by Dave Ramsey
Hundreds of times I’ve seen relationships strained and sometimes destroyed. We all have, but we continue to believe the myth that a loan to a loved one is a blessing. It isn’t; it is a curse. Don’t put that burden on any relationship you care about.
MYTH: By cosigning a loan, I am helping a friend or relative.
TRUTH: Be ready to repay the loan; the bank wants a cosigner for a reason, which is that they don’t expect the friend or relative to pay.
Think with me for a moment. If debt is the most aggressively marketed product in our culture today, if lenders must meet sales quotas for “loan production,” if lenders can project the likelihood of a loan’s going into default with unbelievable accuracy—all these things are true—and the lending industry has denied your friend or relative a loan, there is little doubt the potential borrower is trouble just looking for a place to happen. Yet people across America make the very unwise (yes, dumb) decision to cosign for someone else every day.
The lender requires a cosigner because there is a very high statistical chance that the applicant won’t pay. So why do we appoint ourselves as the generous, all-knowing, benevolent helper to override the judgment of an industry that is foaming at the mouth to lend money, and yet has deemed our friend or relative a deadbeat looking for a place to fail, or at least a loan default looking for a new home? Why do we cosign knowing full well the inherent problems?
We enter this ridiculous situation only on emotion. Intellect could not take us on this ride. We “know” they will pay because we “know” them. Wrong. Parents cosign for a young couple to buy a home. Why do they need a cosigner? Because they couldn’t afford the home! Parents cosign for a teenager to buy a car. Why would parents do this? “So he can learn to be responsible.” No, what the teenager has learned is, if you can’t pay for something, buy it anyway.
The sad thing is that those of us who have cosigned loans know how they end up. We end up paying them, but only after our credit is damaged or ruined. If you cosign for a car, the lender will not contact you when the loan is paid late every month, but your credit is damaged every month. The lender will not contact you before they repossess the car, but you now have a repo on your credit report. They will contact you to pay the difference between the debt and the below-wholesale repo price they got for the car, which is called a deficit. If the lender did contact you, there is nothing you can legally do to force the sale of the car, because you don’t own it; you are merely on the hook for the debt. When you cosign on a house, you will get the same results.
According to Proverbs 17:18, “It’s stupid to guarantee someone else’s loan” (CEV). That pretty well sums it up. Just like trying to bless a loved one with a loan, many people are trying to help by cosigning, and the result is damaged credit and damaged or destroyed relationships. I have cosigned loans and ended up paying them; one poor guy cosigned for me, and he ended up paying when I went broke. If you truly want to help someone, give money. If you don’t have it, then don’t sign up to pay it, because you likely will.
I see cases of people caught in the cosigning trap every day on The Dave Ramsey Show, our radio talk show. Kevin called to complain that a mortgage company was counting his cosigning for his mom’s car against him as a debt even though she had insurance that would pay the loan if she died. Of course they count it, Kevin; it is a debt you are liable for! The mortgage company isn’t worrying about her dying; they are worried about her not paying, which would require Kevin to make her car payments and then possibly not be able to pay his mortgage.
Joe, another caller, was surprised to find he was on the hook for $16,000 on a mobile home he cosigned for fifteen years ago. Ten years ago his brother’s mobile home was repo’ed, and the bank sold it for $16,000 less than was owed; now, ten years later, the bank caught up with Joe and wanted its money. Joe was angry that this could happen! Most cosigners have no concept of the trip they’ve signed up for.
Brian e-mailed me about his girlfriend’s car. It seems ol’ Brian cosigned for a $5,000 car for his sweetie. Sweetie took off with the car, he can’t find her, and, surprise of surprises, she isn’t making the payments. Now either his credit shows him as a deadbeat or he makes payments on a car he can’t find for a girl he doesn’t want to find. That sums up cosigning: broken hearts and broken wallets. That’s how cosigning usually goes, so unless you are looking for a broken heart and a broken wallet, do not do it.
MYTH: Cash Advance, Payday Loans, Rent-to-Own, Title Pawning, and Tote-the-Note Car Lots are needed to help lower-income people get ahead.
TRUTH: These rip-off examples of predatory lending are designed to take advantage of lower-income people and benefit only the owners of the companies making the loans.
Lower-income people will remain at the bottom of the socioeconomic ladder if they fall for these rip-offs. These “lenders” (or, as I like to call them, “the scum of the scum”) are bottom-feeders and legally make themselves rich on the backs of the poor or those soon to be poor. The lending rates of these types of operations are over 100 percent interest, and if you want to stay on the bottom, keep dealing with these guys. You know why these types of operations are located only at the poor end of town? Because rich people won’t play. That is how they got to be rich people.
The Payday Loan is one of the fastest-growing trash lenders out there. You write a hot check for $225, dated one week from now, which will be payday. They will give you $200 cash on the spot. All for a mere $25 service charge, which equates to over 650 percent interest annually! Mike called my talk show recently and was caught in a web of Payday Loans. He had not yet had a Total Money Makeover and was still spending like always. He kept adding loan after loan until he couldn’t beat the shell game he had created. Basically, Mike had borrowed from one trash lender to pay another, and by doing this again and again, he had created a cycle of financial death. He was panicked because he was being threatened with criminal charges for writing bad checks by the very places that have a business model based on postdated “bad” checks. The sad thing is that the only way out for Mike is to pop the balloon. He has to stop paying them, close his accounts, and then meet with each lender to work out payment arrangements. That will mean extra jobs and selling things around the house.
This type of business is legalized loan-sharking. Some states, like Georgia and Arkansas, have legally run payday-loan businesses out of their state. Others, like New York and New Jersey, limit the amount of annual interest they can charge. Even the federal government recognized the problem and put a cap of 36 percent on payday loans made to military personnel. Hopefully other states will follow suit.
The classic Tote-the-Note Car Lot is no better. Most of these transactions involve older, cheaper cars. The dealer purchases these cars and sells them for a down payment equal to what he paid for the car, so the payments at 18 to 38 percent interest paid weekly are all gravy. Tow trucks all over town recognize these exact cars because the car being sold has been sold many times and repeatedly repo’ed by the dealer. Every time the dealer sells the car, his return on investment skyrockets. The payments could have purchased the car for cash in a matter of weeks; in fact, the down payment could have purchased the car if the buyer had been a little more savvy.
Rent-to-Own is one of the worst examples of the little Red-Faced Kid in “I want it now!” mode. The Federal Trade Commission continues to investigate this industry because the effective interest rates in rent-to-own transactions are over 1,800 percent on average. People rent items they can’t possibly afford to buy because they look only at “how much a week” and think, I can afford this. Well, when you look at the numbers, no one can afford this. The average washer and dryer will cost you just $20 per week for ninety weeks. That is a total of $1,800 for a washer and dryer you could have bought new at full retail price for $500 and slightly used for $200. As my old professor used to say about the “own” part of Rent-to-Own, “You should live so long!”
If you had saved $20 per week for just ten weeks, you
could have bought the scratch-and-dent model off the floor at the same Rent-to-Own store for $200! Or you could have bought a used set out of the classifieds or online. It pays to look past the weekend and suffer through going to the Laundromat with your quarters. When you think short term, you always set yourself up for being ripped off by a predatory lender. If the Red-Faced Kid (“I want it, and I want it now!”) rules your life, you will stay broke!
If you use Payday Loans, Tote-the-Note, and Rent-to-Own, please understand that you are being destroyed financially. These businesses feed on the working poor, and you must avoid them at all costs if you want to win with money.
MYTH: “Ninety days same as cash” equals using other people’s money for free.
TRUTH: Ninety days is not the same as cash.
The silly marketing that America falls for has resulted in this: we buy things we don’t need with money we don’t have in order to impress people we don’t like. “Ninety days same as cash” has exploded in furniture, electronics, and appliance sales. I recently met a lady who financed her dog at the pet store. “But I paid him off early,” she said proudly. Good thing for Rover that he was able to avoid the repo man.
Ninety days is NOT the same as cash for three basic reasons: One, if you will flash cash ($100 bills) in front of a manager who has a sales quota to meet, you will likely get a discount. If you can’t get a discount, go to the competitor and get one. You do not get the discount when you sign up for the finance plan.
Two, most people don’t pay off the debt in the allotted time. Nationally, 88 percent of these contracts convert to debt—a debt where you are charged a rip-off interest rate of 24 to 38 percent, and they back-charge you to the date of purchase. Please don’t tell me you are the one who is actually going to pay it off. A $1,000 stereo (don’t forget, you didn’t get a discount) will not make you rich in ninety days. But $1,000 left in a savings account at 3 percent annual interest will earn you $7.50 in ninety days. Wow, some financial genius you are!
Three, you are playing with snakes, and you will get bitten. Marge called my radio show with this little story. She and her husband purchased a big-screen TV at a nationally known electronics store. This couple paid off the big screen slightly early to be sure they would not be tricked into the interest being back-charged. No such luck. They had declined the disability and life insurance (a charge of $174), but apparently the salesperson had fraudulently initialed the contract in that area, something that happens more frequently than you think. So although our brilliant couple thought they had paid off the TV, they still had a balance and were charged interest back through the entire deal. They were fighting it, but it would take hiring a handwriting expert and going to court with an attorney to avoid paying a bill under $1,000, even though they did not owe it. That is disheartening. The little game of “we are going to use your money for free” backfired big-time. I recently purchased a TV in that exact same store for cash; I got a discount and walked out with my TV. No hassle, no court costs, no interest, no lies.
No, Virginia, ninety days is NOT the same as cash.
MYTH: Car payments are a way of life; you’ll always have one.
TRUTH: Staying away from car payments by driving reliable used cars is what the average millionaire does; that is how he or she became a millionaire.
Taking on a car payment is one of the dumbest things people do to destroy their chances of building wealth. The car payment is most folks’ largest payment except for their home mortgage, so it steals more money from the income than virtually anything else. The Federal Reserve notes that the average car payment is $495 over sixty-four months. Most people get a car payment and keep it throughout their lives. As soon as a car is paid off, they get another payment because they “need” a new car. If you keep a $495 car payment throughout your life, which is “normal,” you miss the opportunity to save that money. If you invested $495 per month from age twenty-five to age sixty-five, a normal working lifetime, in the average mutual fund averaging 12 percent (the eighty-year stock market average), you would have $5,881,799.14 at age sixty-five. Hope you like the car!
Some of you had your nose in the air as intellectual snobs when I illustrated how bad Rent-to-Own is because you would never enter such an establishment, and yet you are doing worse on your car deal. If you put $495 per month in a cookie jar for just ten months, you have nearly $5,000 for a cash car. I am not suggesting you drive a $5,000 car your whole life, but that is how you start without debt. Then you can save the same amount again and trade up to a $10,000 car ten months later and up to a $15,000 car ten months after that. In just thirty months, or two and a half years, you can drive a paid-for $15,000 car, never having made a payment, and never have to make payments again. Taking on car payments because everyone else does it does not make it smart. Will your broke relatives and friends make fun of your junk car while you do this? Sure they will, but that is a very good sign you are on the right track.
Having been a millionaire and gone broke, I dug my way out by making a decision about looking good versus being good. Looking good is when your broke friends are impressed by what you drive, and being good is having more money than they have.
Are you starting to realize that The Total Money Makeover is also in your heart? You have to reach the point that what people think is not your primary motivator. Reaching the goal is the motivator. Do you remember the circus game where you swing the large hammer over your head to hit the lever to send a weight up a pole to ring the bell? You reach the point that you want to ring the bell! Who cares if you are a ninety-eight-pound weakling with gawky form? The girls are still impressed when the bell is rung. When the goal, not how you look, begins to matter, you are on your way to a Total Money Makeover.
Today I drive very nice, very expensive, slightly used cars, but it wasn’t always that way. After going broke, I drove a borrowed 400,000-mile Cadillac with a vinyl roof torn loose so that it filled up with air like a parachute. The predominant color on this car was Bondo. I drove the Bondo buggy for what felt like ten years during one three-month period. I had dropped from a Jaguar to a borrowed Bondo buggy! This was not fun, but I knew that if I would live like no one else, later I could live like no one else. Today I am convinced that my wife and I are able to do anything we want financially partially because of the car sacrifices we made in the early days. I believe, with everything within me, that we are winning because of the heart change that allowed us to drive old, beat-up cars in order to win. If you insist on driving new cars with payments your whole life, you will literally blow a life’s fortune on them. If you are willing to sacrifice for a while, you can have your life’s fortune and drive quality cars. I’d opt for the millionaire’s strategy.
MYTH: Leasing a car is what sophisticated people do. You should lease things that go down in value and take the tax advantage.
TRUTH: Consumer advocates, noted experts, and a good calculator will confirm that the car lease is the most expensive way to operate a vehicle.
Consumer Reports, Smart Money magazine, and my calculator tell me that leasing a car is the worst possible way to acquire a vehicle. In effect, you are renting to own. The cost of capital, which is the interest rate, is extremely high, yet most new car deals this year will be a fleece . . . I mean, a lease. They’re baaaadd! Sorry. That’s my impression of a sheep getting “fleeced.” The auto industry lobbyists are so powerful that the law does not require full lender disclosure. The industry argues that you are merely renting, which you are, so they shouldn’t be required to show you the actual effective interest rate. The Federal Trade Commission requires a truth-in-lending statement when you buy a car or get a mortgage, but not on a lease, so you don’t know what you are paying unless you are very good with a calculator. Having seen several hundred lease agreements entered into by people I have counseled, my financial calculator confirms that the average interest rate is 14 percent.
Shouldn’t you lease or rent things that go down in value? Not necessarily, and the math d
oesn’t work on a car, for sure. Follow me through this example: If you rent (lease) a car with a value of $22,000 for three years, and when you turn it in at the end of that three-year lease the car is worth $10,000, someone has to cover the $12,000 loss. You’re not stupid, so you know that General Motors, Ford, or any of the other auto giants aren’t going to put together a plan to lose money. Your fleece/lease payment is designed to cover the loss in value ($12,000 spread over 36 months is equal to $333 per month), plus provide profit (the interest you pay).
Where did you get a deal in that? You didn’t! On top of that, there is the charge of 10 to 17 cents per mile for going over the allotted miles and the penalties everyone turning in a lease has experienced for “excessive wear and tear,” which takes into account every little nick, dent, carpet tear, smudge, or smell. You end up writing a large check just to walk away after renting your car. The whole idea of the back-end penalties is twofold: to get you to fleece/lease another one so you can painlessly roll the gotchas into the new lease, and to make sure the car company makes money.
