How Debt Sneaks Up On Us

I am constantly harping on the damning effect of debt but it is time to identify the primary reasons people get into such financial predicaments. Following are the top 10 causes as I see it.

1) No Mentors - Unfortunately very few of us have good financial mentors. Nobody tells us about the pitfalls of credit. Too often, the very people who should be able to guide us in our financial decisions, such as teachers and parents, don’t really do all that well with their own money. Therefore, we are left to learn our lessons the hard way: By trial and Error. Sadly, most people whom I know that are financially responsible had to make mistakes and learn from their pain; then there are the ones who don’t even learn from their own mistakes.

2) Easy access to credit – It is no wonder we get into credit trouble. The credit card companies converge on new college students before they even unpack their bags. Stores are constantly trying to get us to apply for their cards. Banks advertise on TV and radio why we should get their cards. Auto dealers will hand a set of keys to almost anybody who has a job or a down payment if they will simply sign on the bottom line. We have even heard of dogs and dead people getting credit cards. With cavalier policies like that, ill informed consumers are doomed.

3) Failure to keep score – Budgeting is at the root of financial responsibility. It you don’t know where you are at or where you are going or how you are going to get there you might as well face a certain grim reality: You are lost. How can you possibility expect to “get there” if you have no idea where you are going? Get a realistic budget and stick by it. You will be surprised where your money goes.

4) Instant gratification - In our TV driven world we see crimes solved, remarkable reality TV accomplishments and sporting victories all portrayed as if there is no work involved. We are a lazy society, susceptible to sales pitches about quick fixes, instant food, over-night romance and lottery winnings. Ryan Healy calls it Premature Lifestyle Enhancement. But, very few people have an incentive to tell us about the importance of discipline, hard work, practice and perseverance. If we only hear about the glamorous life, how can we be expected to restrain ourselves?

5) Unwise spending choices - We pay too much for everything from mustard to vacations. When you buy the smallest jar of mustard, you are paying the most per ounce for it. The same about anything else you could buy in bulk and save money. By overpaying for so many things your money does not stretch as far as it could, and this leaves you with unnecessary debt. You should start thinking about using coupons, buying out of season, and getting larger quantities of non-perishables.

6) Excitement – There is a certain flush of power or adrenalin when we buy things. It makes us feel important. We see so many other people throwing money around we want to project a certain degree of prosperity ourselves. So we pull out our credit cards and buy all sorts of things we don’t really need. Before long, our credit cards are at the max. Like all other bad habits, unnecessary spending can become an addiction. We tend to justify such purchase with thoughts like “I deserve this.” But that is actually a counter-productive instinct. Gomestic says that in large part, people make purchase this way to counteract the feeling that nobody cares about them. The truth is that such impulsive purchases deny you the more important items that you really do deserve.

7) Bummers - If you are like me, you are constantly surprised by the unexpected monetary demands that come knocking at the door. When we don’t save for the proverbial “rainy day”, we are not prepared for life’s setbacks. That can easily mean that other debts do not get paid off or we use our credit cards to get by. Here is a good article about "Avoidable vs. Unavoidable" debt.

8) Minimum payments - If you think in terms of “what is the least I can pay” rather than “What is the full amount of the debt” you are asking for trouble. If you don’t pay off your cards every month, the lenders attach interest charges that prohibit using that money for other items. When you get paid you find yourself thinking “who do I owe this to” rather than “How do I want to use this money” Pay off your statement in full every month and you will be much more careful about what you buy.

9) Excessive refinancing – In years gone by, people tried to pay their homes off. But more recently, the masses have looked upon their homes as an additional source of income. Every time the home value goes up, they run out and refinance to get some of the equity out. That is troublesome on several levels. First and most obvious, they owe more for their homes and their payments go up. Second, it sets a false sense of financial health. As long as the consumer can refinance her way out of debt, she sees no reason to exercise restraint in her spending. I have known quite a few people who have run their credit cards up then refinanced their homes multiple times to pay off the debt. Each time they convince themselves they will not do that again. However a year or so later the credit cards are at their limits again and they repeat the process. Sadly, we all know what happened to the housing market a couple of years ago and the gravy train stopped but the debt remained. Many of those people went broke.

10) Imitating Ostriches – I weigh too much and I rarely step on a scale; partly because I don’t really want to know just how bad my problem is. The same thing happens to people who are wrestling with their finances. They know they are struggling, but they just don’t want to know how bad things really are. We can both solve our problems if we would just pull our heads out of the sand, examine the truth and act accordingly.

There are many other reasons why we get into too much debt. Which ones do you think are worth mentioning?

Don't forget to visit my other blog

Just when you thought the real estate market was going to settle down, a new and bigger wave of foreclosures is headed our way! The first wave came from the sub-prime loans; the second wave is from Alt-A loans. A fairly ominous report from the New York Times Is here.

In case you don’t know how all of this began, let me give you a brief overview. Subprime loans have been around since the early 90’s. Sometimes the loans were made to credit card holders but most of the money was lent to home buyers. Sub-prime loans are made to borrowers who are not considered “prime” because they lack one or more of the usual qualifications which lenders require. So, if a borrower has insufficient employment history, poor credit, or too little money they become candidates for those riskier sub-prime loans. To compound matters, many of these borrowers take out Adjustable Rate Mortgages (ARM’s) to keep their payments lower; at least in the beginning.

Prior to 2004, lenders had fairly strict lending practices; but then, in an attempt to help more people become homeowners, they were urged to loosen up their requirements for subprime borrowers. Most lenders are happy to make such loans provided they can transfer the risk in the event that the borrower defaults; but they need a secondary market to sell their loans to. Enter Freddie Mac (They buy the loans from the lenders) Fannie Mae (They get the money) and AIG (They insure the loans).

Around 2007, the interest rates on those sub-prime ARM loans began to adjust higher. Since so many of the borrowers were marginal in the first place, they could not support the higher payments and an avalanche of foreclosures ensued. After two years, we are just starting to see some of the numbers improving, suggesting the worst is behind us. But wait! Another wave is on the way.

In addition to making all of those sub-prime loans, the lenders were also making loans in another somewhat risky category called “Alt-A” loans. These borrowers had better credit scores and other qualifications than the sub-prime borrowers did, but they were not “A” borrowers either; hence they were called “Alternative A” borrowers, shortened to Alt- A. The most common allowance which was granted this group was they were not required to verify their income. So, many people referred to them as “Stated Income” loans.

The underlying problem with so many of these loans was that the borrowers were allowed to make payments that did not even cover all of the interest that was due. The shortfall was simply added to the unpaid balance of the loan. That creative twist seemed appealing to lots of borrowers because home prices were on the rise throughout that time and most of them just assumed that the home value would continue to rise and eventually they would have new equity which they could get to, one way or the other.

But a villain was hiding in the shadows; namely there was a 3-year window on the payment arrangements. Now, the windows are beginning to close on all of those loans. The borrowers can no longer make payments that are less than the interest which is due. Furthermore, they have to also start making principal payments. In the mean time, the market prices did not continue to climb as they expected. On the contrary, most homes have fallen in value. In many cases, that means these borrowers owe more for their homes than they are worth; and that means they cannot refinance them with some less-painful loans.

As a result, a lot of additional homeowners are going to lose their properties; some because they must sell (divorce, corporate transfers, estate sales, etc.) and others because they cannot handle the higher payments. To add more fuel to the fire, there are a lot more Alt-A loans than sub-prime loans. Here is a recent article by our friends at the Money Game. Four states are especially vulnerable: California, Florida, Nevada and Arizona.

There are also lots and lots of commercial loans in the same predicament.

The only silver lining in this gray cloud is that interest rates are very low again so some of those people may be able to get good replacement loans, if they can act soon enough.

If I had to guess, I would say we are in for another two years of foreclosures on every block, but all is not lost. There are three categories of people who can benefit from a climate like this: Real estate investors, Brokers who specialize in working the foreclosure market and First Time home-buyers. Most of us can get in on the bandwagon somewhere, if we just know what to do.

Ain't that a bummer?

Drop by my other blog

The “Fortunate” Ones

Most people don’t know that in spite of recent economic times there are over seven-million millionaires in our country? That is probably because the media has more to gain by broadcasting the plight of the homeless and down trodden than they do by trumpeting the success stories. For some reason people want to hear about crime, struggles, and hardship so that is what garners ratings and sells newspapers. Most good stories are usually hiding somewhere between the later pages.

The politicians like to portray the financially successful people as “winners of life’s lotteries” as if they were merely lucky. This mischaracterization of the accomplishments of these people serves to set up an unnecessary bitterness between the classes. A much better alternative is to show the “less fortunate” group what they can do to raise their standard of living via their own endeavors.

In a previous story (see archives section) I illustrated, through the use of a strawberry farm, one of the main flaws in the mind of many: That is they live in a world of scarcity. They think there is only so much money (or strawberries or practically anything else) so those who have these things must either be lucky or they must have cheated in some way. That cynicism prevents them from achieving their own potential. Instead of looking inward for their successes, they hope the boss, the union or the government will watch out for them.

Sometimes they will try to increase their value by working harder, or taking training or getting more schooling. Those are worthwhile ideas but in most cases their new value, if any, is still determined by their employer or provider. It does not ordinarily lead to financial security, just a slightly plusher rut.

The difference between the “fortunate” ones and their counterparts has to do with how they look upon money. The less fortunate group perceives money as scarce, so they struggle to accumulate it. But the “fortunate” group knows there is lots of money to be had and they learn how to make the money come to them.

The “fortunate” ones understand the difference between good debt and bad debt and are therefore more likely to be debt free in the typical way we think of debt. They usually have some sort of budget and they abide by it fairly well. Because of that budget, they are more likely to save money than spend it on wild indulgences. By avoiding impulsive purchases they can use the savings they enjoy to make investments that generate passive income. Once they get to the point that they can live on the passive income, the rest of the money they earn is available for additional investments or enhancing their lifestyle. Once they get to that point, their net-worth grows exponentially.

It is not overly difficult for the common person to join the ranks of the “fortunate” ones. The first thing to do is rethink the role of debt. Basically, bad debt is a result of impulsive purchases or debt which cannot be paid off each month. It carries interest charges that eat into the buying power of the consumer. Essentially, any money spent this way is wasted and could have been saved and invested. For another list of millionaire practices as told by U.S. News and World report go HERE.

The next thing to do is look for ways to get your money to generate additional income. This can be as simple as buying CD’s or annuities. You might buy stocks or real estate. There are several other asset classes worth considering and each one offers its own risks and benefits. Here is a blog that explores how to earn passive income on line. Overall I like real estate the most because there are 4 ways to make a profit and you can get somebody else (tenants) to pay all of the bills.

Semi-passive investments are also appealing. For example, if you could buy or build one of those drive-thru car washes. Customers will put money in your pocket while you are not even there. A friend of mine has five-dozen laundry machines placed in several apartment buildings around town. They are fairly easy to maintain, they pay for themselves and they generate $30,000 a year in extra money. It only took him about four years of a casual but on-going effort to build his business from scratch. At the rate he is going it will only take a few more years to live off of that money. He can even hire somebody else to do all of the work if he wants to and retire while still in his thirties. His primary job, while respectable, can never offer him flexibility like that.

Even if you can’t think of a way to make money “on the side”, you can still earn a nice return just by paying off other debt, such as a mortgage. If you save 5-7% interest on that money you are using your money much better than running up credit card debt.

As difficult as it may be to believe, it is not impossible to become a millionaire in the US. There are over seven-million people who figured out how to do it. The easiest way to join them is to rethink how you look upon money. The first thing to do is stop wasting it. The next primary object is to accumulate passive income.

What say you?

Drop by my other blog