Debt

Understanding any debt you have, any investments you have, and where your money is going is key to getting a handle on your finances. It may be overwhelming to get started, but once you feel organized and confident that you have a plan, your financial well-being will increase exponentially. This section will help you understand debt and help you think about creating a budget if you haven’t already.

Action: Read below and follow the Take Action steps at the end of the section.

Loans and Payoff Plans

Most people have loans of some type, or will have them in the future. Typical loans include a mortgage, student loans, auto loans, and often, personal loans. There’s a lot to consider when it comes to a loan (be it for a home, a car or home improvement) beyond the basics such as the interest rate. Here are some of the things to take into account when looking at a loan offer:

• Points. This feature of home loans is interest that is paid up front. One point is 1 percent of the loan principal. The benefit of points to the borrower is twofold. First, you get a reduction in your interest rate going forward, which becomes more valuable the longer you stay in the home. Second, you can deduct these points from your taxes in the year you pay them, as long as you pay them as part of your cash down payment.
• Fees. These are also up-front costs, but they don’t necessarily benefit the borrower (you). The biggest are usually “origination fees” that are usually paid to mortgage brokers. These are not tax-deductible as points are. However, some financial experts say the origination fee may be worth paying if they get you a good overall deal. However, if you are seeing other smaller fees for things like document delivery (when you’ve picked up the papers yourself) or notary services when a lender or broker has a full-time notary public on staff, you may want to speak up. A lender or broker who values your business should be willing to waive these.
• Annual percentage rate. “APR,” is one way to measure the cost of all the aforementioned points and fees. It includes these with your monthly payments to calculate an interest rate that reflects what you will actually pay in a given year. The higher the fees and points, the more the APR will exceed the nominal loan rate. ARM (adjustable-rate mortgage) formulas. Borrowers have a wide range of loan choices these days. The question of which to choose—fixed-rate or adjustable-rate—is complex, but you should know how ARMs work if you’re considering them. Their potential costs are not always as obvious as those of fixed-rate loans. All ARMs share some basic features. They use an index, such as Treasury bill rates or a “cost of funds” indicator of what lenders are currently paying depositors in interest. This is adjusted periodically—every year or 6 months, usually. A margin, such as 2.5 percent, is added to the index to determine the rate that the borrower pays. The margin never changes. The index can change a lot, but you get some protection from extreme swings through another ARM feature, the rate cap. These are of 2 types. One is an absolute upper limit for the interest rate. No matter how high the index goes, you’ll never pay more than this cap. Another is a limit on how much the loan can change in each readjustment. Most ARMs have a 30-year term, with a low fixed rate for the first 3, 5, 7 or 10 years. After that, the index and margin are used to set the rate on the remaining principal. Those short-term rates can be tempting because they are always lower than the rate for a 30-year fixed-rate loan. But if you plan to stay in your home past the date when the loan adjusts, remember that interest rates and the related index might be a lot higher than they are now. If you want to avoid the risk of a steep hike in your monthly payments, stick with a fixed-rate loan. And, if you want fixed rates at lower interest (along with faster payment of principal), check to see if a 15-year or even 10-year fixed-rate loan is feasible for you.
• Prepayment rules. Prepayment penalties are much rarer in the home-loan market now than they used to be, and you should easily be able to avoid them. But with other debt, like auto loans, you can still face prepayment penalties that lead to higher costs than you might expect. In all amortized loans—those paid off in equal installments—you pay most of the interest early and most of the principal late. You might find you owe a surprisingly large chunk of principal well into the loan period. Make sure to ask about any and all prepayment rules and penalties before agreeing to a loan’s terms.
• Good Debt and Bad Debt: The word “debt” usually has a negative image in our minds and our society, but did you know some debt is actually beneficial? The most important consideration when you are buying something on credit or taking out a loan is whether the debt incurred is good debt or bad debt. Good debt is an investment that will grow in value or generate long-term income. A mortgage is generally considered good debt because when the housing market is strong homes appreciate in value over time- especially if you put some work and effort into the property. Taking out student loans to pay for a college or post-graduate education is the perfect example of good debt. First, student loans typically have a low interest rate compared to other types of debt. Secondly, an advanced education increases your value as an employee and raises your potential future earnings. If you have student loan debt and you are working for a non-profit organization, you might want to ask about Public Service Loan Forgiveness - a federal program created for those in public service jobs, offering the opportunity to have federal student loan balances forgiven after 120 qualifying monthly payments. Tax free! Find out more about this option here. Bad debt is considered any debt incurred to purchase things that quickly lose value and do not generate any long-term income. Bad debt is also defined as debt that carries a high interest rate, like credit card debt. However, any debt can be bad, regardless of the form, if it's too big compared to your ability to repay it. To help you avoid this kind of bad debt, try to follow this rule: If you can't easily afford it and you don't need it, don't buy it.

Take Action:

1. Watch this video: Take Control of Debt

2. Connect with a Fidelity One-on- Consultant.

Fidelity Workplace Financial Consultants are licensed professionals experienced in helping people address their immediate financial needs while also planning for their financial futures. The planning service that Fidelity provides is complimentary and is provided as part of your caregiver benefits paid by your employer. Call 800-642-7131 to speak with a consultant now or schedule your complimentary and confidential session with a Fidelity consultant to discuss what’s keeping you up at night.