Stupid and Beyond-Stupid Debt
You've learned the basics of intelligent borrowing, but that is only half the road to debt-proofing your life.
Take every aspect of the intelligent borrowing scenario above and think just the opposite. Now you understand stupid debt.
This is the kind of debt you agree to, often impulsively, when your desire is in high gear and your brain is in neutral. It is so easy — much too easy.
While there are many ways to rack up a pile of debt, credit cards are by far the most popular. Almost anyone these days — even high school students — can get a credit card. There's no qualifying process to speak of, no long applications to fill out or references to submit. Students don't even need a job or a cosigner.
Someone with a credit card and available credit limit can in effect take out very expensive loans on a whim and at nearly every place, including cyberspace. You simply make your decision, swipe the magic plastic, sign your name, and presto!—you've made a very long commitment to stupid debt. Painless? Sure, it is in the beginning. But not for long, my friend. Not, for long.
Let's say you use your credit card to acquire the very latest computer, complete with scanner, fax modem, jumbo monitor, DVD player, turbocharged CD Rom, and — the best part — a free printer. It's on sale (which to many naive consumers is a clear sign of providential entitlement) and you want it right now. Why should your lack of cash prevent you from making this really good deal? (Remember the free printer.) You have plenty of room on your account to cover it.
As you haul that baby to the car, the last thing on your mind is how you will actually pay for it. You didn't consider for one second how this new debt will affect your current payment structure. It can't be that bad, you reason, because you got approved. And you get a free printer!
Let's see how this purchase measures up against the criteria for intelligent borrowing:
- Does the borrower have a way out at any time? No. If you don't pay as agreed, the credit card company won't come after the computer — they'll come after you. Unless you can sell the computer for what you paid for it (fat chance), you have no way out.
- Is the debt collateralized? No. The credit card company is holding nothing of value to fulfill this debt if you are unable to pay. But they've got a tight grip on you. They don't want that computer or anything else you buy with a credit card, for that matter. This loan is unsecured.
- Does this purchase have a life expectancy of at least three years? No matter how you cut it, a three-year-old computer is not exactly cutting-edge technology. By its third birthday it has little monetary value even though it may still compute. In fact, that paragraph I wrote only moments ago listing the features of this machine is already out-of-date. Just think about that for a minute!
- Will it appreciate in value? From the minute you walk out of the store, a computer is in the fast lane to obsolescence. It's depreciating with every click of the mouse.
- Is the interest rate reasonable? No. As of this writing, the average credit card annual interest rate is 17.8 percent, while a thirty-year fixed-rate mortgage is 6.79 percent per year.
The computer purchase fails the intelligent borrowing test miserably by getting a "no" response to all five questions. Paying for a computer over time cannot qualify as intelligent borrowing, and if paid for with a credit card or other form of consumer credit, it would qualify as a stupid debt.
Anatomy of a Stupid Debt
Let's say this computer deal we're analyzing has a price tag of $2,000. The credit card terms are typical: 17.8 percent interest with minimum monthly payments of 3 percent of the outstanding balance. I just plugged those figures into my Minimum Payment Credit-Card Interest Calculator' and — hold onto your floppy disk — it will take 13 years and 9 months to pay the total price tag of $3,759, including interest. Did you get that? Thirteen years to pay nearly twice the purchase price for a computer that will be functionally obsolete in much less than half the time. There's no other way to characterize such a transaction than pretty stupid.
What will make things even worse is if, after two or three years, you decide to upgrade to a new computer even though you still have ten years to pay on the first one. Nevertheless, if the credit is available, it is quite easy to add another purchase (like a new computer) to the growing load of debt.
In no time at all, the forever revolving credit card balance is not seen for what it really is (a very high-priced loan on a lot of stuff you might not even own anymore) but rather as a normal part of life — like the rent, phone bill, and cost of food. In fact, I could show you high school personal finance curriculum that suggests keeping consumer debt at a manageable level, not to exceed 20 percent of income. I find that somewhat outrageous.
While the computer example is remarkably illogical, other kinds of stupid debt make the computer scenario appear somewhat reasonable. Turning restaurant meals, travel, groceries, utility bills, movie tickets, vacations, gifts, gasoline and school clothes into debt and then choosing to pay for them with minimum monthly payments over many years and at rates that effectively double the original costs brings new meaning to the term stupid.
Spending money you don't have yet to pay for things you don't have anymore is anything but intelligent. Nevertheless, that is exactly what millions of people in the country are doing every day, every month, year after year after year.
From Debt-Proof Living: The Complete Guide to Living Financially Free, published by Broadman & Holman Publishers. Copyright © 1999, Mary Hunt. All rights reserved. International copyright secured. Used by permission.