The Great Debt Debate: Part 1 of 3

Welcome back!  I have to say, I've been very encouraged by all the positive feedback I've received after my first few posts.  This has been fun for me (so far!) and I've learned a lot from your thoughts and comments as well.  To this point, I've been sharing ideas that revolve mainly around ways to save money, or reduce complications or stresses in your life.  I'm taking a diversion from that for the next few weeks and will try to dive into a topic very near and dear to my heart.

There are many great things we learn through our primary and secondary education years.  We learn reading, writing, math, music, art, science, history, literature, etc.  However, the most crucial oversight within our education system, in my opinion, is the lack of education around how to handle money.  I recall a class in high school that taught me how to write a check correctly but gave no education on how to best manage the money in that checking account.  Even further, there is ZERO education on how to manage debt.  It should come as no surprise that the average citizen handles debt very poorly.  Without access to good information, isn't that the outcome we should expect? 

To make matters worse, even after our critical education years, we are left with almost no resources.  You can hire an insurance agent to help manage your insurance policies, a financial advisor to help manage your assets, a CPA to help with your taxes, or an attorney for help in legal matters, but there is no one you can hire to help manage your debt.  It should be noted that the 800-number credit help agencies are NOT there to help you manage debt.  They exist to make money, many times at your expense.  It should also be noted that mortgage loan officers are not debt managers either.  They can be very helpful in obtaining good loan terms, but that's where it ends.

So, making educated and calculated decisions about your debt is entirely up to you.  For some it will come more naturally.  For most, it requires education, budgeting, knowledge of credit products, etc.  You can't afford to simply be ignorant.  Good luck!!

I will break this topic down into a 3 part series (maybe more).  I will start with credit card debt.  Part 2 will be deductible debt (mortgages, student loans, HELOCs), and part 3 will be all other debt.

Credit Cards

Credit cards, if used properly, can be very powerful financial tools.  If not used properly, they can cause great financial harm.  I will have a future post dedicated solely to my research on the best credit cards available, but for now, I'll focus on some caveats to be aware of when considering whether to use them or not. 

There is one basic and simple rule with credit cards.  If you pay your balance in full each month, get rewarded for it, and if you carry a balance, make sure you DO NOT have a rewards card.  Typically, if a credit card offers 1% cash back, the interest rate is 1% higher than a card that offers no cash back.  However, if you pay off your balance each month, make sure you're rewarded for it (I'll explore the best reward cards another time).  Rewards aren't as generous now as they were a few years ago, but I can still typically get between 1-3% cash back.

Cash back is always my preference.  I can get a check every month and put it right into my savings account.  Airline miles tend to accumulate and be forgotten about, plus the rules can change any time on those miles.  Lastly, you might spend 25,000 miles on a $150 airline ticket.  Earning $150 in cash back would only take 15,000 points.  Which makes more sense?

Rewards are great, but I specifically want to focus on those who carry a balance each month.  While I can't offer specific advice that would cover every variable, I hope I can offer some ideas to encourage you to be disciplined to get your balance paid off.  Credit card debt is what I consider "bad debt" because the interest rates are very high, the interest is not tax deductible, and the minimum payments required can leave you paying on the debt for years and years.

In most cases, people carry a balance simply because they don't have the funds available to pay it off.  This leaves you with two options: 1) Make more money or 2) reduce your spending to free up cash.  While there are things you can do to make more money, realistically, those opportunities may be limited.  Therefore, option two will offer the most flexibility.  There are many options for reducing spending to free up extra cash to apply to your credit card balance.  Look to my last post to find a way to generate a few thousand dollars every year to apply to your debt.  Many times it comes down to making tough choices in order to make significant headway toward your goal.  TV, newspapers, internet access, magazine subscriptions, gym memberships, eating out, cell phones, etc., are all luxuries that can be reviewed for their necessity.  I won't make many friends with that viewpoint, but you must be willing to make those tough choices.

Try this exercise: Inevitably, you've been in a store and noticed a pair of jeans, or a new tool that you would love to have, but was not the reason you were in that store.  Those jeans give you the butt you've always wanted, and they are on sale!  Mentally, you can already picture them hanging in your closet.  You've mentally committed to buying those jeans.  STOP!  You've decided you're going to part ways with $50 from your bank account.  Make the tough choice, put the jeans back, drive straight home and make a $50 payment towards your credit card.  You'll be glad you did.  Plus, let's be honest - you really don't NEED those jeans, do you?

Ultimately, if you carry a balance on your credit card(s), you must become disciplined both on the things you choose to buy and on how you pay it back.  It's not my opinion that all credit cards should be destroyed and you should deal in cash only, as credit cards can be a very powerful tool.  But if you're a crediholic, you have to face the reality of your situation and choose to do something about it. 


I've had clients who play the credit card game.  They will continually transfer a balance to new cards every few months to take advantage of 0% offers as a way to avoid interest charges.  The two reasons someone might do this are 1) they are leveraging the money as best possible but have the resources to pay off that balance anytime they choose, or 2) they transfer the balances out of necessity because they can't afford to pay it off.  I'm not particularly a fan of either option.  Balance transfers usually have a transfer fee attached to it and many times they essentially prevent you from using the card for anything else.  For example, if you transfer a $1,000 balance to card "A" at 0% interest and then use that card for your everyday purchases, many times any payments toward that card will be applied to the balance with the lowest rate (your $1,000 balance transfer) and none of your payments will get applied to your purchases until your $1,000 balance transfer is paid in full.  You'll be accruing interest on those purchases.  That's a rotten deal for you - don't do it.  


Playing this game can also negatively affect your credit score - sometimes substantially.  I had a client who made $43,000 per month but couldn't get a mortgage because their credit score had dipped so low as a result of playing this credit card game.


I am a believer in the debt snowball method.  This method essentially has you pay off your smallest debt first, and once paid off, add the payment you had been making on that debt to the payment you're already making on your next biggest debt.  This makes a lot of sense because it's encouraging when you actually pay off a debt and then see your other balances be reduced more quickly.  Plus, it doesn't require you to make more money or cut your spending.  


There are so many more avenues that I could discuss here, but I think I'll reserve that for another time.  If you have a specific situation that you'd like to discuss with me privately, I'd be happy to do so.  For some of you, this will not be easy, and it can seem hopeless.  Do not give up.  Life is full of choices and sometimes the most rewarding moments are the result of very difficult decisions. 


A great documentary to watch is called Maxed Out.  I own both the book and DVD and would be happy to lend out either to anyone interested.  The DVD is commonly found in many videos stores in the documentary section.  It's also available on Netflix.  It doesn't really explore ways to solve personal credit card issues, but it does shine a light on the credit card industry and highlights things to watch out for.  


http://www.amazon.com/Maxed-Out-Hard-Times-Credit/dp/B001PO64WI/ref=sr_1_3?ie=UTF8&qid=1292039177&sr=8-3

What advice can you share with others?  Had a good/bad experience?  Success story?  Please share your comments! 

My next post will focus on mortgage debt.  Think a standard 30 year mortgage is always the way to go?  Think again. 


Until we meet again...