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Musings of a Debtor–Part 2

(this is part 2, see part 1 here)
I’ve had several friends ask me “Why are you guys so focused on paying your debts off?  What’s the big deal?  Isn’t debt just part of life?”  I’ve had others question my sanity when we’ve bought cars that were several years old. “Aren’t you just going to pay more in repairs? Don’t you want something reliable?” (really? that last question is necessary?!)

Disclaimer time: I AM NOT JUDGING YOU.  Repeat after me “Jim is not judging me.  He’s just writing about his own family’s crazy convictions. He’s actually a nice guy, once you get to know him…”  Of course, if what I write causes you to think about your own situation, great!  Believe me, I’ve logged many sleepless nights pondering this stuff.  I also do not think all kinds of debt are bad. A mortgage, while it can involve serious risk, is often a great investment, given a steady and advantageous rise in property value as it’s paid down. In addition, business-related debt has a whole host of implications and dynamics attached to it – and is often the right move in those situations.  But I’m not talking about those kinds of debts – I’m going to pick on consumer credit debt for this post.

Enough Disclaimers – Example Time
Let’s look at a simple example.  Clever marketing has, for years, presented consumer credit debt as just another line of income. It’s subtle, but it’s there. And when the curtain is pulled back to reveal that you are, in fact, borrowing, with high interest, against your own future, we’re told to “Make other people’s money work for you”. Okay, then.  Let’s look at how other people’s money works for us.

Meet Joe.  He wants an iPad. I mean, there are ALL kinds of ways it would boost his productivity, and lift his mood. (Hey – not making fun, I *am* a developer.  I LOVE tech toys, and I really want an iPad.)  So Joe buys a 64 Gig iPad, and got talked into a really sweet Mac Book Air as well. After his trip to the genius bar, and some mall shopping, Joe now has a balance of $5k on his credit card. Don’t worry, that’s less than 1/3 the average credit balance per household that has credit debt. Joe’s credit card has an average rate of 13%, but he only pays the minimum each month.  I mean, why waste that cash flow?

So, let’s take the iPad specifically.  It cost him $699. If he can only pay the minimum payment, his iPad will actually cost him around $978 by the time it’s paid off. Not *awful*, but that amount could have scored him an iPhone as well – too bad for Joe.  However, the real kicker is how that adds up over all the things Joe’s charged on his card.  His balance of $5k, paying only the minimum, won’t be paid off for *over 21 years* and he will have paid an additional $4900+ in interest. Ouch.

Joe’s really mad about this, so he puts an extra $50 per month towards this credit card.  That helps.  Now he’ll have the $5k balance paid off in just under 3.5 years, and only pay $1100+ in interest. But man, that $1100 could’ve paid for the weekend at the cabin with his wife.  Or it could have been a down payment on the new car he bought recently. But that money isn’t available yet – he has to earn it, and then spend it to pay the interest and principal on something he already consumed. Future income…present debt.

Oh, Statistics
Multiple sources indicate that the average credit card debt being carried per consumer/household is around $15k. At the roughly-average rate of 13%, only paying the minimum payment, it will take almost 31 years to pay the balance off, and you will have paid roughly $15.7k in interest. “Jim, really? Who only pays the minimum payment?”  Well, if Joe is 29, then there’s a chance he falls in the 41% that only pays the minimum for his age range. A third of Americans at any age have only paid the minimum for the last year. The upside is that 54% say that they *have* paid the balance in full in the last 12 months.  But I digress.  The point is that Joe is making other people’s money work so hard for him, that if he only pays the minimum, he’ll pay them double by the time all is said and done. Joe’s not making other people’s money work for him – he’s spending his future income before he’s earned it.

Opportunity Cost
I work for a software consulting company. As developers, we *love* traveling to tech conferences and speaking.  However, we have to be careful about the impact of the travel.  You see, it’s not just the cost of the trip that the company covers.  It’s the fact that I won’t be billing while I travel and speak.  That’s called opportunity cost: “The loss of potential gain from other alternatives when one alternative is chosen.”

Now we get to one of my main concerns with consumer debt.  If Joe’s iPad really costs him almost $1k, and not $700, he’s not only paying $300 more, he’s unable to use that $300 for anything else that could potentially gain value.  At the very least, the $300 could be available for essentials, or even another “want” – even better if it’s earning him money through savings or investment.  But not so, if it’s just paying the creditor.

So – let’s take that car question up again.  I opted to pay $5k cash for a 2004 model car in 2009.  What I *really* wanted was something new that cost in the range of $20k. Let’s assume I financed that new car at 5% interest, no money down, for 4 years (in TN…yay for sales tax): I’ll have $500 per month tied up in the payment, and by the end of the 4 years, I will have paid (just under) $24k for the car.  The interest alone almost pays for the car I actually bought.  Had I bought the new car, $24k of my money would be tied up over 4 years that couldn’t be used to gain value – either through earning interest or paying down debt.  Yes, buying a used car has a risk.  It requires a lot of research, and patience in selecting a vehicle.  It means you need to be prepared for what repairs are normal for the age of the vehicle, etc. However, given my situation, I could pay the value of the car 3 more times in repairs (which I’d never do) before I’d ever come close to if we’d bought something more like what I want. I’m not knocking the peace of mind that can come with the new car smell – the “I don’t have to worry about the transmission dying on the way home” feeling – at least, you hope. But it comes at a cost – nothing is free.

If just the interest alone (from above) was placed in a certified deposit for the 4 years it would have otherwise been tied up, it would earn $163 in interest at 1%.  If I’d had $24k on hand, and still chose to pay the $5k for the car, and placed the other $19k in the same cd, it would earn $774 in interest over the 4  years.  Yes, I know that’s not much to write home about, but consider this: shy of interest bearing savings accounts, cds are one of the most conservative ways to grow money. I could also be investing in my retirement with that money (or some other investment).  I could be paying ahead on my mortgage – the debt for the one asset that tends to appreciate in value (barring epic housing crashes, etc.).

The point?  Getting into debt is easy, but the opportunity cost is HUGE. Our money is not only tied up paying a balance, but the finance charges are keeping us locked in for the duration unless we can climb above minimum payments and attack them aggressively.  Debt compounds.  The same is possible if we have our cash freed up to invest in things that earn value, or at least pay for essentials without incurring debt.

No, not really.  But this is typically where people think I’m getting judgmental. The irony is, if I’m judging anyone, it’s myself. Does living like this mean I have to say no to things I want?  Yes, not going to lie. Being responsible typically does mean you weigh choices and try to aim for the wise one. I wrestle – *a lot* – with what the implications are that our culture feels – that *I* feel -  so entitled, and have so little grasp on delayed gratification, that we’d continue to rack up debt at such a concerning rate in spite of all the warnings signs around us.  I have a problem with stating that I’m for a balanced Federal budget, while being unwilling to balance my own.  To what moral high ground do I have a right, if I rail against selfishness, poverty, our national debt and unfunded liabilities, and more – only to neglect preparing for my kids’ educations, my own retirement and everything in between and after?  In other words – I have no business demanding responsibility from those in power when I’m unwilling to live it myself.  And on top of that, Proverbs 22:7 is spot on: “…and the borrower becomes the lender’s slave”.  Why do I want to pay my debts off, and stay out of debt?

I want to be free.

Musings of a Debtor–part 1

I’ve decided to write honestly about some of the challenges my family has experienced, specifically with finances over the last few years.  Why in the world would I want to share this online? Primarily to provoke thought. You might disagree – fine if you do. “But isn’t this kind of personal, Jim?” Yes, in many ways it is. But I think it’s important and beneficial (personally and for others) to be willing to share from concrete personal experience. If you don’t care what people think of you and the mistakes you’ve made in the past, sharing this kind of information isn’t something that can be held over your head, and that’s a liberating thing.

I’ve worked two jobs for almost 2.5 years. Why? Well, in 2010 I was able to check off “Experience total company collapse thanks to embezzling CEO” from the bucket list.  I’ve held the second job to keep us from being as deep into the red as we would have been after that fiasco.  Most everyone in that company missed the last couple of paychecks, and discovered that withholdings for their medical & life insurance, HSA, IRA & ‘everything-else’ never actually made it to the proper destination (though the money was, of course, *withheld*). Not many families would simply be able to absorb that kind of hit without flinching.  However, the trouble is that we (my family) had been in rough shape prior to that.  We never seemed to be able to get ahead of anything financially. Everything was one more cut in the game of death-by-a-thousand-cuts. It hadn’t always been so.

Course Changes
The first two years after we married, my wife and I worked through all kinds of pain and toil to eliminate our debt (which went moderately well into the 5 figures at the time).  I still remember the incredible feeling of walking into the bank to pay off my Stafford Loan. Amazing! We did the “debt snowball” approach, and watched in wonder as it accelerated – moral victory after victory. But our course changed after becoming debt free. Instead of kissing the ground like passengers who nearly averted a plane crash, but managed to make it home alive, we slowly began to take being debt-free for granted. Of course that’s not entirely fair. But key decisions were made that locked us into the proverbial “financial boot-on-our-necks” posture.

First – lack of savings.  Oh, don’t get me wrong – we had savings, and at one point a nice comfortable buffer in our checking account as well.  But we never worked to put back the often recommended 3-to-6 months worth of expenses. There was always something else – a want, or a need…didn’t matter.  We were out of debt.  The economy was great.  We’d get to that emergency fund at some point. The lack of any savings available when one of our cars was totaled put us in a position to be willing to take on a car note – and our journey back into debt began.

Second – we bought a house that stretched us.  Not only that, but sold a townhome as the market in that side of town was going down in value, erasing what little equity we had.  But the real estate market was booming at the time – what could go wrong? (Ah, the good old days of 2005.) We never adequately planned for what life would look like once we started having kids.  We never thought through what it would entail to furnish three sitting rooms, 4 bedrooms, kitchen, office #1 and #2, and more. We knew the good advice to set aside a bare minimum of 1-2% of your home’s value per year as a maintenance fund – but we were so strapped due to other concerns, we weren’t able to proactively do it.  Then our washer died.  And our dryer. And then we had HVAC issues.  The point isn’t to sing a sad song about it – just to show that buying even slightly beyond your means, and without thinking through longer term consequences limits the scope of what you can do financially far more than you think.

Third – and hardest to describe – is that we lived for “now”.  It’s not that we were always wasteful.  In fact, it’s been a passion of ours to give away a significant portion of our income to charitable causes.  Yet even as we did that, we showed little restraint in other areas and we failed to focus on mid-to-long-term planning. I had a good job – with the best team of developers I’d ever seen assembled. Baby #2 was arriving. My income had – at that point – slightly-more-than-tripled since when we’d first gotten married.  We started carrying a balance on one credit card.  But the Amex?  We paid that thing off every month. Then the ideal job situation evaporated overnight.

Cold Hard Reality
Losing my job was, perhaps, the “Come to Jesus” experience we desperately needed. But much like my young children – who *insist* they’ve learned their lesson, they’ll never do it again, “Daddy can I *please* have that toy back right away?” – we hadn’t quite changed our ways entirely.  On one hand, being unemployed and then moving my family to a new city was taxing in all respects, of course. But our first rental home experience was a disaster (one I still shudder for being responsible for getting us into). We had no savings to fall back on to pay for the move to a second rental home 6 months later – and no savings to fall back on when tornados ripped through our community and left us living out of a hotel for a week right after we moved in.  That house we’d bought that was a stretch? Yeah, we were still paying for it. Had we not been able to find renters (who got a serious discount, no joke), we would have gone under sometime in early 2011. Our consumer debt was working it’s way back into the territory of what we had when we first got married – and even with income from both of my jobs, we were in the red every month. Suddenly the “seemingly-minor-oh-don’t-worry-we’ll-get-to-that” decisions from before my company collapsed had a magnified effect on what we were able to do now in a real emergency, and the severity of that effect came *without any warning*.  For the first time in my adult life I began to seriously consider what I would do *when* we lost everything.  I was angry.  Angry at myself for not being a better husband and father. Angry that I couldn’t stick my head in the sand and just ignore than dangers our debt posed. My impatience and selfishness had deprived my family of better footing and opportunities. No, son, you see – Daddy and Mommy wanted to go out to eat a lot, get the latest gadgets and buy a home in an affluent area that we didn’t think through properly beforehand – and now we owe more each month than we can pay, so *that’s* why you can’t play soccer this season.  First world problems?  Yes, that’s true. But selfishness and impatience is still selfishness and impatience at any income level.

In early 2012, our renters moved out of the house we still owned. It was do-or-die time for us. We tried putting it on the market again.  I did my best calculations – we had until no later than the end of June before everything would collapse. We stayed to let my oldest son finish his school year, and we waited anxiously for movement on our home. A few things came up (as they always do) that shortened the timeline from “end-of-June” to early May. As a last ditch effort, we contacted a leasing agent to see about renting our home out again.  They were shady and pushy.  I had a *bad* feeling about working with them, and decided to think on it over the weekend.  That Saturday our soon-to-be-buyers came to the house.  In the meantime, I’d changed day jobs.  I was doing what I’d been longing to do for years, and working from home, to boot.

So why not just move back to the house we owned? We would have as a last resort.  But for the last two years we’d lived with a boot on our financial necks.  We watched the opportunities we could provide our children recede from reach one by one as more essentials were put on credit. Moving back wouldn’t have been better financially.  The cost of living was higher, and we’d still be in a situation where we couldn’t get ahead, but now with triple the debt (at least). And the market!  Good grief, if my experience in 2010 taught me anything, it’s how quickly it can evaporate. Nashville always has Sr-level developer jobs available, right?  Not quite.

Anyway – moving back would have meant 10-15 years before our *current* debts would be paid off. I’d have two kids in college at that point. (yikes) If we sold, we’d have a fighting chance to do it in 2-3 years.  But there was a catch.  We were underwater on the house.  We scrounged everything we could, and then had to borrow money in order to cover closing – and it still took an additional miracle of some unexpected cost reductions to close. We officially exceeded our earlier debt ceiling sometime in July 2012. Yay?

It’s baffling how much of our situation could have been prevented, or at least mitigated. I can’t take responsibility for my former CEO’s actions that let to the company’s collapse, but I could have been more prepared. Some things just happen, end of story. You can choose to be a victim (bad idea) or you can take responsibility for responding in the best way possible and learn from it. But the things you *can* control are often determined ahead of time by a long stream of small decisions you’ve already made – and you may not be aware of how those decisions will be setting you up for failure or success down the road. Sticking to wise principles will help keep you in calm waters, and help steer you there when things get rough.

So – after the house closed, the reset button was pressed in a big way for us.  Starting over…from scratch…in a nice hole of debt.  But still, it was a fresh start. That’s the backstory. In part 2 I plan to chat a little more about the ‘why’ behind our drive to get back out of debt….