Personal Finance » Debt

Avoiding the money traps

“Action is the foundational key to all success. Knowing is not enough! Lots of people know what to do, but few people actually do what they know.” – Tony Robbins

Debt is a big business. Everywhere you look these days, it seems that there is an ever-increasing number of ways to have whatever your heart desires long before you’ve earned the money to pay for it. Whether you’re looking for a car, a couch or a cup of coffee, if you have access to enough credit, you can have that item right now, regardless of how much money is actually in your bank account.

Research has shown that for gamblers, the anticipation of a win actually fires up more pleasure centers in the brain than actually winning. It’s the same for consumers; the thought of buying something gets us more fired up than actually making the purchase. Retailers know that if we’re allowed time to “cool off” and think about buying something, the chances of us making the purchase decrease. Instant credit allows them to offer us a way to buy things we don’t really need, with money we don’t have and makes them a lot of money in the process.

Related article: Debt is big business

This week I had a phone conversation with friends I haven’t seen in a while. When I suggested that we get together with some other friends for dinner sometime soon, they started telling me how they were “house poor” and had very little spare cash so going out to eat was a challenge. It’s a story that our friendship group has heard several times over the past year or so, and so I didn’t push them on it. I could hear that they were driving while they were chatting to me (hands-free) so, changing the subject, I asked where they were going. They told me they were just dropping their dog off at the kennel before heading up north, to a cottage, for the weekend. As I mentally compared the cost of kennelling their dog, a tank of gas and two day’s meals to the cost of going out for wings it made me think about how, so often, it’s the choices we make rather than the circumstances that really keep us caught up in the debt trap.

I know first-hand how easy it is to justify spending money even when you know that you shouldn’t. I did it for years before I came to my senses but, having been there and then worked my way out of the trap, I find it really hard sometimes to keep my mouth shut when I see someone else heading down the same path. However, I’ve learned that, when it comes to money (and many other topics), it’s better to wait to be asked than to offer up unsolicited information!! My friends are both in their late twenties, they’re recently married and, when it comes to falling into the debt trap, I know that they’re definitely not alone so, I thought that, over the next couple of weeks, I would explore five common money traps and offer up some suggestions on how to avoid them:

Too much house

One of the challenges that much first time home buyers face is figuring out how much house they actually need. There’s often a big difference between what you need (and can comfortably afford) and what your pre-approved mortgage amount can buy you. As tempting as it is to start looking at houses at the high end of your price range, the trouble is, that once you’ve seen what you can buy at the top end of your price range, it can be hard to “settle” for the kind of house that’s more appropriate for your budget. Not only do larger houses carry a larger price tag, but they also cost more to maintain, but their property taxes are also higher and you need to buy more furniture to put in them! When looking to buy a house, it’s important to start with what you can comfortably afford rather than what you’re able to borrow.

Related article: How much debt is too much

My suggestion is to live for several months as if you were already paying that mortgage amount and all the other expenses that go with a new house allows you to see if it’s really within your means. This may also help you save a bit more towards the purchase.

Lack of savings

Without savings, you’re vulnerable. Any unexpected expenses, no matter how small are likely to push you into debt and it doesn’t take long to get behind. Buying a house with a down-payment of less than 20% means that you are required to take out additional insurance through CMHC or Genworth and that adds to your mortgage balance and increases your monthly payment. Too often, people are so focused on getting themselves onto the property ladder and out of the rental market as quickly as possible that they forget how much more they have the ability to save while they’re renting compared to owning. While it’s true that real estate can be a great investment, there are plenty of people who have been burned by jumping onto the property ladder too quickly.

Related article: Principles of saving money

The key is to save as much as you can for a down payment and make sure you have enough savings to cover your moving expenses and still leave you a decent-sized contingency fund.

Simply put, if you don’t take control of your money, it will very quickly take control of you. It’s said that a lack of money is never a problem; it’s a symptom of a problem and I believe that to be true. The choices we make about where to spend our money and how much of it to save have a direct impact on our quality of life, our net worth and our stress levels. It’s easy to justify “misspending” and often we don’t even realize that we’re contributing to our own challenges (or we’re in denial). When we live in a society that places so much emphasis on looking wealthy versus building wealth it can be easy to get sucked into the myth that we don’t have to work for the life of our dreams, we can finance it and pay it off later. The reality though, is that in financing our dreams, we’re actually financing someone else’s. Debt is big business and if we want to avoid putting all our hard-earned money towards helping others get rich, we need to make different choices about how we direct it.

“Buy now, pay later” financing

When you buy a new house and money is tight, the financing deals offered by some of the furniture and DIY stores can seem like a great deal. “Buy Now, Pay Later” deals let you shop to your heart’s content (within your credit limit) and delay paying for anything until 12, 18 even 24 months later. The challenge is that, despite their best intentions, most of the people who take advantage of the Buy Now, Pay Later offers don’t actually pay off their account before it’s due. This is a big money-maker for the store because it can now backdate the interest charges to the date of purchase. With rates commonly as high as 29.9%, that’s a lot of interest: $5,000 of furniture can often end up costing upwards of $9,000.

Buy Now Pay Later offers can be great, as long as you pay off the account before the due date. If you’re not disciplined enough to save, don’t be tempted. Also, make sure you compare prices to make sure you’re paying a fair price for your “great deal”. If you’re willing to shop around, chances are you can find decent furniture at a much more reasonable price at an auction or liquidation center.

Crazy car payments

It seems as though, over the past few years, car financing has boomed. With rock-bottom interest rates and payment terms of up to 8 years, car dealers are able to offer buyers expensive vehicles at much lower monthly payment rates. As a result, more people seem to be buying new vehicles rather than purchasing them second hand. It’s human nature to be tempted by luxury and, when the focus is always on the amount per week rather than the total cost of the vehicle, it can be easy to overlook just how much debt you’re signing up for over the long term. Many clients I sit down with are paying upwards of $600/month in car payments; over a 96-month term, that’s a lot of money to pay for a vehicle that you probably won’t even be driving by the time you’re finished paying for it.

Just like with the house and the furniture, start with what you want to pay, rather than with what you have the ability to finance. Make a conscious choice about what you want to spend your hard-earned money on if it will make you happy to drive the vehicle you’re paying $400 bi-weekly for and you can afford it, then, by all means, buy the car. However, if you’d be just as happy driving a car that costs half as much and putting the $5000 savings towards something else: a vacation, paying down debt or boosting savings for example, then it’s worth considering cheaper options.

Expensive weddings

I’m not sure if it’s the same for guys, but for a lot of women (and their families!), weddings are a big deal. Unfortunately, they also carry a large price tag. By the time you’ve factored in the costs of the venue, the dress, the hair, the flowers, the vehicles, the tuxedo rentals, the food, the entertainment, the open bar, the accommodations and the honeymoon (not to mention the rings!) it’s not surprising that the cost of the average Canadian wedding in 2014 was estimated to be over $31,000. That’s an awful lot of money to invest in one day, and with many couples footing much of the bill themselves, it can be an expensive start to married life.

Try hard to strike a balance between creating a memorable day and staying within your financial limits. Start with a reasonable budget and stick to it. Spend your money on the elements of the day that are most important to you and get creative in finding inexpensive ways to make your day unique. When it comes to décor, you can often find items online that you can sell after the wedding to other brides.

No matter what your situation, chances are that where you are now is a direct result of the choices that you made in the past. While it’s true that life throws curveballs, it’s also true that we have the ability to cushion ourselves from the blows and to choose how we rebound from them. We can’t change the past but we can change the future. What we do today impacts our future self and so we need to keep doing the things that work and also change the things that don’t. Staying out of the money traps is a good way to build a better future for ourselves. It’s not always easy, but it’s worth it in the end.

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