Marianne Schiller, 39, carries just one Visa credit card, which she pays in full every month. She worked part time during nursing school so she could pay off her student loans early.
Before taking out a home equity loan on her Long Beach condo a year ago to start a limousine business with her fiance, Schiller had always lived almost debt-free.
“I try to never get into the red,” Schiller said. “I am not a big risk taker. If there’s something I want but I can’t afford it, forget it. I don’t delve into dangerous waters.”
Surrounded by a consumer culture that encourages racking up credit balances to finance life’s luxuries, people such as Schiller prove it’s possible to live without a lot of debt, even on a modest income.
But fewer consumers are choosing the debt-free lifestyle. Maintaining a high credit-card balance–or even filing for personal bankruptcy–doesn’t carry the stigma it once did, especially for younger consumers.
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“People in their 20s and 30s don’t care about debt. They feel like, the government runs on debt, so they can too,” said Richard Ross, a financial planner and certified tax preparer in Los Angeles.
Total outstanding revolving debt–government-speak for credit cards–passed the $2 billion mark for the first time in November, the Federal Reserve’s most recent measurement. The average household credit card balance rose from $8,940 in 2002 to $9,450 last year, according to cardweb.com. The average home equity line of credit climbed to $36,602 from $30,400 in the same period.
“People are just drowning in [debt],” said Michele Steinberg, a financial planner and founder of financegrrl.com, a Los Angeles financial counseling network aimed at people in their 20s and 30s. “It’s rare to meet someone who doesn’t have any.”
GOOD DEBT VS. BAD DEBT
Financial planners say that zero debt isn’t necessarily the goal. Rather, the key to financial health is differentiating between good debt and bad debt.
Good debt, or high-quality debt, is a loan that allows you to purchase an asset that has value or will have value in the future, said Aaron Newland, a certified financial planner at Marina Advisor Group in Long Beach.
“Good debt is debt that will … produce something–debt for a home or education or investing in a business.”
Credit-card debt taken on to buy a plasma TV, leather pants or a trip to Aruba tops the list of “bad” debt, because while it might provide instant gratification, it won’t increase in value in the future.
Smart debt and dumb debt also can be classified by whether it is tax deductible: mortgage interest, investing in a business and interest on student loans can all be written off.
A car loan falls somewhere in between. While it’s debt for a depreciating asset, a car still has resale value. However, buying an expensive car is definitely bad, from a debt reduction standpoint.
“The biggest mistake young people make is to go into debt for a car. They find they have a $400 a month payment and then they can’t afford a home,” said Ken Miles, a financial planner in San Bernardino, Calif.
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The 5 vital signs
Dan Henrie, a consultant with Debt Free Benefits in Salt Lake City, offers his formula for debt reduction. It starts with a check of what he calls the five financial vital signs.
1. Determine debt-to-income ratio. If it’s above 40 percent, that person is considered to be in the danger zone financially. Steps need to be taken to get that ratio down, preferably to around zero by retirement time.
2. Look at cash flow. Debt can’t be managed if there’s no money coming in.
3. Monitor debt-related fees and penalties. Make sure you are avoiding charges related to late credit card payments, for example.
4. Credit score needs to be above 620.
5. Have accessible savings to use in case of an emergency. Henrie said the ideal amount for the emergency cushion is three to six months of salary. If that sounds impossible, keep $1,000 in a savings account, an amount most people can at least consider a reasonable goal.
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Edited by Lara Weber ([email protected]) and alBerto Trevino ([email protected])
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