The Dollar Stretcher : layoffs

Savings In an Uncertain Economy

Gary — Tue, 09 Jun 2009 13:10:00 GMT

At a time when unemployment has jumped from 5.5% a year ago to 9.4% in May, 2009 it's understandable that people are concerned about their jobs. source: Bureau of Labor Statistics

And their response has been predictable. The personal savings rate (personal savings as a percent of disposable personal income) was 5.7% in April, 2009. That's a 14 year high. source: Bureau of Economic Analysis

The same BEA report indicated that personal consumption expenditures (PCE) declined by 0.1%. In other words, many of us have shifted from spending money to saving money.

That's supported by statistics from the Federal Reserve. "Consumer credit decreased at an annual rate of 7-1/2 percent in April 2009."

So it would appear that much of the money that's not being spent is going to pay down credit card balances.

Under normal circumstances that would be the right thing to do. Pay down the most expensive debt first - i.e. the loan that charges the highest interest rate.

But, for many families these are not normal times. If you are concerned that your income could be cut or cut off, you might need to consider an alternative plan.

Let's look at a situation where your income is cut and is not sufficient to meet all of your bills. And, let's assume that you have a mortgage, one car loan and various credit card balances.

After a cut in income, the first thing you should do is to talk with anyone that you owe money to. Explain that your income has been cut and you need an adjustment to your payment schedule. Some companies will work with you. Others will not.

Next, you need to decide in what order you'll pay your bills. You already know that your income is not high enough to pay all the bills. So someone will not get paid.

Naturally, you'd want to pay the most important bills first. That would be your mortgage. Right behind it would be groceries to feed your family. A roof over your head and food in your tummy are pretty essential.

OK, now for the challenging part. The money that's left isn't enough to cover the car and credit card payments. What should you do?

What would happen if you fail to pay? If you don't pay your auto loan after a few months they'll repossess your ride. That could make job hunting more difficult. Not a pleasant thought.

On the other hand, if you don't pay your credit card bills you can apply for credit counseling. Typically they'll reduce your interest rate and lower your minimum monthly payment. The bad news is that your credit score will be negatively affected and you'll be expected to quit using the cards.

Not being able to use credit cards will be inconvenient. You'll need to use cash to buy groceries and other essential items. But, that can be done.

So logic tells us that it's wisest to pay your auto loan before your credit card bills. But, what does that have to do with today's extra savings at a time when you are able to meet all your obligations?

It may not be best to use that extra income to pay off the most expensive (i.e. credit card) debt today. The reason is simple. In a crisis you'd much rather have that extra money tucked in a savings account or CD so that it could be used to make mortgage and car payments later. The more money you have in savings the longer you can hang on with a reduced income.

There's a cost to this strategy. Instead of retiring 14% credit card debt, you'll be earning 1 or 2% on the savings. So it's fairly expensive insurance.

But, if you think that there's a good chance that you could see a significant cut in pay or lose your job, it might be something to consider until the danger passes. Remember that if you lose your job you won't get a 'do over'. Having some money in savings could be essential to your family's survival.

They say that extraordinary times call for extraordinary measures. This might be one of those times.

Keep on Stretching those Dollars!

Gary

New Car Payments for Layoff Victims

Gary — Tue, 14 Apr 2009 17:45:00 GMT

The new car market is dead. According to AutoData Corp in March 2009 auto sales were 36% lower than March 2008. So the manufacturers are trying to find ways to kick-start sales. And, being the marketing wizards they are, they came up with a beauty.

Here's the latest from General Motors, Ford and Hyundai:

"In GM's case, the automaker is offering to make up to nine months of payments of up to $500 each if you lose your job for what it calls "economic reasons." Ford says it will make up to 12 months of payments totaling $700 per month or less. Naturally, there are additional terms and conditions, starting with the time limit. GM's offer could be renewed, but for now it applies only to cars purchased before April 30. Ford's deal applies to cars purchased before June 1."

Wow! What a great offer! Well, actually not. Yes, it would be nice if someone made your car payment for awhile if you got laid off. But, if you go for this deal and do get laid off, you'll still be in a heap of trouble.

To see how, let's put together some hypothetical situations. We'll compare purchasing a new car (in this case a Ford Mustang 2 door coupe), buying a 5 year old used car (also a Mustang) and doing a little fix-up on your current wheels.

A new Ford Mustang lists for $20,430. According to Cars.com invoice is $18,877. So let's say you negotiated a really good deal and got it for $18,800. And, let's further suppose that your trade-in or cash deposit was $1,000. So you were financing $17,800 for 60 months (5 years).
A 60 month new car loan rate averages 7.38% according to Bankrate.com
and their payment calculator says your monthly payment would be $355.66. So to put those new wheels in your driveway you've reduced your savings by $1,000 and committed to a $355.66 payment for five years.

What happens if you bought a 5 year old Mustang? It would cost $8,004 retail according to Edmunds.com. You could expect to find 60 to 70,000 miles on the odometer. Hardly a new car, but still one that should be dependable and provide good transportation.

Let's suppose that you paid full retail for the used car. And, you put the same $1,000 down. So you'd be financing $7,004. A 36 month used car loan averages 7.74%. Your payment would be $218.64. Those wheels cost you your $1,000 savings and a commitment to a $218.64 payment for 3 years.

So what happens if you buy the new car and get laid off? Let's assume that six months from now your job disappears. So Ford graciously pays your auto loan.

If it takes a year to find work Ford will have paid $4,267.92 (12 payments of $355.66 each) for you. That's the good news.

But the bad news is that you still owe another 42 months (3 1/2 years) at $355.66 per month ($14,937.72). And, your new job might not be paying as much as your old job. Plus you accumulated some other bills while you were laid off. That car payment could look pretty steep. Selling the car is probably not going to be an option. You'll still owe more than it's worth at this point. Bascially you're stuck making the payments on a car you cannot afford.

On the other hand, you could have bought the 5 year old car. You get laid off in six months just like before. No one is offering to make your car payment, but your Mustang is worth just about what you've borrowed on it. So you have the option to sell it and walk away.

An even better option would be to keep the car you have now. Especially if it's dependable. Even if you have to put a few dollars into it. You'd have no car payment.

In fact, let's suppose that you spent $1,500 fixing up the old ride. Put the whole thing on your credit card. Didn't even use the $1,000 that was the down payment when you were car shopping. If you're paying the national average of 12.35% interest (CreditCards.com), and you paid off $218.64 (what you would have paid monthly for the used car), you'd have the credit card balance paid off in 8 months (Bankrate.com calculator). So if you got laid off in six months you'd only have to face two payments.

But, let's look at a more extreme case. What happens if you don't find a job for two years. Well, Ford is still going to start looking for your monthly $355.66 payment after 12 months. And, by that time you're probably going to be squeezed financially. Selling the car still won't be an option. You'll be upside down in it. Let's face it, you'll be cornered.

So my advice to anyone considering GM or Ford's offer? Steer clear of it! This is an accident waiting to happen. And even airbags won't save you in this crash!

Keep on Stretching those Dollars!

Gary

The 401k Layoff Trap

Gary — Tue, 31 Mar 2009 17:43:00 GMT

I was surprised at the "Borrow from your 401k" suggestion. While it's true that it's better than cashing out, so many people are being laid off unexpectedly. When this happens, it must all be paid back or considered a cash-out, which comes at a time when people are least able to repay because they just lost their job. It should at least have been mentioned as a consideration. -- Deborah in San Diego

Deborah makes a very interesting point. She's referring to an article entitled "Need Cash" that discusses 10 ways to raise cash quickly if you're in a jam.

How widespread is the problem? It's hard to find many statistics on 401k loans. But a Harvard report cites two statistics that point to trouble. The vast majority of plans allow for borrowing (over 85% in 2005, Investment Company Institute, 2006). And they also report that 18% of 401(k) participants had a 401(k) loan in 2006.

We can't know for sure, but it's probably not an unreasonable guess that about one in five or six people who are laid off will have a 401k loan outstanding when they get the pink slip.

And, that's when Deborah's problem comes in. As a general rule, if you leave your employer you need to repay the 401k loan in full. You may be given a month or so, but that's it.

Any amounts that you fail to repay are treated like a withdrawal. That means that you add the amount of the loan to your income and you'll pay normal income taxes on it. Plus, you'll be liable for a penalty that equals 10% of the unpaid loan.

What can you do about it? First, if you have a 401k loan and think that you could lose your job, you need to take it seriously. Begin by estimating how much the taxes and penalties would cost you if you didn't repay part or all of the loan. It'll be bad. But since your income will be lower than previous years (because of the layoff), your tax rate should drop (that assumes no tax rate hikes).

In any event, you need to have some idea of how much the penalties and taxes are. You'll want to compare that to the cost of other alternatives.

There are a couple of withdrawal exceptions that might help in a layoff situation:

You were age 55 or over and you retired or left your job
You paid for medical expenses exceeding 7.5% of your adjusted gross income

What if you don't fit into one of those categories? Your options are limited, but you still have some choices to make.

Now might be the time to consider selling a car. Your ride needs to be worth more than any loans on it. Any cash you raise could help pay off the 401k loan. If you're not working transportation won't be such a big issue. You can always buy another car when you're employed again.

Do you have a homeowner's line of credit or enough equity to refinance your home? That could provide some money to repay the 401k loan. Refinancing will be easier before you lose your job. So you might want to consider this if you expect to be laid off.

Using your credit card to pay off the 401k loan is a high-risk strategy. You'll probably pay a higher interest rate. And, you'll also need to keep making payments even if your income has dried up. Plus, you'll be consuming part of your credit line that you may need later.

The only advantage to shifting the debt to a credit card is that you avoid the tax problems of a 401k withdrawal. But it's wise to compare the numbers before you make a decision.

The unfortunate fact is that most 401k loans were promoted as an painless way to 'borrow from yourself'. Turns out that's not so true if times get tough.

Keep on Stretching those Dollars!

Gary

Preparing for Recession

Gary — Wed, 23 Jan 2008 15:40:00 GMT

Lately it seems everyone is talking about a possible recession (or even a depression). When the Federal Reserve drops rates by 3/4% between meetings it's probably time for all of us to take notice. No one knows for sure whether we'll end up with a recession or not. But, as we all do know, it's always better to be prepared for financial challenges. Just in case.

The first thing is to know what your current position is. Are you spending more than you're making? Do you even know? Where does your money go each month? The only way to really find out is to track your spending for a month and compare it to your income. Don't forget to include items that happen just a few times a year (property taxes, auto insurance, etc). If you are working you should be making more than you're spending each month. That extra money can be used for paying down debt or building an emergency fund.

Next, pay down debt. It's easier to survive a job loss if you don't have a lot of bills each month. Now is the time to reduce credit card balances. Even it it means taking a second job or cutting off cable television. You'll be tempted not to do anything. Just remember that if you do lose your job it will be too late.

Look for big savings items. With lower rates now might be the time to refinance your home or car. Compare insurance rates. Make sure that you really can afford the house or car you're paying for. Typically if your house is over 40% of income or your car is over 20% you need to do radical surgery. That means moving to a cheaper home or car.

Take a serious look at your food/grocery/eating out expenses. Most people spend 15 to 20% of their money on food. But, it's real easy to spend more. And, it can happen a little at a time. That luscious $4 dessert won't bankrupt you by itself. But, it will take you one step further from your goal.

Look at your employment situation. If you're honest with yourself, it's not that difficult to recognize job troubles ahead. Is your employer in trouble? Is the whole industry suffering? Could your job be done by someone else for much lower pay? Either within the U.S. or without? Does technology threaten your job? If you can answer 'yes' to any of those questions, you'd be wise to consider what your life would be like without your present job.

Ask yourself if you'd be likely to find the same type of work at a different employer. It could be that your field is changing. That happened to me. If you're facing a similar situation begin learning a new trade now. Don't wait until you lose your job. Waiting will only make the transition longer.

No, I can't say whether you'll be affected by a recession or if there will even be a recession this year. But I can tell you that you'll be better able to handle one if you begin preparing now.