Forgive Us Our Debts ... and the Interest Too, Please
The knot in Ed's stomach tightened as he looked at the pile of papers on the table. This can't be right, he thought. Maybe the mailman delivered our neighbors' bills by mistake. There's no way we owe this much.
But the bills and statements in front of him, the ones that were all addressed to "Edward Pfaff," told a different story:
* $1,275 to Community Hospital for Becky's C-section and Michael's neonatal care
* $6,510 to VISA (payment past due)
* $3,280 to Discover Card
* $7,512 to Ford Credit ($419 monthly payment past due)
* $840 to Workout World ($40 monthly payment past due)
And that doesn't even include the mortgage and what we owe Becky's dad, Ed reminded himself.
He glanced down at his paycheck stub and then at the figure on his calculator. We can't even make minimum payments this month, he realized. And we just paid for new brakes on the Honda, so that means next month is going to be even worse!
Ed shook his head and sighed. "Becky," he called out, "we need to talk. I think we may be in trouble."
* * *
Telltale Signs of Debt
Do you have a bill or a loan payment that's past due?
Do you carry a balance on your credit card?
Do you ever get nervous about your financial situation and wonder how you'll ever be able to pay what you owe?
Do you ever try to disguise your voice when you answer the phone, just in case it's a collection agent calling?
Have your ever considered panhandling as a second career?
Do you have a bumper sticker on your car that reads, "I owe, I owe, so off to work I go"?
If you answered yes to any of these questions, chances are you're struggling with debt.
In ancient times, that might have meant a stretch in prison for you—or at least a future as a servant to your creditor. In those days, people didn't fool around when it came to money.
One way or another, debtors paid what they owed.
Creditors today prefer a different method of imprisonment. What they'll do is offer you credit opportunity after credit opportunity until they've got your financial future locked up tight. It's not quite as dramatic as life behind bars, but it's just as effective. Anyone who's ever fallen into the easy credit trap can tell you that being surrounded by walls of debt does feel like a prison.
The good news is that there's a way out of your financial Alcatraz. The bad news is that getting out won't be easy. There are a few truths you need to accept right from the start.
1. You're not going to win the lottery.
2. A computer virus is not going to permanently wipe out all records of your debt.
3. Your creditors aren't going to let you off the hook because they think you've suffered enough.
4. Ignoring the problem will not make it go away.
If you're counting on a near miracle to rescue you from debt, we're going to ask you to hop on the first bus out of the Land of Make Believe and join us here in the real world—where it really is possible to escape debt, but only with a lot of hard work, tough choices, and personal sacrifice.
The Usual Suspects
Most debt is caused by three common financial mistakes, any of which can put you between a rock and a hard place faster than you can say, "What do you mean I've exceeded my credit limit!" Let's look at these three blunders to see why they're so dangerous—and so easy to make.
Mistake #1: Making the wrong long-term commitments
No, I'm not talking about marrying someone with expensive tastes (though that certainly could be a financial drain). I'm talking about buying big-ticket items that most people consider necessities, things like houses and cars. The long-term commitment to these purchases is in the payments. Today it's not unusual for car loans to be stretched out over seven years or more. And, believe it or not, it's now possible to get a 70-year mortgage.
Seventy years—run that figure through your brain a couple of times. Let's say you bought your dream house when you were in your early 30s. With a 70-year mortgage, your kids, your grandkids, your great-grandkids, and your great-great-grandkids could all watch you write out your monthly payment. When you retired at age 65, you would still owe more on the house than you'd paid. You could even live to see Willard Scott IV wish you a happy 100th birthday on the Today show and still be survived by your payment book!
Fortunately, a 70-year mortgage is still the rare exception and not the rule. Even if you choose not to finance a house for seven decades, though, you'll find that most lenders will be happy to give you more than enough financial rope to hang yourself, if you're not careful.
The average mortgage today runs closer to 25 or 30 years, and even though that's considerably less than 70 years, it's still a hefty chunk of calendar. That's why buying a house is not a decision to take lightly. If you make a mistake in choosing a home, you'll feel the financial effects of it for years, even decades, to come.
That House is Too Much
The most common mistake new homeowners—young married couples, in particular—make is buying too much house too soon. They look for a home based on what they want, not on what they can afford.
As long as we're spending all this money, they reason, we should get something we really like. And that's how the trouble starts.
From there, the preferences get more specific—and expensive.
* "A two-car garage would be a lot more practical and convenient than a one-car garage."
* "We're going to need a big backyard for when we have kids."
* "Wouldn't it be great to have a whirlpool tub in the master bathroom?"
* "Cathedral ceilings look so much better than regular ceilings."
* "The closer we are to the golf course, the better our resale value will be."
And like an idling taxi, the meter keeps running and running. Ten thousand dollars here. Five thousand there. When all of these extras (or, if you prefer real-estate jargon, amenities) are tallied, the final price usually bears little resemblance to the numbers the home-buying couple discussed when they first started talking about how much they could afford to spend.
Talking yourself into paying for these extras is surprisingly easy to do, even without a realtor breathing down your neck. All you have to do is look at your future very, very optimistically. The reasoning goes something like this: "Right now, the monthly payments for this house are almost more than we can afford. But with raises and bonuses, our salaries are bound to get bigger and bigger each year, so in a few years we should be able to make the payments with no problem at all. And although we may struggle in the meantime, at least we'll be in the house we want."
Avoiding Mistakes That Grow with Time
It's not hard to spot the danger in this logic. First, if most of your income is going toward mortgage payments, how will you be able to afford things like a car, furniture, clothes, or even groceries? It's easy to underestimate these expenses when you're trying to shoehorn a big ole house payment into a little ole budget. Second, if you really have the ability to see that clearly into the future, why weren't you able to keep yourself out of debt? The fact is, regardless of how rosy your income potential seems right now, there's no guarantee that your future financial situation will be any better than your current one. Your salary may increase over time, but so will your cost of living.
If you're thinking of buying a house, there are two things you can do to reduce your chances of making a long-term mistake.
1. Don't apply for a mortgage until you can afford to make a 20 percent down payment. If your dream house is selling for $210,000, don't start packing until you have at least $42,000 to put down. If you can't afford that kind of down payment, you can't afford that kind of house. You may want to consider buying a smaller home or one in a less-expensive area.
2. Make sure that your monthly housing costs take up no more than 38 percent of your Net Spendable Income (your income after tithes and taxes have been taken out). I'm not just talking about mortgage payments here. Monthly housing costs include mortgage payments, plus all utility bills, home insurance payments, and maintenance costs (everything from new carpeting to cleaning supplies). Together these expenses should gobble up no more than 38 percent of your post-tithe take-home pay.
Cars and Credit Don't Mix
Car payments, on the other hand, should take no more than 0 percent of your Net Spending Income. You read that right: 0 percent. Zero. Zip. Nada. Goose egg. Null set.
If you'd like to acquaint yourself with the ins and outs of new car investments, here's an exercise you can try.
1. Withdraw $20,000 from your bank account.
2. Flush $4,000 of it down the toilet.
Purchasing a new car is like buying $20,000 worth of stock and finding out the next day that your investment is suddenly worth only $16,000. Most new cars lose about 20 percent of their value the day they're driven off the lot. And no matter how carefully you drive home, there's nothing you can do about it!
If you finance the car, the problem is even worse. Buying a new car on credit—that is, making monthly payments on it for years at a time—ranks right up there with buying lottery tickets or site-unseen real estate offers as one of the worst investments you can make. When you finance a car, you put yourself in the position of paying a premium—sometimes for as long as seven years—for an investment that gets less and less valuable every day.
Of course, that's not something you'll worry about the first few months you own your new car. Writing a check for, say, $419 each month will seem like a mere pittance for the pleasure of owning such a sleek, shiny driving machine.
A year or so later, though, after the inevitable scratches and dings have taken their toll on the exterior and countless spilled sodas and muddy footprints have sullied the interior, $419 a month is going to start to seem a little pricey for such a plain car.
A few years after that, when the transmission is slipping, the timing belt is whining, and the brakes are squeaking, $419 a month is going to seem like an outrageous price to pay for "that hunk of junk in the driveway."
By that time, though, you probably will have decided to trade in that old car, even though you're not through paying for it, for a shiny new one. Like a lot of other people, you'll be putting yourself in the position of paying for two cars, one of which you don't even own anymore! Financial experts have a term for this type of arrangement: not smart.
Here are two helpful rules of thumb to keep in mind when purchasing an automobile.
1. If you can't afford to pay cash for the car you want, find a car you can afford (or learn to love public transportation). Escaping from debt is all about prioritizing your expenses. Your choice of transportation is a good example. There's nothing wrong with having a "dream" car. But are you willing to sacrifice your financial health—your family's financial health—to own it? Committing yourself to monthly car payments, even for the automobile of your dreams, makes you a prime candidate for serious debt problems.
2. Buy used. If a car is affordable and in good condition, does it really matter that it was owned by someone else first? Are you willing to pay thousands of extra dollars just to be able to say that you're driving a new car? If so, who are you trying to impress? And for that matter, why would anyone care whether your car is a year old? Besides, as any car dealer with a semi-sincere smile can tell you, it's not a used car, it's just pre-driven.
(For more useful information on the dos and don'ts of making major purchases, check out chapter 4.)
Mistake #2: Trusting an incomplete budget
Trusting an incomplete budget each month is like walking across a raging river on a rotting suspension bridge. You may make it across once, maybe a couple of times, with no problems. But the more you keep trying it, the more likely you are to hit a weak spot, one that can't hold you up. Before you know it, you're on your way down—and soon you'll be in over your head.
That's why it's important to be extremely thorough when you plan your budget. (For tips on how to anticipate and plan for future expenses, check out chapter 2.) If you don't plan for all potential expenses, you're just giving yourself a false sense of security.
For example, let's say you bring home just enough money each month to cover your tithe, your mortgage or rent payments, your car loan, your insurance payments, your utilities, your credit card bill ($150 maximum), and your grocery bill. If you have a few shekels left over for a good time on the weekend, you might be tempted to believe that you're doing okay money-wise. You might even fool yourself into thinking that you're financially stable.
But what happens if your dream car starts leaking real transmission fluid all over your driveway? What happens if your house's 15-year-old furnace gives up the ghost in the middle of your state's worst cold snap in 40 years? What happens if you break your ankle in a freak croquet accident? Worse yet, what happens if someone in your family gets tired of your budget restrictions and decides to put your credit cards through a major retail workout?
Automobile repairs, home maintenance, medical expenses, and spur-of-the-moment shopping sprees—these are just a few of the unexpected costs that have been known to assault unsuspecting budgets. The reason most people don't plan for these emergency expenses is simple: There's no room for them. Their monthly budget is already stretched tighter than a waistband at Thanksgiving, so there's no money left to set aside for future expenses.
When an emergency arises, you'll probably do what most other people do: pay for it with a credit card. And your already tight budget will be pushed beyond its limit. Instead of breaking even with a few dollars left over each month, you'll find yourself coming up a little short. Instead of a $150 credit card bill that you pay in full, you may have a $1,150 bill (depending on how expensive the emergency is) that you can't pay off. If you make your regular monthly payment of $150, that leaves a $1,000 balance in your account.
Of course, it won't stay $1,000 for long. Your credit card's interest rate will make sure of that. Every day that number is going to creep a little higher, and every day you're going to sink a little deeper in debt.
And that's just with one relatively inexpensive emergency. Imagine what would happen if a couple of unexpected expenses decide to double-team you. Hasta la vista, budget.
You can't avoid emergency expenses, but with some advance planning you can keep them from becoming budget killers.
Mistake #3: Buying when you shouldn't
Before all you bargain hunters out there get too excited, we should point out that I'm not talking about waiting for a "factory closeout offer" before you buy a new coffee table or waiting for a "13-hour sale" before you buy a new sweater. (Though I do strongly recommend waiting for sales or special offers before you buy.)
No, what I'm talking about here are more far-reaching financial choices: buying decisions that are made out of ignorance (or at least a naive approach to finances) or indulgence.
For example, if you don't have a lot of experience in dealing with money matters, you may not recognize poor financial advice when you get it. As a result, you may fall for lies and half-truths like these.
* Maxing out your credit cards is okay, as long as you don't miss a monthly minimum payment.
* Buying a house is always better than renting.
If you can't spot the faulty logic in this advice, you might be tempted to splurge on things like clothes, furniture, or compart discs and then whip out the plastic to pay for it. Or, even worse, to purchase a house before you're able to afford it.
If you didn't know any better, you might assume that maxing out credit cards and buying a house as soon as possible are things everyone does—that this is the way twenty-first century finances work. (Unfortunately, you probably wouldn't be too far off the mark, but that's beside the point.)
Likewise, if you suffer from a chronic case of the "gotta-have-it" or if you have a hard time telling the difference between a want and a need, you'll find yourself susceptible to a different type of thinking—but one that's just as dangerous. I'm talking about mindsets like the following.
* Buy now and pay later, before you're too old to enjoy the things you want.
* You are what you own.