Do You Have Good Debt Or Bad Debt?

Steve Pomeranz: Leslie Tayne is a leading attorney concentrating solely on personal and business debt.  Her book is Life & Debt: A Fresh Approach to Achieving Financial Wellness.  I like the sub-subtitle, which is “Learn to Love Your Debt.”  Let’s find out what she means.  Hey, Leslie, welcome to the show.

Leslie Tayne: Hi.  Thank you so much for having me today.

Steve Pomeranz: I’ve often talked on the show about good debt versus bad debt, and you’ve written about that, too.  Is there truly a difference?

Leslie Tayne: There actually is a big difference.  Most debt starts out as good debt because people don’t take on debt with the intention of not paying it, bu over time, debt can become bad debt when that debt is no longer affordable.  That happens for a number of reasons.

Steve Pomeranz: I was thinking, too, in terms of some debt is good, like a mortgage would be good debt, but perhaps credit cards would be considered bad debt.  You’re thinking kind of in a sense all debt can be good as long as you can afford it, I suppose.

Leslie Tayne: A hundred percent.  Mortgage debt is good debt, but I have seen mortgage debt become bad debt.

Steve Pomeranz: Yeah.

Leslie Tayne: I’ve had clients come to me many times where that mortgage debt exceeds more than 50% of their take-home pay.  What started out as good debt has now become bad debt.  Credit cards you would think stereotypically might be bad debt, bu truthfully, they can be good debt.  They’re used for a lot of good purposes.  They come with a lot of protections and other bonuses.  The problem becomes when they get out of control and you’re not paying the or if you’re only making minimum payments and the balances are continuing to go up, then it becomes bad debt.

Steve Pomeranz: Here’s a quote from you, “All debt is good until it becomes unmanageable.” Right?

Leslie Tayne: Yes, that’s 100% accurate.

Steve Pomeranz: Okay.  What causes people to get themselves into a situation where debt becomes unmanageable?  What is it linked to in terms of what they’re doing and how they’re thinking about their money?

Leslie Tayne: Basically, what happens is there isn’t a lot of thought about money and budgeting.  People will go out and make purchases because it’s really easy to do, so in terms of credit cards, student loans, and they’re not really thinking about the long-term effects of those type of purchases and that type of credit.  For example, let’s use student loans.  If you decide that you want to go or your child is going to go to a school that costs $60,000-$65,000 a year and their intended major is something like social work, where if you research it, the average income is around $45,000, and if you …  I’m just using that as an example…  if you’re taking on student loan, the question becomes, well, are you going to be able to afford to pay that back upon graduation by figuring out how much income you’re going to have, less your taxes and other obligations, to repay those loans?  If you haven’t thought that way, then you’re not really thinking about the best way to manage your money, and it’s a good way to make good debt, which is student loan, turn into bad debt, which is your inability to pay for it and not be able to manage your finances.

Steve Pomeranz: That’s such a wonderful point because in this society, I think we’re learning, but I think in the past we’ve forgotten, that not all college degrees are equal in the sense of earning power.  If you’re going to take debt in order to get this college degree and you’re not going to have the earning power, that could turn into bad debt. Leslie, in your book, you mention guidelines for monthly expenses.  This is actually in Chapter 6.  I find these helpful to guide clients as well.  Some of the guidelines are housing and debt.  You want to take us through these guidelines?  I’ve got kind of the percentages that you recommend should be attributed to each one of these attributes.  What are these guidelines?

Leslie Tayne: Some of the guidelines in terms of going through what you need to consider when you’re taking on different kinds of debt, it really has to start with the budgeting concept.  The budgeting concept is understanding what your income is, what comes into your household, and what your expenses are.  By understanding what your expenses and your income are, then you can allocate certain percentages of that income to a particular debt.
What ends up happening is when that isn’t done, people don’t understand what percentage of their income is going to what type of either expense or even a savings account.  What it comes down to is it’s not really having an understanding of your personal finances.  What the steps take you through is a good way for you to compartmentalize, start to understand your money and how it works for you and really where your money should be going so that when you go out and you’re looking at a new house or a new car or taking on additional debt, you have an idea in your head what you can afford.

Steve Pomeranz: This book is a wonderful primer for those of you who want to get a handle on these issues but sometimes find them too complicated.  The book is Life & Debt: A Fresh Approach to Achieving Financial Wellness.  The subtitle, as I said, is “Learn to Love Your Debt.”  Not all debt is bad.  Just like years past during …  those who came out of the Depression thought all banks were bad or all stocks were bad.  Maybe those were true for that given period of time, but really in the big picture, banks are not bad, stocks are not bad, and debt is not bad if used properly. Leslie, you mention some of these guidelines, that housing should represent—this is a guideline again—plus or minus 30% of your income.  Debt should be 20% of your income.  Can you take us through some of those, too?

Leslie Tayne: Sure.  In terms of the specifics, again, when we talk about mortgage debt or rental allocations of your money toward paying those expenses, again, when you’re looking at what these are, you’re going to have an estimate.  If you don’t have a specific amount and you’re trying to budget ahead of time, you’re going to have an estimate of what you can and cannot afford, so you want to say 30% of the income is going to go toward a mortgage or rent.  That should also include your homeowners association, if you have it, and property taxes.

Steve Pomeranz: All in.  It’s got to include every aspect of supporting that home on a monthly and annual basis.

Leslie Tayne: It does.

Steve Pomeranz: Yeah.

Leslie Tayne: Otherwise, you can’t budget properly because what happens is people look at things that it’s just a number, it’s just a payment.  Same thing with a car.  You look at a car as, “Okay, I can afford this payment,” but then have you spoken to the insurance company to see what the insurance is going to be?  What about gas?  Is that going to be an expense?  Is it a car that’s going to require maintenance?  Again, it’s the same thing with a home.  When you’re looking at a home, can you afford the payment?  Yes, but perhaps you’re in a homeowners association that adds additional fees and there are assessments, or you live in a co-op and there might be additional assessments.  When you’re really considering budgeting and you’re understanding your money, you have to understand what goes along with the expense before you take it on because when you’re going to end up in my office is when you haven’t considered all these aspects and things can roll and get out of control pretty quickly.

Steve Pomeranz: Let’s say you followed the guideline and you made sure your budget was under control but circumstances have transpired against you and you’re not able to pay your debt.  What happens next?

Leslie Tayne: If you’re in a position where you can’t pay your debt, the first thing you need to do is recognize that you have a problem.  When you recognize you have a problem, then you can seek out help.  What ends up happening is that most people don’t recognize there’s an actual issue or a problem.  They say, “You know what, next month I’ll be able to pay it.  I’ll try to borrow from a 401 (k).  Someone’s going to lend me money.  I’m going to come into money somehow.” Especially my business clients think, “Okay, well, if I can just get the next sale, I’ll be able to pay for this, this, and this.” That thinking does not help you.  The first real step is understanding that there’s a problem and recognizing it and then seeking out appropriate help.  I know that it’s difficult to seek out help because people aren’t sure where to go to first.

Steve Pomeranz: Yeah.

Leslie Tayne: My first suggestion always is a trusted advisor, an accountant, an attorney, somebody who has some familiarity with you and your circumstances, who can guide you to another professional to help you.  You can certainly do an Internet search, but be very careful when you’re doing so and look for a company that’s local, that doesn’t charge you up front to have some conversations with them.  If you’re really having that much difficulty financially, there are not-for-profits and there are other agencies like through local bar associations and law schools that offer clinics that are free to help you with debt-related issues.  I’ve even seen it through church and other religious organizations.  Those are really important steps to take.  Again, I think the most important piece and the one that becomes problematic for most people that I see is that they waited too long to come see me and they let it spiral out of control, thinking that if they just borrowed money or got another loan or closed the next deal that it would make or break their situation, but truthfully, it really doesn’t.

Steve Pomeranz: Right.  Debt collection, when you get to that point, if you haven’t been able to short-circuit the process by getting a handle on things, talking to advisors, starting to do some debt restructuring, the process of debt collection is quite serious, isn’t it, Leslie?

Leslie Tayne: Yes.  Once your accounts get to the debt collection process, it’s definitely gone down the road a little bit, especially if you’ve now been sued by your creditors.  Very often, I see people who come to me after they’ve already been sued, and that tells me that their accounts have been in collection for quite some time.  Like I said, things can spiral pretty quickly.  You don’t want to be in a position where you’re now potentially facing legal action or collection because, of course, that damages your credit and you’re in a position where you’re going to feel a lot of pressure from collectors potentially and certainly from the legal system trying to handle that on your own.  Try to avoid that and seek out the help ahead of time.  Really, there are very realistic solutions to assist you, and there’s really no shame in it.  That’s the biggest piece of the puzzle.  Psychologically, people become very paralyzed with debt, and they feel shameful.  They’ve never been in that position before, but somebody like myself who’s been doing this almost 20 years, there’s no judgment on our end.  We just want to help you get to a better place.

Steve Pomeranz: Of course, of course.  To review the steps with regards to getting your debt and keeping your debt under control, first of all, remember debt in and of itself is not bad.  It’s when it becomes unmanageable that it becomes bad.  Get a budget together, start looking at these numbers.  It really isn’t rocket science for you guys listening to take a pencil to a pad and go, “What’s this mortgage going to cost me?  What’s my home insurance?  What’s my taxes?  What’s my homeowners association fees?” and really add them up. There’s really 3 or 4 factors to consider.  Compare that to your income.  Does it match around 30% of your income?  That’s a good way to start, just to be reasonable and to do some forward thinking.  Also understand your credit report is very important.  Understand your credit score and avoid making the mistakes that Leslie is talking about here. Leslie Tayne is a leading attorney concentrating solely on personal and business debt, and the book is Life & Debt: A Fresh Approach to Achieving Financial Wellness.  Thanks for joining us, Leslie.

Leslie Tayne: Thank you so much for having me today.