Recently I spoke with a man whose salary had been drastically reduced due to a realignment of corporate priorities. He’d always made a good living and provided well for his family, but along the way had acquired quite a bit of debt on credit cards and had chosen to buy a bigger house while keeping his “starter home” as a rental. The credit cards instead of being paid off ended up being converted to home equity debt.
Now he’s faced with foreclosure on the bigger house because he’s upside down and can no longer afford the payments on his reduced salary. He’s moved back into his “starter home” and is looking for debt relief with little to no savings or retirement put back.
Sadly this is not an uncommon predicament over the past 20 years. The availability of credit has fueled economic growth and ironically recession during this time period. Financial innovations like the debit card, credit cards, student loans, car loans, and mortgages create easy access to money and to debt. If there is a thing you want, then there is a way to finance it. And not only is this behavior generally accepted it is nearly universally encouraged by banks, Credit Card companies, CPAs, and by financial advisers.
The mortgage interest deduction is often cited as a reason to acquire a mortgage, but for someone with a $1200/month principal and interest payment on their $250,000 mortgage, they will pay nearly $10,000 in interest a year, which assuming a number of variables might lead to a tax savings of say around $1200, which could be easily realized by buying a smaller home, or renting. Take it from the guy facing foreclosure, it is much easier to exit a lease than to sell a home for less than you owe. For prospective homeowners, I often use a $5,000 annual figure for annual upkeep, occasional major repair, emergency, contingency and renovations. And where does that money usually come from? Not from savings. Usually from a credit account of some sort. If you are going from renting to buying, you want to go to a smaller monthly payment (including property taxes and insurance) to account for the things a landlord would normally foot the bill for.
I occasionally run across people who say they pay their credit cards in full every month, but these people are like unicorns, rarely seen and possessing magical powers. Most Americans acquire debt because of their cash flows, unanticipated expenses, increased spending, and a lack of saving. The biggest mistake consumers make is thinking that they should pay off debt before saving. Saving must happen religiously despite debt level or it will never amount to anything, especially with the way Americans acquire debt. The cash flows example is a good illustration. Many corporate payrolls are on a 2-week payout, but most consumer bills are due on a monthly basis. The companies trying to sell this pay schedule will say that you have 2 months out of the year where you get an extra paycheck, but the truth is that a 2 week rotation means that you can never adequately plan for income and expenses because of the timing of when monthly bills come due and when 2-week paychecks hit. Managing these types of cash flows is a difficult task for the average consumer. The only way my family manages it is through a complex borrowing and spending that is occasionally paid down by bonuses or savings.
But even people with a monthly or bi-monthly paycheck encounter expenses they cannot foresee. Unanticipated expenses happen every day: auto accident, medical emergency, death in the family, home repair, etc. Even with savings, many still choose to put those expenses on credit cards for convenience, for points, or to preserve savings. Even anticipated expenses not properly prepared for can add to debt or wipe out savings: tuition, family trip, down payment, home renovation, etc. The want that masquerades as a need is often the culprit of increasing debt. Many people feel obligated to a certain standard of living and keeping up with the Joneses leads to unnecessary debt.
This generation of Americans, for good or ill, doesn’t keep a check register and the number of monthly transactions for an average household continues to increase. This is in part due to the proliferation and ease of electronic payments. Instead of managing off of cash on hand, consumers use a debit card, Paypal, or a credit card, and are encouraged to spend beyond their means by various overdraft programs or generous credit limits. Some of this is the gradual evolution of our standard of living. We thought we were saving money by cutting our cable package and land line years ago, only to find that expense replaced by our smart phone bill and streaming services. If you can imagine though there are households that pay for a land line, have a bloated cable subscription and also have a smart phone bill as well as home internet. The progress of increasing bills is gradual and if consumers don’t occasionally take stock small increases in monthly household bills can lead to crippling debt. This is true not just of our luxuries, but of the essential bills as well. Home gas costs fluctuate seasonally and year to year. Home and Auto insurance premiums will tend to gradually rise year over year as well. Unless you have ruined your credit, our economy makes it quite easy and attractive to spend beyond your means.
Nearly 20 years free of grad school, my wife still pays student loans, and again it is not worth the interest deduction on taxes, nor is it indicative of her current income. It is difficult to make a direct connection from work to my college degree. There are definitely aspects of my education that are priceless to me, but it is difficult to equate the cost of college with the monetary benefits of the salary I now enjoy. How should that investment pay off and was it worth it? I hope that question is more in the forefront of parents minds as they anticipate sending their kids off to spend 4+ years finding themselves. Dear Mom & Dad, I’m still looking 20 years later. Whether there is a direct correlation between education and success, most adults will acquire some form of debt from their education, whether that is in the form or credit cards, student loans or other lending avenues. I applaud people who seek a graduate level or beyond education that has a clear path to employment or at least strong prospects, but would caution against financing too much of that education. I also think it is reasonable to take on a relatively small amount of debt for specialized technical training or for a trade that again has good job prospects or should lead to a certain level of income. However, a 4-year BA or BS should not accrue $100,000 in debt to go work an entry level job at a retail store or restaurant.
We are nearly ten years removed from the last Great Recession caused by a loosening of credit standards and acquisition of debt and seem to have learned little from our past mistakes. Debts must be paid or calamity ensues. Your mortgage company will not let you miss payments indefinitely before you lose your home. We have just seen tax reform pass that will increase government debt. It does so by promising lower taxes and greater economic growth, but it begs the question in 2017 “what is wrong with modest economic growth, low inflation, and low unemployment?” The answer is that there is nothing wrong with the economy, but we continue to reward corporate excess by giving corporations more money. And yes, my 401k is up now, but I still remember 2001-2003 and 2008-2011.
For my friend at the beginning of this piece, he could have avoided his difficulties entirely by staying in the more modest home, which would have allowed him to more effectively live within his means and not acquire as much credit card debt, and maybe along the way would have been able to put more back into some sort of savings. Ultimately what I would like to see is a greater understanding of consumer power and choice. I would like to see consumers consider savings not as a luxury, but as a necessity, and I would like to see more consumers choose to live more modestly and conservatively within their means. It still really bothers me how easily people throw away the largest portion of their income on a roof supported by a few sticks. I get indignant about it. “That’s MY money!!!” I say. And I wish more people saw it that way.