Part 1 of 3 (For Families)
Both have some similarities and many challenges that are unique to their specific situations. And because most business owners also have families there can be a significant overlap. However, I have found that both markets primary concerns can be boiled down to three questions each. Over the next few weeks I would like to expand upon those questions with a series of posts. First up, the family market.
Question One – Do you have any debt?
I’ve gotten a little bit of flack over the years from other financial advisors for being so up front and in your face about debt. Some of my colleagues have tried to tell me that it is not a financial planner’s job to worry about our client’s debts and if a someone comes to us laden with debt, they aren’t going to be a good prospect for our services. I couldn’t disagree more.
Regardless of where you are now, at one time or another throughout our lives, just about all of us have carried debt. From credit cards, student loans, vehicles and of course mortgages, debt is how the middle class drives the economy. Without debt most people would never achieve higher education, home ownership or even be able to get to work everyday. The danger comes when we forget what debt is. It’s a hedge against our future earning power that if we aren’t careful becomes an anchor holding us back from achieving our goals. The person in debt is saying that they are willing to sacrifice their freedom in the future, for comfort today. And that is just bad planning.
In my opinion there are three kinds of debt. Good Debt, Bad Debt, and Really Bad Debt.
Good debt is debt on anything that is going to increase in value faster than the interest rate charged to carry it. Mortgages, home equity lines of credit, and some (not all) student loans could be considered good debt. But no matter how good the debt, there is still no excuse to ignore it and forget that debt is still debt and eventually must be repaid with interest. Understanding the terms of your mortgage and looking for ways to reduce the amount of interest paid is a great place to start when it comes to financial planning. So is understanding what happens when a wage earner dies before the debt is repaid.
A reduction in the interest rate of just 0.01% on a $500,000 mortgage could result in a savings of $500 per year. On a 20-year amortization schedule, that’s $10,000! Even good debt, can be made better with a little planning.
Bad Debt is debt on anything that loses value or grows more slowly than the interest rate charged. Car loans, and large purchases made using credit cards tend be bad debt. If you own your home, or at least have some equity in it, we can usually refinance your mortgage and include some of these bad debts. If we can exchange a credit card debt of $10,000 at 18% for a home equity line of credit at 4.95% we’ve just traded $1800 in interest for $495 and saved you $1305 per year. Without equity in your home your options are limited but there are still lots of ways to trade bad debt for better debt, liquidate some unproductive assets or simply make some better lifestyle choices to pay things off faster. Remember, every dollar paid toward a bad debt means more money later in investable cash. Cashflow will be the key to the rest of the questions we’ll be looking at later.
Really Bad Debt is debt on anything that is consumed and used up before the statements arrive in the mail. Financing your lifestyle, or just living day to day on credit cards for things like groceries and gas for your car without the ability to pay it off before interest charges kick in is a recipe for disaster. Quite frankly, if you can’t afford to pay cash to live your life you need to make some drastic changes. There is nothing worse than paying interest on a meal you ate two months ago.
When you are in this situation chances are you don’t have much equity in your home, if you own one at all, and you don’t have a lot of other assets to work with. Your only chance to start living your best life is to perform what we call plastic surgery, cut up the cards and live on cash for a while. It’s scary, I know but the key here is to stop the hemorrhaging and to do that you need to feel the tangibility of real paper money leaving your possession. It’s too easy to forget that money is a physical thing when all you see are numbers on a screen linked to a plastic card in your wallet. Once you start to feel money again it’s easier to equate that $3.00 latte to 6 times the cost of a K-Cup or half the cost of a package of ground beef.
The key, regardless of whether you have Good Debt, Bad Debt, or Really Bad Debt is to do something. No other action you can take will have a more immediate and lasting impact on your bottom line than debt repayment.
Stay tuned for question two – Do You Have a Plan to Sustainably Grow Your Assets?
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