By Doug Hoyes
I was quite amused the other day to read my news feeds and see several conflicting articles about consumers and debt. In a historical sense, we use debt today much more than any previous generation. While in the United States excessive credit card debt may be down from its peak, student debt is on the rise; yet economists are not concerned.
Consumer debt is driving the economy, which keeps everyone working (theoretically anyway) — but it also means that we can afford our debt. Interest rates are low, so why not borrow today? After all, saving money doesn’t provide enough of a return to incentivize saving more.
And the final argument as to why our debt loads are not a concern is that debt builds wealth. If you buy a home, you’re building equity. If you borrow to fund your education, you’re investing in your future income potential.
That all sounds great at a macro level; however, for the individual, it’s all hogwash. How much debt you can carry depends not on averages and what pundits say, but rather, on how much you can afford to pay now and how much risk you are willing to take.
Let’s put this another way. Cars today are safer and more convenient than ever before. However, if you’re the one driving the car that keeps breaking down or running out of gas, the safety and gas efficiency records of the car company mean nothing. So the general fact that debt delinquency rates across the country have improved really means nothing to you, either.
Here are five signs that you may have more debt than you should, no matter how well you think you are managing today.
1. You’re just making minimum payments.
In our car analogy this is like putting $20 in your tank every two days because that’s all you’ve got. It’s enough to get by and no more.
Credit cards and lines of credit, from a lender’s perspective, are designed to keep you in debt. The longer you remain in debt, the more interest you pay and, by definition, the more your lender profits.
If you’re making interest-only payments or meeting the 2% or so minimum payment requirement on your credit card debt, you won’t pay that debt off.
2. You’re using credit to pay for necessities.
If you already carry a large credit card balance and continue to use your credit card to put gas in your car, pay for groceries and buy stuff, you are digging a deeper hole every time you use your card. The lack of a balanced budget is the number one reason people find themselves suddenly facing tens of thousands of dollars in credit card debt.
The average person who files bankruptcy at our firm owed more than $20,000 in credit card debt — and no, they never expected that it would get that bad.
3. You’re using credit to pay for credit.
If you’re borrowing money from one credit card to make payments on another, or using payday loans or bank overdrafts to keep up with outstanding bills, you have a severe debt problem.
This is a little like siphoning gas out of your wife’s car so you can go to work today. It solves your problem right now, but how does your wife get to work? What about tomorrow?
4. You’re asking friends and family to co-sign a loan.
If your credit history is so bad that you don’t qualify for a loan, asking a friend or family member to co-sign a loan is not necessarily your wisest choice. Yes it may help you get a car loan or mortgage, but the real question you need to ask is can you truly afford the loan in the first place?
Look beyond your credit score to the real reason you may have been denied. Do you have a high debt-to-income ratio already? Will you be able to keep up with the loan payments for this new loan given future job prospects or earning potential?
This is like wanting to own a car but not being able to keep it on the road. If you can’t make the loan payments and can’t pay for insurance, gas, and all the repair costs, you could end up having to leave the car at home, or worse, having the car repossessed. When deciding whether or not to take on a new loan, don’t be over-optimistic. Sometimes thinking about worst-case scenarios is the route to a safer decision.
While all these types of activities work to keep yourself afloat and your creditors satisfied, in each case your overall debt is increasing until the final stage, the eventual tipping point:
5. You are tapped out and can’t get credit.
You bought your car and now can’t afford clothes to go to work. You need transportation and you need clothes, but you borrowed so much for one, you can’t do the other.
Now you are in the worst of all scenarios. Debt payments are using up so much of your income you don’t have enough to pay for the basics, but you can’t access any further cash.
The solution at any stage along the way is to develop a plan to deal with whatever debt you have. You need to create a balanced budget, one that means you spend less than you earn.
In addition, to deal with the debts you do have, you need a debt repayment plan as part of your budget. Your debt payments need to be large enough to pay down your debt within a reasonable period of time. If you can’t accomplish this, you may need to talk to a professional about other programs that can help you get out of debt; perhaps even bankruptcy.
I’m a bankruptcy trustee and by nature and profession, I’m pretty anti-debt. I’m willing to accept that we need to take on a mortgage to buy a home, borrow some money to go to school, and lease or finance a car. However, your debt needs to be manageable, which means you have to live within your means.
You have to be disciplined enough to buy a smaller home, think very carefully about the post-secondary program you choose, and consider buying a smaller car or keeping the old clunker just a little bit longer.
Most importantly, don’t use debt to pay for consumables. Any debt that is used to pay for something today that is gone tomorrow is undesirable. You’ll have that item today, sure — but you’re risking your future for something that will vanish, so it’s just not worth it.
- Construct Your Debt Repayment Plan
- Six Factors That Make You More Likely to Go Bankrupt
- Nine Life Milestones That Double as Debt Threats
Doug Hoyes has extensive experience resolving financial issues for Canadian citizens. A Licensed Bankruptcy Trustee and co-founder of Hoyes, Michalos & Associates, he is also a Chartered Professional Accountant (CPA), Chartered Insolvency and Restructuring Professional and Business Valuator. He regularly comments on a variety of TV, radio, and other media outlets on topics surrounding bankruptcy and writes a column for the Huffington Post. Hoyes has been a Licensed Trustee since 1995 and testified before the Canadian Senate’s Banking, Trade, and Commerce Committee in 2008.