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| The Basics | 3 keys to defeating debt now
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Stop sapping your financial freedom. Quit draining your retirement dreams. Debt is Financial Enemy No. 1 for many Americans, and its time to attack it. Heres how.
By Liz Pulliam Weston
Eight years of writing about personal finance have convinced me of at least one thing: Most people are absolutely clueless when it comes to debt.
They have too much of it, and the wrong kinds. They drain their retirement accounts, strip their homes of equity and bounce balances from credit card to credit card to fuel their overspending. They think that because a lender is willing to give them money, they can afford to pay it back.
They focus on minutiae like monthly payments and interest rates, rather than the big picture of how debt is a cancer eating away at their financial security. They pay interest year after idiotic year, enriching lenders while stealthily, silently, impoverishing themselves. And they wonder why they never seem to get ahead.
Uncomfortable? Im glad
If this description is making you uncomfortable, then good. I just might be saving you from a lifetime of servitude to debt.
Money may not buy happiness, but it can buy freedom, flexibility and independence. Thats the whole point of saving for retirement, so that one day you wont have to be dependent on a paycheck to live.
Most people never get this message. As soon as they get a job, or even before, they get a credit card. Instead of saving and investing, they buy stuff -- usually stuff that doesnt last as long as the payments on it.
If they manage to contribute to a 401(k), they either borrow from it or cash it out when they change jobs. As their homes increase in value, they take out home-equity loans -- offsetting most or all of the potential rise in their wealth with more debt.
National epidemic
Its led to a national epidemic of debt. Consider:
- The percentage of disposable income used to make debt payments is now near an all-time high.
- The number of bankruptcies keeps setting records, with 1.5 million new cases filed in the year ending June 30.
- Foreclosures are at modern highs, and the number of home loans more than 30 days overdue is rising.
It would be naive to lay all the blame at the feet of consumers. Lenders have done their part by loosening loan standards and chasing after people with poor credit in an ill-fated attempt to boost their profits.
Credit-card companies ferociously battle efforts to help debtors see the hole theyre digging, saying it would be too difficult to spell out for individual customers how long it would take to pay off their balances if only minimum payments are made.
But on a personal level, its pointless to blame the rope salesman for selling you rope if you use it to hang yourself. Once youve tied the noose, its up to you to undo the knot.
Meals eaten long ago
Consider the average credit card-carrying household, which is holding more than $8,000 in credit-card debt. At a typical 17% interest rate, that means paying about $1,400 a year in interest. Think about that: $1,400 a year -- just for the privilege of not paying immediately for meals eaten long ago, toys that have since broken and clothes already hauled to the Goodwill.
If instead, the $1,400 each year had been invested and earned an average 8% annual return, the savings would add up to nearly $160,000 after 30 years.
Unfortunately, most people dont consider the total cost when they borrow money. If they can make the minimum payments on their debt, they figure theyre doing OK. They dont see the cash thats seeping out of their lives every day.
Of course it isnt easy
I know its hard to spend less money, regardless of how much you make. But people do it every day, and they advance closer to their goals -- rather than watch them slip away.
This site and the Internet are full of great ideas for saving money -- and moral support -- for those trying to live within their means. In addition to MSN Money's message boards, you can check out The Dollar Stretcher (see link at left under 'Related Sites') for a community of like-minded folk.
If you're still reading and are ready to tackle your own debt pile, heres the plan:
Get intimate with your debt. Its not enough to know how much you borrowed and the monthly payment -- which is all many people know about their debts. You should know everything relevant: your balances on every account, the interest rates youre paying, whether that interest is deductible, when and how those rates can change and whether youll face any kind of penalties for paying an account early. (Prepayment penalties are becoming more common for home and auto loans, for example.) Call your lender and ask questions if youre not sure. Write it all down.
Prioritize your debt. Divide your debts into deductible and nondeductible piles. Credit cards, car loans and personal loans are nondeductible debt; you get no tax break on the interest. Mortgages, home-equity loans and some student loans (depending on your income) are usually deductible.
Once you know which is which, rank the debts in each pile, from highest interest rate to lowest. (If youve got a balance on a credit card with a teaser rate that will expire, use the higher rate that will take its place. Theres no guarantee youll be able to find an equal or lower rate when the teaser disappears, and the last thing you need to do right now is open more accounts.)
Eradicate your debt. You can start with your highest-rate, nondeductible debt -- or the non-deductible debt with the smallest balance, if you need the sense of satisfaction from wiping out a bill as soon as possible.
Either way, pay the minimums on your other debts, and put as much money as possible toward your first debt-eradication target. Once that account is paid off, take the same amount of money and apply it to your next target -- usually the next highest-rate debt.
Keep doing this until all your nondeductible debt is gone. Then you can start tackling your deductible debt, or boost your investing, or both.
Leave the debt-riddled masses
By the way, this plan only works if you stop adding to your debt pile. In other words, cut up those credit cards and dont apply for any more loans.
This also assumes that youre not already falling behind or in other serious credit trouble. If you cant make minimum payments or youre behind on your debts, a visit with the Consumer Credit Counseling Service in your area might be in order. Or, if things are bad enough, you may need to talk to a bankruptcy attorney.
Most of you, however, can pull this off. By making a plan and taking action, you can promote yourself from the ranks of the debt-riddled masses -- and have a hope of achieving your dreams.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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