Reporter, SmartMoney.com
THINK YOU'RE TOO SMART TO make a dumb financial move? Think again. Remember all those folks who plunked their money into tech stocks in the late 1990s?
Here are the top five to avoid.
Grabbing a 'No Interest for a Year' Deal
These days, you can't go into a furniture or electronics store without seeing a "No Interest for a Year" offer. Sounds enticing: You get the product now, interest-free if you pay it off within the specified time frame. Such offers are now available at stores like Sears, CompUSA and Crutchfield.
But be careful with these deals. To get them, you often have to apply for a store credit card. What happens then? If the balance -- even a penny of it -- remains unpaid once the interest-free period is over, all interest payments that would have been charged without the offer are typically slapped onto your balance. "You'll still owe all the interest, and oftentimes it's at 20% APR or higher," warns Pam Poldiak, a fee-only Certified Financial Planner (CFP) in Roanoke, Va. Worse yet, if you make nonpromotional purchases on the same card, your payments are usually applied toward the no-interest balance, while new purchases accrue interest at full speed.
To protect yourself, read the fine print before you charge up that new card: Companies are obliged to fully disclose the terms of their promotional offers. Just recently, Home Depot and GE Capital Corp. agreed to pay $672,000 for pulling this exact trick on its customers in Connecticut and not disclosing their practices properly.
Clinging to Losers
Do you have some duds in your portfolio that you hope someday will recover? It's a common mistake, according to Rick Rodgers, a fee-only CFP in Lancaster, Pa. "A lot of investors think that way," he says. "Psychologically, they don't have a loss until they actually sell," he says.
To see if you're suffering from this syndrome, consider each investment in your portfolio and ask yourself, "Would I buy this again today if I could?" If the answer is no, it's time to get out. The good news: You can use the loss to offset capital gains -- a move that can cut your tax bill significantly. For more on how to do this, click here.
Signing Up for Biweekly Mortgage Payments
Biweekly mortgage payments sound like a great way to pay off your mortgage earlier and save on interest. Here's the pitch: Instead of sending one monthly check to your mortgage company, you make a payment every two weeks for half the amount. That adds up to 26 payments a year -- the equivalent of 13 monthly mortgage payments. The extra payment is applied to the mortgage principal.
But unless you plan to retire soon, prepaying your mortgage may not make sense, according to John Discepoli, a Certified Public Accountant (CPA) and fee-only CFP in Cincinnati, Ohio. Because interest payments are deductible -- basically lowering your after-tax mortgage interest rate -- you may do better if you invest that additional payment elsewhere. To see if prepaying makes sense for you, crunch the numbers here.
Moreover, these programs are typically pitched by third-party companies that charge a set-up fee of $300 or more. "There's really no reason to pay an outside source to do for you what you can do for yourself," says Keith Gumbinger, vice president of mortgage information firm HSH Associates. Mortgage lenders usually offer a biweekly payment schedule directly, or you could just opt to send in an additional monthly check each year without setting up anything official. Bottom line? If you want to prepay, do it on your own.
Buying Too Much House
The McMansion expansion has financial planners worried. At issue: taking on massive mortgage debt. The real estate boom has made what used to be exotic products like interest-only mortgages or 103s and 107s (which require no down payment and actually let you borrow 3% or 7% more than your home's price) more common than ever.
The problem: These products come with big risks. If you purchase a house with an interest-only mortgage, for example, you will have low monthly payments but won't build any equity in your house until you start paying off the principal. Should real estate prices stagnate or even decline at the time you choose to sell, you may actually owe money to the bank. (Confused? Click here for an explanation of how interest-only loans work.)
"When people have to do an interest-only mortgage because they can't afford a principal-and-interest payment, they forget that in [several years' time] the payment will change to principal-and-interest," says Cheryl Hancock, a fee-only CFP in Charlotte, N.C. "Will they be able to afford it then?"
How do you know if you can afford your mortgage? Consider the rule lenders used way back when mortgages basically came in two standard flavors, fixed and adjustable. Your principal and interest payment should not exceed 28% of your gross monthly income, and your total house obligation -- principal, interest, taxes, insurance -- should not exceed 36%. To crunch the numbers yourself, click here
Funding Junior's 529 Plan, Forgetting About Retirement
When it comes to saving for the kids' education or saving for retirement, who wouldn't put their kids first?
But doing so is a mistake. As expensive as college may be, saving for retirement is a much more massive -- and, yes, important -- undertaking. The rule of thumb for retirement planning is that folks should aim to have at least 80% of their current annual income as their annual retirement income. For someone earning $100,000 a year, that means they'll likely need to withdraw $80,000 a year from their savings (or slightly less, if you factor in income from Social Security) for thirty or more years.
So max out your 401(k) and if you really want a comfy retirement, sock money away in an IRA to boot. Then start saving for your kid's college fund. Remember, if you come up short on the college bills, loans are available. That's not true of retirement. Come up short there, and you just may be bunking down with your kids once again — once they're all grown up.
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