cases these low rates apply only to automatic investments (stocks you buy on a recurring basis). But $4 is a big commission if you're investing only a few hundred dollars per month.

Balance transfer cards

You open your mailbox to find a pre-approved offer for a credit card charging 0 percent interest on balance transfers for 12 months. Sounds tempting, especially since you're paying off a balance at a high rate on another card. Deal?

DEAL IF...you plan to do all of the following: Put only the balance on the new card, never pay late, and pay off the entire amount in 12 months. (First you'll want to find out how much the fee for the transfer is; you don't want it to cancel out the benefit.) If that much discipline makes you cringe, read on.

NO DEAL IF...you're not so diligent. This card charges 0 percent on balance transfers, but unless otherwise stated, not on new purchases. What you charge gets hit with a higher rate (sometimes 18 percent), and your payments typically go toward the zero-rate balance first.

Even if you're slowly paying down the balance, the finance charges on new purchases are piling up.

Plus, miss a payment - oops - and the rate on your balance transfer could go from 0 percent to 30 percent in a second.

Car financing vs. rebate

You're at an auto dealership, about to sign for the $30,000 SUV of your dreams. You saw it advertised with a $2,000 rebate. Now the salesperson is dangling 0 percent financing instead. Deal?

DEAL IF...you plan to keep the car for a while, generally at least four years. Only at that point will the interest savings top the amount of money you could have gotten back in the rebate, says Jesse Toprak of Edmunds.com.

In this instance, with 0 percent interest over five years, you'll pay only the $30,000. The same car with the rebate, no down payment and 7 percent financing over five years would cost $33,266. (To weigh other offers, check the Decision Calculator: Low APR vs. Cash Back at Edmunds.com.) If you have the money to buy the car outright but instead put it into bonds and pay off the $30,000 on zero interest over five years from the money you invested you make about $750, less than the rebate.

Manufacturers and dealers usually extend these incentives when they're having a hard time unloading inventory; with SUVs right now, fuel prices have made the vehicles unfashionable. So be aware that you may give back some of your savings in the form of a lower resale value down the road.

No-cost, low-rate Home Equity Line of Credit (HELOC)

You've been thinking of opening a home-equity line of credit when you see the following offer in the window of your bank: no-cost heloc! 2.99 percent. Deal?

NO DEAL! First of all, banks don't usually charge to establish a line of credit, says Keith Gumbinger, a principal at mortgage-data provider HSH Associates. So don't let the no-cost offer sway you.

And that teaser rate? It'll expire, usually within six months; then your HELOC may balloon to the prime rate plus one or two percentage points, while a bank across town is offering prime minus one.

For the real bargains, look to the smallest lenders in your market. Because they don't have the money for big ad campaigns, says Gumbinger, "the little guys compete on pricing."

And don't try to hop from teaser rate to teaser rate. The lender will likely hit you with an early-termination fee if you close the line of credit within the first three years.

10 percent off with store card

Bonanza! Your new fall wardrobe, all in one store! Grand total: $1,000. Ouch. As you pull out your wallet, the sales clerk pitches you on the store credit card: "It'll save you 10 percent. That's $100." Deal?

NO DEAL! Store credit cards generally charge rates over 20 percent. So if you carry a balance, your finance charges will quickly wipe out the $100 you saved.

Say the card charges 21 percent and you make the minimum payment of 4 percent each month. In six months you'll have paid $99.28 in interest.

Put your new outfits on a regular bank card with a 10 percent rate, and you'll pay only $46.20 in interest.

But there's another reason to shun a new store card: Every credit application will ding your credit score, and applying for multiple cards over a few months can really cut into your rating.

That said, it's probably okay to do this once or twice in a lifetime. Simply keep the card for a while, use it occasionally and pay promptly; you may be able to undo the damage.

Don't even think of doing this if you might be applying for a home loan within 3 years. The ten points off your credit score might raise your mortgage costs thousands of dollars over the life of the loan, all to save $100 at the counter!

Cash back on gas

You've just blown $45 on gas for the second time this week when you see an ad for a credit card that gives 5 percent cash back at gas stations and supermarkets. Deal?

DEAL IF...you never carry a balance. The catch with giveback cards is that they generally charge interest rates at least one percentage point higher than a standard card's. No problem for you if you pay in full (just make sure you choose a card that is low fee or no fee).

Your challenge is earning the most cash for your spending patterns, says Curtis Arnold of CardRatings.com. If you charge less than $15,000 a year, choose Citi Dividend Platinum Select (800-248- 4226), which pays 5 percent back on gas and groceries, up to $300 a year. If you charge more, you can earn more with Blue Cash from American Express (800-223-2670). But...

The Finance Wonk carries a Citi Divident Platinum Select and has for years. 5% back at Supermarkets, Pharmacies, and on Gas, 1% on everything else. You have to log on and request checks regularly but if you pay your bills on time it's free money. I also have a Costco AMEX that I use for all my travel (2% back) and restaurant dining (3%), then I have a Discover Platinum for everything else (1-2% back, but better redemption terms). All told my family gets over $1,000 back per year. For now the IRS has deemed that non-reportable income, making it the equivalent of a lot more salary [the Finance Wonk is in a very unpleasant tax bracket because he runs his own business].

NO DEAL IF...you ever carry a balance. "If you pay interest on a rewards card, you lose the value of the reward," says Catherine Williams, vice president of financial literacy at Money Management International.

Forget about rewards and look instead for a card with a low interest rate.

A free credit report

After hearing so many ID theft horror stories, you're nervous. What about those free credit reports you see advertised? Deal?

NO DEAL! Here's what you won't see in a commercial: Under federal law, each of the major credit bureaus (Equifax, Experian and TransUnion) must give you one free credit report a year. The only place to get them is AnnualCreditReport.com.

And what about the offers you've seen on TV and the Web? These kinds of sites (among them, FreeCreditReport.com and FreeCreditProfile.com) are hawking credit monitoring services. You'll have to sign up to get your "free" report, and if you don't cancel within 30 days, you'll be charged $10 to $13 a month.

Unless you've been a victim of identity theft, you don't need to pay for a monitoring service.

I consider these service ads very nearly criminal, as their whole business model is hiding that they are charging you money. But you SHOULD go get your free reports at AnnualCreditReport.com, and only there. If you stagger the 3 agencies you can get a credit report every 4 months, which is what the Finance Wonk does.

Supersizing at the cinema

Your movie ticket cost $6.50. Now they want $8 for a small popcorn and a small soda. But you can get a medium popcorn and a medium soda, which look three times as big, for just 50ยข more. Deal?

DEAL IF...you were planning on investing in the small combo anyway. You do pay less per cup on the medium soda and popcorn.

The reason the concessions folks can afford to be so generous: They buy popcorn and soda cheap and then sell it to you at what some experts estimate to be a 90 percent markup. So they can throw in a few extra cups, knowing you'll smell a deal (or is that the delicious aroma of hot buttered popcorn?).

Granted, you're also tripling up on calories and fat. So, uh, maybe base this decision not only on your wallet but also on your waistline.

The main reason the theater's want you to trade up? They share most of the ticket revenue with the movie studios, but get to keep the concessions revenue for themselves.
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