Debt Management: An Interview with a Credit Counselor

To find out what it takes to live within your means and attain a level of economic literacy, LoveToKnow Credit Cards spoke with Tom Coates, director and co-founder of Consumer Credit of Des Moines in Iowa and an internationally recognized expert on credit and gambling issues. Coates has advised consumers on fiscal responsibility for nearly 20 years and prior to founding Consumer Credit, he was in the investment brokerage business.

Has the American mindset changed over the years regarding debt and debt management?

Yes, and pretty dramatically. There is more of a public and private willingness to incur debt. Publicly, as one example, the current government has demonstrated a bad tone of fiscal responsibility – one of the worst in this nation’s history. For individuals, a lack of savings and a reduced stigma surrounding debt accumulation are more prevalent now than ever before.

There is also a real decline in the average wage earnings – approximately four percent – but not a decline in the expected standards of living. This affects everyone.

Many people don't consider credit card debt to really be a problem. Why should debt concern them?

Because the borrower becomes the slave of the lender. Especially with credit card debt, it’s compounded interest working against you, and that’s a terrible burden.

The debt accumulation simply on credit cards for the average American household is $8,000-$9,000 – and 60 percent of cardholders revolve that balance. That debt doesn’t include other living expenses.

This same family spends $1,000 using credit cards during the holidays, but only pays 2 percent of the total balance through minimum payments, so those gifts end up costing more. Vacations generally cost $5,000 but again, if only minimum payments are made, the vacation might cost as much as $5,600 – and that’s if the card is put away and the payments are kept flat.

Other economic factors, like utilities, gas prices and inflation, reduce the family budget regardless, yet that compounded interest on debt incurred takes even more away.

So it’s better to have compounded interest when it benefits you – like with savings.

Exactly. The average annual rate of return on investments is 8 percent. If someone starts saving $2,000 a year at age 25, by age 65, that individual will have $600,000 in cash. I use that as an example of the possibilities of compounded interest, and how it just grinds you down on the other end – all that potential savings being lost to debt.

Lack of economic literacy is the problem. People need to understand how they can put every dollar to work for them.

Credit cards seem like the most likely debt culprit, but are there other debts people should - and can - avoid?

Two major ones come to mind:

• Home equity financing to buy unnecessary things or to pay off credit card debt. Heavy marketing and an atmosphere of declining interest rates have enticed people to borrow for an unsustainable lifestyle, instead of investing in their property and home. The majority of people do not stop using credit cards while trying to pay both those and the home equity loan off, so it’s just a temporary fix.

Foreclosure rates have doubled recently because of second and third mortgages and the environment of ever-lowering interest rates is gone. So using the home as collateral for a borrowed lifestyle is very risky.

• Car financing with a five- or six-year loan is a disaster: you’ll never get off the financing treadmill. Better to use a car loan of three years on a slightly new car. After the three years, you can start putting the equivalent of the car payment into savings. But more importantly, have the economic literacy to understand your budget. Your total annual transportation costs – that’s car payment, gas, insurance and upkeep – shouldn’t be more than 20-25 percent of your take home pay.

Another point: an informed consumer should look for what's best for him or her, not for the salesperson. It doesn’t matter how good the finance rate might appear to be, because proper financial stewardship is always necessary in these decisions.

Are certain demographics more likely to have trouble managing debts and if so, why?

Age is a factor, especially for the young and seniors, as they are both on the wrong end of the spectrum. The young don’t know enough and have debt thrust upon them. Seniors try to maintain a particular way of life, plus additional living costs on what is more than likely a limited income.

Another consideration is the lack of fiscal education. It doesn’t matter what walk of life you come from: if you don’t budget and understand how to manage your money for the future and avoid debt, there will be problems. This even applies to corporations, many of which have demonstrated poor financial decisions that unfortunately affect the rest of us.

What are three-to-five key factors necessary for successful debt management?

• Proper budgeting as a cornerstone to all decisions.
• Living within your means.
• If you have debt, demonstrate consistent progress in eliminating the debt.
• Establish regular savings plus retirement and most importantly, keep it in place.

How can people change their minds about saving for what they want vs. incurring debt unnecessarily?

It goes back to understanding how to live within your means. One tip I recommend is differed gratification exercises to develop the discipline that what you want can be better savored and more satisfactory if you save for it.

For example, let’s say a real joy for you is eating out. Not at McDonald’s, but at fine restaurants. Analyze your budget and evaluate your cash flow. Put $50 or $100 in an envelope each pay period for eating out, but otherwise, eat at home. When the time comes, reach into the envelope and treat yourself to a good meal. Psychologically, you will enjoy the experience more because you’ve been anticipating it.

Try it with a vacation. Instead of getting online tomorrow and putting everything on credit card, set aside the trip envelope and get the whole family involved with the planning and research. Make a big deal about saving for it so when you actually go, it really matters.

Credit counseling programs are often used as last resorts by consumers who fall into a bad financial situation due to an abundance of debt, not enough income to pay the bills, and a general lack of knowledge regarding how to properly budget for everyday expenses. These valuable services are not necessarily reserved for consumers who find themselves overwhelmed with debt. Many credit counseling agencies offer great financial advice that can be useful to consumers who do not require debt consolidation help. Credit counselors are available to assist consumers with budgeting education and other financial advice.

If you decide to turn to a credit counseling agency for assistance there are a few things you should make sure of before signing any type of contract or agreement with the agency:

• Make sure the agency is a non-profit organization
• Make sure there is either no fee to you, or a very small fee which is only used toward the administrative costs associated with servicing your account.
• Check with the Better Business Bureau to make sure there are no previous or pending complaints regarding the agency you are considering doing business with.
• Make sure the payment schedule the agency is proposing is within your means.

Remeber that credit counselors are available through a variety of organizations. To get on the path of better debt management, visit some of Coates’ recommended Web sites:

• Consumer Credit of Des Moines, a non-profit organization that offers credit counselors to assist consumers
• American Association of Debt Management Organizations
• The JumpStart Coalition, a financial education resource for parents and children

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