Living paycheck to paycheck? Knock it off

Dear Liz: Like many Americans, I often must scramble to make ends meet between paychecks. I vigilantly monitor my account online, and when my balance is getting low, I curb my expenses as best I can.

Recently, I have had an overdraft experience that leaves me wondering about ethics and legalities. It was three days from payday and I had about $45 in my account.

I made four purchases under $10. Then a $54 automatic payment came through that I could not reschedule. One would think I would then be charged one overdraft fee, as all of the previous purchases made were within my available funds at the time.

I logged in today to find that the bank cleared the largest transaction first, which threw all other small transactions into overdraft. I was charged five overdraft fees because of this rearrangement of clearance order. I talked to a customer service manager who said that nothing could be done.

Essentially, it appears that the bank is manipulating transactions to capitalize on overdraft fees. This strikes me as unethical, and I wonder if I have any rights in this situation? Aside from getting a better job and making more money, what can I do to protect myself?

Answer: Of course the bank is manipulating your transactions to increase its fees. Most banks do. Lawmakers and regulators have questioned the practice, but so far it’s not illegal.

What you can do to protect yourself is to stop living paycheck to paycheck. That may sound like a flip answer when you’re on the financial edge, but you’ll never get ahead as long as a $54 overdraft can throw your finances into chaos.

Having just a $500 cushion in the bank can reduce not just bounced-check fees but also worry, sleeplessness and lost productivity at work, according to a savings review by Stephen Brobeck, executive director of the Consumer Federation of America.

How do you get a cushion? Try a “no spending” month. Limit your purchases to true essentials. Eat out of your cupboards instead of at restaurants. Entertain yourself at home or at the library. Most people can raise at least a couple hundred dollars this way, which you could supplement by having a yard sale and selling unneeded items online.

If you want more ideas, there are a wealth of frugal-living websites; start with one of the oldest, the Dollar Stretcher, at www.stretcher.com.

You also need to limit the bank’s ability to swamp you with “gotcha” fees.

First, sign up for true overdraft protection. Banks often automatically enroll you in an inferior substitute, called “bounce protection” or “courtesy overdraft.” These programs allow the banks to approve over-limit transactions and charge you $30 or more for each one.

True overdraft, by contrast, links your checking account to another of your own accounts: typically a savings account, line of credit or credit card. If your transaction exceeds your balance, the money is drawn from one of these accounts. You’ll pay an annual fee of around $50 and possibly a $10 per transaction fee, but the costs for making a mistake will be substantially lower than under bounce protection.

If the bank won’t approve you for true overdraft, ask it to stop approving over-limit transactions. If it won’t, take your business elsewhere.

Why your budget doesn’t work

Dear Liz: My husband and I have not had any credit cards for almost 10 years. We just paid off our vehicle with his retirement account. We now owe only for our home. We have no other debt except utilities. I draw a disability check each month, and I keep thinking we should be able to save but have been unable to. We are not extravagant by any means, rarely going out to dinner or movies. What are we doing wrong?

Answer: Well, for one thing, you drained a retirement account to pay off debt. That’s extremely shortsighted, because you incurred unnecessary taxes and perhaps penalties to tap money that should have been left alone to grow. (And yes, it will grow again. Eventually.)

What’s probably happening is that you’re waiting to save until all your other expenses have been paid. That rarely works, because expenses have a mysterious way of rising to meet your income.

You need to turn your priorities around and save first — something out of every paycheck or other money that comes your way.

The best way to do that is to put your savings on automatic, so the money is swept out of your checking account into a high-yield savings account. If you have to make a decision each paycheck to save, you’ll typically find other things to do with that money.

If you try that and find yourself still falling short, it could be because your fixed expenses are out of whack. Often, when people aren’t extravagant but still have trouble saving, the reason is a home or a car that’s eating up too much of their incomes. If you’re spending much more than 25% of your gross income on housing or 10% on your car, you may find yourself having trouble making ends meet.

What to do now with your extra cash

Dear Liz: My husband and I make good money. We have a low-rate mortgage, a good amount in savings, and our retirement fund is well on its way, despite recent losses. We still have 25 years until retirement. What’s the best thing to do with our extra money? We have been putting it into projects to spruce up the house but otherwise just throw it in savings.
Answer: How about investing some of it in a session with a fee-only financial planner? That’s the best way to know if you really are on track for retirement, if you have enough emergency savings and if you’re adequately insured.
You can get referrals to fee-only planners who charge by the hour at Garrett Planning Network (www.garrettplanningnetwork.com) and the National Assn. of Personal Financial Advisors ( www.napfa.org).
If your finances are indeed as rosy as they seem, then you may want to consider enjoying your money a little more. Research shows us experiences make us happier than possessions, so consider a special vacation or travel to see family and friends.
You also might consider boosting your charitable donations to share your good fortune in these increasingly hard times.

Build savings or pay off debt?

Dear Liz: We have about $800 extra each month after paying bills, but we aren’t sure we’re doing the right thing with it. Should we pay down our adjustable-rate, maxed-out home equity line of credit? Or do we put it toward our savings, which has only $5,000 right now?
Answer: Before doing either, make sure you’re saving adequately for retirement. You may be tempted to cut back in this uncertain market, but the costs of retirement are so great that you need to start saving early and not stop if you want to have a sufficient nest egg. Your human resources department at work probably has tools to help you.
If you’re convinced you’re on track there and you don’t have any credit card debt, the next step normally would be paying down that home equity line. In today’s environment, however, you might find your lender lowering your limit as soon as you start to reduce your balance. Rather than freeing up credit that you could use again in an emergency, paying down your HELOC may actually reduce your overall financial flexibility.
This might not be an issue if you have tons of equity. If your current mortgage balance and your line of credit total less than 60% of your home’s current value, you may not need to worry about your lender reducing your credit limit.
If your loans total more than 60%, however, or if housing values are falling fast in your area, consider instead building up your savings.

Can taking advantage of low-rate offers affect our FICOs?

Dear Liz: We have good credit with FICO scores in the 780 to 800 range. For most of the last 20 years we have paid all of our credit card bills in full and on time, never incurring any interest charges. Recently, though, we’ve started taking advantage of “buy now, pay nothing for a year” credit card offers.

We currently have outstanding balances of over $45,000 on several cards, and one card has an outstanding balance of $26,000 on a limit of $29,000.

We wonder how all this affects our credit scores since we are not really in debt because we have short-term savings to more than pay off these bills. Does this not show up on our credit reports?

Answer: The scoring formula often can’t tell the difference between someone who’s playing a game of arbitrage (essentially what you’re doing) and someone who’s getting in over his or her head.

Your credit reports, from which your FICO scores are calculated, give no clue that you have plenty of savings to pay off this debt.

A FICO score is a three-digit number that lenders use to help gauge your creditworthiness. But it doesn’t take into account your income or any other “ability to pay” information. The FICO score gets its name from Fair Isaac Corp. of Minneapolis, which developed it.

What the formula tracks is your payment history, the number and variety of your accounts and — most important for this discussion — the limits and balances of your accounts.

If you’re close to the limit on any card, that’s potentially bad for your score. So, too, is opening a lot of new accounts in a relatively short period of time, even if it’s just to take advantage of a great interest rate offer.

It’s hard to predict how playing the zero-percent game will affect your scores over time. Some people are able to do it for quite a while with no major negative effect, particularly if they are careful not to use more than 50% or so of any card’s limit. Others find their scores drop over time.