The Simple Dollar

Signs for American Express, Master Card and Visa credit cards are shown on a New York store's door. How best to pay off credit card debt depends on your personal financial situation. (Mark Lennihan/AP/File)

How to pay off credit card debt

By Trent Hamm, Guest blogger / 04.15.13

Kim writes in:

My dad told me that the best way to pay off a credit card is to pay it all off at once so I have been saving up the money to do that. My boyfriend argues with that saying that the best way to do it is to make the biggest possible payment each month. Who is right?

Your boyfriend’s plan is better in a very straightforward sense. I think your dad is also bringing a good concept to the table, too.

If you look at nothing but the debt, the best way to pay off that debt with the minimum total interest payments for you is to pay it off with the largest payments you can throw at it each month.  ( Continue… )

A box from Amazon.com is pictured on the porch of a house in Golden, Colorado. If you use Amazon frequently, Hamm recommends a Prime subscription, which could save you money. (Rick Wilking/Reuters/File)

Is Amazon Prime really worth it?

By Trent Hamm, Guest blogger / 04.14.13

Charlie wrote in with an interesting question.

I wanted to see if you could run the numbers on this. My family is considering signing up for a year of Amazon Prime for $80. I can see a lot of situations where it would save us a little bit of money, but I don’t know if it adds up to enough money to make it worthwhile.

The value of Amazon Prime really, really depends on your buying habits. For some people, I think it’s absolutely worth it. For others, it’s not worth it at all.

First of all, what is Amazon Prime? From the site’s blurb:

Amazon Prime offers multiple shipping benefits, including FREE Two-Day Shipping for eligible purchases. Members also get free access to Amazon Instant Video and the ability to borrow books from the Kindle Owners’ Lending Library.

It costs $80 per year for these services. I see a few primary ways in which Prime saves money for families.

First, it enables you to use Amazon to buy individual items for less than $25 without paying for shipping. Without Prime, you have to pay for shipping for items under $25, meaning that there’s often a temptation to add unnecessary items up to the $25 threshold or just walk away and pay more for the item elsewhere, like buying a book at a bookstore. If you have Prime, you’ll likely find yourself doing all of your gift shopping and small purchases at Amazon rather than buying them at stores.

In that situation, you have to start doing some serious price comparison among the items that you buy. The best way to do that is to grab some receipts from your last few weeks of purchases and start comparing them with prices at Amazon. With shipping as a non-factor, can you save money by buying the item at Amazon?

If you’re a warehouse club member, you should include those in the comparisons, too. You should also carefully examine Amazon’s “Subscribe and Save” program on household products, where you can shave 5% to 15% off of the cost of a household item to have it shipped to you on a regular schedule, such as having shampoo shipped to you every two months (for example). If you’re a Prime member, the shipping costs for those things just vanishes.

Another factor that helps Amazon’s case is the cost of going to the store for these items. If you’re sitting at home and you have two or three things you need to buy, Prime can often save you the cost (and the time) of having to go buy those items.

Is that worth it? It really depends on the things that you buy. I will say that the larger your family is, the more likely it is that you’ll find Prime to be worthwhile.

Another factor is the video streaming service. If you’re a Netflix subscriber, this might be a deal-breaker for you. Amazon Prime provides a video streaming service with content that largely (but not completely) overlaps Netflix. Most of the items that my family enjoys on Netflix streaming is also available on Amazon streaming. If you’re spending $9 a month on Netflix streaming, take a serious look at Amazon Prime, as it might actually save you money to switch (as the cost per month of Amazon Prime is about $7).

The Kindle lending library is pretty secondary. If you have a Kindle, it’s worth looking at simply because it gives you access to more “free” books, but I don’t think the value there is worth a significant amount.

I think the value of Prime really comes down to two questions.

One, would you actually save enough money over the course of a year by eliminating the shipping barrier at Amazon? This is a trick question, of course, as it will become easier for many people to shop more if they no longer have to worry about the shipping issue. If you can get anything you want at a pretty good price shipped to your house in two days without any shipping cost, it can be really tempting to buy more items. Self-control is really needed here. On the other hand, if you have that self-control, the small savings on entertainment items, gifts, household items, and other random things will likely add up fast, particularly if you can clearly identify the savings and switch to buying most of those items through Amazon.

Two, can the video streaming service adequately replace Netflix for you? If you don’t use a streaming video service, then this is a non-issue. You certainly have no reason to subscribe to such a service. On the other hand, if you do use Netflix, Amazon Prime provides a pretty strong subset of what’s available at Netflix plus some minor additional items. Is the mix of content on Amazon Prime’s service an adequate replacement for Netflix for you? (Overall, I do feel that Netflix offers better content overall with regards to streaming, but Amazon provides a lot of good stuff and, given the other benefits of Prime, this might be worthwhile for you to switch.)

Would that $80 per year actually add up to more than $80 per year in savings for you? I think that if you have some self-control, you’re willing to buy a lot of your household and other items from Amazon, and particularly if you’re a Netflix subscriber and would be willing to cancel it and jump ship, Prime can be worth it, particularly if you have a large family (and thus a larger household supply budget). You need to run the numbers for your own situation, and the best way to start is with your receipts for the past few weeks.

The post Does Amazon Prime Actually Save Money? appeared first on The Simple Dollar.

A PC displays a TurboTax online tax computer program in Palo Alto, Calif. TurboTax has an offer that allows you to take your tax refund in the form of a gift card, but Hamm mostly recommends against it. (Paul Sakuma/AP/File)

Gift card as a tax refund: a good idea?

By Trent Hamm, Guest blogger / 04.13.13

Recently, I was using TurboTax to do my taxes for the year. For the last several years, I’ve been paying in a bit each year rather than receiving a return because I’m self-employed, which means I have to handle my own personal taxes and I usually make my quarterly tax payments on the lower end of what’s reasonable.

Anyway, one of the things I usually do with TurboTax is that once my taxes are actually finished, I’ll play around with scenarios a bit. What would things look like if I made $10,000 less this year? Would I get a refund? What if we gave more to charity? How would that have affected things? It’s essentially a big personal finance calculator that’s already set up with all of our data, so it’s really useful for looking at things like that.

As I was doing this, I discovered something interesting. TurboTax has an offer embedded in it that will give you an Amazon.com gift card in lieu of your tax return. If you accept that, they’ll add an additional 5% to the balance of that card.

This isn’t the first time I’ve seen this type of “gift card as payment” offer. Coinstar kiosks usually offer this type of arrangement, where you’ll get more “value” in the form of a gift card than if you simply receive cash. A few banks, such as SmartyPig, also have options where you can receive the balance of your account in the form of a gift card with an additional “bonus” added to the value of that card.

It’s an interesting offer, both for the institution making the offer and for the customer.

For the institution, they’re able to acquire gift cards from Amazon at a slight discount of their face value. Then, they pass along some of that value to the customer (keeping some of that difference

For the customer, it offers an additional option when receiving your payment, and choice is usually a good thing. The question really boils down to whether or not receiving a gift card as payment is really worth it for the customer.

The only time that you should consider a gift card as payment is if there’s significant additional value placed on the gift card and you’re actually going to use the card in the near future and you’re using the card for something reasonable.

Let’s break down these three elements.

First, is the gift card giving you additional value? If your choice is between cash and a gift card with the same face value, take the cash every single time. That’s obvious. The only time a gift card should be under consideration is if the face value of the gift card is higher than the cash option.

Most of the time, your gift card option will have a higher face value than the cash option. Most companies realize that most customers won’t go for the gift card without some incentive, so this aspect is almost a given.

Second, are you actually going to use the gift card in the near future? It’s very easy to put a gift card aside and forget about using it until you find it two years later (at which point, it might be expired). A forgotten gift card can easily be lost or thrown away on accident.

The best gift card is one you’re going to use quite quickly while it’s still fresh in your mind. Will you actually use that card in the near future? Or are you at risk of misplacing that card?

Finally, are you going to use the card for something reasonable? An Amazon gift card isn’t just an excuse to go buy random things. If you’re going to just blow the money on trivial things, it really doesn’t matter whether you choose the gift card or not.

If the presence of the gift card is tempting you to spend it on something purely useless, while the cash might be put to better use in your life, get the cash. If you can actually use the gift card for something worthwhile, such as buying household supplies or picking up a gift for someone, the card is probably a good choice.

If you’re not saying “yes” to all three of these criteria, you should be getting your payment in the form of cash, not in the form of a gift card.

Vehicles move along a traffic jam during rush hour in Sao Paulo, Brazil. A short commute length can leaves more money in your pocket and more time in your day, Hamm writes. (Nacho Doce/Reuters/File)

How much is your commute costing you?

By Trent Hamm, Guest blogger / 04.12.13

A friend of mine works at a Home Depot about ten miles from her home, which means she has a daily round trip of about twenty miles for her commute. She makes more than minimum wage – let’s say $8 per hour after taxes– and she seems pretty happy there.

As far as I can tell, she works five shifts per week, seven hours each.

She drives herself back and forth to work on each of those work days. Her car is reasonably fuel efficient and pretty reliable. We’ll say, for the purposes of this exercise, that she paid $6,000 for it and figures she’ll be able to get 100,000 miles out of it without any major repairs. That’s really optimistic, I know, but it gives us something to work with.

Her car gets about 25 miles per gallon, too. In the area where she lives, gas is about $3.50 per gallon. Her tires wear out at the 40,000 mile mark, so she’s going to be spending about $400 to replace them all. She has to change the oil every 5,000 miles, which costs her, say, $25 per oil change (I’m trying to use round numbers that will divide easily while still being fairly accurate). She tries to stick to her maintenance schedule, too. She also has to cover auto insurance on her car – just liability insurance, mind you – which sets her back about $40 per month.

So, let’s start figuring this up.  ( Continue… )

Blank US Treasury checks are seen on an idle press at the Philadelphia Regional Financial Center. Spending your tax refund on improving your financial situation might not be flashy, Hamm writes, but it will have a far greater lasting impact on your life. (Matt Rourke/AP/File)

Tax day 2013: Your tax refund is not a Christmas present

By Trent Hamm, Guest blogger / 04.10.13

Over the past few weeks, many people have started receiving their tax returns if they filed their income taxes early in the year.

It can be an exciting time, particularly if your income tax refund check is the largest check you receive all year. One member of my family gets a check that’s about four times his normal weekly paycheck when his tax return comes in.

With that kind of cash in hand, it can be really tempting to splurge on something. I’ve seen people buy ATVs, televisions, computers, clothes, jewelry, and other such frivolous things with their check. Another person I know uses his check to go on a trip.  ( Continue… )

A sold sign is posted in front of a home for sale in Mariemont, Ohio last month. Hamm argues that waiting to make mortgage payments because of inflation isn't necessarily an idea that will save significant money. (AL Behrman/AP/File)

Should you make mortgage payments later because of inflation?

By Trent Hamm, Guest blogger / 04.08.13

Karen writes in:

My brother has argued with me that I shouldn’t make any extra payments on our mortgage because we’re losing money over the long term by making early payments. He says that with inflation at 3% and our money able to earn 1% at minimum in a savings account and more if we do other things, we’re losing money by making early payments on our 3.75% mortgage. What do you think?

From a purely financial perspective, your brother does have a good point. However, your brother’s case has a bunch of implied assumptions that don’t necessarily apply to your situation.

First, let’s look at the math of the situation. Let’s say that you get a raise at work that equals the rate of inflation. Since your mortgage payment stays the same (assuming it’s a fixed rate mortgage), that means that your mortgage payment will take up a smaller and smaller percentage of your income over time. With the percentages expressed by your brother, your mortgage payment will take up only about a third as much of your income by percentage during the last year of your mortgage compared to the first year of your mortgage.

Want real numbers? Let’s say your monthly mortgage payment is $1,000 and you bring home $30,000 a year. Right now, you’re paying $12,000 a year in mortgage payments, which is 40% of your take-home pay. Each year, though, you’re getting a 3% raise. After ten years, you’re making a little over $40,000 a year, dropping your mortgage payments down to only 30% of your take-home pay. After twenty years, you’re bringing home around $54,000 per year, dropping your mortgage payments down to about 22% of your take-home pay. During the last year of your mortgage, you’re bringing home $72,800 per year, making your mortgage payments around 16% of your take-home pay.

The argument against early payments is that at the point where mortgage payments make up 40% of your take-home pay, it doesn’t make sense to pay even more just so that you eliminate payments at a later date where the payment is only taking up 16% of your take-home pay.

That’s a pretty powerful argument. It forgets a few things, though.

First, it assumes your income steadily increases at the rate of inflation or better. The truth of the matter is that wage growth isn’t keeping up with inflation in most industries and, in many industries, wages are actually seeing negative growth.

Most Americans can’t rely on the idea that their wages will routinely go up. That’s just not reality for the majority of people out there. Yes, there are people who are smart and work hard and have an entrepreneurial bent and a big pile of transferable skills who can keep increasing their wages, but that’s not something you can plan on unless you’re exhibiting confidence bordering on arrogance.

Second, it assumes that you can earn a sizeable steady return from a small investment. If you have $500,000 sitting in the bank, you can probably find some ways to invest it that can earn a nice return on that money, better than the 4% or so return you might get from other things. It’s much harder to do that with $1,000 in the bank.

Most Americans do not have the capital on hand to buy a rental property. Many Americans struggle to have an emergency fund. With an extra mortgage payment, a person can get a steady 3.75% return (in the mortgage example above) from every single dollar they pay ahead on their mortgage.

Third, it assumes an inflation rate. The Consumer Price Index, which is likely the best tool for estimating inflation, has only touched 3% once in the last several years and is usually around 1.5 to 2%. Some people debate whether CPI is a good measure of inflation and some argue for other rates, but CPI is a pretty solid benchmark for inflation.

Inflation does vary over time, but we’re currently in a period of very low inflation. Most inflation-based arguments rely on an inflation rate of at least 3% for people to make financial moves based on the inflation rate.

Finally, it assumes inflexibility. If you’re in a position where inflation is at 5% and savings accounts are paying a 6% return, it makes a lot of sense to put money into a savings account and make minimum payments on a 3.75% mortgage. On the other hand, when we’re in the position we’re at now, with savings accounts paying 1% and inflation somewhere around 2%, you’re going to want different solutions. Just because you choose to make early payments now doesn’t mean you can’t choose to do something differently later on.

In the end, the decision to make early mortgage payments or invest in something else is a minor point compared to the real issue. As long as you are spending less than you earn, you’re getting ahead. If you’re spending $100 less than you’re earning each month, you blow away any investment returns you might get on that $100 by instead figuring out how to spend $150 less than you earn each month. Spending less than you earn is the real key to financial success, regardless of how you invest it.

A bird used by a Chinese man, unseen, to perform, holds a yuan collected from a tourist as it prepares to drop it into a piggy bank, in Houhai district, in Beijing, China. Hamm argues that when it comes to planning your financial future, preparing for the worst will leave you better off than you expect. (Muhammed Muheisen/AP/File)

Planning for the future? Why pessimism is more productive.

By Trent Hamm, Guest blogger / 04.06.13

What will you be earning in ten years?

Most of us can’t really answer that question. We might have a guess as to the answer, but it’s little more than a guess. However, almost all of us make quite a few decisions today based on our gut feeling about that question.

Let’s say you knew for certain that in ten years you’d be making four times as much as you’re making right now. Would that change how you behaved today?

Let’s say, on the other hand, that you knew that in ten years you’d be making only a third of what you’re making right now. Would you do things differently today?

Now, here’s the real key question. Which one of those two paths will ensure the best possible future for you, regardless of income?

Unless you’re doing something strange, the gameplan you would use for making a low income would be far better for you over the long run than the gameplan that assumes a big income.

Why? If you assume a big income, you’re more likely to make moves today that rely on being able to pay off debts down the road.

If you know you’re going to earn $200,000 a year in ten years and you only make $50,000 a year right now and you’re about to buy a home, it’s going to be far more tempting to buy the most expensive possible home. After all, you know that your future self will pay for it, right?

On the other hand, if you’re making $50,000 a year and are about to buy a home, but you know you’ll only make about $17,000 a year in ten years, you’re probably not going to buy the biggest house you can afford at the moment – that would be completely foolish.

The thing is that we use these kinds of pictures of our future with almost every major financial decision that we make. The more secure and bright we believe our future to be, the more likely we are to commit to big long-term expenses today.

In terms of actually building toward debt freedom and long-term financial security, though, you’re far better off using a pessimistic future as your guide. If you assume that your income is going to be low in the future, you’re going to make more conservative moves that keep more money in your pocket.

That way, when the future really does arrive, you’re far more likely to have more money than you expect than not enough money. This is far better than the other option, in which you assume a rich future and spend accordingly, only to likely find yourself not having enough money when that future arrives.

If you want long-term financial security, avoid making financial moves that rely on you having significant income in the future. If you need to take out a home loan, buy the smallest house you can live with. If you can’t afford the expensive car without debt, buy the cheaper car. With those lower monthly payments, it should be much easier to sock away as much as you possibly can.

That way, when you wake up in ten years, you’ll find that you’re in good financial shape no matter what your income happens to be. It’s a far less stressful way to live.

This road in County Kerry, Ireland, is typical of the nation's hilly, narrow roads with spectacular views. (Jake Coyle/AP/File)

Hope in the future

By Trent Hamm, Guest blogger / 04.04.13

When I first graduated from college, when people asked me about my future, I would fire off a few vague statements about what I wanted. I wanted a great career! I wanted to have kids! I wanted a nice house!

All of those ideas were nebulous and vague. Sure, they echoed sentiments that I held in my heart, but they weren’t anywhere close to being authentic goals. A house? A child? A “power” career? Those weren’t things I envisioned happening any time soon. I didn’t even have any idea as to how to build a path to them.

It took a few years for pieces to fall into place. I got married. We had our first child. I began to seriously re-examine my career path.

Those changes pushed me to start re-examining all of those visions for the future. I started to ask myself what I really wanted for the rest of my life and how I’d get from where I was at to where I wanted to be. ( Continue… )

A money changer shows some one-hundred US dollar bills at an exchange booth in Tokyo. Some banks offer savings accounts that offer bonuses in exchange for regular contributions. Hamm argues that it's a good idea, provided you can easily keep up with the payments. (Issei Kato/Reuters/File)

Do 'savings club' accounts really work?

By Trent Hamm, Guest blogger / 03.30.13

Carol writes in:

My local bank offers an interesting account each year. It starts on the first Saturday in January and the deal is that if you deposit the same amount each week for 49 weeks, they will make the 50th deposit for you and give you the money at the end of the year just before Christmas. You can’t take the money out of the account and if you miss any payments you don’t get the free 50th payment but they do set it up so you can pay in automatically out of your checking account. It seems worthwhile, but is it worth it?

I’ve heard of this type of savings product before. It’s also been called a “Christmas club,” among other things. Let’s walk through this step by step.

I calculated the interest rate on this account as being roughly 4.15% I calculated this based on an account that you deposit money in each week and that compounds weekly, and on the fiftieth week you don’t make a payment and instead receive the total value of the account at the end of the week. In other words, the money you put into this account earns interest at a rate that’s pretty close to 4.15% per year.

That amount blows away pretty much every savings account available right now. There are some catches, however.

First, this account has a lot more in common with a CD than with a savings account. The biggest difference between a CD and a savings account is that you can’t withdraw the balance of a CD before it matures without suffering a penalty. The same thing is true here – if you withdraw the money before it matures (after fifty weeks), you lose that “free” payment at the end, which reduces the interest rate you earn down to 0%.

There’s also the caveat of having to make a payment every week. If you can’t make that payment each week, then you suffer the same penalty as an early withdrawal – your interest rate essentially drops to 0%.

Not only do you have the money tied into the account, you essentially have to have the next payment tied to the account at least a day or two in advance (and even longer unless you’re really micromanaging things).

What about the return on your money, though? Given the restrictions on deposits and withdrawals, you should expect a return that’s similar to a CD and substantially better than a savings account.

Right now, savings accounts are earning at a rate below 1% in most places. You can find accounts that pay out 1% or, in a few cases, even a bit better than that, but they’re unusual cases.

12 month CDs, on the other hand, pay out somewhere between 1% and 1.5% at the moment, depending on the exact CD you find.

Naturally, both savings and CD rates vary over time. In a few years, when overall interest rates begin to rebound, the rates on both savings accounts and CDs will go up, making this type of “savings club” a bit less lucrative.

For now, though, it’s a very good deal. If you have the chance to get into one of these clubs and can easily afford the weekly contribution, it’s definitely worthwhile. In future years, you’ll want to compare the return to savings accounts and checking accounts to be sure you’re getting your money’s worth, though.

The post Does a “Savings Club” Account Work? appeared first on The Simple Dollar.