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Banking & Finance

2003-09-01 15:27:00

Help! I can't get out of debt!

ANSWER: Your problem is common. In order to solve it, you first have to understand, "How money works" and, its effect on Personal debt. This powerful principle makes fortunes for people who understand the process, and unfortunately for those who don't understand the process, can put people in severe financial distress, including bankruptcy.    The term "Personal Debt" is most often misunderstood as a problem within itself, but in fact, it is the result of several things such as uncontrolled spending, not setting the proper financial priorities, and deciding between WANT and NEED. Personal debt has a tremendous impact on our lives by causing such things as personal stress, divorce, and in a lot of situations, bankruptcy. The one realistic thing about personal debt is that it can be managed, and eliminated.   Like everything else of this importance, it requires dedication and personal commitment in order to achieve the desired result. We live in a society where we want instant gratification, and that of course includes using credit to obtain it. It's always the old saying, "I deserve it and I'm going to reward myself". Personal debt is many times the sole result of living beyond our means. The following national statistical data references this:l According to the Consumer Credit Assoc-iation, January 2002, the total credit card debt in the U.S. was approximately $668 billion.l Mismanagement of personal finances including credit card debt is the #1 cause of stress.l 89% of all divorces were the result of mismanagement of personal finances.l Every year, approximately 1.4 million bankruptcies are being filed, and the numbers are increasing by approximately 15% each year. (Bankruptcy report, The Wichita Eagle newspaper, March 2002. Kansas recorded 15,250 filings in 1998. The office handled 13,554 total filings in 1999 and 13,331 in 2000. At the end of September 2001, there were 10,661 filings.) The numbers of filings continue to increase. Note: After reviewing hundreds, if not thousands of bankruptcy filings, over 95% of these filings need not have been filed. Of course, there has to be a source on income.   There is a common saying, "The rich keep getting richer, and the poor keep getting poorer." The only counter to this is that the rich, i.e. banks, mortgage companies, credit unions, and finance companies, understand the process of "How Money Works" and the rest don't. But, the upside to this is that regardless of your financial status, you can effectively apply the same process to make it work for you, and obtain the same results.   There are two main ingredients in this very unique financial process. They are the Rule of 72 and Compound Interest. Dr. Albert Einstein once said, "The most powerful formula in the world was the power of compound interest and it's effect on money." This particular item is powerful enough by itself, but when you combine it with the Rule of 72, the results are at times…unbelievable. I'll share just a few of the many examples of just how powerful this combination is.    The Rule of 72 says: if you divide the number 72 by the compound interest rate, the answer will be the number of years it will take for your money to double in value. For example, if you put $2,000 in an account with 6% compound interest, your money will double to $4,000 in approximately 12 years, without you having to add any additional funding. Obviously, if you increase the rate of return or the amount of the investment, then your final value will be much greater. Basically it's money working on money!   Now, understanding the basic foundation of the unique combination, let's visit how this process works for and against you. When you purchase a home, regardless of the interest rate, you will probably request a 30 year mortgage simply because you want to keep the payment low. After all of the paperwork is finished and you begin making payment, you will be paying approximately 2.83 times what the house is worth. So for a $100,000 mortgage, you will pay approximately $300,000 over a 30-year period, for the home and approximately 2/3 of that amount will go to interest payments. In obtaining the luxury of paying the mortgage over 30 years, which does nothing more than lower your mortgage payments, it also consumes a tremendous amount of money that could have been applied to your retirement or to your children's college education. The common argument against this process is that you lose the mortgage interest deduction. My question is, "What is more important, saving ten's of thousands of dollars in interest and applying the mortgage payment to retirement at a conservative rate of 7% over a period of time such as 15 years and ending up with approximately $300,000 extra for retirement, or having a $1,000 or less mortgage deductions each year?" Again, it's all in understanding the process of "How Money Works".   Let's examine the matter of the infamous credit card and how his process again can work against you. This time it has much far reaching effects. The credit card has been provided to us as a luxury item. Instead, we as a society have abused this capability of buying now and paying later. When we acquire a credit card, we justify it as establishing our credit. However, when we start using it, it has the immediate potential to destroy our financial lives. Credit cards are good and very useful, when properly selected and managed.    Here is a situation that is quite familiar to most individuals. A person obtains a store credit card with a balance of $3,000, with an interest rate of approximately 19.5%. Only the minimum monthly payment is made, and no new charges are added. It will take this individual 39 years to pay this credit card off and cost them approximately $10,000 in interest alone! Consider this, if you were that individual, and paid off the credit card and invested the $10,000 at a modest rate of 7% for 25 years, you could provide for yourself or your family approximately $85,000 plus.   Consider this example of how the situation really gets out of control and the process starts working against you. Suppose that the individual did not pay off the credit card and instead chose to consolidate the family debt problem by refinancing the family home. Now the home is in jeopardy, and chances are, they go back out and charge up the card again.   The examples that I have shared will help you to understand that understanding "How Money Works" is a very important tool to have in your possession. Proper debt management requires the use of proper spending management, personal commitment and dedication, plus the invaluable knowledge and understanding of the Rule of 72 and compound interest to make your financial future a successful one.   I have laid the foundation to understanding the basic aspects of personal debt and how that debt can be properly managed and eliminated. Next month, I will expand on the first of three legs of proper money management controlled spending.