DON’T FEAR DEBT UNLESS IT’S KEEPING YOU STUCK IN THE PAST
DEAR PETE: How do you feel about debt? Is it bad? I’ve heard people call debt evil, but debt has always allowed me to get the things I wanted. I have about $15,000 in credit card debt, $25,000 in student loans, I owe about $27,000 on my car, and I have a sizable mortgage. How do you look at debt?
— ANGELA, LOS ANGELES
DEAR ANGELA: People like to demonize debt, but I don’t really see the point. Debt can be the product of a lack of preparation or simply the result of bad math. In a perfect world, people should avoid going into debt because it divides your financial life into three and not two. And that’s bad.
There are three possible aspects to any financial life — the past (debt), the present (lifestyle) and the future. Your income is divided and used for these different elements. People struggle enough as it is saving for their future, but when you add debt into the equation, financial pasts begin to trump financial futures.
Your financial past is your debt. It was created when you couldn’t afford all the costs associated with your present. Now, instead of your money splitting into two (present and future), your money is forced to split into three (past, present and future). If too much money is allocated toward your present, then you will almost immediately create a past.
I met a gentleman recently who had 26 credit cards — all of them nearly maxed-out. He indulged himself so much that he ended up creating a brutal financial past. His only way out is to reduce his lifestyle to live a spartan existence and pay off his debt. Nearly 50% of this guy’s income was dedicated to his financial past, while the other 50% maintained his current lifestyle. If he ever wants to have a financial future, he’ll have to shift his percentages aggressively.
What’s so disturbing about situations like his is that the future is completely ignored. Preparing for financial independence is challenging enough, but if your past is part of your life for too long, you will struggle your entire financial life to create any semblance of a future.
Grab your bank statement and three different color markers. Begin by circling all your monthly expenditures that qualify as your financial past. These include student loans, credit cards, medical bills and car loans. Add up the payments. As long as these expenses exist, you have a financial past. Once they’re eliminated, then you no longer have your financial past to deal with. Next, circle all the expenses on your statement that represent your financial present. It’s likely you’ll circle most of the rest of the statement at this point. Food, utilities, shopping and just about every daily use of money contribute to your current lifestyle. Finally, it’s time to figure up how much money you allocate to your financial future. Not too many people will find money allocated toward their future on their monthly bank statements. We tend to set money aside for our futures through our employ- ers. If contributions toward your future include a company-sponsored retirement plan, you’re likely going to have to track down your pay stub.
I purposefully omitted one major expense thus far. It’s your mortgage, and it’s the trickiest expense to classify. Sure, it’s debt, but I don’t think that means it should be assigned to your financial past. You live in the home now, which indicates it’s part of your lifestyle and could be considered your financial present. But the process of paying off your mortgage may allow you to become financially independent.
How to classify your mortgage depends on its status. If you are “underwater” on your mortgage (owe more on the home than it’s worth), then you should classify your mortgage as a payment toward your financial past. If you don’t have a legitimate or realistic plan to pay off your current home prior to retiring, then classify your payment as a payment toward your present. And if you
have a legitimate or realistic plan to pay off your current home prior to retiring, then classify your mortgage as a contribution to your future.
Your money should only have two jobs. It should shape your current lifestyle and it should allow for a future. Angela, it appears as though this isn’t your current financial reality. You need to stop taking on new debts and aggressively pay off the debts you have. Evil or not, your debt is preventing you from having a future.