The road to financial independence isn’t always smooth and straight. There can be stumbling blocks along the way, and it’s also possible to end up on the road to financial despair.
How do you know if you are on the right road? What are the three stages of financial despair?
The neutral stage is characterized by a steady state where you live paycheck to paycheck. You earn enough to pay your bills, and you may be saving just enough to pay unexpected and unique expenses. Otherwise, you are stuck in neutral and not really going anywhere. You have the choice of either following the road toward financial independence or the road toward financial despair, but it all depends on what you do next.
This characterized much of my student life. I was working part-time, sometimes up to 30 hours a week while studying full-time, but I was earning just enough to pay rent, a car, and other bills.
This stage is characterized by slowly increasing debt, whether on the credit card or on a home equity line of credit. When I was a student, there was a time when my spending was too high and I was starting down this road. I didn’t have the financial education back then, and didn’t really see the “big picture” of where this road would take me. I also knew friends that were getting into debt on 1 credit card, and then on 2 credit cards. Eventually they had to consolidate their debt onto a single card and work with the bank so that they could start to pay it down.
A lot of people talk about compound interest and the snowball effect of debt reduction. Well, the same effect applies in reverse, too! Accumulating debt leads to higher interest payments, which leads to more debt, and… well, you get the picture. If you are starting down stage 1, it’s not too late to get out, but it will take some short-term sacrifice for a long-term gain.
If you continue down stage 1, eventually you will reach a point where you will be up to your neck in debts, and all of your spare income will be going toward debt repayment. This is the experience I had growing up, when my mother and step-father had money to pay for beer, cigarettes, and a satellite dish, but we ate hamburger helper and mac and cheese every night. Eventually they declared bankruptcy and we ended up having to move to the ghetto.
This experience is one of my strongest motivators to stay far away from the stages of financial despair, myself, and to never put my own kids through the same experience. However, I understand that it’s not always due to lifestyle choices. My own grandmother ended up in this stage when my grandfather died not long after I was born. My mother was only 17, so my grandmother now had four kids to take care of. Managing a house with four kids by herself was a bit too much, so she had to sell. She never went bankrupt, though, and she was later able to open a business and run it with her son for several years, and things were a bit easier to manage after that.
Imagine if you had a debt that could not be discharged by bankruptcy? The kind of debt that could follow you to your grave? I have never known anyone in this situation, but I hear that student loan debts in the U.S. are like this. I suppose things could also get this bad if you deal with loansharks.
It is my personal belief that education is in a bubble, and while education is important, that doesn’t mean that students need to get into massive debt for it. If you are considering taking out large student loans in the hope that it might pay off in the future, please read more of my own thoughts on this subject:
- The Importance of Opportunity Costs, and Why They Should Not Be Ignored
- College: Is It a Complete Waste of Time?