We were asked today by a reporter why people get into debt and some of the reasons why people get into debt and some of the more toxic spending / debt combinations.  Here was our response:

There are a few different reasons people get into debt. 

1. Structural:  cost structure out of alignment with income.  This is a situation that doesn’t persist for long–eventually the consumer fixes this or goes bankrupt.  This can be the result of bad housing choices (as evidenced by the current housing crisis) or bad educational decisions (recent college grads are the fasted growing bankruptcy segment).  But it’s also driven by a permanent shock such as job loss, death of a wage earner, or disability.  Sometimes it’s the accumulation of bad consumption / debt choices.
2. Emergency:  This is generally a one-time spending event that has to be taken on credit since the consumer doesn’t have a buffer Emergency Savings Fund.  New tires, new roof, medical, etc. put people over the edge.
3. Discretionary:  consumer spending on autos, electronics, travel, other consumables. 
4. Investment:  schooling, home.  Ideally these are “good debt” that are essentially an investment in the future.  However, you see areas where these are not. 
   1. Housing:  38% of mortgage holders pay over 30% of income to mortgage payments.  As this is the lending guideline where customers become a real default risk, this means a surprisingly high percentage of mortgage holders took out mortgages that were too big for their means. 
   2. Education debt:  According to benchmarks from a survey by student lender Nellie Mae, borrowers who devoted less than 7% of their gross monthly income to repaying education loans generally didn’t experience any difficulty making their payments. Those with an education debt-to-income ratio of 7% to 11% felt more of a burden, which increased once the ratio reached 12% to 16% or higher. The median ratio for all borrowers was 8%.

1. OK, with that said, here are some incredibly toxic purchase / debt combinations along with alternatives:
2. Rent-to-own:  simply one of the worst decisions you can make.  You’ll two to five times the department store cost of the item, giving you an annual APR of 100-300%.  As an added bonus, since it’s correlated with poor credit behavior, showing a financing loan on your credit report automatically drops your score even if you make your payments on time.  A better option is to buy used or simply save to get the item
3. Financing for cosmetic medical procedures–Botox, liposuction, etc.  This is much more common than you’d think.  Most strip mall cosmetic shops offer in-house credit to customers who can’t pay cash.  You have to question whether going into debt for elective surgery is a smart purchase, but financing through the on-site financing will reflect negatively on your credit report, pushing up future borrowing costs.
4. Refund anticipation loans:  Frequently pitched as a quick way to get access to your refund, these loans have become a major profit driver for Tax Prep firms.  But they are roughly equivalent to a payday loan in terms of interest rates. 
5. Buying a new car:  It takes guts to put this in the list of the top 5 bad purchases, but for many Americans carrying debt it’s simply an incredibly bad move.  By buying a new car instead of used, they’re essentially paying twice for the asset:  they’ll pay interest and they’ll pay depreciation when they sell.  Further, they’ll pay more in insurance and licensing fees.  Most consumers will find it 50-60% less expensive to buy a 3-4 year old car.  If you can save and buy it with cash, the cost differential will be even greater.
6. Student loans for non-accredited schools with poor placement offices:  Although not outrageous, this just isn’t a good investment for most people.  Many find that they’ve gone into debt for an education that doesn’t increase their earnings and with a school that doesn’t have a good placement record. 
7. Student debt in general:  Even for accredited schools, students and parents make some shockingly bad choices.  Up to 40% of students eligible for federally subsidized debt actually opt for a loan through a private lender at a higher rate.  Given the large amount of debt that students take out, this can really set them back.

At GoalSpring, we’ve built our software specifically to help people avoid these pitfalls, and make paying down debt as easy and efficient as possible.   We  help users understand  the “true cost” of any purchase, show them how interest rates effect  them over time, help them negotiate effectively with their creditors , and put them into a plan to get themselves out of debt.  Our users can save an average of $40,000 in interest over the lifetime of their debt without paying any more per month than they do today.