How People Get Trapped by Debt

Debt is a huge problem in the U.S., and many people find themselves buried by it.

In this installment of Industry Focus: Financials, Motley Fool analyst Gaby Lapera talks with Dan Caplinger, The Fool's director of investment planning, about how people get into debt and why debt can quickly grow out of control. As Dan and Gaby discuss, simple changes to your behavior can help you avoid getting into trouble with debt and instead to use credit to your advantage.

A full transcript follows the video.

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This podcast was recorded on Jan. 30, 2017.

Gaby Lapera: Today, we're going to talk about debt and credit. Just so you know, debt plagues Americans. We were talking about this earlier, Dan, so I know you know, but our listeners might not, so I'm going to throw out a few statistics here. About 15% of Americans think they're going to die in debt. About 60% of Americans could not cover an unexpected expense of $500. 34% have $0 in savings, and another 35% have $1,000 or less but more than $0. The average amount of student loan debt is somewhere between $31,000 and $37,000 depending on your source. The average amount of mortgage debt is about $170,000, which I guess isn't that much of you think about houses. But today, we're going to talk about credit card debt. The average American household has about $5,700 in credit card debt. However, if you are a household that carries a balance -- which means that you don't pay off everything you owe on the credit card every month -- the average amount of debt that you have is about $16,000. That's a lot of money!

Dan Caplinger: It's a lot.

Lapera: Yeah, those are a lot of facts and figures I just threw out. It's crazy, that's a lot of money.

Caplinger: $16,000, yeah. When you think about what the median income for a typical household is -- something like $50,000 -- you're talking about, even if you took every penny that you brought in and did nothing: didn't eat, didn't pay for your house, didn't drive anywhere, you would still be spending months just getting that debt paid off.

Lapera: Yeah. And what's even crazier is that the average interest rate on a credit card is 15.2%. So, a lot of that payment would be going to interest, it wouldn't even be paying down the principal.

Caplinger: Absolutely right.

Lapera: So, let's talk a little about how we get there. How do you get to $16,000 in debt? Apparently about 38% of All American households have some sort of credit card debt, maybe not $16,000 but some sort of debt. I think, let's start with one that's common way, it's a little controversial, which is living paycheck to paycheck, so, spending all of your money every paycheck, as opposed to putting some away for unexpected expenses. The reason I say this is controversial is because I know that not everyone can afford to live their life differently, other than paycheck to paycheck. Some people just don't make enough money to live any other way. But there are plenty of people in America who do make more than enough money for their needs, and they're still spending frivolously.

Caplinger: Yeah. And that's a lot of how you end up in that paycheck to paycheck situation. And credit cards actually make it easier, in some ways. When you're really stretching to make that paycheck last as long as you can, if you still have that credit card and those last couple of days are coming up and you spent big early on, right after you got your check, then it's tempting to cover the difference with that credit card. That's how a lot of people start the ball rolling in terms of getting those big credit card balances you're talking about.

Lapera: Yeah. One of the things you could do to prevent this is make a budget and stick to it. Make a reasonable budget, I should say, and stick to that. (laughs) I don't think anyone needs to spend $500 a month on pizza unless you have a family of 24 and you're making $1 million a month. (laughs) But, you know what I mean? Some people make budgets, like, I have seen line items on some of my friends' budgets where it's like, "What? How do you think you're going to spend so much money every month on going to the movies? And you also have three movie streaming services, and you pay for cable. Do you really need all of those methods to consume media? Probably not."

Caplinger: Yeah, interestingly, a lot of credit cards will actually help you come up with a budget that will give you a spending history and break it down by category, so you can actually see how much you're spending at restaurants, how much you're spending on movies, utilities, any category that you're using that card for, you can actually use it to your advantage to figure out, "Do I really need to be spending this much on this? Maybe not," and that could free up money to pay down that balance and get rid of some of that interest and get yourself out of debt that much faster.

Lapera: Yeah, it's really cool, I just got my year-end credit card reports from my banks, and I just spent 20 minutes going over them, looking at all the miscellaneous things that I had spent money on. I spent a lot of money on Lift rides this year. (laughs) Or, I guess, last year now. That's the peril of living in a city with questionable public transportation.

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