Debt has a bad reputation, and it is not hard to see why. Up until 1833 in the United States you could be thrown in prison for not paying your bills. Old melodramas from the turn of the 20th century featured Oil Can Harry foreclosing on the on the farm of Sweet Nell and her good little family. Woody Guthrie sang about some who rob you with a six gun, while others do it with a fountain pen. More recent stories are of people being hounded by 3 a.m. phone calls from bill collectors, and thrown into bankruptcy by out of control debt, often from credit cards. The latest incarnation of this theme is that of students completely overwhelmed by school loans as they come due.
Having debt is not the end of the world
So the moral of this story is to avoid debt at all costs, right? Well, no. Life is more complicated than that. It is true that debt can eat you alive, but it can also allow you to buy things you might not be able to afford otherwise, like a car, for instance, or a house, or an education. And speaking of which, many of you already have considerable debt from student loans. So the point here is that you should learn handle debt so that it does not handle you.
For anyone who may think that the way to deal with debt is to simply default on your loans, the negative effects on your future life would tend to be horrendous, quite apart from questions of right and wrong. No, you will not get put in debtors prison, but your credit rating will be ruined, and this will make it very, very hard to function in modern life. A car loan? Forget it. Rent that nice apartment? The landlord will turn you down, quite legally, based on your credit score. Persistent bill collectors? Probably. Getting hired for a good job? That might also be in jeopardy. Fortunately, debt is usually manageable.
Let’s consider the main categories of debt: Education loans, consumer loans, credit card balances, and mortgages.
If you have them, you will need to figure out what your payments will be, and how long you will need to keep making them. If you are considering taking out such loans, you still need to get quite specific about your repayment schedule, and ask yourself if the employment possibilities opened up by your contemplated educational goals will give you enough income to cover the debt.
The big one here would be a car loan, so let’s think about that by way of example. The car dealer is there for one reason, to sell you a car. They don’t care one bit about how much debt you will incur. They get their money from any financial institution willing to give you a loan, and will then be done with you, even if the financing is arranged right there at the dealership. You may remember that car friendly salesman for years, but he (and it probably will be a “he”) is quite unlikely to remember you even next week. The salesperson (or the “finance person” you get shuffled off to) won’t point out the high interest rates, or give you time to consider how the car loan will impact your life. No one will invite you to imagine what it would be like to have your car repossessed, but will try to upsell you on an extended warranty for your new vehicle.
If you have never bought a car before, I can tell you that you will be mightily pressured to get confused, lose your bearings, and sign a bunch of complicated paperwork you don’t really understand just to get out of there with your shiny new (or used) car, without being clear in your own mind as to whether you can afford the financial obligation or not.
In the end, its all on you to go into any consumer loan situation with a clear understanding of your financial limits. That means two very specific numbers: The top monthly payment you can afford, and how many months you will have to make those payments. It should be a mantra for you. “Top payment $X; longest repayment period, Y months.” And visualize yourself walking away from any fabulous, today-only, chance-of-a-lifetime, you-would-be-a-fool-not-to-take-this-deal opportunity if it violates either of your two numbers. Easy to say, tough to do.
What to know about credit card debt
Credit Card Debt—If there is any hard and fast rule about borrowing money, it is to avoid credit card debt. That does not mean you should avoid credit cards. They are unbelievably useful managing your money, as long as you pay off the balance every month. If you don’t, the interest rates are very high. Currently, the average is around 16%, and can go much higher than that. In addition, apart from interest income, the credit card companies have powerful incentives to encourage your impulse buying. Even if you pay off your balance every month, they still make lots of money, because they charge every merchant an average of 3% when you use your card. Item price: $100. Merchant gets: $97. Card company gets: $3. If you buy $20,000 by credit cards in a year, the credit card company has just made $600.
Monitor your spending carefully
The downside of credit cards is that you can easily be cajoled into spending more than you can afford to pay off monthly, and therefore, you can slip-slide into more debt. These days, you don’t even need to swipe or insert a card, much less sign a receipt. Just go to Amazon, or any other online retailer and click, click, click. The best defense against this kind of impulse buying is to get in the habit of reminding yourself this is real money flying out the window. And the best way to develop that habit is to get into doing monthly budgets. That will be the subject of some future blogs!
Mortgages—As a renter, this one would not apply to you, unless you hope to one day be a homeowner (or even a landlord). But it is good, even as a renter, to appreciate what a mortgage is, namely a whopping big debt on a piece of real estate that, if it goes unpaid, means that the real estate is taken away by the bank. As you contemplate your own debt woes, you can sympathize a bit with your landlord, who has debts as well.
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Looking for more money management tips? Check out our other blog posts here.