The Importance of Being Free of High Interest Debt
Americans are consumed by debt, on a personal and collective level. Consumerism is the worst it has ever been, with people stampeding like spooked wildebeest when Wal-Mart says it’s selling $399 72” TVs on Black Friday. The concept of striving for the newest and shiniest possessions is hard wired into our psychology and DNA. The capitalist markets of the world take full advantage of this. Marketing, or this systematic brainwashing convincing you that you need to possess this widget or that gizmo, is a sour practice in a place so riddled with depression and stress due to debt. Marketing is so powerful that it makes people buy things with money they may never have, so they can look and appear a certain way for a fleeting moment. The way that new things make you feel fades faster than anyone would like to admit. There’s nothing wrong with buying new things when you feel you deserve them and can afford them. There is something wrong when you neither deserve nor can afford any of these things.
The main problem arises when individuals become crippled with debt from stacking on these entitlements and self back-pats. It has unfortunately become the norm in our society that debt is simply something that you have to live with. It’s tied up in our automobiles, our homes, our vacations, and educations. Not to say loans cannot be beneficial. It would take a long time of living very frugal, renting a cheap space and eating ramen noodles to be able to buy a home with cash outright. When is it appropriate to get a loan? What kind of savings should you have, relative to your current debt? Should you have savings at all if you’re in debt? I intend to explore the answers to some of these questions.
The name of the game is avoiding high interest debt. This is credit cards, personal loans, and automobile loans if you didn’t fight for a fair rate. It takes tenacious loyalty and a periodic phone call to credit card companies in order to get a reasonable rate for your cards and keep it that way. I’ve heard advice before that it’s as simple as calling your credit company and asking for a reduction in your rate. I personally gave this a shot and got nowhere, so I’m interested in experimenting with threatening to cancel the card and see where that gets me. More on that in a follow up.
Credit card debt is most likely the one we are all familiar with. Signing up for a credit card and starting to build a credible credit history(see what I did there?) is a necessary part of becoming a productive member of society and “responsible adult.” Rates on credit cards are nothing short of outrageous when compared to auto or home loans. I’d say you’re sitting pretty if you have consistent sub-15% APR on all of your cards. Most cards are in the 20-30% APR range, depending of course on your credit score when you apply and other factors shrouded in darkness by the industry.
Personal loans are another heavy hitter, but I doubt anyone reading this article often hits up the paycheck advance places that have six payphones and a guy named Darren who offers you drugs on your way in the door. You know the spot. These often have insane interest rates if the loans are not paid back in a timely manner. Legislative efforts have advanced in recent decades to prevent loan sharking from being legal, but still, some places have APRs far in excess of 100% for paycheck advances.
If you have crippling credit debt or any other high interest and high risk money you owe, the best solution is to obtain a debt consolidation loan from a reputable bank or credit union. Banks want your money, period. They will pay off high interest debt from multiple sources to transfer income from other parties into their name instead, often at a reasonable rate. Short of inheriting a pile of money and being able to clear your name with cash, these loans are the best solution to people that struggle with making interest-only payments on their loans.
When is it appropriate to get a loan? As with every answer ever, it depends on your situation. If you're riddled with debt, obviously a debt consolidation loan might be a really good deal. Suppose you're well off and debt free. I consider loans on homes to be very reasonable. The shorter the term, the better your interest rate is, of course. So if you have the means to do 15 year fixed rate mortgage in place of a 30, you should do that. Kick that mortgage more than the minimum payment, and that will benefit you as well by reducing the total interest you pay over the course of the loan.
Auto loans are questionable. I think that unless it is your goal in life to cruise off the dealer's lot with your dream car, for us practical folk, a used car is always the one that makes financial sense. The average cost of a passenger car in the United States is $33,560. If you get a 72 month term, you're paying $466.11 just on principle alone. You'll pay over $4000 in interest if you take the full length of the loan to pay it off. Now suppose you buy a used economy car for just the cost of the interest, 4k. You get to sock that $466.11 that you would be spending on a car payment, into some kind of investment that will actually start earning money, instead of burning it.
Now that you're thinking about what you're making instead of what you're spending, we can move onto the topic of savings vs. debt. My advice is to only have enough savings to work your way through a job loss or layoff. Traditional advice says you should have six months of savings. I agree with this if you are debt free. But your capacity to save for an emergency is greatly reduced if you're paying a lot on loans and interest. So reduce that figure to two or three months while you pay off debt. If you have six months of living expenses in savings, cut a fat wad of that to credit cards or other loans. Not only does that mean you won't have as much of that debt looming over your head, but your capacity to recover in the event of a layoff or family emergency hasn't lessened. You can use that credit card to pay that if that happens before you rebuild your buffer fund.
Avoid debt if you can. Home mortgages are the exception. Credit card debt is the worst. Pay it down as soon as possible. Get a debt consolidation loan to reduce interest and pay down extra principle. Once you are free, cancel cards if it makes sense to do so, or simply stop using them. Sometimes your credit score can take a hit if you close cards and reduce available credit, so it might be better to keep them and put a candy bar on it every month to keep it active with good payment history. Play it smart and be practical. Drive a used car and don't buy things that you don't need. We all know this stuff instinctively, yet so few of us practice good fiscal policy. Be one of the few.