The biggest castoff is debt. When we lived with high taxes, high inflation, high interest rates and steadily growing paychecks, borrowing money was not only safe, it was savvy. But one by one those debt-friendly conditions have melted away. The middle-level tax rate is 35 percent lower than it was in 1980. Inflation is 74 percent lower. And paychecks are shrinking– assuming you have one. “Debt is a lot riskier today,” says Harold Evensky, a Coral Gables, Fla., financial planner. Here’s a blueprint for reappraising debt’s role in an insecure world.
The hallowed mortgage deduction spawned a good-for-you mentality back in the 1980s. “Stretching” to afford a house–with as big a mortgage as the bank allowed–became commonplace. So did buying a house you could quickly “flip” when you moved up to something bigger. But lower taxes and interest rates have chopped the value of that deduction. In 1980 a new $100,000 mortgage at 12 percent–the prevailing rate–saved a middle-bracket taxpayer about $5,200 in taxes. The same mortgage at today’s 8 percent is worth only about $2,300. And home-ownership costs are likely to mount. “If the flat tax happens, those deductions are worthless. And even if it doesn’t, you’ll see real-estate taxes go up as states receive less help from Washington,” says Janice Johnson, a tax director at Coopers & Lybrand.
The remedy: buy less home than you can afford. Either put more money down than the bank requires or buy a less expensive house. The old rule of thumb (total housing costs should not exceed 25 percent of your gross income) is excellent. Lenders have allowed that ratio to rise, but you shouldn’t. Cut it back even more to weather job losses, pay cuts or property-tax hikes. if you already own a house, resist the urge to scale up when you’ve got extra cash flow. An addition or even a modest face-lift may do nicely instead. Or make extra principal payments to shorten your mortgage’s life.
Everyone knows that credit-card rates are exorbitant. But few people realize card debt is more expensive than when they first used plastic. Why? Credit-card rates have fallen, but inflation has too. In 1981 the average bank credit-card rate was a lofty 18.04 percent, according to the American Bankers Association, but the real cost was only 7.66 percent after inflation. By last year card rates were down to 15.81 percent, but real cost had actually risen-to 13 percent.
Don’t pay a penny in card charges. To get a better handle on your charge habits, cut down to just one or two cards. Also get a debit card, which automatically deducts a charge from your checking account.
Ken Howse, a newly self-employed consultant in Livonia, Mich., has hit on a novel way to buy a car: save for it ahead of time. But if you have to finance, try to minimize the cost first by choosing a used car. Pick a model that has a record of longevity. The more modest your choice, the lower your insurance, repairs and taxes, too. Buy instead of lease, so that you can drive it as long as it lasts. Try to make a big down payment to minimize your borrowing expenses and loan term. A home-equity loan may be your cheapest source of credit, but compare its after-tax cost to alternative rates carefully. Remember, the goal isn’t to be debt-free. It’s to cut back on debt that’s not such a good deal anymore.
