Tuesday, December 21, 2010

Get Out of Debt Tricks? No....

 You can't get out of debt by buying kits.

Some financial gurus claim that you can use special tricks to get out of debt.  But there are really no tricks, and many of their techniques will cause you to end up in debt longer and pay more interest.

Who pays these guys, the credit card companies?

Here are some of the "Tricks" some of these "debt experts" teach and why they don't work:

1. Pay off your smallest debts first:  The idea behind this scheme is that you can "pay off" entirely a smaller debt, like a smaller credit card, and thus psychologically reward yourself by retiring a debt. Dave Ramsey preaches this (literally, he also touts tithing 10% to your church) and the DebtGuy does as well.

There are two problems with this.  First, it will not get you out of debt faster and it will not save you money, unless your smallest debt is also your highest interest debt.  If you have two credit cards, one at 25% interest with a $5000 balance, and another at 12% interest with a $1000 balance, the more you pay off on the higher card, the less interest you will pay overall, and the sooner you will retire the total debt.  Paying off the smaller debt may be psychologically rewarding, but the interest on the larger debt will be, well, larger, and thus the overall time to pay down the debt will be longer.  Again, who pays these guys, the credit card companies?

Second, psychology is fine and all, but psychological tricks are how you got into trouble with credit card debt in the first place - spending money and not realizing it, and looking for emotional rewards for logical situations.  Paying down your debts and being debt-free is NOT about emotional rewards.  Emotional rewards are what got you in trouble with debt in the first place - the Whee! of buying a new car, or the fun of spending on credit cards.  Think logically, not emotionally.  If your brain is so starved for feedback that you have to trick yourself, then maybe that is really the core of your problems.

2. Pay the minimum on your card and build up savings, instead:  Both the DebtGuy and "Suze" Orman preach this one, on occasion.  The theory is this:  If your savings are depleted and you start paying down debts, and then an "emergency" arises, you won't have money for the emergency, or you will just rack up your debt again on the credit cards.

Again, nice try, but no sale.  If you keep paying minimum payments on your cards only, you will take years and years to pay down the balance - and pay the largest amount of interest allowed by law.  Again, who is paying these "gurus" - clearly the debt industry!

If you took that money you are putting into savings (earning a paltry 0.5% interest) and applied it to your debt, you save money on the interest payments, which in turn accelerates the paydown.  If you have an emergency?  Then maybe you can use the credit card - or perhaps nothing in life is really that much of an emergency, anyway.

The problem with trying to save while in debt is that the temptation to spend is always there, and let's face it, people in trouble with credit card debt are spend-a-holics who don't need the temptation.  Pay down the debt, pay less interest, get it over with faster.  Building up savings makes no sense at all - do that when you are debt-free.

And by the way, paying down debt is the best "investment" you can make, as you get a guaranteed rate of return in the form of the interest you are NOT paying as the debt disappears.

3.  Don't bother cutting budget items, the savings are minimal:  I saw this on a CNN site once, and it is echoed on other sites, such as the DebtGuy ("When people come to me, they usually have already cut their budgets to the bone!").  A CNN financial adviser pooh-poohed expense reduction as too little, too late and not enough to stem the tide.  I disagree.

Living beyond your means is how you get into debt, and it is often a ton of small expenses that sink the average family, not huge single expenses. And what some people think is "trimming expenses to the bone" leaves a lot of fat on the bone.

A friend of mine came to me saying she had an intractable $5000 Visa credit card balance and no matter what she did, she could not bring it down. She could only make the minimum payments. I reviewed her finances with her and came up with the following:
 1. Cut up the credit card and stop charging on it. PERIOD, PARAGRAPH, END OF STORY.
2. Call the company and arrange a payment plan, perhaps at a lower interest rate, perhaps with a rollover to a 12 months 0% rate to another card, and then cut that card up, too.

3. Cut out her cable bill - she paid $75 a month or $900 a year, enough right there to pay off the card (along with the minimum payment) in five years. Go to the library and check out books and free videos instead. Live life instead of watching it.

4. Cut out the high-speed internet access - $35 a month PLUS a $9.95 a month "virus protector". She could access the internet for free at the library or at a local internet cafe and several other locations nearby. Free web-based e-mail (Yahoo) has virus protector built in, for free.

5. Cut the cell phone or the land line (pick one). If you keep the land line, get minimum service and use a calling card for long distance. If you keep the cell, look into a tossable phone or rechargeable plan. I gave her one of my old phones and a $100 rechargable card. Potential savings: $50 a month.

7. Cut other expenses - they liked to drink name-brand booze and wine and refused to shop at Wal Mart because they were "too good for that" but instead shopped at the local food boutique. Estimated savings: $100 a month - at LEAST.

8. Cut collision, comp, car rental, and towing insurance on their 15 year old $2000 car. Put the savings into a savings account to buy another $2000 car if they wrecked that one. Savings: $50 a month, or more.

9. Cut restaurant meals - they were spending $250 a month on restaurant meals and cocktails and - you guessed it - putting it all on the credit card.
In about a half-hour I came up with about $250 to $500 a month in potential savings, more than enough to make a good start on paying down the debt.

But, as you guessed it, each proposal was shot down on the grounds that each item was a sacred cow and there was some reason they could not cut it. Cable TV? That's our window on the world! What would we do all day without it? (Live, perhaps?). Cut the Internet? But my husband spends all day on it playing games! (go walk the dog, instead!).

And so on and so on. When push came to shove, her real agenda was this: Can you "loan" me $5000 to pay off my credit card? After all, you've done well, right?

Well, yes, but only because I don't have cable, or collision insurance on my cars or spend money at boutique food stores, etc. My expenses ARE cut to the bone, the raw bone. No fat.

In many cases, people who claim to be "broke" have a Harley parked in the garage or a jet ski on a trailer in the back yard, or a Camaro, or whatever.  And in many cases, their idea of "cutting expenses to the bone" is not very deep cuts.

As I noted in an earlier post, to get out of debt, you first have to know how you got into it, so you can stop the cash hemorrhage that is "living beyond your means". Until you do that, all your efforts will be naught.

* * * * 
I am not sure why these "Gurus" like to give bad advice which would keep people IN poverty longer, only that some of them do have religious agendas, and perhaps others have been co-opted by the credit industry.  And yet others are clear sell-outs to big business, which wants consumers to spend, spend, spend their way to the poorhouse.  And yet others, like the "kit" advertised above, just want you to send your money to THEM and not to your debtors.  Forget financial gurus.  There is no "secret" to paying off debt, other than hard work.  There ain't no such thing as a free lunch!