5 money mistakes in a bad economy

5 money mistakes in a bad economy

Making
a blunder with your finances can make a downturn even worse. Here are
tips for sidestepping the pitfalls in credit cards, investing, college
costs and other areas.

By Bankrate.comConsumers
have plenty to worry about during a challenging economy, and making a
wrong move in personal finances could make a bad situation worse. Obtaining
cash through credit cards, retirement plans and home equity could end
up being a costly quick fix. And complacency over personal investments
and looming college costs could lead to missed opportunities for
keeping hard-earned dollars.Here's how to avoid some common pitfalls during an economic downturn.1. Living la vida Visa

One
of the most common responses to a financial crisis, such as a job loss,
is to continue spending with credit cards, says Gail Cunningham, a
spokeswoman for the National Foundation for Credit Counseling."We're
great spenders but lousy savers," Cunningham says. "We're a hopeful lot
of people. We keep thinking that our ship is going to come in."But
the reality is that it typically takes a job seeker one month to
replace $10,000 of lost income, she says. So a prospective employee
should expect it will take five months to replace a $50,000-a-year job.Rather
than continue a lifestyle financed by credit cards -- and compounding
debt in the process -- consumers should "circle the wagons" by figuring
out where they spend their money, Cunningham says.

• Talk back: How has the poor economy affected you?
  

Just
as calorie counters keep logs of each meal and snack, consumers should
keep a meticulous watch on incidental purchases, including meals in
restaurants, nights at the movies and gourmet cups of coffee. Think of
it as an expense report to yourself."Nobody likes to do it, but
you can do anything for 30 days," Cunningham says. "Tracking your
spending is one of the most basic elements of financial stability."Once consumers have a handle on spending, do they have to go cold turkey on all of the good life's trappings? Not necessarily.Cunningham suggests that cutting back on some expenses is better than cutting them out.Comb
through cable bills, cell phone plans and other services for lower-cost
alternatives. Folks who haven't watched HBO since the finale of "The Sopranos" or have never started a conversation with a text message may save a few bucks per month by dumping these options.What to do:

• Stop using credit cards.
  

• Track monthly spending.
  

• Cut down, but don't cut out, your lifestyle spending.
  

2. Invading your nest egg

Economic
downturns have a way of drying up consumers' liquidity. Meanwhile,
creditors only get thirstier. But as tapped-out consumers have fewer
options to get cash, they may be tempted to withdraw from an individual
retirement account or borrow from a 401(k) plan.Taking
cash out of a traditional IRA can lead to a double whammy of a 10%
penalty and taxes of at least 25% if the individual is younger than 59
1/2, says Ira Marks, a certified financial planner in Lawrenceville,
N.J.For example, a couple with a combined yearly income of
$100,000 who withdrew $25,000 would pay a $2,500 penalty, plus a tax of
$6,250, for a total of $8,750, Marks says. State taxes would also be
added.Taxes and penalties would be more for a couple who earn
more money. A couple who make $200,000 annually would pay $10,833 for
the same $25,000 withdrawal, Marks says.There are exceptions, such as if the withdrawal is made to pay for medical expenses, he adds.Another
caveat to note: If the money is replaced within 60 days, there will be
no taxes or penalties -- good to know if you need a quick infusion of
cash for a college tuition payment before a commission check comes in,
for example."But most people don't become aware of that until
they are working with their tax preparers the following year," Marks
says. By that time, the 60-day window to avoid losing money to taxes
and the penalty has closed.For a Roth IRA, a person younger than
59 1/2 who withdraws the earnings within the first five years of
opening the account would pay the 10% penalty and taxes. There is no
penalty or tax assessed when direct contributions (not including
rollover contributions) to a Roth IRA are withdrawn.People who
may be leaving their jobs soon -- voluntarily or not -- may want to
think twice before borrowing against a 401(k) plan. Once an employee
leaves a company, the loan turns into a taxable withdrawal, triggering
the federal government's 10% penalty, Marks says.Video on MSN Money



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What to do:

• Consult a tax preparer or financial planner before tapping into retirement plans in order to understand all the associated costs.
  

• In
  some cases, withdrawals from a traditional IRA can be subject to a
  federal 10% penalty and can be taxed. But an individual can avoid these
  costs if the withdrawal is paid back within 60 days.
  

• Withdrawals from a Roth IRA can be subject to a 10% penalty, but there are no additional taxes.
  

• Withdrawing
  from an IRA should be the last resort because it diminishes money set
  aside for retirement. However, if faced with a catastrophe, such as
  foreclosure on a home, it may be a justifiable move.
  

Continued: Paying for college3. Paying for college without seeking aid

An Aug. 20 Sallie Mae/Gallup survey
indicated that one-fourth of families with children in college did not
send in the Free Application for Federal Student Aid, or FAFSA, for the 2007-08 school year."It's
probably the simplest thing you can do to make sure you're not missing
out on free money or low-cost money," says Patricia Nash Christel, a
Sallie Mae spokeswoman.The federal government uses the
information on the form to determine an applicant's eligibility for
Pell grants, subsidized Stafford loans and other financial aid, she
says. Private organizations often use the information when awarding
scholarships.The survey also found that only 9% of the 1,404
families questioned reported using a 529 savings plan, a
state-sponsored investment account that accumulates tax-free earnings.
Those with a 529 plan used up to $8,000 toward last year's education
costs, which on the average were $14,628, according to the survey.Meanwhile,
38% of the families surveyed paid for tuition, room and board, and all
other college-related expenses with personal income.Christel
says parents are so committed to sending children to college, seeing it
as an investment in their family's future, that they often give little
thought to education costs and what happens after graduation, such as
paying back loans and what the student's income will be after school
ends.What to do:

• Complete
  and send in the FAFSA, even if the fall semester has started, to be
  considered for federal grants and loans for college.
  

• Families with younger children should investigate college savings options, including 529 plans.
  

• Find plans administered by each state as well as track loan rates and calculate contributions to the plan at Bankrate.com.
  

• Sallie Mae's Upromise Web site offers a rewards program that allows consumers to contribute to 529 plans through everyday purchases.
  

• Other
  college savings options include custodial trust accounts, in which a
  child owns the money but the account is controlled by a parent or
  guardian. Coverdell education savings accounts may be used to pay for
  elementary and high school expenses as well as college.
  

4. Investing inertia

Long-term
investing used to be easier: Pop the cash into the mutual funds and
annuities, and watch the returns rise like bread in an oven. But even
consumers with a little dough are prone to avoiding the complex
implications that the volatile stock market may have for their
investments.Lyle Benson, who owns a financial-services firm in
Baltimore, says investors can get lulled into complacency when they
should be reviewing their asset allocations to make sure they are
keeping up with earnings targets.

• Talk back: How has the poor economy affected you?
  

Though
a portfolio should always have some amount of stocks to ensure growth
in the long run, keeping too many stocks during a down market can be
costly, Benson says. Sheltering cash in Treasury bills or bonds can
help a portfolio hold up in a bear market.Older investors are
often attracted to the low risk of certificates of deposit, especially
because some analysts are projecting rates will increase in the coming
months.Benson advises investors to avoid locking in large
amounts of cash for periods longer than a year. An investor hasn't
gained anything if living expenses increase 4% or 5% and the deposit is
locked in at 3.5%, he says. Depositing in new CDs every six months to a
year will allow for rate changes."The idea is to have money coming due each year," Benson says.What to do:

• Meet
  with a financial planner at least twice a year to review asset
  allocations in your portfolio to continue working toward investment
  targets.
  

• Investigate investment options in bonds or Treasury bills.
  

• Deposit in short-term CDs or consider building a CD ladder.
  

5. Obtaining cash from your home

They don't make home-equity loans like they used to.Tom
Kelly, a spokesman for JPMorgan Chase, says that previously the bank
had been originating loans at 95% to 100% of a home's value. But after
the subprime-mortgage meltdown, that threshold has dropped to 80% in
most housing markets, he says."So on a $200,000 home, the most you can expect is $160,000," he says. "Our standards are probably in line with other lenders."Marks says he hopes people's spending habits would change as a result of the limits on home-equity loans.But in some cases, tapping into a home's value may be the only option to get cash.David Certner, AARP's legislative counsel, says he expects people over age 62 to become more interested in reverse mortgages.
Living expenses will continue to increase, and seniors on fixed incomes
and no assets other than their homes will need to establish cash flow.A
reverse mortgage allows a homeowner to receive nontaxable payments
based on the value of a home with a mortgage that has been paid. It is
sometimes described as a house paying the homeowner back.Certner says the U.S. Housing and Economic Recovery Act of 2008 makes reverse mortgages more attractive by:

• Raising the amount of equity homeowners can borrow against.
  

• Capping origination fees.
  

• Protecting seniors against inappropriate practices by lenders.
  

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However,
a reverse mortgage should remain a "last resort" for seniors because it
is still an expensive proposition, Certner says.The new housing
law allows a maximum of $6,000 for an origination fee. The fee is based
on the law's new scale of 2% for the first $200,000 of home value and
1% per $100,000 of remaining home value. Previously, homeowners were
charged 2% of the home's value.A reverse mortgage could use up
the entire value of a home, and the homeowner is responsible for
property taxes and home maintenance, which is why Certner suggests
considering all options before using a reverse mortgage."It may be more appropriate to sell your home and move," he says.Previously,
seniors had fallen prey to being sold annuities, long-term-care
insurance and other inappropriate products by the same agents who sold
the reverse mortgages. The new housing law prohibits this practice, but
Certner says seniors should remain on their guard."Those products are rarely in your interest," he says.What to know:

• Home-equity loans aren't as viable in the current economy. It's better to find ways to control spending.
  

• A
  reverse mortgage may be the only way for some seniors to establish an
  income. But selling the home may net more cash for the homeowner.
  

• The
  new housing law requires homeowners to meet with a mortgage counselor
  before entering into a reverse mortgage. Use the meeting to review
  assets to determine if a reverse mortgage is the best option.
  

Published Nov. 19, 2008http://articles.moneycentral.msn.com/SavingandDebt/ManageDebt/5-money-mistakes-in-a-bad-economy.aspx?page=all