When faced with problem debt people typically make an emotionally charged choice on how to deal with it.
Generally the choice they make addresses their emotional needs but fails to logically solve the underlying math problem. This is a subject I’ve talk about a lot here.
Today I want to talk about the real cost of getting out of debt. Dealing with debt has two costs. The one is the immediate cost of whatever solution you choose. Think about that as the program cost. The second is the future cost of making that decision.
In this example I’m going to use a credit counseling program as an example. But the fundamentals apply to any extended repayment plan by a creditor or in debt settlement as well.
A credit counseling plan seems responsible and innocent enough. It feels like the right thing to do for many.
In this example let’s say our 30 year old couple has $30,000 in unsecured debt they are struggling to pay. They contact a credit counseling agency and are told they can be out of debt in only five years with a monthly payment of $650 a month. Part of that payment, $50, is the credit counseling fee. That monthly fee in the credit counseling program will cost a total of $3,000 over the length of the program.
Our couple says they feel an obligation to repay the debt even if the monthly payment still leaves things tight and unable to save each month. For our young couple the emotional feeling of repaying their debt feels more immediate and of a higher priority.
In reality this might just be a classic example of hyperbolic discounting. Want to learn more about that, click here.
Our couple in trouble decides they can just make the payment and decide to launch into the program.
But what if the credit counselor had told them the program wasn’t going to cost them $650 a month but $1,043,721 in lost retirement dollars. Would our couple make the same choice to proceed?
If you would like to try the calculator for yourself and see what getting out of debt will cost you in retirement dollars, click here for the debt repayment calculator.
Now let me be clear, while clearing the debt quickly for our example couple would most likely mean a chapter 7 bankruptcy, which 70% of people qualify for, I’m not advocating the only answer is bankruptcy.
What I am trying to help people think about is in the face of a uncertain retirement funding for most people, and a concern if Social Security will be around in a few decades, making an educated decision about how to best deal with debt and what it will cost you is a smart thing to do.
Considering the facts here, what do you think? Is it better for someone to repay their debt today over five years or make some tough choices now and be better prepared for retirement when they will need the money the most?
What choice would you make?