Understanding Debt

Floral Finance®

In our society, delayed gratification is not a popular discipline. In fact, we avoid it at all costs.

Why wait for anything?

"Why wait for that car you want? Just head down to your local credit union."

"Wouldn't it be nice to have a portable spa in your back yard? Call, and we'll deliver and install it today."

Almost everyone who wants to sell you something has a credit plan. Buy now and pay later.

A bank advertises "Freedom Loans." Take out the loan, and you'll be free to ______ (fill in the blank).

In one sense, being able to borrow money does allow you some freedom you wouldn't otherwise have, such as the freedom to fulfill a desire.

However, that freedom is very temporary. As soon as the payments lock in, the loan doesn't seem quite as free as it did before.

Debt is Bondage

When you sign on the dotted line, you are putting yourself in bondage for the length of the loan.

Solomon said that a borrower is a slave to the lender. That's pretty strong language. But it's true.

Once you lock yourself into monthly payments, you feel anything but the freedom the advertisements suggest.

Debt Creeps Up

Debt can come in big chunks, such as when you buy a home. Or it can creep up slowly — as it often does with credit cards.

Suppose you spend $3.35 per day more than you make. That's the price on an inexpensive value meal at the local fast-food restaurant. You just finance the extra spending with a credit card.

In one month, you will have spent $100 more than you make. In a year, you will have spent $1,200 more than your income.

Do that for 10 years, and your overdraft will be $12,000. Of course, that figure doesn't include the 18 to 21 percent interest most credit cards charge.

Suppose you have a "low-interest" credit card that only charges 12 percent. Spend an extra $100 a month for 10 years, and you will owe $23,003.

Now suppose that instead of spending $3.35 more per day than you make, you saved $3.35 per day. That would be saving $100 per month, or $1,200 per year. At 6 percent interest (you won't get as much on savings as you will pay on loans), your total savings in 10 years would be $16,378.

In other words, the difference between spending an extra $3.35 per day and saving $3.35 per day is almost $40,000 over a 10-year period. That's a lot of money for such a small amount each day.

The Cost of Borrowing

Interest expense is a significant factor to consider. Consider a simple home mortgage — something of which most of us can relate.

If you borrow $100,000 at 8 percent for 30 years (a standard home mortgage), the numbers will look like this:
 

The interest will cost you more than one and one-half times the amount you borrowed.

Now suppose you borrow the same $100,000 at 8 percent, but pay it off in 15 years instead of 30. Here are the numbers:

The amount of interest you save by paying off your loan in 15 years instead of 30 years is a whopping $92,160.

That simple example shows how much debt costs. By paying off your mortgage in 15 years, you would have $92,160 extra to spend in your lifetime. By delaying your gratification and putting extra money toward the mortgage, you see an enormous return.

In a nutshell, that is the principle of debt. Over time, debt is expensive and will lower your standard of living.

Good Debt Versus Bad Debt

Not all debt is bad debt. Most people could never afford a home if they couldn't borrow money to buy one.

At other times you might borrow to increase your future income. Student loans to get a college education are a good example. That type of debt can be very prudent.

Over a lifetime, the average income of a college graduate vastly exceeds that of a non-graduate. The extra money graduates earn far outweighs the cost of a student loan.

You might also borrow money to build your business. Again, you are borrowing money to produce additional future income.

Borrowing to increase income makes sense. Borrowing to consume does not.

Rules of Debt

Never borrow for a consumable. Except in emergencies or in the case of getting started (as in buying a first car), you should not borrow money to buy something that is going to be used up. Food, clothing and vacations are examples of consumables that will not produce future income.

Borrowing for these items will add interest expense, and you will ultimately have less to spend in your lifetime.

Always pay off the full balance of your credit cards each month. Credit card interest levels are obscenely high. This form of borrowing costs you dearly. Use a credit card as a convenience, not as a means to finance purchases. If you can't control your credit card spending, consider throwing the cards away or keeping them only for emergencies. Don't carry the cards with you every day. Remove the temptation.

You will spend less money if you force yourself to use cash.

Strive for no debt. The last rule? Set a target for your own D-Day: Debt-free Day. Imagine the freedom you would have if you had no debt. How much would it cost to live if you lost your job but had no debt? Not much.

It is possible for most individuals and couples to get out of debt — excluding their home mortgage — in five years or less. It all depends upon how much you are willing to tighten your belt to make the necessary changes.

Most people can get totally out of debt — including their home mortgage — in 10 to 12 years. For some individuals, becoming debt-free will require a major move or two, such as driving a less expensive car or moving into a more modest home.

Whatever it takes, it's worth it in the long run. Freedom has a price. You'll be glad you paid it.

Live better over the course of your life. Get out of debt.