Conquer Debt and Keep Spending Habits Under Lock and Key

Physician's Money Digest, March15 2004, Volume 11, Issue 5

Here's a conundrum for you.Over the past 3 years, the USeconomy has been flat,unemployment levels haveclimbed to troublesome levels, and thestock market, until recently, had beensluggish. Despite these trends, theFederal Reserve reports that consumerdebt hit a record $1.9 trillion in October2003. That figure includes credit cardsand car loans but not home mortgages,and it translates into approximately$18,700 per US household. Are wespending money we don't have? Hereinlies the key to debt management.

"Debt, in and of itself, drives the economy,"explains Jeff Cronrod, CEO ofOldDebts.com, an online debt collectionservice. "You can't function in this societywithout debt. You can't build skyscraperswithout debt, and physicians can't expandtheir practices or purchase new equipment.All of us have debt, but not everyoneknows how to manage it."

Understanding what causes debt andrecognizing the warning signs that youmight be incurring too much debt are thekeys to managing it.

Widespread Problem

It would be easy to point a finger atthose who are destitute and blame poordebt management as the reason they'rein such a negative financial state. Itwould also be only one side of the coin.That's because debt management can bea problem, no matter what earningsclass you're in.

"Poor debt management knows noboundaries," Cronrod says. "There aresome extremely wealthy debtors andsome very poor people who have debtproblems. It's a universal problem."

Mike Sullivan, director of educationfor Take Charge America (www.takechargeamerica.com), a nonprofit debtcounseling company, says that debt managementis such a large problem, we mayonly be seeing the tip of the iceberg.

"Typically we see people when theircredit card companies encourage them tocome talk to us, and we know a lot ofpeople are out there who have not yetbeen encouraged," Sullivan explains."They're holding on by the skin of theirteeth. They refinance their homes, movecredit card debt from one card to another,and barely keep above the radar."

Physicians, unfortunately, are part ofa segment of the population that hasbeen particularly prone to debt managementproblems. One of the main reasons,suggests David Bendix, CPA, PFS, presidentand founder of Bendix Financial(www. bendixfinancial.com), is that mostphysicians start off their careers with alarge amount of debt. Before they've evenbegun to practice, they have incurred collegeand medical school loans that easilyreach the 6-figure level. According toAAMC, for a 2003 medical school graduate,the average education debt loadreaches $104,000.

Jeff Swantkoski of Kanaly TrustCompany agrees, and he refers to thephysician side of debt management as amedical industry problem.

"Doctors get out of medical schooland they're in residency for a period oftime where they get paid very little,"Swantkoski explains. "In the past 10 to 15years, that pay scale has gone up meagerlyin comparison to the cost of insuranceand the cost of their education. So whenyou consider a salary that has remainedconstant while costs have continued torise, you can only imagine why doctorsare getting into more debt. It's an industryissue that puts doctors at the forefront ofpeople who could have the worst debtmanagement problems around."

In addition, Bendix notes, physiciansare viewed as individuals who earn a goodincome. That further opens them up toevery line of credit you can think of."Everyone is willing to take a chance andextend a physician more credit, which isgood and bad, if it's not controlled."

Concept and Cost of Debt

It would be easy to simply say thatpeople cause their own debt problemsand leave it at that. In reality, it's amuch deeper issue.

Cronrod points out that debt isn'tfree, but too many people don't understandthe concept and cost of debt, andthe concept of interest.

"We're living in an undereducatedsociety when it comes to debt and debtmanagement," Cronrod says. "Schoolsand colleges really don't prepare people forhow to deal with real-life consumer debt.People rent apartments and are unable toafford the rent. When you fall behind inrent, it becomes debt. But too many peopledon't quite understand that."

Low interest rates the past severalyears have brought about record numbersof mortgage refinancing, with many consumersusing the cash from that refinancingto pay down credit card balances.Combining all credit card balances intoone payment at a lower interest rate thatalso allows for an added tax deductionmakes sense on the surface, but it doesn'talways work out that way.

Dangerous Interest Rates

The first and most obvious problem isthat with credit card balances wipedclean, too many consumers have the tendencyto run them up again. It's no wonderthat Americans now spend a nearrecord18.1% of their after-tax income tocover debts, including mortgages. But, asSullivan explains, the potential problemgoes even deeper.

"I spoke with a banker recently whotold me that they loan people 107% ofthe equity of the home on an adjustablemortgage," Sullivan says. "People aregambling that home values are going toincrease so much that in 3 or 5 yearswhen that adjustable mortgage is due tobe refinanced, they can still get a goodinterest rate and the home will haveappreciated considerably."

That scenario becomes dangerous,Sullivan points out. If something happenswhere you can't make the payments andyou have to get out of your home, youcould wind up selling it and still owingmoney on it. "Most people accumulatewealth through their home. That's agood way to build wealth. But if youconstantly take the equity out, you're notaccumulating any wealth. And if yourhome equity is your first national bank,you're going to dig yourself in deeper andhave nothing to fall back on."

Why would people have to suddenlysell their homes? According to Cronrod,people tend to rely on certain incomestreams. But when those income streamssuddenly dry up, the impact can be severe.

"You think you have this great jobwith a nice, big company that happensto be Enron or Global Crossing or KMart,"Cronrod explains. "You take outa car loan or a home equity loan basedon the fact that you have this job with anice, big company, but you're relying onsomething that won't be there in thefuture. That's the kind of thing that createsa lot of debt problems."

Recognizing the Handwriting

Fortunately, there are numerouswarning signs to indicate that you'reaccumulating too much debt. The signsmay differ slightly from individual toindividual, but essentially, they're allbased on your income and your abilityto pay back debt.

As a guide, Swantkoski suggests thatif your debt service level (ie, the amountof money that you spend each month ondebt) gets above 10% of your grossincome, it's time to be concerned.

Sullivan notes that the first really serioussign that you've accumulated toomuch debt is when you can't afford tomake more than the minimum paymentrequired on a credit card. But there areother, more dire signs, such as beingturned down for credit, or when you failto qualify for the lowest financing on ahome mortgage or car loan. Then you'rein serious trouble.

"Too many people take rejections asno big deal," Cronrod says. "We see peoplewho apply for as many as 15 or 20 carloans within a week or two, until theyfinally get approved." The problem, heexplains, is that these people are no longerconsidered "A" borrowers. Instead ofbuying a car at 5% interest, they mightpay as much as 25%. "That should be abig warning sign. You need to recognizethat you are overextended."

The problem, Sullivan says, is thatmany people—physicians among them—wait too long in taking corrective action.They live in denial, and the larger theincome, the longer they tend to remain indenial. The rationale is, "I can't be infinancial trouble because I make $150,000a year." But, of course, they can be.

"It's the physician-wealth syndrome,"Sullivan explains. "It's the idea thatbecause of who I am and what I make, Ican't have a debt problem." Many physicians,he says, finish medical school andtheir residency, hit age 30, and then suddenlyfind themselves earning a 6-figureincome. "There's this assumption thatthey should have a nice home and a nicecar. If you're a physician, you're wealthy.Society believes that, and so there's thisexpectation that physicians try to live upto. And when they don't have the moneyto do it, they use credit."

Bard Malovany of Sagemark Consultingbelieves that most high-net-worthindividuals do recognize that they're accumulatinga fair amount of debt, but theyare comforted with the knowledge thatthey're also earning a significant wage. Ineffect, their concerns are not immediate.

"At the same time, those people arenot thinking clearly about what they'regoing to do in 15 or 20 years when theyretire," Malovany says. "People often endup rationalizing their expenditures by sayingthey're investing in real estate, andthey don't mind being cash-strappedbecause their house is going to be a greatinvestment. The problem is, that doesn'talways happen."

Controlling Your Debt

It should come as no surprise thatthere's no magic formula for managingdebt. Sure, cutting up credit cards is a firststep, but that's all it is. More importantly,you need to put a plan in place.

"Sit down and do a budget," Sullivanrecommends. "And do a realistic budget.Too many people lie to themselves. Theysay that their miscellaneous expense is$20 a week. But when they stop atStarbucks every morning and spend $4 ona latte, they've already exceeded that miscellaneousbudget."

Sullivan says that if you stick to arealistic budget (ie, putting down theactual amounts you bring home as wellas your expenses and spending onlywhat's left), things will get better. Toomany people, however, panic when theysee that they can't balance their budget.Instead, consider other actions you caninitiate to decrease your costs.

"Call up your creditors—the creditcard companies and banks—and explainthat you have a temporary problem, andmany of them will give you relief,"Sullivan says. "That's what we do forpeople. We get them relief from their creditorsso that they can more easily lowertheir payments. People can do that ontheir own, but most don't. They're afraidthat if they admit that they're in debt tosomeone they'll get in worse trouble. Sothey stay in a state of denial."

Enlisting Debt Help

Many people seek counseling orenlist the aid of debt management programs.But Cronrod suggests exercisingcaution in this area. "We work with creditcounseling companies every day, butsome of these companies take advantageof people who are already in trouble.These companies wrap themselves in ablanket of ‘we're here to help you,' andthe truth is they wind up injuring peoplemore than helping them."

Bendix suggests that to be safe, youshould work with someone you trust.Your accountant or financial advisorcan help you figure out a strategy forgetting out from under debt within areasonable timeframe. Also considerwhat expenditures you might be facingin the near future.

"You may have college bills comingsoon, so you're going to want to clearup any debt beforehand in order tohave any chance of paying for your children'scollege education," Bendix explains."You may have to considersome alternative income opportunities,such as working an extra day or anextra round. That's because debt multiplies.And if you're just paying the minimumand have a high interest rate,you'll end up paying off nothing eachmonth."