“Never Spend Your Money Before You Have It.” -Thomas Jefferson
Ahhh, what wise words by one of our founding fathers. I know he’s old (and dead), but this quote is timeless. If only more people listened to it. But let’s face it, at one point or another, I think its safe to say that almost all of us has experienced some debt (and if you haven’t kudos to you!) I know I have. I ran up some serious credit card debt in my early 20s and I came out of grad school with a whopping $130,000 in student loans. Now? I currently have no debt except my house mortgage.
To simplify the concept of personal debt, I put debt into three camps: 1. low interest debt (<5%), 2. high interest debt (>5% but <10%), 3. really high interest and credit card debt. Contrary to where this post appears to be going, I am not completely averse to the concept of keeping and incurring debt. I believe low interest debt can be left alone if you can leverage your available cash in proper investments that are likely to return more than 5% (i.e. investing in your 401K or other retirement accounts). I’ve heard of people taking student loans and investing the loan money. Now do I recommend this? Probably not and also I wonder if its fraud. But at any rate, the point is sometimes it might be better to keep or even incur debt and invest available cash elsewhere. Several of my former classmates were lucky enough to consolidate their student loans at an amazingly low interest rate of < 3%. While their loan amounts are hovering in the range of $90,000+, each of them makes over $100,000 yearly and should be able to accumulate some extra savings. Instead of trying to pay off that loan, any extra savings or windfall of cash might be better off invested elsewhere, like retirement if they aren’t maxing out their 401k or putting money into a Roth IRA. But of course there are other benefits to paying off debts, such as the psychological freedom that comes with becoming debt free. Interesting tid bit, the only way to escape student loan debt is to die. Yup that’s right, while you can declare bankruptcy or negotiate down most other debts, student loans will follow you to the grave.
While having some low interest debt is probably ok and maybe even necessary, one debt that shouldn’t be tolerated is credit card debt (and other really high interest debt). The higher the interest, the more important it is to get rid off this debt ASAP. I’m talking about selling your big screen TV or Louis Vuitton purses to get cash, borrowing money from your family or getting a loan at a lower interest rate to pay it off (e.g. home equity line of credit). No one making a $100,000+ should have credit card debt. Seriously, if you have credit card debt and you make over $100,000 as a single person, you have a spending problem and are most likely in terrible financial health.
Sorry to be so harsh, but sometimes a patient has to hear the cold truth. You are overweight and its affecting your heart. You have emphysema, you should stop smoking. Below is a simple graph depicting the average credit card debt in the US per household net worth I took from this website Value Penguin. I added the “What the heck??” because I can’t believe people with household net worth over $100,000 can allow themselves to have credit card debt.
Credit Card Debt (or other super high interest debt >10%):
If you and/or your spouse currently have credit card debt (not at a low introductory rate) you need to pay this off ASAP, like this month if possible. If you don’t have well off parents (or siblings) who would be willing to loan you the money, then consider these alternatives alone or in combination:
- Balance Transfer to a 0% or low interest rate credit card. This is an easy way to buy yourself some time to aggressively save money to pay off your debt. Depending on the card it should buy you 6 months to 1 year of 0% or lower interest rate. Remember, pay it off then shut. it. down.
- If you own your home/condo, apply for a home-equity line of credit/loan (HEL). This should only be done if the interest rate is significantly lower than your credit card interest which most likely it is since the average credit card APR currently is 15+%! An additional benefit is that you can deduct the interest you pay on the HEL like you do on mortgage interest. HEL can also be used to pay off other high interest debt as well. The caveat here is you can’t do this if you have bad credit or no equity in your home (i.e. underwater mortgage).
- Sell your stuff! Downgrade! Go back and read Basics Step 1 minimize your life. I really don’t think people utilize this simple option enough in this day and age. Just as people don’t think to break a window in a fire to save their life, they don’t think to sell their stuff or downgrade big ticket items to save their finances. If you’re renting a luxury 1-bedroom apartment in downtown LA at $3500/month, you need to move girl! Or at least a roommate or two, which is another fairly easy way to cut several of your expenses at once. Or move back to your parents home temporarily and pay them a lower rent.
- Negotiate a lower rate or settlement with credit card companies. If you’re really drowning in credit card debt, don’t rule this out. Credit card companies may be willing to negotiate a lower rate or settlement of your debt (check out this article on Nolo.com a legal website). While this isn’t the first option I would go with and it’s not easy, I know someone who negotiated a lower settlement that allowed him to pay off his credit card debt easier and this allowed him to fix his credit sooner and not have to deal with hounding creditors.
Things I don’t recommend: Personal line of credit. This is really another high interest debt replacing a really high interest debt. Wells Fargo’s starting APR is 9.25%. Read it, starting meaning you need to have excellent credit and if you’re taking out a personal line of credit to cover debts then you probably don’t. So yes if you can get a lower APR than your current higher interest debts it might be an option. On the plus side this could also allow you to consolidate your debts in one place if you have multiple debts. But do the math before you go this route. Also on a psychological level it might make you feel more lax about paying off your super high interest debts.
Taking a loan from your 401K. Ugh, a huge mistake in my opinion especially if you are young(ish). That’s because the younger you are, the more you have compound interest on your side for your investments. While its certainly an option, it should really be treated as a very last resort.
Along the same lines, touching your Roth IRA principle. Don’t do it!
So, that’s it for now, until next time It’s simple really, if you have credit card debt, you need to stop and walk out of Starbucks or Nordstroms, take any cash you have and pay it towards your high interest debt. Remember, don’t spend your money before you have it. I know easier said than done, but you can do it. I believe in you. After all if you’re reading this that means you care about your financial health.