Getting out (and staying out) of debt is such an important part of developing your personal finances. The temporary enjoyment of the fancy meals, new clothes, vacation trips, etc., soon disappears when the bills arrive and you don’t have the money to pay them. To make up for your past excesses, you have to consume less, and doing so is at least as hard as cutting back on calories. Just as things beyond your control can make you gain weight, unexpected expenses or a drop in income can result in creating or increasing debt.
A big tax bill is often one of those unexpected expenses pushing people over the edge into debt. In my experience, self-employed people are especially prone to this debt creator. One of the hardest things about being self-employed is that since you’re not sure what your taxable income for the year is until December 31 (or later, if you have not kept track of your expenses), it is all too easy to get stuck with a bill at tax time. And most people I know really have to scramble to come up with the money. A self-employed couple from San Diego, with small children was recently referred to me for exactly that reason despite making many of the right financial moves (like buying enough insurance, putting money in retirement plans) they still were stuck every April 15 paying their taxes with a credit card advance.
If at tax time you have looked at credit card advertising, you will know that this is a common way of paying taxes; in fact, it’s encouraged. When I assured this couple that their problem was by no means unique, they told me that it wasn’t just the fact that they took the advances that was a problem but the size of the last advance ($25,000) that really concerned them. This was exactly the credit limit of only one of their credit cards.
Now, before you write Wayne and Carly off as financial incompetents, it is important to see why the advance was so large. They were trying to do the right thing by contributing every tax-deductible dollar they could to their retirement plans, to the tune of almost $15,000 in the year in question. Essentially, more than half of Wayne and Carly’s short-term debt was racked up so they could deduct as much as possible on their tax return and also get the benefit of saving for the future. As parents of small children, they also found that day care and school tuition made balancing the budget near possible. Each year, they would dig themselves out from under last year’s debt; then tax time would roll around and they would be stuck going into debt all over again. This couple was determined to get ahead of the credit game for the first time in their lives. They wanted to stop the cycle of accumulating and then working off their financial fat.
Although that amount of Wayne and Carly’s advance seems high, the basic facts of the story are not that unusual. In fact our love affair with debt is long-standing. In 1960, our outstanding consumer credit (not including mortgages) averaged 18.5% of our disposable personal income. In 1992, it was about the same (17.9%). But although our debt load is not higher as a proportion of our income than it was all these years ago, we are using credit more and more for convenience sake. For example, total credit card spending was $201 billion by 1980. By 2000, that number rose to over nine hundred billion dollars. As we put more on credit cards, it becomes easier to be tempted to overextend ourselves.
Some studies show that we spend up to 30% more if we put it on plastic instead of paying cash. I am not suggesting that using credit makes you a bad money manager (after all, only 3 1/2 percent of people with credit cards get into serious trouble with them). But debt and interest payments are becoming an increasingly substantial part of our economy, and the problem is that we end up using current dollars to pay off the past instead of saving for the future. In December of 1993, we carried 297 billion of credit card debt, and there was currently over one billion credit cards floating around in Americans’ pockets. And the problem got worse. By the year 2000 experts noticed that our credit card debt was almost double and the number of credit cards had increased by 30%. We simply have to stop mortgaging the future to pay for the past, but it’s hard to develop the willpower to do so.
A client of mine in Los Angeles recently expressed the credit card dilemma to me in personal terms. After looking at her debt load and the amount of time it would take to pay it off, she realized that it would be at least three years before she could save even one penny for the future. As Bonnie said, “it is as if there is a dance going on and I am always three steps behind everyone else.” This is actually a very accurate description, because I know from personal experience that daily living and the expenses associated with it can seem to have a life of their own and can make you feel as if you are simply along for the ride.
Not all debt is inherently bad, and most people do need debt at some point in their lives. If you had to wait until you could pay cash for a home, you probably never would be able to buy one! The same is true with starting a business or buying real estate as an investment. Debt can also help tide you over when there is emergency dental work to be done or the water heater bursts. The problem with debt is that it can become the financial flu. If you have a lot of it, you wake up in the morning feeling dragged down, and you find it difficult to focus on doing anything productive. It’s hard to feel positive about life in general when you have the burden of big monthly payments stretching out for years to come.
Debt mortgages your future in order to pay for your past. The only exception is when you take on debt to make an investment that you anticipate will increase in value, such as a home or business. As I writer for California Loan Find, I will be discussing what happens to our dollar from the moment you receive it until some part of it is available as savings. Remember, out of your income dollars comes the “TED squeeze” – taxes, expenses, and debt payments. Those debt payments can put a real drag on your finances because you end up with less money to save this year and less savings to invest and grow next year.
Let’s assume you get a $1000 raise next year. If you are like most people, you immediately start daydreaming about what you’re going to do with that money. But let us also say you are carrying a $1000 balance on your credit cards. Though you haven’t even earned your raise yet, it will probably have to go to pay off your debt. To get your debts under control, you must know exactly how much and what kind of debt you have, examine your attitude about debt and how comfortable you feel having it, and come up with a workable plan to pay it off.
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A LOAN CALCULATOR FOR CRUNCHING YOUR NUMBERS IS BELOW; Enter your loan amount, how many years, the interest rate, and payment frequency (14 for biweekly, 30 for monthly, 7 for weekly. Very helpful so you know exactly what the loan will cost you in interest payments and you will know the total COB (cost of borrowing).
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