6 Debt: How to Avoid Its Trap

Debt: How to Avoid Its Trap

Debt is one of those things that can just build up on you so high and heavy it seems like you are no longer working for yourself and family, but rather are working in service to your debtors.

In fact, it might not just seem like that but also actually be like that. When so much must be spent on interest payments, it is difficult to live on the lean incomes common when starting an art career.

Eliminating the debt you have and not taking on any more can bring you a long way to a reduced cost of living and a more fulfilled life. Interest payments are purely wasteful drains of our resources, offering practically nothing in return.

Often we don’t look at the actual numbers to realize just how wasteful borrowing money is. Here’s one example that shocked me.

As a general rule I automatically refuse any credit card offer. However, I found myself in a conflict between wanting to pay off my home while suddenly facing about $3000 in dental costs. (I can still hear that drill grinding on my teeth.) Anyway, there was a special promotion that would lend me $3000 on a credit card with zero interest if it were fully paid off in 12 months.

This seemed worth looking at, so I read all the fine print. The rules were that I had to pay at least the minimum payment each month: $90. If I failed to pay off the full amount in 12 months, I would then be paying something like 26% interest! If I was ever late with a payment, I would immediately be paying a whopping 31% interest!

Just what does that translate into for out-of-pocket costs? The really fine print stated that if I simply paid the minimum amount due ($90/month) on the $3000 loan, it would take 244 months to pay it off. Some quick math tells me how much that is. 244 times $90 equals a grand total of $21,960!

So for the privilege of borrowing $3000 I could end up paying an extra $18,960 in interest payments. That’s what I would call extremely wasteful spending. Granted, this is an extreme example in terms of interest, but sadly I don’t think it is that rare of an offer from a credit card company.

This brings me to some of the schemes I’ve seen encouraging us to take on debt and/or stay in debt. One is what I call the “lower your monthly payment” scam. It’s often just about putting a spin on the wording to make you think you’re saving money. The situation I described above is ripe for this. If a borrower of $3000 paid $250/month for 12 months their entire loan would cost them $3000. That’s actually a generous offer if no other strings are attached. (Often similar “one year same as cash” offers involve placing a lien on your home or some such thing.)

In the “lower monthly payment” scam, you might see wording such as, “Slash your payments from $250 a month to just $90. That’s a savings of $160 a month! Just imagine what you could do with an extra $160 each month.”

On the surface this would seem like a great offer you’d be crazy to turn down. How could saving $160 each and every month be hurting your financial picture? What this sort of scheme does is distract you from the big picture and keep you focused exclusively on your month-to-month struggle to make ends meet. It’s all done with how the “deal” is worded.

With the above example, it’s absolutely true that you would save $160 a month (and here’s the important part) for the first 12 months. In the long run this “savings” will cost you $18,960!

Once you can actually see the cost over the long haul, you must ask yourself if the fulfillment you receive is worth the expense. I highly doubt it will be. Now I’m not saying all offers to “lower your monthly payment” are scams to keep you in debt. Some may genuinely save you money - but you need to look at the total cost, not the monthly cost.

Another scheme I’ve seen grow in recent years is the “home equity loan.” I believe this used to be called a second mortgage or “betting the farm.” The general wisdom used to be “don’t bet the farm.” These days the constant barrage of advertising makes it seem like you are a fool if you don’t “unlock the equity in your home.”

When I first saw these ads I couldn’t believe anyone would go for them. Who would take out a second mortgage on their house to have a vacation in the Bahamas or spruce up the kitchen? Now it seems to have become so popular that not only do the ads push the idea at you, but also respected friends and neighbors, who have taken out such loans, present it as though it’s a good idea. Our homes have come to be viewed in terms of monetary value, a sort of savings account we didn’t realize we had.

From my perspective, the real value of my home is the shelter it provides me from the elements, the spaces it offers to create my artwork and live in, and all the psychological benefits provided by securing these things. No way am I going to risk all that for a vacation or some new countertops and a coat of paint! My house is not a revolving bank account. It is my home.

When you take out a home equity loan, you are essentially selling part of your house back to the bank and agreeing to repurchase it with interest. It’s a scam to keep you from ever paying off your home and thus it keeps you in debt. In this way it’s really a clever twist on the “lower your monthly payment” scheme. If you paid off your home instead, you would stop making those interest payments and suddenly find you have much more available money on hand.

A couple of years ago, when I was still making mortgage payments, my bank tried another scheme I thankfully haven’t seen since. I hope this means no one took them up on their offer. Here’s what it was. In order to give me some “extra spending money” for summertime vacations and recreation, they were willing to allow me to skip a monthly mortgage payment Naturally there would be a small fee for this added onto the next month’s payment. The fee itself was really quite large in proportion to my monthly payment, but that isn’t even where the real cost was. What they would do is extend the term of my entire loan out another month. I never did calculate what that scam would have actually cost me, but it would have been huge for just getting a few hundred dollars of “extra disposable income” for a month.

Once again it is through clever spins on wording that they are attempting to sell me something which is clearly a poor financial choice. Upon later reading the loan agreement from this bank, I could see that they had simply reworded what would happen if you missed a monthly payment anytime. The fees and penalties were the same! What they were doing was actively encouraging people to miss a payment. Another way to view it was that this bank was trying to get me to take out a long-term loan equal to one month’s mortgage for no particular reason at all. That scam so irked me that if it had been easy and inexpensive I would have taken my home loan to another bank. However, since I knew I was going to pay off the loan soon, it wasn’t worth the closing costs to refinance.

Banks make a great deal of money collecting interest on debt. It is in their best financial interests to get you to borrow as much money as they can. I suggest being very wary of all bank offerings. Read the fine print and consider the total end cost.

In a past article I wrote about housing and the strengths of buying your own home rather than renting. I’ve since heard of a new type of home loan being pushed; I can’t believe anyone would accept it, but it appears to be getting quite popular. It’s called an “interest only” loan. As I understand it, you borrow however much in principal and only have to pay the interest on that principal each month. This is the ultimate “lower your monthly payment” scam in that your monthly payment is only the interest. Unless you pay extra, you will never pay off the loan. There’s no way to even calculate the total cost of such a loan because the cost doesn’t end. If you buy a home with an interest-only loan, you are essentially renting with all the added costs of home ownership added to it. The crazy thing is people don’t even seem to be using this type of loan to “lower their monthly payment” but rather to buy a way more costly house than they could otherwise afford. I guess the thinking goes, “since you only have to pay the interest on the loan, you can borrow much more.”

To reiterate what I was advocating in my previous housing article, I recommend buying the most minimal home that will meet your needs, with the smallest loan possible. Then once you have paid off that house, all the money you would be spending in interest can be quickly saved up to purchase the home more fitting to your dreams with cash. You may find your dreams don’t actually center around the large beautiful home in the trendy neighborhood, but instead on the activities of your life, such as making art. Find what really brings you happiness and spend your money and energy there.

It is my opinion that credit cards are a dangerous thing to possess. What a credit card provides is a very easy way to borrow money.

From what I’ve seen what gets most people to accept their first credit card (and always keep at least one) is fear. That fear I usually expressed in the phrase, “I like to keep a credit card in case of an emergency.” I have a feeling this fear is played up and used to sell more credit cards and cell phones than any other reason.

I’ve never used a credit card. I don’t even have one. They certainly are convenient at times. In fact, it seems almost indispensable as an artist who must continually order supplies from far-off states. However, I’ve found a debit card works just as well, without dangling the carrot of easy borrowing in front of me. Haven’t I ever run into some financial troubles? You bet I have.

A credit card can be an easy solution, but it isn’t necessarily the best solution. We are creative people.

One of the skills an artist learns is creative problem-solving. I will apply this first. I see borrowing money and incurring debt as a solution of last resort. I will enter it only with extreme reluctance and lengthy consideration.

Credit cards seem specifically designed to encourage easy and impulsive purchases. Heck, isn’t that why we accept them in our art fair booths or galleries? It’s so easy to borrow money with a credit card, usually with the good intentions of paying it all off when the monthly statement comes in.

I’ve only heard of one situation where a credit card seemed to be the only option in an emergency. It involved someone stranded in a foreign country with no money and no plane ticket to return. However, I hear stories all the time where credit cards have created financial emergencies because they are so easy to abuse and rack up enormous amounts of debt.

If you’re already in debt (and I believe it’s a very rare few who aren’t), how can you get out?

I am in debt. It’s a carefully considered debt, but it’s debt all the same. This is what I’ve been doing to eliminate it.

First, stop taking on more debt. As I’ve said, borrowing money is always a last resort for me and only on major things. For most areas of my life, borrowing money is never even a consideration. If I see a great sale but don’t have enough money on hand to buy what appeals to me, I just do without. With interest added on, that sale price is no longer so low. Borrowing money for basic shopping and paying interest just doesn’t seem like a fulfilling use of my resources. Next, I built up that six-month savings buffer I wrote about last time. This, not credit cards, has been the financial key that takes care of my emergencies. I can just pay with cash and rebuild the buffer. As I said before, it can take some time to build this savings - but the security and freedoms it gives you are powerful.

Then each month I look at my total income and total expenses. Assuming I made more than I spent, the difference between the two is what I gained.

This amount used to be called “savings,” but with today’s rewording it’s being called “disposable income” in the hopes that you will dispose of it. Since I already have enough savings to keep me secure, all my extra income each month is paid directly to the principal of my loans. This pays them off much more quickly than taking the loan to full-term, thus getting me out of debt and saving me money I’d be paying in interest. For maximum savings it’s generally best to first pay off the loan with the highest interest rate and work your way down.

If I have higher expenses in a month that take away from my six-month buffer, then I put my extra money into savings until I’m secure again. Then it’s back to paying off debt. At this point I’m down to just my student loan, which is rapidly decreasing. Once that’s paid off and I’m debt-free I expect I’ll be a little giddy with all the extra cash I have coming in that used to be servicing my debt.

I’m able to do all this with my very modest income as an artist. If I can do it, you can - these things aren’t out of reach for anyone.

Debt is a tremendous strain on our resources. Readily incurring it in the pursuit of your dreams may just prevent you from achieving and maintaining those dreams. Eliminating the unfulfilling waste of my energies put toward servicing debt is solidifying my dreams to sustain being an artist. It can help you get there too!