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Anybody who really wants to live cheaply needs to start by casting away some of the bad habits that banks, car dealerships, and real estate professionals have reinforced in the last 30 years. They are the enablers that sell consumers on the toxic 'monthly payment affordability' trap. I'm sure you all have a relative or friend that shops for a house or a car with a sign on their back that says "I want a monthly payment of X." Every time I hear that phrase, it makes me cringe. The monthly payment mentality is probably the single biggest factor that leads to debt overload. It starts innocently enough but can quickly spiral out of control.
For the average wage earner, the monthly payment mentality leads to an irrational thought process that goes something like this : "I make $3,500 a month in take home pay. If all my monthly payments are less than $3,500 a month, then I can afford whatever I am buying." If life were always kind, that might be the case. Unfortunately, most lives are tales of unexpected events: the unplanned emergency visit to the hospital, the layoff that disrupts your cash flow, the HVAC system that breaks down on the hottest day of the year, etc. When life's unpredictable twists and turns throw you a curve ball and you've been living on a month-to-month basis without any cushion, things can get tough real fast.
But even without the speed bumps that disrupt most life journies, people that play the monthly payment game can still find themselves on the short end of the stick because they fail to pay attention to the terms of the installment contracts they sign. Their lifestyle seems affordable when they are paying 9.99% on their credit card, but when the interest rate jumps to 17.99% or their monthly minimum payment increases from 2.5% to 5%, they find themselves in a jam. Or maybe they opted for one of those interest free programs from Best Buy or other retailers; they sound great if you pay on time for 18 months. Unfortunately, when you miss a payment, you get saddled with a ridiculous interest rate that qualifies as usury.
Let's not forget that the now infamous variable rate NINJA (No Income No Job) mortgages were largely responsible for the huge economic mess we're in. Once the initial teaser rates expired, the payments repriced and the result was an avalanche of foreclosures. The table below demonstrates how horribly things can spiral out of control if just a few things go wrong. In this example, we have a 7% reduction in take home pay, an increased payment for being late on a Best Buy zero interest loan for an HDTV and a similar increase for a late payment on furniture that was also purchased with a zero interest loan. In addition, we have an unexpected credit card minimum payment increase from 2.5% to 5.0% of a $10,000 outstanding balance. Read your credit card contract - banks can change the minimum payments on a whim.
| Monthly Payment Mentality and How It Easily Goes Wrong |
|
Base Case |
Changed Case |
Change Amount |
| Take Home Pay |
$ 3,500 |
$ 3,250 |
$ (250) |
| Mortgage/Rent |
$ (1,500) |
$ (1,500) |
$ - |
| Car Payment |
$ (500) |
$ (500) |
$ - |
| HDTV Payment |
$ (75) |
$ (110) |
$ (35) |
| Food |
$ (500) |
$ (500) |
$ - |
| Credit Card Payment |
$ (250) |
$ (500) |
$ (250) |
| Furniture Payment |
$ (200) |
$ (275) |
$ (75) |
| Other |
$ (400) |
$ (400) |
$ - |
| Total Payments |
$ (3,425) |
$ (3,785) |
$ (360) |
| Net |
$ 75 |
$ (535) |
$ (610) |
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