5 Surprising Sources of Debt
By Maryalene LaPonsie
Unemployment, medical bills, a shopping addiction – these may all be obvious causes of debt, but they certainly aren't the only ways people end up in the red.
Other forms of debt are more insidious. They arrive looking like a big break or a money-saving option. But instead of getting you out of your financial hole, they actually dig you in deeper.
Don't let these five hidden sources of debt say "Gotcha!"
Your New Job
The problem: Your new job is supposed to be your ticket out of paycheck-to-paycheck living, but a big boost in income is often accompanied by a big boost in spending.
"When people get a new job, it looks like a limitless amount of money so they splurge on a new car or a buy a lot of clothes," says Joe Heider, founder of Cirrus Wealth Management in Cleveland.
Cecilia Beach Brown, a certified financial planner at Lincoln Financial Securities in Annapolis, Maryland, says it's a common trap. "When the money's there, it's hard to say 'no.'" Then people lose their job or are otherwise unable to maintain their new lifestyle.
The solution: Rather than increase your spending, continue to budget based on the amount you previously earned. Then, bank the extra for retirement, travel or a big spending goal, whether that be paying cash for a car or a 20 percent down payment on a house.
A Financial Windfall
The problem: Like a new job, a windfall can be your financial undoing. Whether it's an inheritance, divorce settlement or lottery winnings, Brown says people notoriously mishandle large sums of money that fall into their laps.
"People tend to spend money more than once in their head," Brown says. "It's the mental accounting that gets them in trouble."
By spending without a plan, people blow through their money and end up financing big purchases they can't afford that push them into debt.
The solution: Brown advocates that everyone use the one-third rule when dealing with an inflow of cash of any kind. One-third of the money should be set aside for taxes, the second third should be put in savings for the future and the final third can be used for fun.
Leasing a Car
The problem: Leasing seems like a good way to get more car for your money, but contracts can include expensive provisions that make it difficult to simply turn in a vehicle without owing cash.
"When people lease a car, they're excited and don't pay attention to what happens when they turn it in,"
Leased cars have strict mileage limits, and people who go over could get hit with fees that run from 10 to 20 cents per mile driven over the limit. In addition, there may be acquisition fees, disposition fees and early termination fees. In many cases, Heider says drivers roll one lease into another to avoid paying fees out of pocket. Then, they never get out from under their monthly vehicle payment. The solution: Think twice before leasing a vehicle, or at least read the fine print more carefully. Be realistic about how many miles you drive, and add up the total cost, including taxes and fees, to determine whether buying a reliable used car is a better deal.
A New Cellphone
The problem: You want that shiny new smartphone, and the cellphone company is happy to give it to you – provided you sign up for a two-year contract. The phone seems like a freebie, but you have, in fact, just signed up for more debt.
"Really what you're doing is taking a loan out to pay for the phone," says Phil Jacobson, managing director at United Capital in Rockford, Illinois. You're not getting the phone for free; you're financing it with your cellphone contract.
Your new phone could also cause further problems if you have an expensive data plan you can't afford. There's no way to cancel most cellphone contracts without paying a sizable fee.
The solution: Reconsider contracts. Many wireless providers now offer non-contract service options, and those may be a better choice. While it costs more to buy a new phone out of pocket, you might save money on a monthly plan. If you still want a new phone, look for a cheaper, refurbished one or get a used one from a trusted source.
Buying a House
The problem: Obviously, buying or building a house typically comes with the debt of a mortgage. However, some people compound that debt by insisting on new furnishings or expensive renovations before moving in.
"What's a couple hundred here? What's $500 there?" Heider says of many people's mindset when constructing a new home. "Then they realize they're $20,000 to $30,000 over budget."
Buying or building a house can feel like permission to replace appliances, furniture and electronics. However, it's a trap that can create a vacuum of debt and turn a dream home into a nightmare.
The solution: Having a written budget for building or renovating a house is the first step to avoiding this debt trap. The second step is to stick to the budget. Also, consider whether an existing home will have expensive maintenance issues in the near future and look for a house that is move-in ready. If you don't start a renovation project, you can't overspend on it.