Getting Weird With Debt

http://www.fool.com/news/commentary/2005/commentary05111605.htm

By Selena Maranjian (TMF Selena)
11/16/2005

If you listen to one of 260 radio stations in America, you can enjoy three hours per weekday of "The Dave Ramsey Show." Ramsey discusses finances, which should put him on the radar of many Foolish radio listeners. But he's controversial, too. What's good is that he's against credit card debt. So are we. We differ, though, in some details.

A recent New York Times profile described his platform: "Ramsey rejects debt in nearly every form (credit cards, auto loans, 30-year mortgages, home equity loans), advising followers to pay for every single purchase (oatmeal, bath towels, dishwashers, even a split-level) with cash. He reserves one day a week for callers to join him in screaming the words 'I'm debt-free!'"

Sensible and... not so sensible
I agree about the importance of getting out of credit card debt, but car loans are sometimes necessary, if one needs a set of wheels. The important thing to do is to avoid buying more car than you can afford, and to get as good a deal as you can on the car and the loan. Regarding mortgages... well, Dave, I'm afraid I'm not clear on how the average American is going to buy a home with cash. If that had been my only option when I was buying my home, I'd have had to wipe out all my stock holdings, and I would likely not have snagged as nice a home as I did. True, I have a mortgage, but I got it at a good rate, I'm paying it off on time or early, and I'm building equity in the meantime.

Another problem with avoiding mortgages is this: Ramsey does concede that people are going to get mortgages. But he advocates minimizing them. He likes people to save large down payments -- as much as 50%, 70%, or even more of the home's value. He recommends 15-year mortgages over 30-year ones. This is troublesome to me.

Let's say I'm saving like crazy for a big down payment, perhaps $100,000. As I accumulate that massive pile of cash, what do I do with it? If I invest it in stocks, the stocks might temporarily slump. The stock market is great for long-term investments, but it's risky for short-term ones. If I invest in money-market funds or CDs, I'll be earning meager amounts of interest. I'll be losing the opportunity to sock much of that money into better historical performers (stocks, funds) for the long haul. And one more thing -- if all this saving makes me put off buying my home for a few years, the average price of a home in my area may well go up. If I'd bought, I'd be enjoying the equity appreciation.

Success is possible
I do like his celebrating people who are debt-free. We've got a lot of that right here in Fooldom. Pop over to our Consumer Credit discussion board and, amid many discussions, you'll run across people rejoicing after paying off tens of thousands of dollars of debt. Really. They even explain how they did it and are happy to encourage others who are trying to do the same. Some examples:

MilleniumFalcon paid off $28,000 in debt.
Pennsyltuckian paid off $32,000.
AngryGeek owed $36,000 when he was earning less than $14,000. He paid it off.
RadioPhool dug out from under $84,000 of debt.
Mlk58 paid off nearly $140,000 in non-mortgage debt.

But back to Ramsey.

Opposition from academia and Fooldom
One of Ramsey's critics is Robert Manning, finance professor at Rochester Institute of Technology and author of Credit Card Nation. The Times writes that Manning sees Ramsey overlooking "the new category of debtor created by the exploding lending industry."

"Ramsey discourages his followers not only from filing for bankruptcy, but also from availing themselves of debt-settlement and consolidation packages, some of which allow for satisfying debt at 20-40 cents on the dollar, arguing that these packages cure the symptom, not the disease," the Times article continues. "Manning points out that such compromises are, for many people, the only hope of restoring stability."

On our discussion boards, Fool Community members have discussed Ramsey, too. Many Fools are fans -- with good reason, as he does seem to be very motivational and his bottom-line message -- paying off debts and living within or below your means -- is sound. But others take issue here and there.

Royinstl, for example, wrote on the board, "I also thought [Ramsey's book] was an excellent read. But, I have serious problems with his snowball method. Killing the lowest amount of debt [first, before tackling larger obligations] regardless of interest rate would cost a fortune in finance charges over time compared to [tackling the] highest interest rate [first]."

Bisonrules responded to this, saying, "You forget about the psychological portion of paying something off, though. It is a quick win... that sustains someone and lets them know that, yes... I can do it. It is not more expensive if the person feels better about where they are going and follows through. Eating away at larger bills may cost less, but there is no 'rush' or victory had by that. Many people need the boost of paying something off early to sustain any momentum."

Alstroemeria added: "Another reason to consider paying off a small [credit card] debt first is to (hopefully) get better [balance transfer] offers and more 'Yeses' to requests for lower rates."

Who's responsible?
Another apparent flaw in Ramsey's position relates to blame. He comes down hard on those in debt, seeing a nation of overspenders. Many people do overspend, but there's more going on. The folks at the Consumer Bankruptcy Project found that among 1,250 people who had filed for bankruptcy, profligate spending wasn't the root cause for most. The loss of a job or a drop in working hours was the most common culprit. Second place? Medical expenses. Credit card debt was named by only 4.5% of the respondents.

It's a complicated situation. Sure, many people with debts have discipline problems when it comes to money. But they're -- we're -- all working within a tough environment. Credit card issuers are quickly hiking rates whenever they can. Those with maximums recently between 24% and 30% include MBNA(NYSE: KRB), JPMorgan Chase(NYSE: JPM), Morgan Stanley's (NYSE: MWD) Discover, Capital One(NYSE: COF), and American Express(NYSE: AXP). As I described in another article, it's not so hard to end up owing $40,000.

Be smart
Be smart about your credit card usage. Protect yourself from being taken advantage of by being an informed and savvy consumer. You can learn a lot in our Credit Center, which features tips on getting out of debt, along with guidance on how to manage your credit effectively and the inside scoop on how the credit card industry works. (We even offer a spiffy Motley Fool credit card.) Really. I mean it. There's some great stuff in our Credit Center, and it's all free reading.

The following articles may also be of interest:

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Selena Maranjian is Senior Worrywart at The Motley Fool. She owns a few shares of Microsoft. The Fool has a disclosure policy. For more about Selena, viewher bio andher profile. You might also be interested in these books she has written or co-written:The Motley Fool Money Guide andThe Motley Fool Investment Guide for Teens. The Motley Fool isFools writing for Fools.

This story ran on on November 16, 2005.