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