(This article is a part of the series aimed at dispelling some of the popular financial myths. Please refer to the full index for myths related to other financial topics. Oh, and a quick disclaimer: I am not a financial advisor. I have made every effort to research the facts before presenting them here. But, if you have a reason to believe any of the statements are incorrect, please feel free to correct me.)
- Myth: “The furniture/appliance/gizmo store offers zero interest, zero payment loan. So I can afford it.”
- Myth: “I am in such a crunch – maybe just this once I can get away with taking a payday loan.”
- Myth: “I can ignore the debt collection letter since it is only for a small amount” Variation: “I don’t owe any money, this is obviously fraud, so I can ignore this debt collection letter.”
- Myth: “I am under 18 years of age. So I am legally not liable for the debt I rake up on my credit card.”
- Myth: “All my friends have more debt than me. So my debt is not all that bad.”
- Myth: “I have dug myself into so much debt. I am such a loser!”
- Myth: “With the amount of debt I have, I am never going to be debt free. So why bother even trying?”
- Myth: “I have too much debt. Maybe I should just file for bankruptcy and start with a clean slate.”
- Myth: “I can help my friend in debt by co-signing a loan for him.”
- Myth: “All debt is bad.”
The zero interest, zero payments are usually valid for a fixed period of time. At the end of the promotion period, the interest rate usually shoots up to a large figure. In addition, some lenders include a clause that the promo terms are valid only if you payoff your whole loan amount at the end of the introductory period. What this means is, if you carry a balance beyond the promotion period, interest will be calculated for the entire promotion period and added to the loan! Taking out a loan that you cannot payoff is the first sign that you are getting into debt. Not knowing the exact details of the loan makes matters only worse! So beware of promotions that sound too good to be true!
This is a very bad idea. Payday loans charge a flat rate fee for the amount you borrow with a maximum period restriction (e.g., two weeks) to repay the loan. If you do not repay the loan within the set time, the fees are added back onto the original amount and the fees based on the new amount is calculated for the next term. This form of compounding can be a really bad trap and if you are snared in it, it will be very hard to get out. Do you know that when the APR is calculated on an annualized basis (like credit cards and other legit loans do), this could result in anywhere from 400% to 1460% APR? No those numbers are not typos!! Compare that to the 20% or so interest that credit cards and other lenders charge! Here is an article that does a great job of explaining this huge APR. If you are in a real crunch and absolutely need the cash, then please consider these alternatives to payday loans. Please avoid the payday loans like the plague.
Irrespective of whether you actually owe the money or not (yes, you can get debt collections letters even if you don’t owe the money!), please do not ignore the debt collection letter. According to this Washington Post article - “If a creditor or collector sends you a legal notice, do not ignore it. The National Consumer Law Center says most collection suits and arbitration proceedings against consumers result in default judgments because consumers fail to respond to the legal notices. When they fail to respond, collectors may proceed to request a payment order from the court, and in many states may seek to garnish wages, even if the debt is not valid. On the other hand, the law center says cases are often dismissed when a consumer challenges the validity of the claim.” So, your first step must be to educate yourself of your rights and then follow it up with an appropriate action based on your situation.
Credit companies allow minors under the age of 18 to have a credit card if an adult adds the minor to their account or co-signs for a loan. By law however, a minor cannot be held responsible to pay back the debt on the credit card. So it is true that if you are under the age of 18 you are not liable for the debt. But it is still not free money, since the credit card companies will now go after the adult who co-signed for your loan. So essentially, by raking up a lot of debt you are getting the person who was kind enough to help you get the credit card into a lot of trouble.
C’mon… that’s just lame and you know it! According to this report titled Generation Broke, “Bankruptcy rates for young Americans aged 25 to 34 increased by 19% between 1992 and 2001; An average indebted young American spends nearly a quarter of every dollar earned servicing debt; If mortgage and student loan payments are included, 13% of indebted young Americans spend more than 40% of their income on debt payments. […]” I could just go on, but it is up to you to decide which statistic you want to be a part of – the growing number that spends most of their life struggling with debt or the small number of smarter people that stay out of it!
There is taking responsibility and then there is guilt. The first sentence above is about taking responsibility. The second is guilt. Taking responsibility is a good positive step in the direction of becoming debt free. Guilt on the other hand makes you take two steps backward. It makes you lose your self esteem and punish yourself unnecessarily. Instead of giving in to this negative feeling take charge of your life and your debt!
If you have the will power and the discipline, you can get rid of any amount of debt. If you make becoming debt-free your goal, then you will learn to overcome the obstacles and find a way to get there. Here is a very inspiring article on MSN Money about Huge debts, paid off fast. The article shares the stories and secrets of debt-payoff champions who paid off $150K mortgage in 5 years, $50K credit card debt within one year, etc. Heck you can just look around the blogosphere and you will be overwhelmed by how much debt can be eliminated only if you try hard enough. NCN at the No Credit Needed network maintains charts of members and their goals to reduce debt. The network now has more than 125 members with possibly hundreds of thousands of dollars paid off!
Please, go back to the previous myth and read the inspiring stories there. If you need some more stories, here and here are more stories of people who took extreme measures to get out of debt. Why would people take these extreme measures? Because bankruptcy is not an option! It is neither easy nor pain-free to go through bankruptcy. It takes an enormous toll on your emotional well being and affects your relationships and outlook of life. And also how others look at you. And, as if all that is not bad enough, your credit history will be trashed and the black mark will remain on your records for anywhere between seven to ten years. If you are seriously considering bankruptcy, then you must read this article on Dave Ramsey’s site (based on his personal experience).
The credit industry is a billion dollar industry. Lenders are willing to pay hundreds of dollars in referral bonus just to have some clients walk in. In spite of all this, if the banks require your friend to have a “co-signer” what does it say about him? You may think you friend is the best person in the world, but are you really willing to put your (and your family’s) future at risk to bail him out? When you co-sign for a loan, you agree to bear the responsibility for the whole loan if your friend defaults. And considering that the banks do not have much confidence in him, he likely will. So be very wary of co-signing for a loan. Don’t make your family pay for your mistakes. I should know - I have been there!
How can I wind down this post without tackling this one! When people “become aware” of their debt and decide do beat debt down, they usually go all out. At that point, all debt is bad. Well, good for you. It’s that attitude that will get you out of debt. But at some point, when you have paid off your consumer debt, you should take a short break and decide which debt is really bad, and which is OK from your perspective. For instance a lot of people advocate that mortgage is good debt and you should go for the longest term possible – I don’t subscribe to this theory. On the other hand I dabble quite heavily in credit card arbitrage. So it is up to you to decide what works for you. Here is an interesting article by SVB to get you started on your quest to determine what debt is good for you and what is not.
That concludes the edition of debt related myths and misconceptions. If you would like to add more, feel free to leave a comment below. And please stay tuned for more myth busting. Once the series is complete, you should be able to access the full list of myths via this index.