Consumer Debt – The Worst Kind of Debt

Consumer debt is the kind of debt you put on credit cards and other types of revolving retail accounts.

What makes this kind of debt so odious is: There are no fixed minimum payments. And there is no fixed term in which to clear the debt. You could be making (mostly interest) payments for decades.

It’s not that hard to rack up large amounts of consumer debt shopping at malls, retail stores, and department stores. Twenty dollars here, twenty dollars there… next thing you know you’ve got some serious financial obligations.

My wife stumbled on a show last night called Clean House: Search for the Messiest Home in the Country. This show shines a light on families who have shopping, hoarding, and cleanliness/organization problems.

Sharon Baglien: Shopaholic in Denial

Last night was a re-run of the third episode of Clean House in which the crew tackled Sharon Baglien’s home in Cincinnati, Ohio. From the first scene, I could not believe what I was seeing. Baglien’s house, garage, attic, basement, and an off-site storage unit were crammed floor-to-ceiling with junk.

I say “junk” because not much of it was getting any use. But the truth is, most of the junk was brand new — still in the box, tags intact!

There was so much stuff in the attic that the ceiling was cracking. There was nowhere to sit for meals. And when the house was finally emptied, it took 400 50-gallon plastic containers, 75 large packing boxes, and 300 large garbage bags to hold everything.

The show’s crew then had to rent a 7,000 sq ft space for the “yard sale” to sell all of Sharon Baglien’s stuff. I was truly stunned.

But what stunned me more than anything else was Sharon’s persistent denial. She repeatedly denied being a shopaholic. She repeatedly excused her own behavior by saying that it was “just 30 years’ worth of accumulation” — as if the amount of time that had passed made everything okay!

If I accumulated for 30 years straight, I wouldn’t have had even a fifth of what this woman had in her house.

Anyway, with such an addiction to shopping and hoarding (she had been paying monthly rent for a storage unit for decades), I have to imagine that Sharon is also facing some substantial consumer debt. And while her situation is extreme, it paints a vivid cautionary picture.

The Problem with Consumer Debt

The problem with consumer debt is that it must be paid off by the sweat of your brow. Clothes and food and dishes and kitchen gadgets and “stuff” all depreciate rapidly. In most cases, you’d be lucky to get pennies on the dollar when you tried to resell your stuff, even if it was barely used.

Cars depreciate, too, but not nearly as fast as consumer goods.

This is a unique quality of consumer debt when compared to secured debt. Debt that is secured can usually be cleared by simply selling whatever was used to secure the debt.

Consumer debt, on the other hand, cannot be cleared by selling the items you purchased. Unfortunately, you will have to work off the debt — or settle it, or declare bankruptcy. And none of those is much fun.

Secured vs. Consumer Debt Ratio

As you take stock of your own finances, pay close attention to the ratio between your consumer debt and secured debt. If you have debt, it’s better to have secured debt.

There was a time not that long ago when the majority of my debt was consumer debt. Now that has changed. I mostly have secured debt now. Which means that in a pinch I could liquidate a few items and clear my debts quickly.

(Of course, being debt free is best of all, but I’m not there yet.)

Another option that I recommend is consolidating consumer debt into a Prosper loan. I did this at one point and it worked really well for me.

What’s nice about a Prosper loan is that there is a fixed monthly payment and there is a fixed pay-off date. You’re not making payments for the rest of your life. The whole point is to pay off the loan. (This is in contrast to credit card companies who want you to carry balances forever.)

Remember: Consumer debt can be ugly. So stay away from it as much as you possibly can. And if you have consumer debt, develop a plan for how and when you’re going to pay it off.

Debt Snowball – The Accelerated Debt Payoff Method

The first time you hear “debt snowball,” you’re likely to wonder: What is it? I will tell you…

Did you ever see How the Grinch Stole Christmas — the classic cartoon version? And do you remember how the little dog-reindeer got stuck in a snowball that careened down the hill and got bigger as it went along?

That’s the same idea behind a debt snowball. The more balances you pay off completely, the more money you’ll have available to pay off each successive balance.

Debt Snowball Explained

Let’s say that you have five different balances that you want to pay off. Naturally, each balance is being charged a different interest rate. And you will owe a different amount of money on each balance.

Here’s what you should not do:

If you have $100 extra to put toward your debt each month, you should not divide the money equally and pay down each of your five balances by $20 each.

This may feel good because each balance is decreasing — but it’s definitely not the most effective way of paying off your debt.

But which balance do you attack first? That’s the question.

How to Decide Which Debt to Pay Off First

Usually, you will want to pay off the smallest balance with the highest interest rate. If your smallest balance does indeed have the highest interest rate, it’s a no-brainer. You pay off that balance first.

Then, after it’s paid off, you take what you HAD been paying toward that debt — add it to your debt snowball — and start throwing it at the next balance in line. Here’s a brief example:

Watch Your Debt Snowball Grow!

Extra Money to Pay Off Debt = $100

Debt #1: Minimum Payment = $50

Debt #2: Minimum Payment = $125

In this short example, you pay $150 toward Debt #1 until it is paid off. You then take this amount and add it to the minimum payment of Debt #2. So $150 + $125 = $275.

You now have $275 per month to put toward Debt #2. As you can imagine, you will pay off this debt even faster than you paid off your first balance because your debt snowball is now much bigger.

Imagine how big it will be by the time you get to the fifth and final balance!

Debt Snowball: Better than Consolidation?

Some will tell you that it’s actually more effective and less expensive to use the debt snowball method to pay off your debts.

This is because consolidating debt often has some costs associated with it: balance transfer fees, management company fees, etc.

If you can manage your own finances, and start your own debt snowball program, you may be able to reduce your debt — and ultimately become debt free — faster than you might imagine.

So what’s next?

You might consider searching Google for a debt snowball calculator. There are some free calculators out there that can help you figure out what order in which to pay off your debts.