Quite often I create financial plans for people with excessive debt. Mortgage debt is typically the largest form of debt that I see, but student loans are certainly catching up. Auto loans and credit card debt are also very common.
During my conversations with people that carry excessive debt, we typically talk about their budget, and potential areas where they can save money.
When you carry debt, a tight budget is even more important because every dollar you spend costs you more than a dollar.
My reasoning is as follows: Let’s say that over the course of a year you spend $1200 at restaurants, where instead you could have eaten the same number of meals at home for $200. How much additional money did it cost the individual to go out to eat? The additional cost was $1000, correct?
If the individual has debt, the calculation isn’t that easy. What if instead of eating out, you ate at home, and paid the $1000 towards your credit card debt that carries finance charges of 10% per year? Now, it should become more clear: The act of eating out instead of at home, not only cost you $1000, but $1000×110%, or $1100.
When you have debt it’s almost as if everything you spend money on costs more.
Next, let’s say you own an old boat that is worth $1000 that sits in your back yard for 365 days per year. Does it cost you anything to store in your back yard? Most people would say no. If you have credit card debt with finance charges of 10% per year, I’d say that boat ‘costs’ you $100 per year. The calculation is the same: If you sold the boat for $1000, and used the proceeds to pay off your credit card debt, you would save $100 per year in finance charges, so the unused boat sitting in your back yard costs you $100 per year.
With these two simple examples, I hope to have shown that when you have debt, it makes everything you spend money on, and even your assets more expensive.