By: Kathryn Canavan
April 19, 2010
The road to financial hell is paved with alluring options: credit cards, payday loans, reverse mortgages, 401(k) raids and more.
And even though parts of the economy are starting to look stronger, the unemployment rate remains at 9.7%, many families are absorbing weeks of unpaid furloughs and others are simply trying to rebuild what they have lost.
Don't compound your problems by making these eight major money missteps:
1. Raiding your 401(k)
Don't think of retirement savings as "now" money. It's money you've really got to save for later, says Mackey McNeill, a CPA who serves on the American Institute of Certified Public Accountants' Financial Literacy Commission.
"Our parents' generation generally worked for someone who gave them a pension check for the rest of their lives," she says. "Today, we actually control our pensions. People think, 'I can see those dollars there. They have my name on the account. I'm going to use that money.' "
It's particularly foolhardy to dip into your 401(k) if you're in danger of bankruptcy, McNeill says, because retirement accounts are protected under bankruptcy laws in most states. You don't have to surrender your retirement to get a fresh start.
"Some people use their IRAs, and then they wind up in bankruptcy, anyway," she says. "So now, they're bankrupt and they don't have any retirement."
2. Walking out on a mortgage
If you owe more than your house is worth, walking away is not your only option, providing that you still have some income to pay a mortgage. McNeill says the first step is to look honestly at your finances and determine whether you face a short-term issue or a long-term one.
Short-term means you just got laid off and have no savings or small savings, but the job market in your town is such that you can probably get some part-time or full-time work to keep money coming in. Long-term means you've been unemployed, you've depleted your savings, and you don't see a way back into the job market.
"If it's long term, then you can't afford your home anymore," McNeill says. "The faster you recognize it and make plans to let it go, the better it will be. Put your best foot forward to sell your home. Move into a smaller, less-expensive place and preserve your capital for when times are better for you.
"If it is a short-term situation, talk with your mortgage lenders and see if they will suspend or lower your payments over the next three to six months," McNeill says.
For information about modifying your mortgage, go to MakingHomeAffordable.gov, a website sponsored by the federal government with the goal of helping the 12 million American families whose homes are now worth less than they owe. The site lists HUD-approved counselors who will work with you for free. If you do not use the Internet, you can contact the program toll-free at 888-995-4673.
3. Ignoring the card balance
Although credit card usage dipped more than 13% in February, almost 15% of American families still owe more than 40% of their income, according to the Federal Reserve.
A credit card should be used strictly as a convenience, not as a means to spend more than you can afford, says Ken McDonnell of the American Savings Education Council.
"Ask yourself the question, 'Do I really need that?' Or, more important, 'Can I afford it?' These aren't radically new concepts."
McDonnell recommends reading the new government-mandated box on your credit card bill that shows how long it will take to pay off your balance if you pay only the minimum and how much interest you pay to carry a balance.
"You won't get out of debt overnight. It's going to take time," he says. "Behavior modification just doesn't happen overnight."
4. Debt-wipeout scams
Be careful when talking with debt-consolidation firms.
"Most of the ones I've seen are shams," says McNeill. "I would be very, very cautious. Pretty much, stay away."
An alternative: Seek help through a local United Way chapter, which provides referrals to non-profit counselors, or through the non-profit National Foundation for Credit Counseling.
5. Co-signing a loan
If a friend or relative asks you to co-sign a loan, it means his credit is so shaky no lender will give him money on his own merits. Why should you?
"Co-signing is a business transaction, but people don't think of it as a business transaction. They think, 'I'm helping my friend out,' " McDonnell says.
"But what you're really doing is co-signing for a loan," McDonnell says, "and you could be on the hook for that."
Nessa Feddis of the American Bankers Association says you should always assume you will have to repay the loan you're co-signing.
"I would be more cautious about co-signing for a romantic relationship than in a parent-child relationship," Feddis says. "Relationships can end up badly. There can be a lot of acrimony, and that could change someone's interest in repaying that loan."
6. Payday loans
About 19 million Americans have resorted to these high-interest loans, although the number has dropped in the past year.
They are marketed as short-term cash advances to meet emergency expenses between paychecks.
But consumers often become trapped in repeat borrowing, says Jean Ann Fox of the Consumer Federation of America.
For the average two-week payday loan, the annualized interest rate ranges from 391% to 521%, says Kathleen Day of the Center for Responsible Lending.
7. Reverse mortgages
Older actors pop up on television marketing these mortgages as an easy income stream for seniors who are house-rich and cash-poor. But the fees and other costs associated with reverse mortgages can sometimes be considerably higher than on other loans.
David Certner of AARP says a reverse mortgage may be a reasonable choice for some homeowners, especially the nearly one-third of retirees who have almost no income other than their Social Security checks, but the high fees associated with it make it a last resort, not a first resort.
Other options: Take out a home equity loan. Sell your home and move to a smaller, less-expensive one. Or sell your home to your kids and create a multigenerational family under one roof. When you die, they can use their inheritance to pay down the mortgage.
8. Trying to stiff Uncle Sam
"If you look at the small print when you sign your tax return," says Gerald Feffer, a Washington, D.C., tax attorney, "you'll see that basically you're affirming that everything in it is accurate and true."
What happens if you are audited and everything is not accurate?
"If it's a small amount, and it's accidental and not intentional, it will be resolved," Feffer says. "If it's a large amount, and they can be sure it's intentional, then they could charge you with fraud, and there could be penalties involved."