Welcome to Part Three of our fun educational “Back to Basics” series original started here with Part One “The Emergency Fund” and continuing with Part Two, Protection Planning, and now on to Debt and Debt Planning!
The goal of this series is to cover the most important Foundational Financial Planning items in not only order of importance but also order of technical difficulty. Once complete we expect to have a foundational, almost college like course of Financial Planning topics and goals that can be shared all at once in Netflix series drop like format for any that may be in need or interested. Longtime clients will most certainly find a repetition of items we have spoken or written about before but may occasionally uncover a topic that needs addressing due to a change in our situation.
Debt and Debt Planning – The Good the Bad and the Ugly
Debt and Debt Planning is an extremely important topic, ESPECIALLY in today’s buy now and pay later constantly pushed promotional items. But be careful, nothing is for free and one misstep could lead to an unneeded compound interest tragedy….
In a perfect world, no debt of any type may be a desire and many might feel success is reached upon this achievement, but not all debt is bad, and there are likely mandatory times of debt!
Once again, adhering to Part 1, and having a healthy Emergency fund allows control of ones own destiny giving full control of this topic… so let’s jump in!
The Good Debt
Student Debt May Be The Best Debt Someone Can Have
An investment in ones self in the form of higher education … while we can discuss the merits on how enrollment costs have increased rapidly, is generally a very helpful item for the long term and again generally, if career pointed will frequently pay off in the long term.
- Reflect on what you are incurring the student debt for with watchful eye for help upon completion i.e. Might not be a good idea to incur debt for something you may never use career wise in the future
- Keep an eye on the total expected amount of debt you may be saddled with upon completion and mind possible less expensive options
- Watch the terms of the debt, deferred interest, government subsidized, zero interest, low interest
- Of course try to keep it at a minimal
Residential Mortgage Debt
With long term Mortgage rates (30 year) recently in the 2% -3% range we can argue that Mortgage debt is not bad debt. Cautiously we put Mortgage Debt here in the good, but there is an interest rate that would make it bad debt i.e. An exaggerated example from decades ago of 10%+ would not be good debt.
Tax Benefits of Mortgage Debt can help make the headline rate even lower after tax benefits. But those can come and go as tax laws change.
Most can qualify for WAY WAY more than one should actually have! Our conservative view equation is generally a mortgage of twice annual earnings is a really good place to start, especially for those early in their careers.
Free/Zero Interest Debt is Ok if Handled Properly
Again pointing to our healthy Emergency Fund, Interest Free/Zero debt CAN be ok. Do not take it as an excuse to make an unaffordable purchase!
Watch the terms, as one mistake often carries a huge carry forward of interest, far negating the extra interest one would earn by using the “Free” debt.
Also be careful with a large lump sum payment at the end of a “Free” term… make darn sure we have the funds available and it will not damage our Emergency Funds stash!
The Bad Debt
Interest bearing debt for an item not needed is Bad Debt and borderline Ugly debt. As mentioned earlier, we live in a highly promotional world of “Buy Now, Pay Later” …. Do not bite.
Examples may include what we call Toys, such as extra motorized or floating vehicles, overly expensive devices or equipment and the like.
It is fine to “Treat” ourselves every once in a while, but don’t do it on Bad Debt and don’t mess up your Emergency fund !
The Ugly Debt
Any high interest debt, especially Credit Card type debt.
With interest rates very low on savings rates, having a debt interest rate over mid single digits would be called Bad Debt!
Most of the time this debt occurs is usually attributed to our Part 1 Emergency Fund inadequacy … possibly combined with a “life’s curve ball” unexpected event.
Rates as high as 20% are not common in this swimming pool… please don’t swim here and keeping that emergency fund healthy will keep you out of the water!
Now that we have a good foundation…. next up, Retirement Planning!
Have a Great “Debt Planning” Day!
John A. Kvale CFA, CFP
Founder of J.K. Financial, Inc.
A Dallas Texas based fee only
Financial Planning Total Wealth
Fed Week, Tough Decisions … New “Happy Bank” Back Stop Facility – The BTFP – Bank Term Funding Loan Program … Bank Headlines Continue – Reminder Thought On Late Cycle Headlines …
A while back we mentioned the FOMC – Federal Open Market Committee, lead by Jerome Powell were in a Pickle .. as at that time one of their regional banks had a research report out that GDP- Gross Domestic Production -Economic Growth indicator – was dropping fast and they were going to raise interest rates against a hot CPI = Consumer Price Index – blunt inflation gauge which would exacerbate the situation.
Fast forward to today and that Pickle is not any better…. maybe even more dill! With the afore mentioned Part 1 Advance Analysis M2 review showing dramatically dropping or the pulling of liquidity out of the system, bank fatigue has been seen and felt and here our comments on Banks being a slave to confidence for solvency.
On Wednesday of this week, March 22. 2023 the FOMC is bound by their goal of slowing that sticky inflation we are all seeing, especially at the grocery store, and best measured by the CPI … BUT, this additional rate increase will add fuel to the fire of less liquidity, AND on top of that our neighbors across the pond just raised rates .50% last week, albeit from a much lower 3.00 to 3.50% rate….currently the US rate is 4.75% …
We did say Pickle ? Right….
Enter the BTFP – Bank Term Funding Loan Program – Happy Bank Program
On March 12, 2023 the Federal Reserve Created the BTFP as another backstop for possible Bank Fatigue ..
March 12, 2023
Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors
For release at 6:15 p.m. EDT
This new program is a sort of Fed Discount Window on Steroids, meant to improve Bank confidence.
Long ago the FED (going back in loose form to the 1920’s – the start of the Fed) started a program for Bank help during stressful times, the Fed Discount Window –
Fed Discount Window –
BTFP – Bank Term Funding Loan Program
All of the above but the following additions:
The last bullet is the most important and lending a helpful hand from the Fed’s fastest in history rate increase…. as mentioned repeatedly, increase of rates are a headwind to Fixed income aka Bonds, especially longer term bonds….
Some Banks may be seeing a need for immediate liquidity due to loss of confidence and liquidity drain, so this new program essentially gives them liquidity to meet those demands if needed and may have negative assets due to the fast fast rate increases!
While this is being written – Sunday late morning in between Newsletter Articles, UBS a Swiss neighbor of Credit Suisse has made a much telegraphed offer to buy their friend out… no idea what the market will make of this starting tonight as overseas markets open…. but something just crossed the mind that we have mentioned many times before…. and may be applicable….
“Headlines are always the worst near the end of the Cycle!”
Have a Great “Heads Up for a Busy Week” Day!
John A. Kvale CFA, CFP
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Posted in Debt - Debt Management, Economy, FOMC, Interest Rates, Investing/Financial Planning, Market Comments, Retirement Planning
Tagged Bank Term Funding Loan Program, BTFP, FOMC, Interest Rates, Jerome Powell, Pickle