Chapter Six: Debt, Debt, and More Debt
If you live in mainstream society, chances are good you will, at some point, wind up with some form of debt. Whether you wind up with a wallet stuffed full of credit cards or a mortgage loan to purchase your own house, there are very few people who avoid debt altogether. Debt does not have to be a bad thing, but if you aren’t careful, it will take control of your life.
Have you ever experienced the feeling that comes along with owing someone money? Suppose you owe your friend $20. Imagine every time you see that friend he says, “Hey! Where is my $20?” Pretty soon he says, “You know that $20 you owed me? Well now you owe me $25 because you didn’t pay me quickly enough.” Later, if you still haven’t paid him back, he says, “Because you haven’t paid me back yet, I’m going to talk to everyone who might want to lend you money and tell them to stay away from you because you don’t pay your debts back fast enough.” Then, when you do finally pay the debt back, he turns around and says, “Would you like to borrow $30 this time?” This is similar to how credit works. As long as you owe a lender money, the lender is going to pursue payment. If you don’t pay the money back like you should, the lender is going to tell other lenders (through your credit report) they shouldn’t lend money to you. Then, when you do pay the lender, you might find the lender is suddenly willing to lend you more money. It’s a perpetual cycle, and it only ends if you make the conscious effort to end it.
Case Study: Earning Your Own Way
Mary — High School Student
Ever since I was 14 years old, I have had to pay for everything by myself, without my mom’s help. On my 14th birthday, my mom hired me to work for her. She purchased a laptop for me — shortly after I started high school — so I can use it for my school work; her condition was that I pay her back for it. Every month I pay her a certain amount of money, I will continue to do that until I have paid her the correct amount.
I receive my paychecks through direct deposit from my work. It goes straight into my bank account, which I access online. That is how I pay my mom back each month. I use my debit card when I need to spend money. I only spend money when I absolutely have to. I keep my debit card in my mom’s desk so I’m not tempted to spend money. I am saving my money so I can buy a car when I turn 16, or shortly afterwards, and also so I can pay for college.
I often have to convince myself that I can’t spend money, because I have to save it, but sometimes it isn’t easy. Because my mom doesn’t pay for anything, I have to buy myself everything that I want. If I need clothes for the new school year, I have to buy them; if I want to go out with friends, I have to pay for it; if I need school supplies or anything else, I have to pay for it. I have to keep track of how much money I have, which I do both online and in my checkbook. Every time I spend money using my debit card, my bank automatically puts $1 into savings, which helps me save money.
Good Debt and Bad Debt
Financial experts put debt into one of two categories: good debt and bad debt. Don’t be fooled into thinking that just because something is called “good debt” that it doesn’t mean you have to pay it back. “Good” and “bad” just refers to what you are getting out of the things you buy with the debt.
$ave $mart Tip
“Learn the difference between healthy and unhealthy debt. Generally, only four types of debt can be healthy:
1. Student loans — Further one’s education and increase future earning potential.
2. Mortgages — Home ownership is an asset that can build equity and net worth.
3. Necessary medical bills — One’s health always takes priority.
4. Business debts — Often necessary to build a business and future earnings.
All other types of debt — especially credit card debt — create more problems than they solve.”
Andrew Housser, co-CEO of Bills.com
Good debt
“Good debt” refers to debt that was used for purchases that have the potential to grow your wealth over time. For example, a mortgage loan used to purchase a house is considered good debt because houses hopefully appreciate in value over time. When a house appreciates in value, it means that a house purchased for $200,000 may be worth $210,000 in a year. In theory, people are supposed to be able to purchase a home with a mortgage for a certain amount and then be able to sell the home for more money than they originally spent, thus increasing their wealth. This isn’t always the case, but debt from buying a home is still considered to be good debt.
Student loans also fall into the category of good debt because they are considered to be a way to finance your education, thereby investing in your future. You will learn more about student loans in Chapter 7. Keep in mind that just because something falls into the category of good debt does not mean you should aspire to obtain as much of it as you can. Good debt has to be paid back, just like bad debt.
Bad debt
Some people will argue that all debt is bad, no matter what it is labeled, but there are some debts that are always considered “bad.” In other words, you should avoid this type of debt if at all possible because it will do nothing to make you wealthier in the long run. Credit cards, car loans, and other types of loans that aren’t for housing or college expenses fall into the category of bad debt.
When trying to figure out if a debt is good or bad, think about how the debt will affect your overall finances. Ask yourself these questions:
• Does this item help me make more money in the long run? A student loan may someday pay off because a college degree may help you to make more money in the future, but a shopping spree for clothing using a credit card will only hurt your finances.
• Will my purchase appreciate in value? When something appreciates, it means that the item becomes worth more over time. A home may appreciate in value, making a mortgage loan a good debt, but a car will probably depreciate (lose value) over time, making it a bad debt.
• Does it really matter if it is good or bad debt? Putting your debt into one category or another does not mean you won’t have to pay the debt back with interest. The more debt you can avoid, the better your finances will be.
While it is true you may never be able to afford to buy a house in cash, almost everything else can probably be obtained using the tried and true method of saving for what you want. Are there people out there who buy cars with cash and who pay for their entire college education without ever taking out a single loan? There certainly are, although these people have learned the important talent of working toward what they want and delaying their gratification. They have spent a long time saving money and have set clear plans to achieve their financial goals.
Case Study: The Importance of Saving
Michelle — High School Student
One thing kids today don’t realize is that saving for life after high school is very important. I have started to save for college recently, though I don’t have as much money set aside as I probably should. However, I am applying for many scholarships, and I hope that through these, I will be able to gain more money to pay for books and transportation. In the state of Florida, the Bright Futures Scholarship Program is also offered, and I qualify for it, so at the present time I do not need to worry about tuition as I am commuting to a community college during my first two years. I have been told this is a good idea to follow because I will not only avoid paying tuition, but I won’t have to pay for dorm and food expenses.
I have realized that, even if I didn’t plan on going to college, it’s still important to save money throughout and after high school. Though I could plan to go directly into the workforce after graduating, money saved can serve as a backup for any sort of emergency. Your job may be fine one day, and then layoffs are conducted a week later. I could get sick, and if I have no medical insurance, I would have quite an expense to worry about. In either circumstance, I believe it’s vital to start saving money whenever I can for whatever the situation calls for.
I have also learned how to manage household bills over the last year and a half, which helps me to see the importance of money management. I learned I not only need to have enough money saved on my own to take care of everyday things and emergencies, but I also must have a sufficient amount of money to cover my expenses. Sometimes, it doesn’t seem easy, but once a system is worked out, I have seen it’s actually something that’s very simple to do — if you have the means to do it.
On a final note, I have come to see that if I can learn to save money now, I can practice discipline when it comes to spending. This is a trait that will carry over with me into the future and will help me to manage my money in an even better fashion. If other students will practice this now, many of them will see they don’t have to struggle as much in order to make it through college or their first few years out of high school. All it takes is a little practice and a lot of patience.
Handle your debt
If you are going to have debt, you will need to learn how to handle it. Here are some basic rules to follow regarding your debt:
• Don’t get credit you don’t need. It is one thing to get a loan to pay for college when you don’t have any other way to pay for your education, but it is another thing entirely to get a credit card from your favorite store in the mall so you can buy clothes whenever you want. Before you obtain credit, think about whether you really need the things you are about to finance. While there are important expenses in life such as tuition and rent, using credit unnecessarily should be avoided.
• Don’t view available balances as invitations to splurge. Credit card companies would like nothing more than for you to charge your credit card accounts to the maximum limit because it makes more money for them in the long run due to fees and interest charges. It will also make it more difficult for you to manage your finances, and you will probably find yourself psychologically affected by the debt. Don’t make the mistake of thinking that owing a large sum of money won’t bother you, because it will.
• Don’t hoard credit. You may like the idea of getting credit in your own name, and while this can indeed be something that makes you feel more independent, it is also something that can get you into a lot of trouble. Remember that just because a creditor is willing to give you a loan or credit card does not mean they know you can actually afford the payments. For this reason, avoid the temptation to apply for every credit card you’re offered, especially when shopping at the mall or at department stores.
• Keep track of your debt. Being unable to pay off your balances in full every month should be a huge red flag to you, warning you that you have too much debt. While trying to pay off the balances you have, always keep track of how much you owe along with when the payments are due. The last thing you want to do is to fall behind in your payments and wind up being harassed by collection agencies all day long.
• Don’t forget to save. If you find yourself scrambling to pay off the debt, you might be tempted to drain out your savings account or stop saving altogether. Use caution. You need some money in savings to handle any financial emergencies that might come up. What will you do if your car breaks down and you don’t have any money left in your savings account to pay for the repairs? Chances are you will use a credit card to cover the repairs, and this starts the whole debt cycle over again.
• Don’t rely on credit. If you find you are using credit in order to cover basic expenses, such as for groceries or to pay utility bills, you are already in trouble financially. Scale back your spending to allow you to pay for everything in cash while getting your debt under control.
How do you get your debt under control? It can be an easy process if you haven’t yet fallen too deeply into debt, and it can be a really tough process if you’re in serious financial trouble. Either way, the effort is really worth the end result, and the sooner you get started, the more quickly you can start to actually enjoy your money instead of seeing it as nothing more than a way to pay off the debt you owe.
Why should you bother to learn about getting out of debt if you aren’t even old enough to get credit on your own? The fact is that you never know what the future will hold, so learning about these methods now will prepare you for when you are older and may find yourself in a situation where you need to turn your finances around. Better yet, maybe reading about debt will keep you from ever getting in too deep to begin with.
Keep in mind that you don’t have to use credit if you don’t want to. There are people who live without any debt at all. Do you remember the story from Chapter 1 about the man who gave up money altogether? If a man can give up using any form of money whatsoever, it doesn’t seem so far-fetched to think you can live without incurring debt.
Case Study: Your first car
Margaret — High School Student
Every 16-year-old has the dream of their perfect car. For me, it was a lime green Volkswagen. I wanted this car ever since I was a little girl. So, naturally, I almost died when my mother gave me my dream car on my birthday. Little did I know, this car would put me in financial, emotional, and mental agony.
My mother surprised me with me car on a Friday after school. She told me earlier that morning that we were going to go car shopping after school, but what I didn’t know is she had already struck a deal with the dealer. I was so happy and sad at the same time. Not only did this mean I was growing up, but it also meant I had a responsibility — car payments. We didn’t have enough to pay off the car, and insurance payments were now in my future.
At the time, I didn’t have a job, so all the payment issues were on the shoulders of my mother. I did little odd jobs like babysitting to help pay all the expenses, but we were still behind. With all these problems, you would think we already had enough on our plate, but the story just gets better and better. My precious car was experiencing some mechanical difficulties that would make it almost impossible to drive — problems the dealer claimed were not his problem now that we had exceeded the warranty. We went to every car repair shop in town. Time and money seemed to vanish right in front of our eyes as we went to every pointless car repair. It seemed there was no hope in sight for our little bundle of chaos. Our last resort was to take the car to a foreign car dealership and see if there was anything they could do. Of course, in the back of my mind, I knew that it was going to cost an arm and a leg to fix — an arm and a leg I didn’t have.
“The problem is in the computer’s memory within the car,” the repair man said. You can imagine the look on our faces. I had never heard of a car having a computer within it. To repair it would cost too much, and who’s to say that this problem won’t happen again? I was able to trade it in for a wonderful car that is better on payments and (knock on wood) hasn’t given me any trouble since I bought it.
I know that if it wasn’t for me making reasonable and logical decisions, I would still have that money-munching vehicle. I am satisfied with my decision, and happy my mother was able to help me along the way. My advice to teens buying used cars: Always look into what you are purchasing. Always make sure that you are financially stable enough to be able to handle whatever life hands you.
People who live without credit have to “live within their means,” which basically means they just don’t buy things they can’t afford. Instead of pulling out a credit card to pay for a trip to the mall, these people pay with cash or just stay out of the mall to begin with. If they don’t have the money to buy something, they just don’t buy it. The funny thing about this lifestyle is that oftentimes, these people find they have more than enough money for everything they need. Why? It is because their money stays in their wallets or savings account instead of being used to pay credit card and loan payments.
If you avoid credit and debt altogether, you may run into a few issues that will complicate things just a little. For example, when you try to reserve a rental car or hotel room, most companies want a credit card to make the reservation. Some companies will accept a debit card for reservations, but they may put a hold on a large chunk of your money in your account until you pay the final bill. That means that if the company insists on putting a $500 hold on your checking account, you won’t have access to that $500 until after you are finished with the car rental, hotel stay, or whatever it is you paid for. If you have the money available for a hold of this amount, it won’t be a problem for you, but if you aren’t expecting a hold like this, it can be a rude surprise.
You might also run into small problems when you apply for a job, insurance, or to rent an apartment. In all of these situations, your credit might be checked, and if you don’t have any sort of credit history at all, you may have to show that you’re able to pay your bills in other ways. You may be able to show copies of other bills you have paid, such as your cell phone bill or your cable bill, to prove that you are able to make your payments on time before you can get approved to rent an apartment from a landlord who only allows renters with a good credit history.
$ave $mart Tip
“Save as much as possible for college, and apply for every scholarship and contest that you possibly can. It is possible to win enough to actually pay for college and put extra in the bank.”
Debra Lipphardt, scholarship coordinator and author of The Scholarship and Financial Aid Solution: How to Go to College for Next to Nothing with Short Cuts, Tricks, and Tips from Start to Finish.
You don’t need credit, but it does make things easier if you can maintain a good payment history. The trick is to manage your credit well so that it doesn’t become a problem. If you decide to live without credit, even if it’s only in the beginning of your adult life, here’s how to do it:
1. Have ample savings. Lots of people use their credit cards for financial emergencies, but if you don’t plan to have credit cards, you need to have money stashed away in case something happens. Suppose you are away from home for your first year of college and one of your family members has been injured in a car accident. You want to fly home and see that person, but if you don’t have a credit card to buy the ticket and don’t have any money available in your bank account, you will be out of luck. A portion of your paycheck should be put into a savings account to accommodate such emergencies.
2. Keep records of your payments. Because eventually you will need to prove to someone that you know how to make payments on time (like when you try to rent an apartment, for example), you should always keep detailed records. Hold on to your statements and receipts for any bills that you pay monthly, such as rent from the place where you live now (if you pay rent) or car insurance. If you don’t have monthly bills, you may need to get reference letters written by someone who you have paid a debt to; however, some potential landlords and other people won’t accept something like this as proof of good payment history. As you can see, credit is sometimes a necessary evil. You will likely wind up with some sort of credit eventually, and when you do, the trick is to learn how to manage it effectively.
3. Get ready to explain yourself. Suppose you go for ten years without obtaining any credit whatsoever, and then you decide that the time has come to get a loan so you can buy a house. When you submit an application for your mortgage loan, chances are good the lender will contact you and want an explanation as to why you have no credit history. During your late teens or early 20s, not having a credit history is expected. However, by the time you are in your late 20s or early 30s, lenders expect for you to have established some sort of credit history. If you manage to get to this point without using credit, you will definitely shock most lenders, and you may have a difficult time buying the house. With a large amount of savings, it is entirely possible to get approved for a mortgage loan without having a credit history, but it will be a lot harder than if you obtained credit and used it wisely before applying for the home loan.
Most likely, you will eventually get a credit card or obtain some other form of credit, whether it is a car loan or a mortgage. Credit cards, when used responsibly and when only used when you have the money to pay off the balance each month, don’t have to be a negative thing. Some people, however, lack the self-control to only spend what they can afford to pay, and that is how many people get in trouble with credit cards. So, if you do eventually get a credit card, remember to pay your bills on time and try to pay off the balance of the card each month. If that’s not possible because you have had to use the card for an emergency, pay off the balance as quickly as possible and try to pay more than the minimum payment each month to avoid paying a lot of interest.
Case Study: Creative Ways to Get By
Gary — College Student
I pretty much got cut off by my father’s checkbook for dating a girl. Being young and arrogant, I told him I didn’t need his money when it would have just been smarter to hide my girlfriend until I had my college paid for. Anyway, my girlfriend, Amy, and I survived and were pretty clever at getting things for nothing.
Food:
I took a job at the university’s cafeteria. It didn’t really pay anything, but for washing dishes for an hour a day, I got free meals at the cafeteria.
Amy took a job at a convenience store. When they had supplies that were about to hit their expiration date, the manager would sign them off, and Amy was permitted to take them home. Milk actually can last after the date if unopened. We used it up quickly, but for free, it was worth it.
Entertainment:
I had a friend who was a bouncer for a Cincinnati concert arena. Because our school was about two hours away, he made a deal with me that if I did the driving to and from the concert, he would get me into them for free. I got in through the security gate and got free concerts for two summers. It also helped to have a friend who worked the local movie theater. I tutored her in math, and she got us into the movies for free. Also, I was taking theater courses which required that we attend the university plays for analysis and discussions, and the good part was that we got free tickets for them.
Rent:
Because we did not go home for the summer when school was out, we had a deal with the landlord to keep an eye on things (parties and such), so we got discounted rent during the summer months. Plus, when college kids left for the summer, a lot of their furniture and such was being thrown out. We pretty much had a really stocked apartment and didn’t pay for any of it.
College:
Helping as a lab assistant worked well to get access to computers, copier machines, and other equipment I needed but could not afford.
All in all, I lived by using improvisation skills and fast-talking to get away with it.
The debt spiral
It is really easy to get into trouble with debt. Even if you manage to keep up on all your payments, you might find yourself overwhelmed with the amount of money you owe. It can be frustrating to know a portion of your paycheck will go straight to a creditor instead of going into your savings account or toward buying something you really want.
The bright side to a frustrating situation with debt is there is always a way out. It may take you years to get your debt paid off, but with a conscious effort, eventually, it’ll happen. You have to first recognize the fact that you are in financial trouble and decide you want to do something about it.
Debt may not be a huge problem for you now, especially if you have not yet entered college. College is when many people first experience financial difficulties, not only because of the financial obligations associated with attending college, but also because this may be the first time you have some control over your finances.
Case Study: Lessons Learned the Hard Way
Chris — College Graduate
I spent myself into a frenzy when I was in college. I spent so much money that I graduated with a car-sized student debt going to state schools. I did it in part to live like the kids I hung out with. I wanted to go home for the holidays. I didn’t want to work full-time and go to school full-time. This makes perfect sense given I was from a cash-strapped family. Education was important, recreation was desirable, and resources were available.
I racked up a bunch of debt and then stopped paying for it. I couldn’t possibly afford my private debt. The only reason I started paying back my student loans is because creditors finally got serious. My student loans are back on deferment as of now. My credit has been ruined.
We were taught to create debt. We have created debt, and in doing so, we have taught our children to create debt. But debt usually has a creditor. In the United States, we have historically had much more liberty from harassment and mistreatment by creditors than in most other countries. Still, they have some options available to them.
But more important than the threat of a repo man is the empty fulfillment offered by the accumulation of debt and stuff. Everything I like to do costs money. Everyone I love costs money. This is not because I am money-hungry, nor are those I care about. These are problems because money is a lens through which all of the light of the world passes.
Are you in trouble?
If you’re still in high school, you are probably wondering why this is important to you. The best time to learn about how to get out of debt is before you’re actually in it. Learning about debt now may stop you from ever getting into trouble with debt in the first place.
Chances are, if you’re having trouble with debt, you’ll know it. While it is certainly true that mounding debt seems to sneak up on people when they first begin using credit, it is not difficult to realize when things begin to get out of control. Here are some of the signs that you are heading toward trouble with debt:
• You can no longer pay off the full balance of your credit card each month.
• You use credit cards to buy necessities like food or gas because you can’t afford to pay for them with cash.
• You have no idea how much money you owe or when your payments are due.
• You have to borrow money from other people to make all your debt payments.
• You start missing payment due dates.
• Your credit applications get turned down for reasons other than lack of credit history.
• You have creditors trying to contact you because you are behind on payments.
• You feel anxious or depressed because of your financial situation.
This last sign is important. No matter how effectively you manage your bills and how careful you are about making your payments, the second you start to feel uncomfortable about how much money you owe to creditors, it is time to make some changes. Trust your instincts. If it starts to feel like you are losing control of your money, you probably are.
Case Study: Amassed Student Loans
Josh — College Graduate
I amassed $40,000 in student loans over the course of four years in college while pursuing a degree in filmmaking. I worked about 25 hours a week as a salesman at a department store, and my pay wasn’t enough to live on. The student loans covered my college tuition, books, and living expenses such as rent. The last year of school, I had a car loan, so some student loan money went to pay that, too.
Looking back, it might have been too easy to get the large amount of money from student loans. In retrospect, if I had more self-discipline, I would have borrowed less from student loans because, really, I didn’t need it all. I could have found a job that paid more and been more frugal, but it was just so easy to get the money from the student loans.
About six months or a year after graduating from college, the student loan payments started, and I paid them off and on. I then went on a payment plan with the loan creditor for awhile, where payments were automatically taken out of my checking account, but it wasn’t a mandatory program; it wasn’t like they were garnishing my account or anything. After two or three instances of having insufficient funds when the withdrawal was attempted, they took me off the automatic payments. After that I was supposed to start paying them on my own, but I haven’t yet. This was about two years ago, and I’m not paying on them now because I’m out of work.
I wasn’t paying on them before because I didn’t think I had the money to spare, but I’m not paying on them now because I know I don’t have the money as I am not working. When tax time rolls along, there is a tax lien on any return due to me; so last year, my whole tax return went to the student loans. I was due a tax return, but I never saw any of it.
Frankly, I stopped keeping track of the late fees and penalties that have been added to the student loan accounts because I know I don’t have the money to pay it, so there is nothing I can really do about it at this point. I would guess the penalties and fees have added up to around $3,000 or more.
I have some advice for college students who are thinking about getting student loans to help pay for college: Get as little money as you possibly can. Get just what you need, and nothing more. There were times when I wasn’t working too much in college, so I pretty much relied on the student loan money to pay all my living expenses, which was a huge mistake. Try not to use the funds for anything except expenses directly related to college, like tuition and books.
Getting rid of debt
There are many different ways to pay off debt. The best way to pay down debt is whatever method works best for you. There are many different financial experts who claim their ideas for paying off debt are better than anyone else’s, but unless the plan works with your situation, you will likely be unable to stick with the system.
Keep in mind that this is something you may not have to deal with right now at all. You may not even be at an age where you can obtain debt on your own. For this reason, this book only presents a brief review of the two most popular ways to systematically pay off debt. The important thing to learn right now is that there are methods to help you pay off debt, and if you sit by idly, dwelling on your woes rather than working to better them, you’ll likely be in debt for the rest of your life. Remember this in few years if you find yourself in a financial situation you aren’t prepared to handle on your own.
Debt laddering: Climb on down!
Debt laddering is a method used to pay down debt when you have more than one credit account. Here is how it works:
1. Look at all your credit accounts and figure out which one has the highest interest rate charged on the account. You can find the interest rate by examining your monthly statements. This is the card you should work to pay off first. Payments sent to this card should be substantially more than the minimum payment. You should pay the minimum monthly payment on all your other accounts, while the account with the highest interest rate should get as much extra money as possible.
2. When the account with the highest interest rate is fully paid off, move on to the next account with the highest interest rate. Do the same thing with this account: Put as much extra money toward the balance as you can and only pay the minimum monthly payment on all the other accounts. In order for this method to be effective in getting you out of debt, the financial experts who endorse this method suggest the accounts should be closed after you pay them off.
3. Each time an account is paid off, move on to the next remaining account with the highest interest rate. The point is to keep doing this until all the accounts are paid off.
This method will only work quickly if you stop using the accounts you are trying to pay off; otherwise, you will spend more time paying off your balances because you keep adding to them.
Debt snowball: Watch it melt!
The debt snowball method is similar to the debt-laddering method, but with one small difference. Instead of starting with the credit account with the highest interest rate, you start with the account with the smallest balance and go from there.
This method may not make as much sense mathematically as the debt-laddering method because you will probably wind up paying more money in the long run because of interest. However this method is said to be more gratifying because, in theory, you will pay off accounts quicker than with the debt-laddering method. The idea is that quickly paying off accounts will keep you motivated and make you want to keep working toward paying off all your debt instead of getting discouraged and giving up. After all, a huge part of managing your finances is psychological. If you can talk yourself into getting serious about paying down your debt, you will have a better chance of succeeding with your goal than if you only worked toward it half-heartedly.