Do We Take Debt Seriously Enough?

Debt is hardly a new part of the human experience. From the time that man first developed money, people have wanted to buy things they can’t afford. Although most Americans don’t run much risk of being sent to a debtor’s prison like a character in a Charles Dickens novel, debt can still have far-reaching and life-ruining implications.

In the simplest terms, debt happens when a person borrows money to pay for something. When he pays it back he will owe interest, causing the total cost of his purchase to increase, sometimes exponentially, the longer he maintains the debt. The problem is that, for many consumers, the consequences of debt never seem important until it’s too late.

Buy Now, Worry Later

The image many people have of consumer debt is skewed by the idea that only wasteful spending can create debt. It’s easy to understand how a person can quickly max out a credit card by buying luxury items, or how a person’s car payment for a sports car can become too much to pay. The problem is that it’s not only frivolous spending that leads to debt, and in many cases the people who have the worst debt problems are the same people who are financially unable to deal with them.

For some people in the lower classes, they often try to become credit card experts and loans become a way to compensate for painfully low incomes. Many people live paycheck to paycheck, with their income only barely covering their exact cost of living. If a bill comes due before the corresponding check arrives, a person may be faced with a choice between paying with a credit card or facing late fees and cancellations.

In these occasions, the people taking on the debt often know that it’s bad, but the consequences seem even worse. Paying off debt happens later; buying food for the family happens today. Because low-income families are constantly living “hand to mouth,” there is often no time to put off expenses or save up for purchases. Every day can feel like an emergency until payday.

The working poor aren’t the only people who face similar problems with debt. The sad truth is that income has much less to do with financial security than proper money management does. Many people never learn how to manage their money and find that the more they make, the more they spend; even though their income has doubled, they still barely get by every week.

People with higher incomes will expect a higher standard of living: nicer cars, better furniture, fancier electronics. They may be every bit as likely to live from check to check, though, as they’re living the same lifestyle as people below the poverty level only with more expensive substitutes.

Do We Take Debt Seriously Enough?

The nation is in debt. Businesses are in debt and go bankrupt every day, celebrity bankruptcies are pretty common and foreclosure defense lawyers are enjoying their most profitable time in decades. Most American consumers are in debt, too, and the amount of debt just keeps growing.

A 2010 survey by the Federal Reserve Bank of Boston estimates that the average American with debt has around $15,965 in credit card debt alone. Most people have several credit cards, many of them carrying maxed-out balances and generating compound interest for years as the consumer struggles to make minimum payments.

Nevertheless, despite the pervasiveness of debt in America, most consumers do not shy away from using credit cards or financing major purchases. Because of the way debts are applied, many people hardly realize the true price of items bought on credit. They may not realize the danger of unpaid debt, either, until they’ve already done damage to their credit score.

Buying things on credit tricks the consumer into believing he’s paying less when he’s really paying more. By breaking a purchase down into several small payments, a purchase seems much more affordable — even when the sum of the payments is more than twice the item’s value.

There is also a disconnect in many people’s minds between the money they make, the money they spend and the bills they pay. A person may not associate his credit card bill with the cost of purchases he’s made. Each month, a credit card bill or car payment arrives, and he pays it without thinking about why it costs what it does or how he may still be paying off a purchase from two years ago.

Debt as a Financial Quagmire

When compound interest is used in a savings account, it’s a great tool for increasing a person’s funds. When it’s used by a lender, it leads to debt quickly spiraling out of control. Essentially, compound interest means that the interest is added to the principal. This means that the overall cost of interest increases more and more as time goes on, even if no new charges are added to the debt.

Unsecured debts like credit cards and signature loans will have higher interest rates than debts with collateral, such as mortgages or car payments. All debt has interest, though, and interest will always cause the cost of a purchase to rise. In the case of car loans, for example, the vehicle may be depreciate faster than it takes for the loan to be paid off. If a person has a total loss accident an insurance company may not pay for everything and the owner may end up continuing to make car payments for a vehicle they can’t even drive.

Credit card companies are sometimes the worst about adding additional costs to debtors. In addition to interest fees, credit card companies might assess harsh late payment fees or fees if the balance exceeds the card’s limit. Some cards even charge fees for having a card without using it.

Although credit may look like an easy solution to financial troubles, it nearly always results in a long, difficult-to-pay quagmire of interest fees, monthly payments and hidden costs.

The True Cost of Debt

The worst and most insidious effects of debt are indirect. While the financial strain of making payments each month is certainly a serious concern for some consumers, the effects on a person’s credit can be life-altering and, in some cases, devastating.

A person’s credit score represents his financial dependability. People with good credit pay their debts on time and don’t keep multiple lines of credit open at once. People with bad credit don’t pay their debts, or they make late payments and maintain many lines of credit at the same time. Once the credit score has been damaged, it will take a long time and plenty of work on the consumer’s part to repair. Credit scores are traditionally used to assess whether a person might qualify for a major loan, such as a home mortgage or a new car.

Unfortunately, credit scores are used for more than pre-screening loan applicants. Many businesses equate a person’s credit with his character, as though financial responsibility were a moral quality. People with bad credit pay more for car insurance. They may have a harder time getting approved for an apartment. Some jobs even selectively hire only people with good credit scores.

Some types of debt can have an immediate financial impact on the debt-holder in addition to destroying his credit. If a person doesn’t pay back the money that he owes, he may have his wages garnished. This will remove money from an individual’s paycheck before he has a chance to see it, often severely limiting the amount of is income and causing an already-strained financial situation to worsen. In other cases, debt can lead to repossession of a person’s house or vehicle. This can be ruinous if the person has no way of recovering their property and nowhere else to go.

A subtler long-reaching consequence of debt is the effect it has on younger generations. Children raised by parents with heavy debt may not learn the skills necessary to avoid debt themselves. Money management skills must be learned, and if a person doesn’t incorporate these skills early in his life his finances may become damaged early on. This creates a dangerous self-perpetuating cycle that can only be broken through education and self-control.

The Solution

As Americans get better at dealing with their debt, the economy may begin to follow suit. Economies only function properly when money flows freely through them. If a consumer’s income is diverted into paying off debts for purchases he’s already made, he can’t make new purchases that will stimulate the economy, generate demand for products or create new job opportunities.

Governments and businesses should be accountable for their financial health, but accountability begins at home. Individuals must learn to master their finances before they become a slave to debt. The sooner someone is able to learn money management, the better his chances of living a debt-free life and repairing any damage that’s already been done to his credit.

The only way to avoid debt entirely is to only buy what you can afford. This is harder than it sounds, as sometimes it’s not as easy as not splurging on expensive luxuries. Sometimes, it’s necessary to “go without” for a while in order to set aside money for the future. This level of self-discipline is hard to learn, but it’s invaluable, and is one of the most important skills that any individual can learn.

Alan Dunn

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