Financial Abundance

Is too much of your income vanishing due to interest payments on credit cards, car payments, mortgages and other debt? Perhaps the American family’s ever-increasing debt helps explain why 75% of Americans think that the economy is in bad shape, when unemployment is only at 5%, interest rates are close to historic lows, inflation is not (yet) spiraling out of control and the stock market is approaching its historic high.

In the past, my financial planning clients mainly came to me for investment advice, to help determine if they were saving enough for their children’s college expenses and their retirement and/or wondering if their retirement savings would last throughout their lifetimes. Recently however, more clients are seeking help in reducing their massive debts. These clients are unable to spend less than they earn due to the high cost of servicing their debt.

Many of my clients earn over $200,000 annually. After paying their taxes, home mortgages, home equity loans, car loans, credit card debt and vacation home payments, they often have less than 30% of their gross income remaining. They have no remaining income to save for educational expenses and retirement. Often, even paying their current bills puts them deeper in debt.

In the past 20 years, Americans have gone from saving 10% of their gross pay to saving less than 0%. Over the same time period, the average mortgage payment has increased from 15% to 30% of gross pay and average non-mortgage family debt has increased from 5% to 35% of gross pay.

After taxes, mortgage payments, non mortgage debt service (such as car loans and credit card interest payments) the average American family has less than 45% of their gross income remaining. Twenty years ago, the average family had 60% of gross income remaining after these payments.

Are you in the “debt danger zone?” To find out, calculate your total annual “debt,” including all taxes, mortgage payments, car payments, home equity loan payments, credit card interest payments, second home costs (net of income) and any other interest paid to service debt. If the sum of these payments exceeds 50% of your gross income you have entered the debt danger zone. If the sum exceeds 60% of your gross income, immediate action is critical.

If you are in the debt danger zone, consider the following:

1. Examine your spending habits. If you are spending more than you earn (including all of your “debt” payments) reduce non critical spending and put nothing further on your credit cards until their balances are completely paid.
2. If you have a vacation condo, selling it will not only provide equity to pay down other debt, it will also eliminate mortgage payments and HOA fees.
3. Use funds held in a savings or a brokerage account, to pay off credit card debt. However, do this only if you can still maintain an “emergency fund” that will cover at least 6 months of your total living expenses
4. If your 401(k) contributions are greater than the maximum employer matching amount, reduce your contributions to the matching amount cap until your high interest rate debt is eliminated.
5. To pay off credit card debt you could borrow from your 401(k) account, if your plan allows. The interest rates for repayment of a 401(k) loan will be considerably less than credit card interest rates. However, if this is done, immediately begin a scheduled repayment plan of the borrowed funds.
6. If you are still in the “danger zone,” consider downsizing your home. Reducing your mortgage by $100,000 can save you over $7,500 annually.

Because our government and financial institutions encourage us to increase debt and reduce savings, it is easy to fall into the debt danger zone. By paying close attention to your personal finances, you can reject this path to financial scarcity and discover the “path less traveled” to financial abundance.