Thursday, January 15, 1998

It Can Happen To You
by George Runkle ([email protected])

My finances have generally been pretty good. They should be, considering I'm a full-time engineer and a part-time personal finance writer. I am very fussy with numbers and spend a lot of time concentrating on keeping my financial house in order.

There's only one problem. I'm up to my ears in debt right now. Does that make me the proverbial shoemaker who lets his children go without shoes? Not at all. In fact, what has happened to me can happen to anybody.

My spiral into indebtedness started simply enough with a contract to replace the carpets in my basement. The seventies-ish shags were worn and full of funny-looking stains. And they smelled like garbage on humid days. We'd run out of excuses to prevent visitors from going downstairs (storing nuclear waste, pet lion chained up, visiting mother-in-law). It was time.

Evidently, it was also time for the computer to die. Actually, a couple of its SIMM chips went, so it was repairable. Since it was an old 486 with a Pentium Overdrive stuck in it, in computer years (human years multiplied by 25), it was 100 years old. There was no point fixing it, so I went out and bought a new one. I was expecting to come into some extra money, so the new carpets and computer would be covered.

Then our cars took a cue from the computer. Head gasket and valve job for my wife's car, windshield and new brakes for my car. Several thousand dollars accumulated on the MasterCard. Still, we decided to dump my wife's car. It had 120,000 miles. Then the refrigerator died one Saturday morning. On my way home from buying a new one, I noticed the front tires on my car were wearing funny. I was also due for inspection. Since my car had 221,000 miles on it, I bought a new car too.

With the new carpet, computer, two cars and a fridge, I had a heap of expenses that I hadn't anticipated. There were three things that worried me: the monthly payments, the interest rates, and my cash flow. If I made monthly payments that were too low, I would never pay off the debt. If the payments were too high, I would have nothing to live on. If the interest rate I paid was too high, the payments I made would pay less of the debt principal, and I'd be paying forever.

The cash flow was important too. One of the worst things that happens when you're in debt is that the monthly payments get so high you can't pay for things you normally would in cash. You get deeper and deeper in debt, and ultimately disaster happens. Even if you don't get into this downward spiral, poor cash flow can make it hard to live in a decent manner. Heck, everybody needs to buy a cup of coffee or a Coke once in a while.

My wife and I used a neat little trick to buy the computer, carpet, and refrigerator. Many stores offer "0%" financing. (I added the quotes because there is a catch.) The 0% rate is for a fixed period, usually about 6 months or so. If you don't pay off the item in that time, an interest rate at an insanely high rate (usually around 18% to 20%) kicks in retroactively to day one. The finance company is betting you won't pay off the loan in that grace period.

The key is to calculate how much you need to pay each month to pay it off by the end of the grace period. If you can't complete the payment by that time, pay off the remaining amount with an advance from your credit card. If you can't do that, don't attempt this trick at home, folks. (By the way, our refrigerator and computer are already paid off. The carpet will take a bit longer.)

My wife and I sold some of our stock portfolio to pay the debt down. Oh, I'm sure some of you are saying that this was a big mistake -- that we're in an unbelievable bull market and we're missing the opportunity of a lifetime to make money. Sure, the return on stocks right now is far greater than my credit card interest. Too bad bull markets don't last forever. One day, Mr. Greenspan may decide we've got a little too much inflation, and he may raise rates. My stocks will stagnate, and (uh-oh!) the interest on my debt will go up. Then, if I sell stock, I'll be selling it at a depressed price to pay off debt that is costing me a lot more each month. That's not too smart in my book.

The last thing we did to free up funds to attack our debt was to do away with unnecessary purchases. We got rid of all the little extras on our phone service, such as voice dialing, which we never figured out how to use anyway. We also quit the automatic withdrawals for our Dividend Reinvestment Plans (DRIPs) for the time being. We'll invest again when we get our debt paid down. Until then, we will not be putting additional money into the market.

Getting out of debt is not fun. Fortunately, if you work your finances well, you'll have the resources to handle debt when the tough times come. You can get the low interest rates and have assets to pay your debt down. In the end, however, self-discipline and work will get you back on sound financial footing.

[For more on how to handle debt Foolishly, visit our new Credit Area in the Fool's School.]

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