Money Obedience

A while ago we wrote about getting rid of clutter in our home office (”Lower Debt and De-Cluttering My Office”), which also serves as our library. (Yes, we each own a lot of books, so together we really do have a home library.)

At that time, we said that we found that the process of cleaning up our office was kind of like de-cluttering our finances, especially eliminating debt. In cleaning up our finances, for example, we consolidate our accounts (like consolidating stacks of papers), pay off debts (get rid of paper we don’t need), put some of our expenses on autopilot and automatically add to our savings accounts (cleaning up mess and putting in place a process for putting things away as we get them). The problem with doing all this work is that it is so very easy to fall back into old habits. That is, we once again accumulate piles and stacks of papers or we run up credit card debt again, just to later have to go back to do another major clean-up.

But recently, I took a look at our office and noticed that it is still pretty neat! I wondered how that happened! Do you know that I could not think of one single thing that kept the office pretty neat? Maybe it’s as simple as not being able to stack as much stuff anymore, because in the cleaning process we also got rid of some furniture that somehow always begged to be cluttered with papers. But maybe it’s also the case that we now go through our papers more often so that they simply do not pile up as easily. Then again, maybe it is just pure coincidence – and maybe it’s just a matter of (a very short?) time before the office is cluttered again. But for the time being I revel in the fact that we have kept the office pretty clean for a few months now.

The clean office also reminded me of the post we wrote a while ago. There’s no question that it is a good idea to de-clutter one’s life, one’s office, one’s finances, etc. But that is only part of the battle. It is just as important to keep things in the “de-cluttered state,” to not accumulate crap again. This is much easier to do with finances than it is with more intangible things like the mess in the office or in the kitchen, because much of our finances can be put on autopilot, but rooms in a home can’t be put on autopilot to clean themselves! Like I said earlier, once a personal finance autopilot is set you are all done, and you simply don’t need to touch whatever you set on autopilot again, or at least not until you have some major life changes that require you to make changes to the autopilot settings. If only more things in life could go on autopilot, right?

When I talked to a friend of mine yesterday, I mentioned the high percentage of people who owe more on their house than the house is worth. He told me that he was one of those people. I should not be surprised that I know a lot of people who are in this situation since about 25% of all mortgages are now larger than the values of the houses are. If one out of four friends could admit that my group of friends would represent the national average.

To say the least, it is obviously not so good if your mortgage is higher than the value of your house. But since I am the eternal optimist I would like to point out that such a situation is not all bad, (1) if you can afford to pay the mortgage and (2) if you neither want to nor have to move.

Hey, nearly all of us have to pay for housing one way or another. Unless you have a SugarMama or SugarDaddy (who might even be real Mom or Dad!) you either pay rent or pay off a mortgage. If you have your personal finances well organized, you should be able to afford what you’re paying to keep a roof over your head. If the difference between what you’d pay for a mortgage versus what you pay for rent is small, why not pay off a mortgage instead of paying rent? Over time the balance on your mortgage will go down and eventually the mortgage will be lower than the value of your house if all else stays the same. It may take a while, but nevertheless you will be ok at some point in the future if you keep making the monthly mortgage payments on a traditional mortgage. Another bonus – mortgages don’t rise! (Well, property taxes do, but you know where I’m going with this.) Rents rise according to the landlord’s dictates. So, if you can swing it, buying is better. Yes, even if you end up like many homeowners who owe more than the home value. (Hey, but don’t start out your mortgage that way, okay?)

This brings me to the next point. Surely, when your mortgage is larger than the value of your house, your net worth is diminished. It may even be negative. What that means is when you add up everything you owe and everything you own, you will owe more than own overall. Again, this is not a good situation to be in, but it does not mean that you cannot turn positive again. As I said above, as long as you pay off the mortgage balance you will turn the situation around at some point in the future. Then you will own more than you owe and you will have “something to show” for your labor. A nice life in a nice home, and some equity!

Let me give you an example. Say, you own a house that is now worth $200,000. Your mortgage is $220,000 and has a fixed interest rate at 6%. You owe $20,000 more on the house than it is worth. But you dutifully pay your mortgage every month. If you have a 30 year mortgage, your monthly mortgage payments will have taken the mortgage balance to $200,000 in about 6 years’ time. Then you are even with the value of the house. After that, each additional monthly mortgage payment will keep lowering your mortgage balance moving you into the positive. To keep the example going, after another 4 years your mortgage balance will have gone down to less than $185,000, which puts you in a much better position than the one you find yourself in right now. If the value of the house – $200,000 - does not change, your mortgage will be nicely below that and dropping further with each monthly payment.

Let me sum it up. Not all is lost of you find yourself in the unfortunate position that you owe more on the house than it is worth. The important thing is that you make your mortgage payments every month. Then you will be okay, eventually.

One of our readers is looking to get our input with her financial problem. She wants to take a trip to an exotic destination, and is trying to figure out how to finance it. She has some credit card debt on four different credit cards. She has some cash savings – and she could use it to eliminate that debt, but then she would not have any money left in her “emergency fund”. She’s thinking about eliminating her debt because she thinks that she could have her credit limit increased if she paid off her cards, since that way she would appear to be a good credit risk to the credit card companies. This higher limit, in turn, would allow her to go on an exotic trip overseas with her girlfriends since she could put the expenses for her trip on her credit cards with sufficiently higher limits.

It almost sounds like this plan that could work out, right? Well, I’d certainly advise against it.

Say she goes on the trip, and that she even has a great time. But now back at home she realizes that her credit cards are almost at the upper end of the higher credit limits and she has no savings. In a way, one might say that her finances are back to square one. But I’d say she is even worse off. She’s still carrying debt, and now she has no more cash left over for emergencies or for paying down her debt. I’m not sure how much the trip costs, but if it costs more than her original balance, it will be a lot harder to accumulate cash again and eliminate that debt, since the monthly credit card payments are higher than they were before the trip when she carried lower debt.

The way I think about debt is that I look at the underlying reasons for incurring it. Does she have something new in the skill set? More education, or a new language acquired? Did she decide to stop renting and go into debt to buy a home? Of course, none of this is the case. What does she have to show for the debt? She will have some memories of an exciting trip that lasted for a week or so. Maybe she will have some pictures to remind her of the great time she had, but that would be it. The money she spent on the trip would be gone and she would not get that much back in return. While relaxation is valuable, how much more stress will be added after she returns to face a poor financial state?

I think there is no point in sugar coating such a “financial problem”. If you ask me (and I supposed she did!) I’d say our reader clearly cannot afford to go on such a trip. I think we as a society shy away from saying, “Don’t do it,” but sometimes that really is the right answer. We supposedly make our own individual choices and we have to live with the consequences of our choices.

But the consequences, as bas as they are, are only part of the equation. The other part is our exposure to a general attitude in our society that doesn’t question increased consumption. I think, further, that this attitude is fuelled by very smart advertising that makes us believe that “more is better” (or, in the case of our reader, money should really be spent on this exotic trip). Happily, there is an alternative vision – I’m sure I’m not the only one noticing that journalists are talking about an emerging trend toward taking “staycations”? Tell me, what is your take on this situation?

A friend of mine once told me that she had declared bankruptcy a couple years ago to eliminating debt. She and her ex-husband got themselves in over their heads starting with an expensive honeymoon that they could not afford. Next thing you know, she is getting a divorce and she is left with most of the bills. It was tough enough for her trying to dig herself out of the hole having two incomes when she was married. It was nigh impossible to dig herself out on her own. So, she had to declare bankruptcy.

I was very surprised when she told me that she had gone bust in the past. I had never met anybody like that before. I think it was very hard for her to take that step, but she did not take it lightly. She knew that she had no choice. And when I met her, she was already on the rebound – both, in her romantic life and her financial life.

She appeared perfectly okay to me. She had her finances under good control, she did not overspend, and she had savings. In short, bankruptcy was indeed a very cleansing experience for her that set her on the right track. In my opinion she did the same thing I did when I assessed the progress of two goals I’d set for myself (and discussed in a couple of previous posts). First, she faced the bald facts without whitewashing anything. Maybe she procrastinated a little, like I did, but in the end she must have taken an honest look at her financial situation. This in turn allowed her to take the second step: decide on how to improve the situation. She must have developed a Plan B – hers was bankruptcy – and maybe she even had a Plan C if the bankruptcy didn’t have the result she desired. No matter. The end result for her: she got herself in a better financial position.

Let me sum up what I think it takes to move forward and to get ahead. First, be honest with yourself when you take a look at your situation. In personal finance this could be assessing your net worth, for example, which requires really getting a handle on your debt situation, and acknowledging all sources of income and assets, and noting how they balance out. Second, decide on the best way to stay ahead of the game or (if you’re behind) to get ahead of the game. Again, to think about personal finance, you might want to set some financial goals (like a retirement plan, or deciding to make a major purchase, like owning your own home or paying for a dependent’s education) and decide on how to pursue them. Last but not least, never give up. Financial wellbeing is too important! Again, keep in mind one of the most important adages on this: “It is okay to fall down. It is not okay to stay down.”