You and Your Student Loan--Suze Orman is Wrong About This Too

If poor financial advice were currency, we could get rid of the dollar and just trade copies of The Money Class in exchange for all goods and services.  A couple of months ago, I took exception to Suze Orman's statements that homeowners who are underwater on their mortgages need to simply "walk away" in a strategic default. 

Yesterday, Orman was featured on Marlo Thomas's blog on AOL and once again, I am encouraging readers not to follow at least one of her money tips.  Yesterday's AOL page featured six tips from Orman about money management.  Some of these are innocuous--for instance, Orman's advice to live below your means so that you are consistently spending quite a bit less than you earn.  But her tip about which debt to pay first is another piece of extremely bad financial advice from a woman whose financial views appear to line up closely with the Progressives in this country who don't care whether we as a society pay any of our bills as long as we make sure that the government always gets its share first.

Orman's advice was that the first debt we should always pay off is student loans.  In the letter from a viewer that Marlo Thomas read on the video program, the writer said that his credit card has a 2.99% interest rate and his student loan has a 6% interest rate, and he wondered which one he should pay first.  Orman replied that he should pay the student loan first, and not just because in this example the student loan carried the higher interest rate.  Even if the student loan carried a lower interest rate than the credit card, viewers should still pay the student loan first.  Why?  Student loans are government-backed loans which cannot be discharged through bankruptcy, while the credit card is unsecured debt which can be discharged in bankruptcy.  If you don't pay the credit card, says Orman, it's really not that big a deal.  "What can they really do?"

Really?  It is appalling to me that we have sunk to a level in our society where one of our leading financial experts constantly preaches the joys of defaulting on credit obligations.  Following Orman's logic, we should never pay for anything.  The fact that we knowingly took out a loan and that by refusing to pay it, we are actually stealing from the creditor is unimportant.  Morality is not an issue.  Nor, it appears, is just good old-fashioned common sense.

The reality is that typically student loans carry lower interest rates than credit cards.  With the Card Act of 2009 and now the Durbin Amendment which is part of Dodd Frank, we can all look for the interest rates on our credit cards to continue to rise regardless of our payment history.  My brother, who has spotless credit, was complaining last week when he was visiting that after the Card Act passed, all of his credit cards saw huge interest rate hikes. When he called to complain since he has a perfect pay history, the representatives told him that the interest rates are going up because of new legislation.  In other words, if credit card companies can no longer price higher-risk borrowers according to their pay history, they will make up their lost revenues by charging more to everybody.  So this whole concept of the cheaper interest rate on the credit card than on the student loan is disingenuous to start.

Second, student loans offer extremely favorable terms.  Not only are the rates low, but they offer fixed payments for a set period of time.  So if you pay their student loans on schedule, at the end of the fixed term the loans will be paid in full.  Since loan payment is often deferred until six months after you finish school, you have a chance to find a job and start working before repayment begins.  And since many student loans offer an interest-only feature for up to two years after payments commence, you ease into the payment.

Credit card balances, on the other hand, are revolving balances. Without making a concerted effort to pay them off, a credit card holder will be carrying that balance forever.  For that reason, the traditional logic has always been to put extra cash toward paying off the revolving debt--the credit cards--first and then concentrating on fixed, lower interest rate installment debt.

But Orman does not encourage us to spend years struggling to pay off our credit cards slowly. Instead, she quips that the cards can be discharged in a bankruptcy.  The implication is that since the creditor does not have collateral to back up the debt, we can walk away from this obligation unscathed.

That may sound nice, but it flies in the face of some basic facts.  Fact # 1:  A bankruptcy stays on a credit report for up to 10 years.  Ten years is a long time to have to explain why you were unable or unwilling to pay your debts.  Fact #2:  Bankruptcy ruins your credit, and in today's world, your credit determines much of your life.

I realize that in Orman's world, nobody needs credit because we are not going to be using credit--we all live below our means so we don't buy anything except what we have the cash to pay for. But a good credit rating is useful for more than just getting a flat screen with a surround sound system.  Many employers do routine credit checks as part of the hiring process. This is particularly true in federal government jobs and many corporate jobs where an applicant's ability to successfully manage his own financial affairs is considered an indicator of his overall integrity and competence.  In a society where high unemployment is a serious issue, filing bankruptcy so that you don't have to pay Visa can lock you out of a job that you would have otherwise gotten. 

Lousy credit costs money on so many different levels. Low credit scores cause insurance premiums to be higher than they would have otherwise been. And it can cause a financial institution to deny someone wanting to open a bank account.  Credit is tied to character in our society--poor credit makes a person a bad financial risk for all types of financial products--not just loans.

Your credit rating also determines the cost of all of your future credit.  And, yes, Orman's advice aside, someday you will probably want to have future credit.  For example, under the new qualified residential mortgages which have been proposed and are about to be implemented, a 60 day delinquency can prevent you from qualifying for a low interest rate mortgage.  Without pristine credit, you will be forced to go into a mortgage that will be approximately 3 times more expensive than the prime mortgages.  Again, I realize that in Orman's world everybody is supposed to be happy renting a home forever, but in America most people eventually want to own their own place.

Working in financial services for 13 years, I saw so many people who were victims of the same cavalier mindset toward credit that Orman teaches.  A few of them had a huge debt or collection that they could not pay due to a catastrophic circumstance--an illness, loss of a business, etc.  But many more had pages and pages of bad credit reflecting dozens of small decisions not to pay their bills.  I saw a lot of people whose credit was terrible because they owed a lot of money that they had not repaid, but normally they did not owe a great deal to any one creditor. What was more common was the borrower who owed lots of small amounts of money to many creditors and had let all of it go into collections.  They had the $35.00 collection from the video store because they never bothered to return the DVD and the $50.00 bounced check to the local chain restaurant. They usually had a number of small bills (under $200.00) for the portion of the doctor's visit that the insurance didn't cover. And they had the collection account to the satellite TV company and the mobile phone company for using their services and never paying the first bill.  Somewhere, years ago, these people embraced the idea that it was all unsecured debt and the creditors "couldn't do anything about it anyway."

Because they chose not to pay any of these bills, which in most cases they could have paid by doing a little budgeting, they paid more for everything else.  They paid higher interest rates on their mortgages, their cars and their insurance.  Because they had learned early in life that "nobody could make them pay" they went through life paying substantially more than they would have otherwise had to for almost every product and service they used.  And they dragged their bad financial decisions around behind them like Jacob Marley's chain--every year their credit defaults became a little heavier and more ponderous.

That is the reason that Orman's advice bothers me so much.  Even if today you do not file bankruptcy--if you just simply allow your credit cards to go into collection--you will be living with that decision for many years.  Collection agencies sell collection accounts as the accounts get old and every time they sell your account, your credit report updates as if it were a new collection.  Collections follow you around for up to seven years--even without a bankruptcy to formalize your refusal to pay.  And if later you decide to settle the balance with the collection agency so that you can get a loan, or a better rate on your car insurance, the difference between what you owe the creditor and what you agreed to pay becomes subject to federal income tax as taxable income.  So while you may get by with paying $1000 on a bill that was originally $2500.00, as far as Uncle Sam is concerned the remaining $1500 that you failed to pay is income and subject to taxation. When you decide to "stick it to the man" you look up in a few years to find out that you were the one who got stuck.

One thing Orman is right about--student loans must be paid.  The government has powerful collection tools including the ability to garnish wages.  But they are not the only debt that needs to be paid. And to say that they need to paid first before everything else is ridiculous. Pay them as scheduled and pay them off.  That should leave funds to deal with your other debt. When you purchase on credit, implied in the contract with the creditor is your promise to pay.  And unless you are willing to keep that promise whenever possible by paying your bills, you can never have any genuine financial success.

For books by Alexandra Swann visit her website at http://www.frontier2000.net/

The New American Poverty Part I

This week as we get ready to celebrate Independence Day, I am taking a look at the American Dream as it stands today.  The American Dream is dying around us--being murdered actually--and although Progressives such as Suze Orman say this is a good thing, I disagree.  The country that has offered so much opportunity to so many is fast becoming a land where freedom from responsibility trumps freedom to dream, to achieve and to succeed.

When we hear the words the American Dream, many of us think immediately of homeownership, since for millions of people, the ability to own our own homes has embodied the American Dream.  For many Americans, their home represents their largest single investment.  But there is a concerted effort today in this country to steal that dream of homeownership from most Americans and reserve it instead for the wealthy and privileged.

In her book "The Money Class", financial guru Suze Orman encourages homeowners who are underwater in their houses because they owe more than the house is worth to walk away from those homes in a "strategic default."  Her rationale is that the housing market will not come back for 20 years, so it is ridiculous to make payments on a house that is not going to increase in value, even though if the loan is a fixed rate principle and interest loan, the payments are reducing the balance owed.  Even though a decision to practice strategic default ruins the creditworthiness of the person, and may mean that in today's tough lending environment the homeowner may not ever be able to purchase a home again, Orman tells us that this is okay.  It is okay to rent for the rest of our lives, because we are about to experience "The New American Dream."

Orman anticipates that in the future 60% of Americans will be renters (a very interesting number considering that 60% was roughly the number of Americans who were home owners before the boom and subsequent bust.)  She says that in the future all homebuyers will be required to put 20% down as a downpayment and have at least 8 months of mortgage payments in their savings on top of the down payment.  But this too, is a good thing she says, because in "The New American Dream" people don't aspire to have much materially.  We have enough to cover our needs and we don't have the stress that prosperity apparently brings.

What many people do not seem to understand is that the concept of putting 20% down on a home mortgage is not the traditional way of purchasing a home in the United States.  A couple of months ago, I wrote a blog post about this entitled, "The Myth of the 20% down payment."  If you don't believe what I am saying, I invite you to read that post which has a lot of supporting documentation to back up the following statement:--in the last 80 years, during which the U.S. has experienced an explosive growth in homeownership, many Americans have purchased their homes with less than a 20% down payment.  And many of them have been excellent homeowners.

The problem today is that Progressives want to re-engineer our society to be something it has never been. And since the desire for homeownership is so deeply ingrained in our American psyches, and since acquiring a home represents tangible wealth for many Americans, the first place to start is to strip us of the opportunity to own a home of our own. 

The Dodd-Frank bill, which passed last year, is really designed to lock Americans out of homeownership.  By killing the primary delivery system for mortgage loans--the independent loan originator--the government has assured that less mortgage money will be available.  And by introducing guidelines such as the Qualified Residential Mortgage, which is virtually unattainable for most Americans, Dodd-Frank guarantees that most would-be homeowners will never qualify to buy a home.  Currently the comment period on the Qualified Residential Mortgage Proposal has been extended two more months, through August 10, 2011, to give the public an opportunity to weigh in on the proposal. But after the comment period ends, we can expect to see the following guidelines:  20% mandatory downpayment, debt to income ratios of no more than 36% percent, and no 60 day lates on consumer credit in the past two years.  Fewer than 20% of people who bought houses on "A" paper loans in the last decade will qualify to purchase a home under these new guidelines.  As a result, overnight we will become a society of renters.

What many forget is that Chris Dodd and Barney Frank of Dodd-Frank were deeply involved in the housing boom that led to the housing bust.  As a then junior member of the House Financial Services Oversight Committee, Frank recommended his significant other for a job at Fannie Mae in 1991.  Frank admits this, but denies that there was any conflict of interest.  And though for the past several years Frank has spewed vitriol about evil mortgage entities getting rich off of the people, he did not seem to object to Fannie Mae's excessive executive bonuses as long as his partner was one of the executives.  Just to put this in perspective, former Fannie Mae CEO Franklin Raines, who left Fannie Mae in 2004, reportedly earned $90 million from 1998 to 2003, and $52 million of that was performance bonuses for Fannie Mae reaching its lending goals.

Chris Dodd was equally involved in the mortgage boom.  Dodd was part of "Friends of Angelo" an exclusive list of power brokers to receive mortgage loans from Countrywide CEO and founder Angelo Mozilo.  Mozilo built Countrywide from a small mortgage company to one of the top residential mortgage lenders in the United States.  Although many people associate Countrywide with mortgage brokers, Countrywide actually had a huge retail network of branches throughout the country and bragged that over 50% of their loans were done in house.  Always on the cutting edge, Mozilo pioneered the "Fast and Easy" loan which allowed borrowers with good credit scores to state their income and assets without documentation.  The program became a huge success among the self-employed and  those who generally did not want to have to document what they earned or what they had saved.  In fact, "Fast and Easy" became something of an industry standard--in order to compete other companies copied the program and stated income stated asset loans became the norm.

In 2007, I had dinner with a friend of mine who was the Vice President of Ohio Savings Bank--a regional bank competing in the wholesale market.  That evening she told me that Angelo Mozilo had just dumped his stock in Countrywide--just as problems in the subprime market were about break open.  "Countrywide is going to be another Enron," she told me.  But Countrywide was not Enron.  True--they were taken over by Bank of America, but unlike Jeffrey Skilling, Angelo Mozilo is not sitting in a prison cell--nor will he ever be.  Through the "Friends of Angelo" program, Mozilo had made residential mortgage loans at below market rates to special people who had the power to help him later in what amounted to a series of very well placed bribes.  So when his company collapsed, he had "Friends" in high places to make sure that he did not collapse with it.

These two bastions of morality profited personally from the huge housing boom and then used the ensuing crash as an excuse to give us Dodd-Frank--at 2000 plus page bill which has codified into law financial ruin for this country and for Americans individually.  The same bill which authorizes HUD to hand out $1 billion in the form of "lottery" to subsidize a tiny percentage of mortgages for the next two years (see my post "The Mother of All Entitlements" if you are unsure what I am referring to) also sets up safe guards to make sure that in the future we will be a society of tenants rather than homeowners.

And financial guru Suze Orman seems to be the lead cheerleader for the Progressives. Orman and her Progressive friends tell us that we should not worry about being renters.  In The New American Dream we live within our means, and we focus on "what really matters" rather than materialism. But destroying home ownership has nothing to do with the American Dream--new or old.  Instead, this is about a calculated re-engineering of our society to create The New American Poverty.  In the New American Poverty, we know that home ownership is beyond the reach of all but a few elites.  Our society is content to own nothing, to have nothing, to aspire to nothing because we know that as individuals we have no future and no opportunity.  Having never experienced the thrill of success, we will not feel the sting of failure. We will know neither achievement nor disappointment--we will just exist.

If individual homeownership is no longer an option, then what do we have to look forward to?  Tomorrow, I will look at the Progressive's model for the new American lifestyle.

                                                                                           
                                                                            

Suze Orman is Wrong--Don't Walk Away

On Sunday our pastor decided to preach about the dismal state of the economy and how we should react to it.  During the sermon, he mentioned that his brother's house is worth fifty percent of what it was purchased for and that his brother has no choice but to walk away from his home.  Now, our pastor's brother is self-employed, and I don't know his specific set of circumstances; if he can no longer make the house payments on his house due to loss of income he may, in fact, have no choice but to walk away from a home he can't sell.  But more and more, we are hearing that if our houses have lost value we should just "walk away" from what has turned out to be a bad investment.

One vocal proponent of "walking away" is financial guru Suze Orman who has been quoted in numerous articles stating that those who are "underwater" in their mortgages should walk off and let the houses get foreclosed on.  This past Monday, Ms. Orman appeared on "The View" with what has become her new rallying cry, "If you are upside down in your mortgage and the bank will not work with you, walk away from the house."

In Orman's book The Money Class, she advises borrowers, "Do the calculations everybody. How much is it costing you to actually stay in that house? How many years will it take for you to pay more for that house than it is worth? If it's 3 years, 4 years, 5 years, are you kidding me? That's a house you really need to say bye bye.  It's not worth the money."   Orman advises people who are upside down in their home mortgages to try to get the bank to modify the loan.  Failing that, she says that homeowners should seek out a short sale or a deed in lieu of foreclosure. "If they won't do that, then walk away. It's just how it is."

The fact that a respected money expert is telling American borrowers that they can and should default on their loan obligations when they have the ability to repay is really a sign of just how far we have fallen as a nation.  It is deplorable to think that we have come to a place as a society where defaulting on our obligations is considered some kind of a moral high road.

CBS Sacramento carried a story on April 28, 2011 of borrowers who did just as Orman suggests and let their homes go into foreclosure because they no longer have the equity they once did.  Mary Beth and Bob Stucky were underwater $200,000 and the bank refused to reduce the principal, so they walked away and became renters.  They are now renting a larger house for a smaller payment, and although they may not be able to buy a home again for many years, they say they feel "peaceful" because they realize that their home was a "bad investment."  CBS Sacramento also interviewed Rob Sorenson who walked away from his home and allowed it to go into foreclosure.  All of his credit had previously been good, but his decision to allow his home to be foreclosed on resulted in his having all of his credit cards cancelled so that when his dog got sick and had to go to the vet he had actually had to borrow $2000.00 from a family member since he does not have any access to credit.  So he has not only defaulted on a major obligation, but he has actually become a burden to family members who are having to loan him money that he used to be able to borrow on his own.

Other than the nuisance factor, what is really wrong with walking away from a home that is underwater?  Plenty.  For one thing, it doesn't make any sense.  If you have a fixed rate, fully amortized mortgage for thirty years, or fifteen years, or twenty years, you know at the time that you sign the mortgage documents how much your monthly payment will be and also how much you will be paying for that home.  The truth in lending document included in every mortgage package contains the exact dollar amount you can expect to pay for that loan over the life of your mortgage, and it is normally two to three times higher than the amount you borrowed due to interest and finance charges.  So in that sense, every mortgage holder is upside down on his or her mortgage when they sign the papers.  But if you have not suffered a job loss, a health crisis, or a financial tragedy, you have no reason not to make those payments.  Why?  Because the appreciation or depreciation on the house is just a number that changes arbitrarily.  When properties were appreciating at a skyrocketing pace, no homeowner ever went back to their mortgage company and said, "I know I bought this house for $200,000 and I financed $150,000 but now it is worth $500,000.00 so I think I owe you some additional money."  So why, in the reverse situation, should the bank lower your principal simply because the value has dropped?  You didn't owe them more when the values were rising, and you don't owe them less now.

If we had no moral obligation to pay for things that depreciated, no one would ever make a car payment again.  Virtually everyone understands that the moment they drive their car off the lot, it has less value than it did twenty minutes before when it was sitting on the lot.  If we applied the same logic to all items as we do to homes, we could not have any credit system at all since the moment that something became old or worn we would no longer need to make the payments.  The problem with housing is that we no longer look at our homes as a place to live.  We have decided as a society that our houses are supposed to contain enough equity to pay for our summer vacations and to give us a credit card  to spend on whatever we wish during the  year.  If the house can no longer be a source of free fun money, it has failed us and we should not have to pay for it.

Second, the boom was artificial, and so is the bust.  When real estate values were booming, we all seemed to forget the basic principles of gravity "What goes up must come down."  Right now we are in a double dip, and values are dropping this summer and will continue to drop for a while as underwriting guidelines continue to tighten.  But, after that, we can look for values to rise again as properties become more expensive.  That house that today is worth $200,000 less than it was 4 years ago may have regained its losses in 5 to 10 years.  In any event, when you walk away from a home you are making the payments on, you are throwing away all of the money you have already put into that home, which is ridiculous. 

Third, although some people are forced into foreclosure by financial circumstances, many have other options.  Most borrowers who are practicing strategic defaults have high credit scores and have not suffered a job loss.  They simply do not see the value in making their payments.  If you want to move into a cheaper house fine--how about renting your current home to someone else?  As more and more people are forced to become renters, the demand for rental housing is going to grow.  For a little effort, you can save your property and your credit.

Fourth, odds are very good that the house you are walking away from today may well be your last.  As underwriting guidelines continue to tighten, many homeowners who have abandoned their homes for no reason are going to be shut out of homeownership in the future, either by much higher interest rates and financing costs, or by credit guidelines that do not give them a second chance.  And Orman actually knows this.  She says that the new American dream may not include ever owning a home again.  "And if you do rent for the rest of your life, it's not a big deal. Who cares? Just invest that money you would've put in your home somewhere else....The new American dream really is a dream that allows you to sleep at night where you feel secure, and you know what is yours cannot be taken away again, because of the actions of others."

That's just nonsense.  Orman acts as if strategic defaulters go off to a happy paradise with no more problems.  Renters make the payments on properties that other people own and put wealth in the pockets of property owners--period.  And while "what is yours cannot be taken away again" what is not yours certainly can be.  Your landlord can lose the house you are renting to foreclosure if he does not make the payments regardless of whether you are making your payments to him or not.  Or you can find yourself in the same situation as a woman who recently called me to tell me that her landlord is not renewing her lease because the landlord has decided to give her house to her own son and evict the tenant.  Life does not come with guarantees, whether you rent or own.

Finally, homeownership provides security for people in their senior years.  While young couples in their thirties and forties may not feel the pinch of renting, older Americans have typically relied on having their homes paid off as part of their retirement.  A home that is paid off is good security towards any financial crisis, and many communities now protect seniors against out of control property taxes.  Reverse mortgages provide seniors with the option of using the equity in their homes to offset living costs or to get rid of a mortgage payment that is too high.  A home that is owned free and clear provides a senior with many options that a renter simply will never experience.

Orman is pushing all of those unhappy homeowners out there to hurry up and default sooner rather than later since the federal tax break for foreclosures and short sales will expire at the end of 2012.  That would mean that if you default on $100,000 debt in 2013, you owe federal income taxes on $100,000.  So in addition to ruining your credit and your future homeownership chances, you will owe a massive tax penalty to the IRS.

If you have lost your job, experienced a divorce resulting in loss of income, or gone through some other life changing experience beyond your control that has cost you your home, don't beat yourself up.  Life happens.  But if you are considering strategic default because your home is not worth what it used to be, don't be fooled by this concept that you are going to be better off "letting the house go." In the end, you will be better off if you act responsibly and meet your obligations--either by continuing to make the payments or finding a tenant who can make them for you.  A few years down the road, when values have recovered and houses are very difficult to purchase, you will be glad you held on to your property.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books.  For more information, visit her website at http://www.frontier2000.net.