Dear Dave,
Is debt consolidation a good way to get out of debt?
Erikah
Dear Erikah,
No, it’s not. Debt consolidation companies try to position themselves that way, but they don’t even come close to addressing or solving the real problem.
Here’s the big reason debt consolidation isn’t a good idea. It makes you feel like you truly did something to change your whole financial outlook when you didn’t. When you move things around, or suddenly have a lower payment each month, you end up thinking you’re making real progress. The thing is you didn’t do anything to address the actual problem— which is you.
I meet people and talk to folks on my radio show all the time who don’t quite grasp this. They’ll tell me they paid off all their debt by using a debt consolidation company or taking out a second mortgage on their homes. Well, the truth is they’re not debt-free. They didn’t do anything but shuffle the same old debt around.
Personal finance is 80% behavior, Erikah. When it comes to getting out of debt, staying out of debt and getting your finances into shape, you have to change your habits and behaviors with money. Interest rates aren’t the problem, and the number of payments you’re facing aren’t the problem. The problem is the person you see in the mirror every morning.
Until you change that person, and start living on a strict, written monthly budget and decide to kick debt out of your life once and for all, you’ll never make any real progress toward gaining control of your money!
— Dave
Dear Dave,
We’re trying to get control of our finances by living on a budget. We also have about $18,000 in debt we are trying to pay off. My husband brings home $3,400 a month, and I am currently taking care of our eight-month-old baby. We would like to have a date night once a month, and he thinks we should set aside $200 for this. Under the current circumstances, I feel like this is too much. What do you think?
Carolyne
Dear Carolyne,
If you’d told me you guys make $150,000 a year, I’d say go have a great time. But with your income, and a lot of debt on top, I’d put the brakes on that amount. It sounds like he’s looking for an outlet to unwind and have a little fun, without giving a lot of thought to the big picture. The good thing, though, is you’re working together and beginning to take this personal finance thing seriously.
My advice would be to lower the date night amount to about $50 right now. That’s plenty for a reasonable dinner and a babysitter for a couple of hours. You might not have to figure babysitting expenses into the equation at all if you have family or friends nearby.
Going out on a date doesn’t have to mean spending a lot of money. Years ago, when my wife and I were broke, we did tons of stuff that didn’t cost a dime. Things like hiking and picnics are great ways to spend quality time together, while keeping your pocketbook in your pocket. Just be creative, talk about it together and make sure you find ways to have a little us time on a regular basis.
I think you’re right on this one, Carolyne!
— Dave
Dear Dave,
I’ve been seeing lots of ads lately for debt consolidation companies, debt settlement companies and the HELOC. Are any of these methods for reducing debt a good idea?
Brent
Dear Brent,
No. These are all bad ideas when it comes to getting out of debt. There’s a lot of buzz these days surrounding all the “quick” and “easy” ways to clean up debt and get control of your finances. But the truth is neither one is ever easy. If something sounds too good to be true, it probably is.
Debt consolidation is basically a loan that combines all your debts into one single payment. Sounds like a great idea at first, right? But then you find out the lifespan of your loans increase, and that means you’ll stay in debt even longer than before. The low interest rate that looks so appealing in the beginning usually goes up over time, too. Stretching out the amount of time you’re paying off debt, plus adding interest, is just dumb.
Debt settlement companies are awful. These crummy outfits will charge you a fee, then promise to negotiate with your creditors to reduce what you owe. In most cases, they take your money up front, do a bad job “negotiating” your debt and leave you responsible for what’s left.
A home equity line of credit (HELOC) is also a bad idea. With a HELOC, you’re borrowing against your home. On top of that, you risk losing your house if you can’t pay it back on time. All these plans are really just gimmicks that only treat the symptoms of your money problems. They never help you address the root issue of why you landed there in the first place. Personal finance is always 80% behavior, and 20% head knowledge. You have to change your behavior if you want to make a lasting, positive impact on your finances!
— Dave
Dear Dave,
My wife and I own a small catering business. We have a few big corporations as clients, and our company has been very successful over the last two or three years. Now, we are planning to build a house. I was wondering what you think about how much should be spent on the land itself versus the construction of the actual house.
Lee
Dear Lee,
When the whole thing is done, the payment you end up with shouldn’t be more than 25% of your take-home pay on a 15-year, fixedrate loan. The ratio of land to house can vary, and that part’s up to you. If you’re buying a big piece of land, you’re probably going to have a higher ratio of land cost to home cost than if you bought a simple lot and put a really nice home there.
Generally, a standard subdivision lot is going to be around 20% of the total price. If you spend $100,000 on the lot, you’ll end up with a total project cost of about a halfmillion. Now, keep in mind that’s just a fairly standard ratio. It’s not a rule.
The only rule here is my rule about mortgage payments. Again, no more than 25% of your takehome pay on a fixedrate, 15-year note. Otherwise, you can end up house poor. And when you’re house poor, it takes away your ability to save, build wealth, and give.
Having a big house and a lot of land is cool if you can afford it, Lee. But it’s not worth it if it’s financially stressful and prevents you from living your best life!
— Dave
Dear Dave,
I finally paid off all my debt except for my house, and I have an emergency fund of six months of expenses saved. It feels great to be in control of my money, but I am afraid I might lose control again and end up back where I started before I began following your plan. How can you make sure your leisure spending doesn’t get out of hand?
Lavell
Dear Lavell,
I get what you’re saying. You don’t want to go back to those days of being scared and out of control where your finances are concerned. You spent a lot of time, made tons of sacrifices, and put in lots of disciplined hard work getting out of debt, changing your behavior, and finally reached a point where you’re winning with money. Most people don’t forget the hardship and sacrifices that go into something like that, and I don’t think you will, either.
There’s a season to be strict, hard-nosed, and deny yourself things. There’s also a time to act like an adult, and forego instant gratification, like during those early Baby Steps. But some self-care and a little fun is important once in a while, too. One way to enjoy life without going financially overboard is to make a budget line for fun money.
Putting fun money in your budget isn’t a green light to forget your money goals, or go on a spending free-for-all. It’s actually part of sticking to your budget. Remember, you want a zero-based budget. That means giving every dollar a job, and having a fun money category helps you focus on all your spending, so you don’t accidently waste money on little things here and there.
When you give yourself a budget line for fun, you can spend that amount on whatever you want. We talk a lot about goals and how they need to be a balance of empowering and realistic. Budgeting fun money helps with the realistic side, because it lets you stick to your goals and have a treat every now and then.
When you think of your budget as permission to spend, you get a new perspective on budgeting. You’re giving your money permission to go where you want it to go. Plus, when you treat yourself once in a while, you’re less likely to fall back in your old, financially-out-of-control ways!
— Dave