30 January 14
Readers of these posts will by now have figured out that I benefit from a particularly sophisticated, highly calibrated money management system to make my financial decisions: my wife.
But it wasn’t always that way. Especially in the early years after the kids came along (when she had more important things to look after), I was in the driver’s seat when it came to the family finances. I wrote the cheques, paid the bills, relied on Amex gold cards to manage daily expenses… and generally made a mess of things. One of the arcane meanings of ‘husband’ is to manage prudently – let’s just say there was not always enough of that.
Thanks to interest and fees, I’ve paid more for things than I care to admit, and thanks to easily available credit, I’ve racked up more debt than I was ever comfortable with.
Nowadays, happily, things are much less stressed. Yet it’s not just because I’ve left the bill paying to my better half, but more importantly because we’re now on the same page and gotten much more savvy about borrowing.
When it comes to the pitfalls of debt, there are generally two types of traps to avoid: paying way more for things than you ever intended to in the first place, and carrying so much debt that it drags too much on your finances. The more we dance around these, the more we get the chance to grow and actually get ahead.
I came home one day to find the television suddenly paid off. This was somewhat of a surprise – although it’s always a good feeling to pay things off – since there were many months still left on that interest-free HP agreement.
‘It was getting too hard to figure out whether they were going to charge us interest or not,’ my wife explained.
In the case of that television, what started as a typical HP had morphed into a credit card. That is, we thought we signed up for an HP, but got mailed a credit card. And it had a ‘generous’ credit limit to go with it, of course.
When we used the credit card for everyday expenses, intending to pay it off in full after each month (which is always a good way to avoid paying interest), it became hard to know how much was going to pay off the television and how much was going toward paying for the expenses.
Would we make it to pay the TV off in the interest-free period? It was hard to tell. If we had gone even slightly longer, we may have been on the hook for all those months of interest we were so keen to avoid paying!
There is always a cost to borrow, even for interest-free deals, which typically have set-up costs. So as soon as you decide to put something on credit, expect to add to the price tag, especially if you are going to pay it off over a number of months or years. Is it still a good deal?
Sorted’s debt calculator can help you calculate the true cost for credit cards, car loans, personal loans or HP.
So we got rid of it. The television payments, the credit card. But not the television.
Just to be clear, this is not a screed against taking out loans in general or paying for things on credit. Besides being darn convenient – you get the stuff now, you pay for it later – loans can help us move forward financially, especially when we’re borrowing for something that increases in value like a house, business or education.
But let’s keep in mind that credit limits are not our money. They’re really only how much we can borrow. Can you really see yourself paying all that back? If not, you may be in danger of overextending your finances – the second debt trap! – or taking on so much debt that it becomes a burden even to make just the minimum payment each month.
So much is sold on ‘teaser rates’ these days, which anchor our thinking to how much the payments will be each week instead of how much we’re borrowing in total. And that’s precisely what gets us into deeper waters than we planned on. Sure we can handle that minimum, but how long will it take to pay it all back? (Yet again, the debt calculator can help.)
Overcommitting doesn’t only happen to people who find themselves in credit card trouble; it applies to all of us with mortgages, too. With all the rumblings about rates rising over the next year, will family budgets get too tight? And how much is too much when you add to your mortgage for renovations, a new car or that trip overseas?
If you’re shopping for a mortgage, try plugging into our mortgage repayment calculatorand key in higher rates of 8%, for example, to see where your repayments could be in the months to come. Hopefully you’ve got some room to spare to absorb any rises that come and stay within your comfort level.
So those are the two main types of debt traps from someone who’s had to dig himself out of a few: paying more than you ever wanted to, and carrying so much debt that it becomes too much of a burden for the budget.
Just dance around them and get ahead!