What Went Wrong in the Mortgage Industry

We have all heard about ARMs - Adjustable Rate Mortgages and Interest Only Mortgages and Balloon Mortgages, but how did this debacle start? In 1929 the Glass-Steagall Act was passed to prohibit banks from accepting both deposits and underwriting securities. In 1999, the Gramm-Leach-Bliley Act was passed which effectively repealed this separation for many large financial institutions.

Investment banks had previously assisted lenders in raising more lending funds. They had the ability to offer longer-term fixed interest rates by converting loans into bonds. The banks would make house loans in the form of a mortgage, and then use the investment bank to sell bonds to fund the debt. The money from the sale of the bonds can be used to make new loans. This is called securitization. The banks began to securitize loans themselves, and the investment banks also became lenders.

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Which Debt Should I Pay Off First?

There is good debt and bad debt. Good debt is called good debt because it is tax deductible if you itemize your taxes. This includes mortgages, some types of student loans and business loans. It makes no sense to speed up paying off low-interest, tax-deductible debt if you have any other kind of debt. You should first pay off your highest-rate, nondeductible debt first. Do not pay more on your mortgage at the expense of not saving more for retirement. The sooner you start saving for retirement the more you will save because of compounding. Plus you can’t get back an opportunity to contribute to a tax-advantaged retirement plan once you have missed your chance. Withdrawing from your retirement early should never be considered. The money you will lose in the long run, plus the taxes and penalties that you will have to pay now make this a very bad choice. You will sacrifice 1/4 to 1/2 of what you withdraw to taxes and penalties. Borrowing from your retirement is a bad idea also. An additional risk to borrowing from your 401(k), is if you lose your job, you have to pay back the loan in a short amount of time or it will be taxed and penalized as a distribution.

A Mortgage is Good Debt - Don't Pay It Off Credit Cards are Bad Debt - Pay Them Off

If things get really bad and you end up in bankruptcy, the credit card debts can be wiped away. You don’t want to risk losing your retirement money also.

Focus on paying off bad debt which consists of credit cards, unsecured loans, and loans that are not tax deductible. Start with the highest interest bad debt and pay more towards it each month until it is paid off. Then focus on the next highest.

Why America is in the Mess It is In

The Federal Reserve Board does a survey every three years of Consumer Finances. This post is based on the results published from the 2004 survey. The results for 2007 have not been published yet. The 2004 survey is based on 4,522 families that were interviewed.

Average Debt Has Increased

The average debt for families from 1998 to 2001 increased by 5.2%. From 2001 to 2004 the average debt increased 33.9%. The reason for the large increase was home-secured debt, home equity lines of credit and second mortgages were taken out against the increased value of homes. Normally this is seen more in the higher income brackets, but the lowest wealth group in 2004 had the highest rate of borrowing - 86%. Home-secured debt rose 27.3% from 2001 to 2004.

The Tax Reform Act of 1986 created an incentive for homeowners who needed more funds to borrow against their home equity. They could no longer deduct the interest payments on other types of loans from their taxes, but they could on their residence.

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Answers To Your Questions About Managing Credit Card Debt

We are receiving several questions about existing credit card debt and whether to close open accounts with no balance. So I will answer several of your questions here.

1. Should I close open accounts that have a zero balance?
   • Leave at least one open to show you have more credit than you are using.
   • Don’t close them all at one time. Close one or two and then check your credit report and credit score in about 60 days to see how it affected your score.
   • Close newer cards with zero balances. Keep older cards that show a lengthy and successful credit history.

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