Tuesday, July 3, 2012

You Have to Pay it Back

Unless you can relieve a debt through bankruptcy, you have to pay it back.  There is no third path.

I have received a number of inquiries lately from folks about their personal predicaments with regard to savings and debt.

First of all, I am not Soozie Freaking Orman, or Dave "Praise Jesus and give him 10%" Ramsey.  I am not going to say "You're Approved!" for your latest new car purchase.  I will just tell you that you are an idiot for even considering it.

And this isn't Ann Landers, either.  I don't give advice.

If you are in debt, you have only two choices:  Pay it back or work it out through bankruptcy.   There is no third choice, no "trick to the tiny belly" and all that other crapola they try to sell you these days.

And if you believe that sort of thing, they will take all your money and leave you destitute.

And if your debt is student loan debt, well, you can't even discharge that through bankruptcy.  Student Loan Debt forgiveness is very, very hard to come by, and you have to show a real hardship to get it.

And by real hardship, I don't mean doing without Cable television, a smart phone, and a new car.

You do have one area of control in your life, and that is in SPENDING.   And what I have learned in this blog, going from living on over $100,000 a year to less than $50,000 is that spending is the key - and we spend a LOT on crap we don't need or want.

For example, Suzie has $50,000 in student loan debts and pays $100 a month for Cable Television.   How can she ever pay off this debt?   It seems intractable.  Hard to believe she actually went to college and can't grasp how compound interest works!  Yes, the first year is almost all interest.  The last is almost all principal.  Google "loan amortization" sometime, Suzie!

Which is why, if you make even one extra payment a year it can knock years off a loan.   What?  They didn't teach this in Kollege?

Consider a 10-year student loan, $50,000 at 8% interest.  That's $606.64 a month in payments, over ten years.  Now Suppose Suzie decides to pay an additional $45 a month on that loan.   $45 a month - not a lot of money - not even one full loan payment a year.   What is the term of the loan now?  Yup, nine years.  It knocks a full year off the loan.

Why?  The magic of compound interest.  When you pay down principal, you pay less interest, which means more of the remaining payments go toward principal, which in turn knocks down more interest.  Even a small additional payment every month makes a difference, over time.

Yet, most people fail to see this.  "I paid an additional $50 last month," Jeff cries, "and my student loan still isn't paid off!   So obviously, that idea doesn't work!"

Might want to give it a wee bit more time there, Jeff!  But that is the attitude of the young.  They put $100 in their 401(k) and don't become instant millionaires, so they quit.   No, really, I've seen this happen!

Seriously, these people went to College and took Calculus and still can't figure out compound interest?

Getting back to Suzie, suppose she calls the cable company and cuts the cable entirely.   She needs it like a hole in the head, anyway.   Just bad normative cues.   She takes that $100 a month and puts it toward the student loan.  Now the term of the loan is eight years.

Seems like magic, right?  After all, $50,000 is a "lot of money" and $100 is a "small amount".   Right?  Subscription services are evil this way, which is why I say, cut them out whenever possible.  Stupid stuff like XM radio and Onstar are just worthless wastes of money - enormous amounts of money, over time.

You can play with the numbers - the interest rate, the balance owed, the term of the loan, whatever.   What ends up happening is pretty amazing.  If you make an extra mortgage payment every year on your house, for example, you can slice seven years off a 30-year mortgage.  But you have to cut your spending by an equal amount.  That's the trick!

And where you get the money to make these extra payments really doesn't matter.  I use Cable television as an example of an utterly worthless subscription service you could really live without (and yet many folks think is like oxygen).   Giving up Starbucks, cutting up credit cards, not "shopping", doing without a smart phone, making your lunch and taking it to work - all of these can save you an enormous amount of money over time.  $5 a day is a lot of money, yet many people spend that on coffee at Starbucks.

The key is, of course, to get into habits like this.  Most of us - myself included - spend up to our income and pay the minimum amount due on our debts.   We have more 'stuff' in our lives and enjoy going out with friends to restaurants and eating lunch out with our co-workers, and of course, watch 4.6 hours of TeeVee every night, after driving home in our shiny new Acura.  And then we wonder why we are broke, fat, in debt up to our eyeballs, and unhappy.

It is a choice, a conscious choice.  And one we all make -for good or bad.   There is no easy way out, no trick, no "Obama debt forgiveness plan" (college graduates really think this?  What do they teach in college  these days?  Macram√©?)

And these same college graduates read my blog and miss the entire point of it.  They pester me whether it is "OK" to buy a brand-new car, since used ones are "so expensive these days" and Brand X "doesn't depreciate much" (both lies we tell ourselves), and hey, maybe Dad will co-sign the loan for me?  Sorry!  No Sale!

This blog isn't about consumerism, and how to spend more money, but how to spend less and spend it more effectively.   Your average salary slave pays a ton of money for a brand-new econobox - more than twice what I pay to drive used BMWs.    He drinks lite beer and pays more for it than I pay for champagne.    He pays more money to live in Foreclosure Mews Townhouse Estates that I pay to live in a State Park on an Island.  Why? because he isn't smart about how he spends, and when he spends, he does it all with borrowed money.

So what is the "trick to the tiny belly?"  It is not in spending more but in spending less - and being smart about how you spend.   Paying off debt so you are not on the hamster wheel of interest payments for the rest of your life.

Many people want the opposite - they want all this brand-new "stuff" right this very second and are not willing to sacrifice now to have it later for less cost, or even free.  So they sign loan documents, and sacrifice the later for the now.

The problem with this approach is that if you sacrifice now it is done and over with, and it does not hang over your head later.   Moreover, it is not an open-ended commitment.  When you leverage your later for the now, what happens when later changes - for example, you are laid-off at age 55 and still paying back loans for stuff you bought  when you were 30?  Bad things happen, that's what.

There is time to change course - to rethink your life and stop viewing it through the consumerist mindset touted by television and the media.  And yes, this goes against everything you have been taught since you were a child.  That spending is "fun" that consumerism is "great" and that being hopelessly in debt is "normal" and the only problem in life is how to raise your credit score so you can acquire more and more debt and more and more crap.

The hardest part of getting out of debt is making the decision to do so - seriously!

And yes, it is not impossible to do.  I have friends who are very frugal and smart with money, and have lived this way since age 21.   They do very well for themselves as they avoid going into debt for something as stupid as a car, and instead put money in the bank.   It isn't impossible to do - it is just that few people choose to do it.

So, my "advice" for Suzie is this:  Cut back on spending - and you know there are places in your life you can cut back.  Get rid of cable.   Cut out the smart phone.   Cut out the Starbucks.  Get a roommate and split the cost of rent (or have them help pay off your mortgage).  Stop shopping.  Cut up credit cards.  Whatever. 

In everyone's life there are places they can save money.  I switched from drinking coffee to drinking tea, and saved $450 a year.  No, really!  Amazing what a few minutes with a calculator will reveal.

It can be done.  You have to choose to do it.   And it means changing your whole value system.  Once you stop watching television, however, it becomes much, much easier.  You have to stop engaging in weak thinking and stop using the television and your brain-dead neighbors and co-workers as normative cues on how to live your life.   This is why immigrants do so well - they don't buy into the crap that native-born Americans do - they save their money and build wealth.  And we hate them, because they are successful and show us up at every turn.

But, alas, some folks still want the secret "trick" that lets them buy the new car, keep the Cable TV and the smart phone, and still reduce their debts.  But it ain't happening.   They would rather mortgage their lives than make small sacrifices.   And in this regard, my giving advice to them is like telling a pothead to stop smoking pot, if they want to move out of Mom's basement. 

"No, seriously, dude, besides giving up pot, what can I do?"

Uh, dude, you just took the only real answer, off the table.

Sorry, but there is no Genie.  And if a Genie seems to appear, well, watch out!

That's all I can say.