It seems that everyone has been watching our government play tug-of-war over raising the debt ceiling. The lack of progress on a possible solution to the nation’s debt has been frustrating regardless of which side of the aisle you are on. Why is it so hard to talk about debt? To put together a workable plan? Debt is crippling the country (literally) as well as its citizens, and we have got to get rid of it if we ever want to become money smart. That’s why my Money Rule #5 is No Debt.
Unfortunately, debt has become the norm and getting rid of it is the first big step many people need to take. It may feel overwhelming, but it almost always can be accomplished. Yes it’s hard, and it might take eighteen to twenty-four months or so of really “doing without.” But eliminating debt will turn out to be one of the best things you have ever done in your life. Seventy-five percent of Forbes’ richest people in the world say the best way to build wealth is to become debt free.
Is any debt good? Yes. Taking on a reasonable level of mortgage or educational debt is usually a good thing, and if you are hit with a true emergency and haven’t the funds to handle it, then the debt you take on resolving the emergency is good debt, provided again that you pay it off and don’t add to it. Each of these is an acceptable debt to take on, but that’s about it.
When you carry a lot of debt, the impact is probably a lot greater than you realize. Take a look at what percentage of your income is available for your use after you pay for the basics of life like rent, food, healthcare, gas, etc. How much is free for large purchases such as a car, a new TV, vacation, college education, or for saving toward financial freedom?
It’s not a very large percent, is it? After you’ve made the minimum payments on your debts, what’s left? Do not judge the impact of your debt payment by comparing it to your income. Compare it to your free (discretionary) money because that is the money that matters when you talk about all your future options. For example, to have debt payments (excluding mortgage) of 10% of your take-home pay may not sound bad. But, if your discretionary money is 20% of your pay those payments are taking away half your free money and your future options have been greatly reduced.
If you make only minimum required payments, your debt will never go away. Nothing will ever change. If, on the other hand, you aggressively start paying things off, you will find a terrific momentum developing. More free money each month attacks less debt each month and the process begins to accelerate dramatically. Once the debt is finally gone, all of that money, including all the interest you were paying to others, is now yours. What a positive impact this money will have on your life from that moment on!
Let’s compare two couples in their mid-thirties that earn about the same amount. Couple-A does not save any money and averages $15,000 in credit card debt at 15% interest. The interest on their debt costs them $2,250 each year. If their tax rate is about the same as the average family, it takes about $3,750 of their income each year to get the $2,250 they need after taxes to make their minimum payments. Couple-B has no credit card debt and saves that same $3,750 in a tax-deferred investment account with an average return of 8% a year. The following chart shows the result for each couple over time. As the years go by, the gap between the couples becomes pretty amazing, doesn’t it? The power of no debt, especially when tied to the power of compounding, or making money on your money, is just huge.
If you have a debt problem, you are probably sitting there nodding in agreement that you need some serious debt reduction. Unfortunately, that’s not enough. What’s necessary is for you to truly decide to change both your spending habits and your attitude regarding debt—and to do it right now! In Money Smart I’ve written a chapter called, “Getting Out of Debt,” with an action plan to eliminate debt and some of my advice for eliminating debt is also on www.MoneySmartOnline.com.
It’s time to stop and look at our debt problem, (nationally and personally) and create a financial action plan to eliminate that debt once and for all. After all, money should be adding to your happiness not taking away from it. By becoming debt free you will inevitably change the game in your favor.