My $45,000 Mistake

In the day-in, day-out task of covering stocks, it becomes easy to lampoon business blunders. After all, I have the benefit of hindsight for everything I write. Considering how much I've enjoyed sticking it to opponents of stock option expensing, crooks who get big bucks for their lectures, and mutual fund managers who whine about reforms, it would be easy for me to stay in my comfy perch.

But, alas, that isn't the way it works here at The Motley Fool. It's a tradition for Fool writers to admit our mistakes for the benefit of others. As I haven't eaten much crow lately, it's my turn in the chow line. Ready? Here's my confession: At the opening of 1998, my wife and I had more than $45,000 in credit card debt and no plan to get out. (Crow, meet mouth.)

I hardly knew where to start. I knew so little that when we finally talked about a plan, I suggested extra payments to my truck loan, figuring we could free up cash for the high-rate cards that we'd get to eventually. Of course, this was in my pre-Fool days, and I didn't stop to consider that my truck loan was my lowest-interest obligation, on an asset that was depreciating as fast as a boulder in the ocean.

Fortunately, my wife was a Fool, even if she didn't yet know it. She formulated a better, and more Foolish, plan, which all started with a little purple notebook.

Swimming in the (very) deep end
The notebook was key since we couldn't slay the debt dragon if we didn't know exactly what it looked like. Here's a rough picture of the ugly beast as of January 1998:

The Ugly Debt Beast
Loan/Credit card Balance Interest
Rate
Household Finance personal loan $8,423.81 24.4%
Beneficial Financial personal loan $3,395.94 22.3%
United Airlines credit card $2,956.36 22.3%
Macy's store card $364.26 21.6%
Chevron gas card $848.52 21.5%
Advanta credit card $5,844.75 21.39%
HRS computer loan $2,009.42 19.8%
CalFed credit card $5,743.32 18.9%
Citibank credit card #1 $6,883.14 17.9%
Citibank credit card #2 $4,390.43 17.9%
Capital One credit card $3,072.74 16.41%
American Express Optima credit card $1,630.32 16.4%
TOTALS $45,563.01 20.32% avg.


If this chart isn't enough, think about this: We were due to pay at least $8,000 in interest during 1998. Turns out we actually paid a little more than $9,000. Sick to your stomach yet? I was. Heck, I still get queasy thinking about it.

Bait for the loan sharks
Unsecured personal loans, though legal, seem to me a lot like loan sharking. Don't know what loan sharking is? It's a simple concept, really. A loan shark is someone with cash who loans it to people who can't go elsewhere, allowing the shark to charge through the, uh, nose in interest and fees. That's how it was for me with Household Finance Corp., now a part of HSBC (NYSE: HBC  ) . Before I was married, the financier wrote me a really nice note and included a big, fat check, which I promptly cashed because, being young and stupid, I thought I needed the money. In doing so, I accepted all the terms of their loan.

HFC immediately took advantage, of course. Right away I was hit with bills charging 20% on the principal. The rate never went lower. In fact, it topped out at 27.5% by the end of '98. For comparison's sake, consider that investing hall-of-famer Peter Lynch averaged 29% annual gains during his time leading the Fidelity Magellan (FMAGX) fund.

You want what?!
You'd think I'd have really gotten serious about wiping out our debt after seeing what HFC was doing to us. Nope. You know what we did instead? We went house shopping. We should have known better.

Back then, our monthly debt payments were more than 45% of our gross income. We didn't know that lenders tend to like applicants whose total debt, including a mortgage, is less than 40% of their gross monthly income.

And there was our credit, which stunk. We owed too much, and we had too many accounts. Of course we would have known this had we checked our credit reports. It would have told us that no lender wanted anything to do with us, except American Express (NYSE: AXP  ) , Capital One (NYSE: COF  ) , Citigroup (NYSE: C  ) , and all the others we owed money to. They loved us. How could they not? We were paying them hundreds in interest every month. I'm surprised we didn't get a few Christmas cards.

Of course, it took us less than a week to find a D.R. Horton (NYSE: DHI  ) home we really liked. Reality finally sunk in when we met with a loan officer. We were all but laughed out of his office.

I've rarely been so embarrassed or angry since. And it was all the inspiration we needed to dig our way out of our hole.

Starting over
As soon as we got home that day we vowed to start over. Our relatively simple plan -- constructed with a fair amount of help from fellow Fools on the Credit Cards discussion board -- had only four steps:

  1. Renegotiate with creditors. This actually went really well. Citibank immediately lowered our rates on request, and many others, including MBNA (NYSE: KRB  ) , issuer of the Motley Fool Visa, provided low fixed rates.
  2. Start with one thing, and only one thing. We plowed all extra funds into paying down one loan at a time, starting with HFC, our largest and highest-interest obligation.
  3. Spend every extra dime on debt reduction. We were lucky to earn some nice raises and bonuses in '98, '99, and 2000. The vast bulk of these proceeds went to paying down debt.
  4. Live below our means. Resolving to be an LBYMer had a heavy influence on our decision to leave the San Francisco Bay area for the Rockies. Doing so offered huge savings.

Although it wasn't part of our four-point plan, avoiding temptation certainly has a place on the list. The biggest temptation in '98 was stocks, for we were still living in Silicon Valley and our neighbors were getting rich investing in tech. Fortunately, I read -- and re-read -- the reprimand in The Motley Fool Investment Guide to stay away from stocks until we were debt-free. That, and some encouragement from fellow Fools, allowed us to stay the course.

Three years later, in January 2001, we emerged, debt-free and living in a new house.

You can do it, too
If you're in debt now and you're reading this, make me a promise. Get your own purple notebook and write down everything you owe and how much interest you're paying. Then compile a list of every asset you have. Total it up. You've just calculated your net worth. As you pay down debt, track this number, and watch how it improves. You'll be encouraged. Heck, you may even beat the market.

I'm not kidding. During the great bull run, we walloped the market. By investing in debt instead of speculating on stocks, we improved our net worth by more than 350%. And, now that we're debt-free, it's still rising.

Fools, I'm no miracle worker, and our story is not unique. The goal is within your reach, but you have to start sometime. There's a saying that the best time to plant a tree is 20 years ago. The second best time is today. Go get that purple notebook.

Fool contributorTim Beyersthinks inspiration can be found daily on the Fool'sCredit Cardsdiscussion board. He also thinks everyone there deserves a Happy Dance. Tim owns no stake in any company mentioned. The Motley Fool has adisclosure policy.


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