Common cents: what educators won't tell you about managing personal debt
Black Issues in Higher Education, May 16, 1996 by Bill Keating
What Educators Won't
Tell You About Managing
Personal Debt
Why take 15 years to pay off a personal debt
amounting to $2,162 that will cost almost $4,000
in interest, calculated at 18.84 percent per month?
Who would do such a foolish, thing? The
answer is a simple one: neighbors, friends and
relatives -- millions of people -- who have a lack of
understanding of how to properly manage their personal debts.
This long, long list of fiscal self-abusers could even
include you. Welcome to the club.
Degrees don't protect you. I have two degrees from two
highly respected institutions (Johns Hopkins University
and the University of Chicago), yet I can state categorically
that the business courses I took did not prepare me to
handle my personal finances. In short, the system does not
provide the education needed to manage debt.
Also to blame are the lenders for not providing the
information needed to make intelligent financial decisions.
Insurance companies and bankers don't want us to be too
smart -- they would lose money.
The solution, of course, is to get out of debt and stay
out of debt.
I tell my students that four basic rules must be
understood and applied in order to get out of -- and stay out
of -- debt: (1) desire; (2) education and
information; (3) a plan; and (4) the tools, to
generate information and a plan.
Without the desire to become debt-free, nothing will
happen. You have to want to. The "want to" could be driven
by the fact that each month you spend $800 to $2000 to
retire debt. Money that could be used to fund a retirement
plan, educate the children, create an emergency fund or
improve your lifestyle.
Add a Dollar
Education about debt begins with an understanding of
how interest is calculated. It won't take long to conclude
that the higher the balance, the greater the
"rent" or interest for the period. Education continues
with understanding the devastating impact late charges can have
on an account and the realization that late charges should be
avoided at all costs. It's also, important to understand that
it's never too late to pay a late charge; simply include it with
the next payment. Add an extra dollar to eliminate the
compounding at the interest.
Two other concepts are needed to round off your
education -- an understanding of "minimum payments" and the
impact of "extra dollars" on an account.
Consider my opening example: balance, $2,162;
monthly payment, $36.00; interest rate, 18.84 percent
This is all the information we normally have for our
accounts, but unfortunately, it doesn't tell us
much. The missing piece of information is the number of
remaining payments. Would you believe that it will take more than
15 years to retire this account and that the true amount the
lender will be paid is $6,615? That's almost $4,000 in
interest.
In other words, if you couldn't afford $2,162.00, you
certainly can't afford $6,615.00. If we were to analysis for
each of our accounts, we would determine
that our true debt is not the sum of our balances but the sum of
our balances plus the projected interest charges. Our true
debt is 20 to 60 percent greater than our current balances.
Being in debt is expensive.
The good news: increase the payment by just $1
($37, instead of the $36 minimum payment)
and you will reduce the number of remaining
payments by two years and save almost $700
in interest. That means that your money is
working at a guaranteed rate of more 20
percent. What a difference a dollar can make!
The Triage Method
The most common instrument for getting
out of debt is loan consolidation.
Unfortunately, in most cases, this practice
puts us deeper in debt because it lowers our
monthly outlay. To counter this, I have
developed a methodology for getting out of
debt that I call the Triage Method.
It's similar to consolidation, in that your
monthly outlay is fixed until all bills are paid.
In other words, if you are currently paying
$1,000 a month, you would maintain that
amount until all bills are paid in full. Your
accounts are ordered by the number of
remaining payments, lowest to the highest. As
a bill is paid in full, its payment amount is
applied to the next bill. This continues until
all bills are paid in full.
This has the same impact as adding extra
dollars onto your bills. The screams that you
hear, this time, will be from your lenders.
Following a plan that uses this formula will
guarantee that you will get out of debt sooner
and save hundreds or even thousands -- of
dollars in interest. It's like magic.
Best-kept Secret
A final word about staying out of debt
-- I encourage my students to develop an
emergency fund. it should have six months of
expenses in it. If your monthly expenses are
$3,000, your goal for your emergency fund
should be $18,000 -- and it should be the best-kept
secret in town.
When you need to borrow, borrow from
yourself. Of course, do not forget to repay
yourself. Never buy an automobile that you
cannot pay cash for. If you cannot afford it at
$20,000, you probably cannot afford it at
$24,000. Accumulate money for your next car
in your emergency fund. if your goal is to
purchase a $25,000 automobile, I guarantee
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