Getting Out of Debt

In these times of global economic crisis that just wouldn't go away, the phrase "austerity measures" as the means by which various countries try to bring their financial house in order gets thrown around so often, you probably don't have to Google it anymore. But what exactly does the concept of austerity measures mean to you as an individual? Is it workable for someone who is not Greece, Spain, Portugal, or Ireland - someone with very limited (if any) options when it comes to debt financing and collaterals, who must nevertheless take care of his or her financial matters in order to eat and clothe oneself and one's family?

Among numerous programs on the market that claim to help you reduce and even eliminate your debt obligations, a quite popular one - the name of which I will not mention for trademark reasons - claims to allow you to get out of substantial debt in a very short period of time, and to do so without resorting to bankruptcy, negotiating down your debt, or consolidating your debt. The concept of the program is highly admirable - as someone with strong libertarian leanings, I'm all for taking responsibility for one's incurred debts instead of looking for an easy way out. (This doesn't mean, however, that I'm against declaring bankruptcy or negotiating down your debt. I've used debt negotiation myself in the past, but that was when my income was nowhere close to allowing me to pay off my debts at their full amounts. However, neither of the aforementioned options teaches you fiscal discipline to the same extent that does the program under discussion.) The gist of the program is that for anywhere between three and seven years, depending on the size of your debt and your income, you basically enter the zone of no discretionary spending whatsoever - the purest form of austerity measures possible. The intent of this article is to show why such an approach is practical for only a very small segment of the population - mainly unattached singles and childless couples - and is impractical for a very large segment of the population, namely home-owning couples with children. (Interestingly enough, it is this group - the widest sector of the American middle class - that the program actually targets most actively.)

NO DISCRETIONARY SPENDING

The basics of the program can be summarized as follows: you don't spend on anything but the barest essentials, and all the money remaining once these essentials are met go toward debt reduction. If your income allows (for example, if you find a way to augment your current source of earnings, which the program strongly recommends), debt payments should be ramped up progressively so as to reduce what you pay in interest. When one debt is paid off completely, the money thus freed up is applied toward other, yet unpaid debts so as to speed up repayment even more.

Now, even single people like to go out once in a while, to maintain social and familial connections with the outside world. And what couple would survive for years of bare-essentials living, without pampering one another with gifts, outings, or vacations at least occasionally? It is not just impractical - it is virtually inhumane to require people to become hermits for the time it takes to repay their debts. And for families with children - especially young children - austerity-level spending is out of the question if their union is to have any practical chance of surviving. The level of stress associated with caring for children is tremendous, and with no positive release of that stress, people are likely to resort to negative one in the form of fights with one's significant other or personal emotional deterioration, or most likely both. Positive release - a date night, a day at a spa, a vacation, you name it - on the other hand, requires what the author of the programs considers "stealing from oneself," namely discretionary spending.

NO SAVINGS

Saving money doesn't just get the back seat in this approach - it gets thrown off the bus altogether, along with discretionary spending. The only thing the author of the program recommends to keep contributing to is one's 401k retirement plan - that is, if one has such a plan, and only if one's employer is providing matching funds for the plan.

Within the realm of pure finance, where mathematics reigns, this approach makes sense. Regular savings nowadays give you less than the rate of inflation in terms of return on investment (ROI) - 1.35% at best. To get a better rate, you would have to go with a Certificate of Deposit account, but this means losing your liquidity for a considerable period of time, especially taking into account the fact that the money you save is likely to be needed, possibly urgently, at some point in the future. Compared to interest rates on any type of bank-provided personal financing, from a somewhat affordable car loans or equity lines of credit (starting at around 2.75%) to completely ludicrous credit cards (regular [nonpromotional] rates starting at around 13%), putting money into a savings account when one still has high-interest debts to pay does seem like stealing from oneself.

What the program ignores, however, is that we live in the real world, and in the real world, unexpected expenses - the ones that go beyond bare essentials - are a matter of course. I'm sure you can come up with as many, if not more, examples of such expenses as I can, or anyone else, for that matter. The two most obvious, to me, are a car accident or a medical emergency. If you're on the program, since you're already limiting yourself to the barest essentials, there is nothing you can forgo to compensate for such expenses. What are you going to cut down on if you need to shell out $250 for a new crown on a broken tooth, or $1,000 for body and paint work on your vehicle? Cut dinner portions in half? Wash clothes less often? Stop watching TV for a few months? Dilute your child's milk with tap water? And even if you were to go to such ridiculous extremes, how long do you think it would take you to recoup this unexpected expense? Two months? Three? Half a year? Longer?

If not for any other reason, money needed for a sudden, unforeseen emergency is the best reason to NOT utilize all of your funds remaining after bare-essentials purchasing and instead maintain a savings account and to contribute to it regularly, to be used to cover such unexpected expenses. Otherwise, the only option available would be - you guessed it - borrowing; borrowing against your property, or borrowing off credit cards, and thus acquiring more debt, which defeats the purpose of being on this particular program in the first place.

RECOMMENDATION: AUSTERITY LIGHT

As I mentioned earlier, the basic idea of this program is highly admirable and, like any other undertaking requiring high levels of commitment and willpower (think diet and exercise, for example), can be followed successfully if such commitment and willpower are accounted for. However, it also significantly raises the levels of stress for people adhering to it, which potentially can lead to unfortunate developments discussed earlier. Furthermore, it doesn't account for life's emergencies, which, needless to say, is rather unrealistic.

If you are truly serious about paring down your debt quickly and effectively while at the same time not putting your life on hold for the time it takes to achieve this, my suggestion (a practical one, since my own household is following this practice) is to institute what I would call "austerity light" measures. Beyond bare-essentials purchasing, split your remaining funds, percentage-wise, 80-10-10. Eighty percent will go toward your debt - and there you can actually follow the ramp-up repayment practices the program recommends. Ten percent will go into your emergency fund, and another 10 percent will go into your discretionary-spending fund, to be spent as you see fit: vacation, dinner with friends, gifts, and so forth.

It is important to remember, however, to maintain strong fiscal discipline and to NOT shuffle funds from one account to another. In other words, no matter how much you want these new shoes or new jeans, no matter how much you would like to stay at a more luxurious, hence more expensive, hotel during your vacation - if your discretionary-spending fund doesn't have enough in it to cover this expense, you must NOT "raid" your emergency fund or, worse yet, your debt-repayment fund for additional money. It is easy to justify this by mentally committing to "repay" into these funds from the next paycheck, by moving the regular discretionary-spending contribution to cover the borrowed amount. What usually ends up happening, however, is that you borrow too much, or something else comes up for which money is needed, and this "debt to yourself" never gets repaid.

Aside from this, all I can add is: Good luck in your future debt-eliminating and wealth-accumulating endeavors.