Debt: Are you an ostrich?

By:  Shelly Gigante

Shelly Gigante specializes in personal finance issues. Her work has appeared in a variety of publications and news websites.

This article will ...
Outline the most common reasons for chronic debt.
Explain how debt limits your ability to meet other financial goals and how being debt-free can save you money.
Offer tips for taking back control of your spending and paying down debt effectively.

Debt can be a significant source of stress — so much so that it can be tempting to bury our heads in the sand. And many do.

Those who live with chronic debt often choose to pretend it doesn’t exist, ignoring notices from creditors and letting late fees pile up. Some are convinced that their financial fortunes will soon change, writing themselves a permission slip to punt on paying back loans. Others hope that by leaving their monthly bills unopened they will somehow disappear.

Spoiler alert: That doesn’t work. In fact, by avoiding your debt obligations, you only make matters worse. You pay more in interest and late fees, which causes your balance to grow. Your credit score will likely suffer, making it harder to secure future affordable loans. And you may start getting calls from collection agencies, which contributes to emotional stress.

“Acknowledging debt means giving up your lifestyle and making a change,” said Armando Sallavanti, a financial professional with MassMutual Greater Philadelphia. “Most people would rather take that beach vacation than face the mountain of debt they’ve built.”

To restore financial wellness and rein in debt it helps to explore:

• Some of the most common reasons for chronic debt.
• The factors that shape our spending and saving behaviors.
• The steps to living debt-free.

Debt eats away at other financial goals

Debt, such as credit card balances and car loans, is borrowed money that must be repaid, typically with interest. The repayment schedule and interest rate you pay are determined by the terms of your loan.

For example, some credit card companies charge an annual percentage rate of 20 percent (or more) in interest fees for carrying a monthly balance, while fixed mortgage rates are tied to the 10-year Treasury yield and often come with a payoff period of 15 or 30 years.

According to the most recent data, U.S. households carry an average credit card balance of $10,170.1

Monthly debt obligations eat away at disposable income and limit the borrower’s ability to meet other financial goals, such as saving for retirement. It also forces those who carry a credit card balance to overpay for consumer goods, including furniture, clothes, and flat-screen TVs, due to the interest charges that accrue.

Assuming an 18 percent interest rate, that $5,000 vacation you paid for with plastic would take nearly 23 years to pay off and cost an additional $6,923 in interest if you make only the minimum monthly payments, according to the minimum payment calculator on Bankrate.com.

If you’re missing payments, only able to afford the monthly minimum, borrowing money to pay your bills, been denied a loan or new credit card, or maxed out one or more credit cards, it may be a red flag that you’ve overextended yourself financially.

Financial fitness coach Saundra Davis, who is founder and executive director of Sage Financial Solutions, notes that debt has value when used responsibly. Mortgages, for example, can potentially help consumers build wealth by helping them purchase a home that may appreciate in value. And student loans can lead to higher lifetime earnings for some. Even credit cards, if paid off monthly and on time, can help improve your credit score, which may save you money on future loans.

“In our modern society, you almost have to have credit cards in order to be able to function,” Davis said. “You have to have credit to rent a car or an apartment. Everything requires you to have a relationship with the credit system, but there’s no requirement for you to understand how that relationship works.”

Indeed, it’s all too easy to get in over our heads. A 2023 survey by J.D. Power found that 51 percent of Americans can’t pay off their entire balance each month and instead let it revolve to the next month, accruing interest.2

The common reasons for chronic debt

In some cases, debt problems are self-inflicted — borrowers who fail to appreciate (or don’t care) that overspending today denies them the ability to meet other goals, including saving for college tuition and retirement.

“People buy things they cannot afford to impress people who don’t care,” said Sallavanti. “Our habits become our life and money is no different. If you’re caught in a cycle of putting clothes, dinners, and vacations on a credit card, it can be difficult to give that lifestyle up.”

Financial literacy can also be a factor, something Davis herself was forced to contend with before becoming a financial coach.

“I was a single mom working three jobs, and I had more money in my son’s video game collection than in his college fund,” she recalled. “It wasn’t that I didn’t care about education. It was that I didn’t understand that I needed to balance what I wanted for him now with what I wanted for him later.”

But the fiscally prudent can experience debt challenges, too, especially those with limited income. A temporary job loss, health challenge, or big-ticket home repair can deplete an emergency fund in a matter of months. In fact, medical debt is among the leading causes of personal bankruptcy, cited in 67 percent of bankruptcy cases, according to a recent study.3  

Factors that shape our relationship with debt

Davis notes that financial behaviors are often forged in life experience.

“If you grew up in a household where the message was always ‘we can’t afford it,’ either because the parents did not make enough money or because they did not make good choices, the child may grow up to declare that they will never live like that and they may save every dime. Or, they may have the opposite response and say they will never live like that and spend every dime.”

Our comfort level with debt is also shaped by the spending and saving habits of our spouse and former partners, as well as our own financial history. For example, you may become debt averse if your ex overspent, prompting you to only pay cash for cars and never carry a credit card balance.

“Even moderate financial experiences can swing behavior to the extremes,” said Davis.

With clients who are struggling with debt, Davis said she starts by asking them to explore their financial philosophy and where it comes from. Beyond their upbringing and prior relationships, for example, their financial journey may be influenced by physical or mental health challenges that make it difficult to maintain financial wellness.

The steps to living debt-free

By exploring your relationship with debt, you regain control over your financial future and can begin managing your money with intent.

“As a coach, the first thing we want to do is capture a vision for what you want your life to look like,” said Davis. “You may say ‘I want to be debt-free,’ but I then ask you to describe what being debt-free will mean for you. How will it impact your family? What will your life be like then?”

Next, you would create a step-by-step plan for reaching your goals. Start with a list of everything you owe, complete with repayment terms and interest rates, which becomes the road map to paying down debt. Look for opportunities to consolidate high interest loans or negotiate with lenders for more favorable terms.

“We need a plan beyond just paying the minimum balances to restore financial health,” said Davis, noting so-called good debt like mortgages and student loans can become bad debt if you borrow more than you can comfortably repay. “Maybe you decide that you will only use credit cards going forward if you can pay them off in full by the due date.”

Conventional wisdom dictates that borrowers should make extra payments toward their highest-interest credit card first while making minimum monthly payments on the rest until all credit cards have a zero balance. From a financial standpoint, that makes sense as it minimizes the total amount of interest you pay. But psychology plays a role in debt repayment, too. Some feel a greater sense of accomplishment in paying down their lowest-balance credit cards first for a faster win, which motivates them to continue on the path toward financial wellness. The right strategy is the one that works for you.

“The most important piece of the process is accountability — not to me or anyone else, but to your future vision,” said Davis. “What will this look like day to day, month to month, when the holiday season comes? You have to bridge the gap between where you are now and where you want to be.”

An analysis of your income and expenses can help highlight opportunities to pare back spending.

Depending on how much you owe, you may need to downsize to cheaper housing or trade your car in for one with lower payments. On the other hand, it may be sufficient to simply slash your travel, dining, and entertainment budget to free up extra cash, if only temporarily.

Most lenders like to see a debt-to-income ratio of 36 percent or less, with no more than 30 percent of your gross income allocated to housing expenses. A financial professional can suggest options tailored to you as part of an overall financial planning strategy.

Just remember that debt repayment is not your only financial goal. As you chip away at the balances you owe, it is important to continue funding your retirement. By waiting to contribute to your 401(k) or IRA until after you’ve dug yourself out of debt, you may have sacrificed years of potential compounded growth, which could make it harder to achieve financial security.

Additionally, protection for your family and income is important as well. Misfortune does happen. And when it does, it can derail the most carefully laid financial plans. So, your budget and debt reduction plan should allow for:

• Life insurance to help make sure your loved ones have some wherewithal in your absence.
• Disability income insurance to help protect your livelihood should you become too sick or injured to work.

Often, life insurance and disability income insurance are offered through employer benefit programs, providing for some protection at affordable levels. If you’re debt situation is such that even insurance isn’t affordable, you may want to consult a debt consolidation service provider.

Conclusion

When the bills start racking up it can be tempting to stick your head in the sand. But facing your financial problems head-on can eliminate chronic debt faster and save you money.

“Failing to manage debt responsibly is giving away your dream life,” said Sallavanti. “Debt pays current expenses with future income. Investments pay future expenses with current income. Balancing these is tough, but it’s easier to save and invest prudently than it is to work forever.”