A How-Not-To on Debt

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The first rule for living life in the black is: Don't spend more than you earn. Easier said than done.

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About 10 years ago, Joe Paretta, an English professor at Lafayette College in Pennsylvania, found himself about $12,000 in debt on his credit cards. He hadn't lost his job or bought a new house or faced a health crisis. But little by little, over about four years, he had built up a debt that was out of control.

"I wasn't making a lot of money, but I was irresponsible," said Paretta, 44, who used his unhappy experience to write a how-not-to book, Master the Card. "I was using a credit card habitually, and when I got the bill at the end of the month, a lot of times I didn't even remember what I had bought. I was making minimal payments, and I was satisfied."

Until he wasn't.

He got no wake-up call, nor did he hit bottom. Rather, Paretta said, "I felt like I was the middleman with my own money. I was getting my paycheck and paying the credit-card company."

So he decided to change things. First, he figured out "to the penny" what he owed. He started paying down his debt, which took about five years. When he got married, he helped his wife reduce hers. Now he has no outstanding balance on his credit cards.

Americans' devotion to debt has been paralleled, and aggravated, by their lack of interest in saving.

Mortgages, home-equity loans, credit-card debt, and student loans--these all pile up. According to Consumer Reports, credit-card users shouldered a median debt of $3,793 last year. College graduates in 2009 who borrowed money for school owed an average of $24,000, according to the Project on Student Debt at the Institute for College Access & Success. And that understates their debt load, because it doesn't count the loans that their parents took out.

It's no mystery how this culture of debt came about. Years of easy-to-get credit and mortgages--way too easy--along with persistently low savings rates meant that many American households were regularly spending more money than they earned.

What's the solution? Paying down debt, unfortunately, is a lot like losing weight. It isn't fun, and it means making some daunting choices. "Cutting back is inconsistent with popular American culture," said Barbara Dafoe Whitehead, director of the John Templeton Center for Thrift and Generosity at the nonprofit Institute for American Values.

The initial step is often the toughest: taking a hard look at the numbers and figuring out where the money goes. "Surprisingly few people do that in any systematic way," Whitehead acknowledged--including herself. "I try to save receipts and look at everything, but then I rationalize that I'm too busy."

Next is the biggie: Don't spend money you don't have.

This is Mary Hunt's No. 1 rule. Hunt, who runs the website DebtProofLiving.com, is the author of a forthcoming book 7 Money Rules for Life. Her advice: Don't put something on your credit card unless you know you have the money in the bank. This simply isn't how most people think, she said, but unless you spend less than you earn, rules "Nos. 2 through 6 won't help."

No. 2: Save 10 percent of everything you earn.

No. 3: Give some money to charity. This helps to check your sense of entitlement, Hunt said, reminding you that what you think of as needs are usually wants.

No. 4: Anticipate your expenses. "You may spend less than you earned," she pointed out, "but Christmas is coming, and you didn't save a dime for it."

No. 5: Tell the money where to go. Don't let friends influence you to shell out $150 on a Friday night--which adds up to $600 a month.

No. 6: Watch your credit score and protect it. A low credit score, Hunt cautions, can cost you $100,000 over a lifetime in higher insurance rates, mortgages, and car loans. Some employers even look at credit scores in deciding whom to hire, she said, because "they don't want someone who can't manage their money."

No. 7: Never borrow more than you know you can repay.

Hunt also offers rules of thumb on borrowing. For starters, she advises, never take out an auto loan that lasts longer than three years. That's when cars typically start to need repairs, so you would be paying for your car and for fixing it simultaneously.

Of course, for some people--especially the unemployed and underemployed--simply cutting back won't be enough. No matter how carefully they budget, their debts will overwhelm them. In that sort of fix, Paretta suggested, "you should contact your credit-card company and tell them your situation and see if they can work with you." At a minimum, negotiate for a lower interest rate.

"But people need to be honest," he added. "Some people say they can't [reduce their debt], but it's that they're not willing to do this. They're not willing to change a lifestyle, at least temporarily, to get things under control."

Not all debt, however, feels like a burden. Rachel Dwyer, an assistant professor of sociology at Ohio State University, distributed questionnaires to about 3,000 Americans ages 18 to 27; she found that those who owed on student loans generally said they felt greater self-esteem and more in control of their lives than those without loan debt did.

It's counterintuitive, perhaps, and Dwyer acknowledged the researchers' surprise at the finding. "But if you look at it not as the debt itself but [as] the trade-off of [getting] a college education," she explained, "it makes sense." Students may view education loans as money invested in their future. And, indeed, the poorer the student, the greater the boost in self-esteem. Students whose family incomes ranked nationally in the bottom 75 percent typically reported a greater jolt of self-esteem from taking out loans than wealthier students did. Dwyer figures that students from lower- and middle-class families, in greater need of money for college, may feel empowered by the ability to borrow.

Or--a darker interpretation--maybe students with loans are merely short-sighted, apt to focus on the education they're getting right now while ignoring the fact that it's money they'll eventually have to pay back. This interpretation is supported, Dwyer said, by the study's finding that having student-loan debt did nothing to enhance the self-regard of members of the next-older cohort, ages 28 to 34, who are likely in the throes of repaying it.

Americans' devotion to debt has been paralleled--and aggravated--by their lack of interest in saving. Nationally, households currently save about 5 percent of what they earn, according to Commerce Department figures. That's better than the low of 1.5 percent recorded in 2005, but well below the 7 to 10 percent that was common from the 1950s to the mid-1980s.

Until the 1980s, people typically put their savings into bank accounts. But in the following decades, such a conservative approach to investment was seen as foolish or underleveraged--"a 19th-century idea," Whitehead said. Better, it was thought, to put your money into booming stocks or rapidly appreciating housing. The Great Recession showed the folly of such thinking. But the lesson came too late, because the bust left people with very little cash to fall back on. In 2010, 27 percent of American workers reported having less than $1,000 in savings of any kind, "and that includes retirement," she noted--up from 20
percent just a year earlier.

Americans' tendency to borrow more and save less than people in other industrialized countries isn't solely a failure of character, according to Princeton University history professor Sheldon Garon, but also of government policy. "Most of the developed world offers restrictions on how much credit can be offered people," he said. "It's pretty strictly regulated. And easy credit is inversely proportionate to how much people save."

In major European countries, he said, the average savings rate hovers around 10 percent and hasn't dipped for the past 25 years. In Germany, the ubiquitous savings banks won't offer credit unless they believe that the borrower can pay it off; credit limits can vary widely depending on the banker's view of the applicant's financial worthiness and responsibility.

"In Europe, there's a legal concept of 'overdebtedness,' which we don't have," said Garon, whose book, Beyond Our Means: Why America Spends While the World Saves, is soon to be published. "In Belgium, if you miss partial payment of your consumer or housing loan over three months, it's considered overdebtedness, and your name is reported to the Central Bank--which sends social workers to your house to straighten you out."

Not exactly the American way. "Here, it's all about personal responsibility--sink or swim," Garon said. Is this the best way to save people from debt? He cites "empirical evidence that most people exercise financial responsibility poorly. If this was an experiment, it didn't work."

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Alina Tugend writes the Short Cuts column for The New York Times.

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