After the economic stress caused by the pandemic and 12 months of surging inflation, the debt burden carried by U.S households is rising. According to a recent survey by the New York Federal Reserve, U.S. households carry an average of $161,749 in debt, including mortgages, home equity lines of credit, credit cards, auto loans and other consumer debt—a jump of 6.2% from a year ago.
If you have found yourself slipping deeper into debt, now is the time to take a stand for your financial independence. Debt is one of the biggest threats to financial independence. Although a mortgage may be helpful if it is scaled properly to your income, consumer debt and the interest you pay on it is a relentless task master.
Albert Einstein famously said: “Those who understand [compound interest], earn it; those who don’t, pay it.” A more pointed indictment of consumer debt was given by J. Reuben Clark who said, “Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation. … Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, or orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.”
If you want to be financially independent, you need to understand some hard realities:
- Consumer debt is the enemy of financial independence.
- Those who entice you with buy-now-pay-later schemes are trying to destroy your financial independence.
- Choosing to live beyond your means is an act of self-betrayal.
When you buy on credit, you become subject to what I call the debtor’s paradox, a situation in which buyers are actually sellers. In the debtor’s paradox, debtors sell their financial freedom—something of tremendous worth—in exchange for things of trivial value. Some people may think I am being overly-dramatic about this, but anyone who has faced serious debt issues understands what I am talking about. Certainly, it is a matter of degree, but any degree of consumer debt diminishes your independence.
Living within your means may require you to gain greater control of your spending. You may have to eliminate some purchases that have become part of your day-to-day spending pattern. For example, how often do you go out to lunch? How often do you stop at Starbucks on your way into the office? Do you have a gym membership that you don’t use? What kind of cable TV subscription do you have? What is in your grocery basket? These are little things, but they add up quickly.
While you are getting your spending under control, you will also need to get a clear view of the debt you are in. You can do this by making a list of every penny you owe. This list will include every credit card, every auto loan, every medical bill—anything you owe to anyone. For each loan on your list include the outstanding balance, the interest rate, and the minimum monthly payment.
Once you have a complete list of your debt, decide how much money you will set aside each month to pay down your debt. I call this your ransom fund because it is the money you will pay each month to buy your freedom. The larger your ransom fund, the faster you will gain your financial independence. If possible, the ransom fund should be at least twice the total of your minimum monthly payments.
Every month, you will apply your ransom fund in a systematic way to pay off your loans. Your first step will be to take money from your ransom fund and pay the minimum monthly payment for each loan. You will then take the remaining money in your ransom fund and apply it to the balance of your smallest loan. Repeat this every month until that loan is paid off. Once it is paid off, add that loan’s minimum payment to the ransom fund and continue the process as before. As each loan is successively paid off, the ransom fund grows and the rate of payoff accelerates. If you follow this process and maintain your spending discipline, you will be surprised at how quickly you reclaim your financial independence.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have about investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to smerrell@montereypw.com.