Suze on a financial backup plan that may backfire. Plus, how to test the investment waters.
By Suze Orman
Q: I have three store credit cards because I was tempted by the discounts offered when I applied. But the annual rates range from 24.5 to 26.99 percent, which I fear could get me into trouble. Should I just close the accounts?
Suze: I've always advised staying away from store cards, which their insanely high interest rates. The retailer lures in with a 5 or 10 percent discount, which becomes worthless as soon as you're charged 25 percent interest on your unpaid balance. If you have any balances, pay them immediately. Don't tell me you can't afford it: Use my free Expense Tracker at SuzeOrman.com to figure out ways to reduce your spending. There's no advantage to closing the accounts, and doing so could actually hurt your credit score. But once the balances are paid off, cut up those cards!
Q: I owe $11,000 on my mortgage at 4.87 percent interest, and I have four years left. I'm hoping to find a lower rate and apply for a cash-out refinance that will yield an additional $20,000, which will help me cover some monthly expenses and my son's college tuition next fall. Is this a smart strategy?
Suze: Unlike a home-equity loan or line of credit, a cash-out refinance replaces an existing first mortgage with a new one for an amount greater than the current balance. However, if you choose that option, under no circumstances should you think about a 15- or 30-year loan. Apply for what's called a 5/1 hybrid adjustable-rate mortgage with an interest rate (currently 3.3 percent) that stays fixed for the first five years, then resets annually. To pay off a $31,000 mortgage over that five-year period, you'd owe about $560 a month. If you can't handle that amount or pay off your mortgage within five years, I wouldn't do it. More to the point: If you can't cover your expenses now, you might need to rein in your spending -- and you certainly won't have the funds to pay for college next year. Advise your son to take out federal student loans. (For more information, go to StudentLoans.gov.
Q: I'd like to start actively investing. What dividend-paying investments would you recommend?
Suze: Companies that regularly pay dividends (a percentage of their earnings offered to shareholders) tend to be stable firms with strong balance sheets and stock worth owning -- especially if they consistently sustain or increase the payouts. Be aware, though, that companies cut back or suspend stock dividends altogether if faced with real trouble, such as a major financial crisis. You could start by choosing low-cost, no-load (commission-free) mutual funds or exchange-traded funds (ETFs) that focus on the stocks of dividend-paying companies. The SPDR S&P Dividend ETF draws from S&P 1500 companies that have increased their dividend payouts for at least 20 years in a row. Both the Vanguard Dividend Appreciation ETF and the Schwab U.S. Dividend Equity ETF include the stocks of companies that have paid dividends for at least ten consecutive years; they charge slightly lower annual fees than the SPDR (0.10 percent or less, compared with 0.35 percent). If you prefer not to open an account with a broker, you'll have to invest in a mutual fund rather than an ETF. Try the Vanguard Dividend Appreciation Index Fund, which charges a low 0.20 percent annual fee.
A well-diversified investment portfolio also includes international stocks and bonds, as well as some cash. I encourage you to learn about asset allocation and consider your options beyond U.S. companies. You can find free information on the websites of the brokers Fidelity, T. Rowe Price and Vanguard. If you decide to see a financial planner, avoid any potential conflicts of interest by selecting an adviser who charges a flat fee rather than a commission.
Suze Orman's latest book is The Money Class: How to Stand in Your Truth and Create the Future You Deserve (Spieglel & Grau).