People just make the assumption that they'll have more money in the future to pay the cards off. You know, like the stereotypical temporarily inconvenienced rich person that so many people think they are.
Sorry if someone here already said that but I'm studying frugality hard these days. I'm challenging your wisdom (I hope).
The debt adds up quicker than they expect and that spare cash never materializes b/c they spend everything on "lifestyle extras" and boom, they are $35K in the hole at 17% interest. Only when they can't spend any more do they discover Dave Ramsey. ;)
I can't help but move around my town looking at people's stuff wondering how much of it is financed now.
Is there some metric that explains how high a person's debt can go? Can a person have 4-5 times their income in debt? Mortgage plus consumer debt like CC's and vehicle loans?
I live in a town with a fairly low median income in flyover country. Clearly some folks here do very well. Most do not. Still there are people living "fancy" lifestyles with a four door Jeep, big brick house, fishing boat, etc.
For as long as I have lived here I've wondered - "where do these people work?". There just aren't THAT many good jobs here.
I look around town and feel like I can expect each retail business to support two good incomes - the owner plus the manager perhaps. Everyone else would make ~$10 per hour. A doctor's office might have a few good jobs - doctor, couple of well paid assistants plus the office staff making $30K per year.
Anyone want to take a stab at this? How much debt can a family of four making $55K take on?
It depends on what their tax burden is, which will vary with location, and whether they itemize deductions. Also, the kind of debt is highly relevant. I can get this imaginary family more than half a million dollars in debt without anything outrageous like divorce or medical expenses.
Suppose they bought real estate with 30% of their gross income going to mortgage: their payments would be $16500 per year. How much is interest depends on how it was amortized (interest-only loans have been available in the past). If that was the payment for a 5% interest rate, Excel tells me the mortgage could be as high as $350,000. If so, the interest portion could be deducted from their taxable income if they live in the USA, along with the property tax which will again vary with location. With four humans in the household that's another $12,000 to $24,000 off the taxes depending on things like what the Basic Personal Amount is per capita that year and whether anyone is blind. Given that it's a family of 4, Earned Income Credit is going to be applied.
My seat-of-the-pants estimate for the family's federal income tax burden is therefore close to zero. It could in fact be possible for the family to qualify for some forms of social assistance.
Now if health insurance is included in the benefits package that go with the $55k income, and property tax and insurance are about 2% of the property value ($7000 per year), we have $55k - $16.5k - 7k = $31.5k available after taxes and basic housing.
Utilities for an overpriced McMansion (in flyover country, remember) will be on the order of $200 per month, or $2.4k per year. We're down to $29.4k now. If the family is in distress and has scaled back food and living expenses to a fairly average (spendypants) $500 per month, subtract a further $6000 per year. We're left with $23.4k to cover everything not related to food, clothing, shelter, and taxes.
The amount of debt that can be supported on this remaining $23.4k depends on what the interest rate is, and whether there's spending that goes along with the debt. A car loan of $25k, over 60 months at 3.11% is a $450 per month payment. Let's suppose it's a 2-car family that has two such loans for a total car debt of $50,000. They're spending $900 a month, or $10.8k per year, just on the car loan. There's now just $12.6k of income left, of which about $300 per month will be earmarked for car insurance so that the lender doesn't call in the car loan. Accordingly, the family is down to $9,000 per year. Suppose miscellaneous car repairs, maintenance, gas, oil and such run about $500 per year per vehicle. The family now has $8,000 that could be conceivably allocated to service on debt, but owes $400k between the mortgage and the two car loans.
Student loans could be a very plausible addition. At an interest rate of 5% and a loan balance of $100k ($50k per adult for degrees in classical basket-weaving and Alien-American Studies) the Sallie Mae Web site tells me the annual payments will be about $6444. So the family now has a little over $130 a month for other types of debt service. What kind? Cell phones and credit cards!
You can get cell phones at 0% interest, so if the family is paying $100 a month for a couple not-quite-new Smart phones on the installment plan, it's plausible that $1,000 could be outstanding on the phones. $30 a month remains for debt service.
At 18% interest rates (because you know these guys missed some credit card payments here and there), with a minimum payment of interest plus 1%, $30 per month can get you $1200 carried month to month on a credit card. So.....
$350,000 mortgage
$50,000 car loans
$100,000 student loans
$1,000 phones
$1,200 credit card debt
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$502,200 in total debt is mathematically possible without having to go bankrupt.
If the family is clever and knows how to exploit low-interest balance transfers it's possible they might carry more credit card debt. Same goes if they aren't "living the stereotype" in terms of overconsumption of real estate or cars, or if they've gotten some kind of 0% introductory loan for furniture or other items.
The lower the interest rate, the more debt a person can pile on without realizing they're in trouble.
Now, if I made other plausible assumptions like a sick family member or a co-breadwinner who is injured in a car accident or as a victim of a crime, I could add on oodles of medical debt to that number and nobody in the USA would blink an eye.