One of the reasons my debt is so out of control is that I got in a cycle of paying off debt with other loans. My favorite way to play this game was to pay off credit card debt with student loan proceeds. It was my justification for always taking the maximum student loan amount allowed - I figured that since my student loan interest rates were much lower than my credit card rates, it was only sensible to use the “cheap” loan for my financing needs.
Create new debt to payoff the old
So why do I have so much credit card debt today? My logic was sound, but I made a crucial error - a mistake I have seen my clients make over and over again: I didn’t cut up the credit cards once they were at zero balances. My cycle went like this: I would let balances sit a zero for a couple of months, and then something would come up (I would have to buy a gift for a wedding shower or I’d go with a friend to Miami for a long weekend), and that would be the catalyst that would bring me to charge my cards back up. So when the next student loan disbursement came along, my lines were maxed out once again, and I would repeat the previous semester’s activity all over again.
The home equity trap
It’s a vicious cycle, and I’m not the only one guilty of doing it. Most of my clients are into or approaching middle age and have been in their homes for awhile. In the Midwest, we haven’t seen home appreciation sky-rocket anywhere near the rate it happened on the coasts, but even here, many people saw the value of their homes double in less than a decade. This has proved too great a temptation to many, and several of my customers chose to use their homes as piggybanks (against my professional advice, I may add). Now that the market appears to be correcting, some of these clients are upsidedown on their homes - or more commonly, refuse to sell their homes for a loss - even though they have already relocated to a new home. They figure it’s better to go on with two mortgage payments then take a loss on a sale.
Debt in retirement
Retirees are at the greatest risk of coming out way behind in the refinancing game. Fixed income and home equity advances do not mix (except in the case of reverse mortgages - but that is a topic for another article).
In one extreme example, I had a couple, both well into their 80’s approach me about refinancing their credit card debt. Turns out they had taken a few family trips on plastic and had acquired $89,000 in credit card debt.
I put the first lien ever on their family farm to pay off that debt, and I felt awful about it (although I was doing them a huge favor, based on the interest rates they were paying on the unsecured loans). We termed it out over ten years (likely past their life expectancy), and they could barely afford to make the payments, even with Social Security and cash rent income.
The moral of the story, don’t throw good debt after bad debt if you can’t eliminate bad debt habits from your life. Better yet - don’t spend more than you make - and avoid loans altogether.Stumble it!