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There’s a secret regarding debt that no one finds out about until it’s too late. It’s vital that you understand how your credit score is calculated and be smart about planning your debt; the simple fact is you will learn this debt secret, unfortunately, by the time you do, it may be too late. If you’re an American consumer and don’t have money coming out of your ears, you absolutely must take a proactive approach to debt management.
A lot of us carry debt, and there’s certainly nothing wrong with debt in moderation, but it can get away from you and spiral out of control; and it can happen a lot easier than you may think. A lot of us carry some debt, but it’s easy to let it get away from you, even if you don’t have a whole lot of it. Let me illustrate this with an example.
The Example of Kelly
Kelly is a 23 year-old college who’s about to graduate and get out into the professional world. She had a full-time job in college, but, with the current cost of even a public university, she managed to rack up $25,000 in student loan debt. She’s a smart girl and calculated that the monthly payments on her student loans, which carry only a 3% interest rate, would be manageable when she gets out into the workplace after school if she can get a decent job. She knew that going into credit card debt was not something she wanted to do, and through smart money management, she kept her credit card debt to almost nothing. She’s soon offered her dream job with a great company in Southern California; the only issue is that she’s from Ohio. She thinks about it and decides, although she’d incur some expenses moving across the country, the opportunity to work for such a successful company will pay off in the long run, so she accepts the offer.
She graduates in May and doesn’t start at her new company until July, so she’s got time to kill, but is having trouble finding a company that will hire her for only 2 months until she moves to California. She’s living at home until she moves, so she doesn’t have a whole lot of expenses and she manages to round up some money to hold her over by selling some things on eBay. Finally, it comes time to move, but she doesn’t have any money saved and charges all of her moving costs. She got pretty good at living off pennies a day in college and manages to keep her total cross-country moving expenses to $1,000.
When she finally gets out to California she needs to put a deposit on an apartment and, since she doesn’t have any money saved up, she gets a cash advance on her credit card for the deposit and first month’s rent, a total of $1,900, bringing her credit card balance to $2,900. She knows it’ll be worth it if she can just hang on until she starts getting paid at her new job.
She needs to buy some various household items for the new pad and, being a smart consumer, decides to get another credit card to pay for the items so that her balance on her first card doesn’t go over 50% of the limit of $6,000. She charges $1,500 on the new card to cover the cost of a mattress and other various household items. She doesn’t have a problem getting a 0% intro APR card because she’s always made her payments on time and her credit score is 750. Now she has $4,400 in credit card debt and $25,000 in student loan debt, but the jalopy she drove through college suddenly breaks down and she needs to buy a car. She takes out an auto loan of $8,000 for a reliable, reasonably priced car.
Her total monthly debt payments are a lot more than they used to be, but she’s started getting paid at her new job and is bringing home $3,000 a month after taxes, so she’s able to pay a little extra and plans to completely pay off her credit cards in a year.
Kelly’s Situation Worsens
After only 6 months at the new job, the market turns and she’s laid off. She really hasn’t had a chance to save any money and, though she got her credit card balances paid down to $1,500, she has to charge her living expenses, including her rent, until she finds another job. She’s in real estate and since the market turned, it takes her 3 months to find another job; she charges all of her living expenses during that time. She was down to $1,500 on her credit cards, but over the course of 3 months unemployed, charges another $5,700. Now she’s over 50% of her limit on her 0% APR card and about 40% of the limit on her other card; as a result, her credit score drops to 700. Because of all the stress of being laid off and searching for a new job, she ends up forgetting to pay her 0% APR credit card bill; as a result, the company cancels the 0% intro period and jacks the rate up to 20%. Additionally, the company re-evaluates her credit and decides to reduce her credit limit to $3,000, just to be safe. Unfortunately, she’s now at 100% of the limit on that card and her credit score drops to 680.
Her new job doesn’t pay nearly as much as the original company and she’s barely able to make her minimum monthly payments. She realizes she’s in a dangerous situation and decides to get a personal loan with her bank, unfortunately, her bank won’t approve a loan because she’s only been at her new company for a couple months, her credit score’s dropped to 680, and her only available credit is on a card with a balance over 50% of the limit; her other card is maxed out.
Then one day her car breaks down; as if she needs this now! She has to charge another $1,000 for repairs. Her situation’s become pretty sticky; her two credit cards are now maxed out and, because of this and her credit score, for the first time in her life, she can’t find anyone to give her another credit card or loan. She’s really feeling the stress now and realizes that if one more financial problem strikes she’s not going to be able to cover it. She starts searching more for someone to give her a loan, or at least consolidate her credit cards so she can lower her monthly payments. During the search, she has her credit run at 10 different companies, all of which deny her request for credit. Those credit inquiries lower her score even more and now she’s feeling a little ashamed of her 630 credit score. She’s never been in serious debt before and is starting to have panic attacks as a result of all the stress. She goes to the doctor and is prescribed an anti-anxiety medication, unfortunately, her individual insurance won’t cover the medication because she took it 7 years ago when her parents were going through a divorce and the insurance company is calling her anxiety a pre-existing condition. Now she’s paying $130 a month for her medication that her insurance won’t cover.
Now She’s In Trouble
Kelly, a smart girl who’s always taken care not to get into a lot of debt is now barely making her minimum monthly payments and has absolutely no extra funds to save for a rainy day. She feels like she tried really hard to keep from getting to this point, but just got hit with a couple bad luck streak, none of which would be a big deal, individually, but combined, they’ve taken her on a ride that a surprisingly large number of otherwise responsible people get caught up in every year; I call it the debt spiral.
So, how could Kelly have avoided this situation? I’ll cover that in part 2 of my debt spiral series.
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