First Steps Out of Extreme Debt

When you are extreme debt, the first big steps in the right direction are the hardest.  Even if you feel completely committed to tackling your debt problem, there are just so many areas that need improvement that it is difficult to know where to focus your attention, and at the same time it feels like small changes like not buying that coffee at the coffee shop couldn't possibly dig you out of the enormous hole that you're in.

There is no shortage of good advice on personal finance blogs, or in books.  But reading through the majority of these sources, people are generally trying to eliminate something like $20-50K of student loans, on top of $5-20K in credit card debt.  Few and far between are stories of people in hundreds of thousands of dollars in debt, and still trying to stay afloat.  Perhaps this is because most people who get to this level of extreme debt just don't make it, declare bankruptcy, and pay a dear price. 

Does this mean that the general techniques for debt recover don't apply to those in extreme debt?  No, I believe the same techniques do apply, but since the problem is of a significantly larger scale, the solutions must also scale if they are going to succeed.  Also, it will likely take much longer to recover from extreme debt compared to "regular" debt, so patience and persistence are key.

The first steps you take in the right direction will seem trivial compared to the size of your debt load.  But don't let that be a reason not to take those steps anyways!  Remember, you got yourself into an extreme amount of debt through both small and large purchases, and so you can get out of it the same way, but in reverse.

Here are the first steps that I took:

1. Cut spending on anything that was not really important to me and my family.  This included things like eating out, trips to the coffee shop, new gadgets and home electronics, most new clothing, and house cleaning services.
2. Gave up our second car.  Instead, make more use of public transit, walking, bicycling and occasionally renting a car.
3. Stopped eating out for lunch at work.  Instead, bring leftovers or a quick sandwich from home.
4. Downgraded to basic cable.  No time to watch all those extra channels anyways!
5. Stopped using the dry cleaner for clothing that isn't "dry clean only".  Time to dust off that iron!
6. Switched to regular coffee from premium coffee beans.  Sure, doesn't taste quite as good, but if you experiment with different brands you can get close enough.
7. Started to grocery shop in more than one store, to maximize value from sales.
8. Consolidated as much credit card debt as possible into a new line of credit, with an interest rate of 5.75%, versus the 19% I was paying on the cards.
9. Started to investigate additional income sources, both online and off-line.

Along with all of these changes, I also started tracking my incoming, expenses and savings meticulously every month.  After a couple of months went by, what I found was that I was almost breaking even: that is, I was no longer accumulating new debt, but there was also no progress in paying off any debt.  Also, I was so close to the break-even point, that it didn't take much to push me over the line, and add a little more debt to the pile.

This was discouraging at first, but I decided to think of it as the first step, as opposed to the final solution.  And for a first step, putting the breaks on accumulating debt seemed like a reasonable accomplishment.  The key now, of course, is to take the next step, and then the next, so that we can start seeing some actual debt reduction.

Running out of Rope

Anyone in a significant amount of debt knows all too well the feeling of running out of rope.  This is a gut-wrenching, sinking feeling you have when you realize how close you are to complete financial chaos.  Now, for those people without any significant debt-load, you may see a situation such as mine as financial chaos in the first place, and you are probably right.  But for those of us in the midst of such a situation, chaos means not knowing how you are going to pay your basic bills, or buy groceries for your family, or simply make the ends that you have meet anymore.

When you have extreme amounts of debt, you become good at finding ways to pay what you need to pay.  When I say "good", I don't mean good in the financially sound sense, but good in the get-it-done-at-all-costs way.  You may do things like withdraw some cash from a credit card, transfer money around between credit cards or lines of credit to make minimum payments, or even withdraw from retirement or other savings.  All of this behaviour is why you are in debt in the first place, but regardless, when you have an expense staring you in the face that you feel must be paid, this is what generally takes place.

But what happens when you start to run out of options?  First, panic.  Your mind frantically starts searching for other possible alternatives.  When you can't think of any, the panic increases, followed by a deep sense of dread.  Could this be the end?  Will I lose everything?  Unfortunately, for someone in extreme debt, this is not just paranoid thinking--it could happen on any given day that brings just too many expenses to handle, despite how many financially questionable tricks you have up your sleeve.

Of course, anyone in this situation knows what the right thing to do is: cut back spending to only what is absolutely necessary, make sure this results in you spending less than you earn, and use the difference to pay down the debt for as long as that takes.  But the problem, of course, is that while this may be so incredible simple in concept, it is very, very difficult to implement when you have so many conflicting habits rooted in your life.

For example, if your mortgage is so large that the payments consume too much of your income, there is no way to reduce these payments other than to sell your house and move to a less expensive one, or a rented property.  According to basic math, there is no doubt that this is the #1 fastest way to fix your financial problems.  But selling your house is a huge emotional endeavour, not to mention a logistical one, and gaining the mental momentum to actually do this, unless you have no other choice, is extremely uncommon. 


This is the case for me: as I have mentioned previously, we bought the most expensive house the bank would allow us to finance, and we absolutely love everything about it.  Giving up the house, the area, the neighbours, and the life here that we expect our children to have would be a huge sacrifice, and not one we feel able to make.  On the other hand, selling this house would immediately wipe out the vast majority of our debt, and would likely leave us free and clear.  We could easily afford to rent a nice enough house in a nice enough area for several years, while we accumulated the cash to buy another house in the same area we are in now.



Doing what you know is the right thing financially is far from easy.  But when you start running out of rope, and are losing your other options, everything is on the table.  That said, I think that until you are forced to make a major change that everything but the dollars and cents says is right, it just will not happen.

Driving and Money

To turn around your financial life, you need to take a holistic approach.  That is, you cannot make changes in some areas of your life, while leaving others the way they were.  Without applying a new way of dealing with money, and everything related to money, to every area of your life, your savings in one area will simply leak out another.

A good example of this is driving.  Until recently, I had always been someone who drove a little faster than the speed limit (and sometimes, without even paying attention, quite a lot faster).  I also did not take much care to fully stop at stop signs, or follow other rules of the road too closely.  For years, this seemed fine--I did get the occasional minor ticket every couple years, but nothing to worry about.

Then, all of a sudden, over the course of just over three years, I ended up with four minor tickets: three for speeding and one for an illegal U-turn.  To make matters worse, I then had a car accident which included a charge for an unsafe turn, a ticket for not having my ownership signed (who knew I hadn't signed it for the years that I'd had it), and a ticket for not completely stopping at a stop sign.  Uh Oh.

At first, I was frustrated and confused as to why I was being caught for what seemed like so many insignificant issues, especially when I had been driving the same way for many years.  Having this many convictions on my record will certainly result in a huge insurance rate increase, which is the last thing I need, and flies in the face of all the other changes we have made to get our financial situation under control.

But then, it dawned on me: if I was serious about revamping my financial outlook, it was hypocritical to continue to drive the way I was used to.  An article on The Simple Dollar with some Thoughts on Speeding drove the point home.  From that moment on, I decided to completely change my driving habits: it was time to slow down, and obey all the rules.


The first week or so of driving this way seemed unnatural, and I had to continuously resist the urge to speed up.  One useful technique I continue to use is to put on the cruise control when I hit the speed limit, as long as the road is open (which is when speeding is most tempting anyways).  But after the initial adjustment period, this new, slower, safer way of driving seemed just fine.  In some ways, it is a relief not to have to worry about passing cars--now I just smile when I see someone weaving through traffic, trying to get home 10 minutes before everyone else.

The moral of this story is that there are many obvious ways that you can reduce spending, and manage your finances more responsibly.  But there are also some less obvious areas of your life, where your behaviour can eventually result in places where your money will start to leak out.  Sometimes, sealing those leaks requires a change in mindset about what is really important.

Living on the Edge

Most personal finance blogs and articles focus on getting out of debt so that you have the freedom to put your dollars towards what really matters to you.  For some, it is buying a nice house in the right neighbourhood.  For others, it is starting and providing for a family.  There are many lofty and admirable goals that can be achieved once you are freed from the risk of a large debt load, and the burden of large interest payments each month.


But what if you went into debt in the first place to conquer those lofty goals?  In my case, I put myself and my family in over half a million dollars worth of debt to get us where we are today.  Yes, some of that money was spent on frivolous things, but it also bought us the house we have always wanted, in what we think is the perfect area, a roomy and reliable van to move us around, everything our children have needed, a top-notch home theatre, and more.  Do I regret making these purchases?  No--they have built the foundation for a truly fulfilling life, filled with what is important to me.  Do I regret accumulating this much debt?  Yes, of course.


You may ask whether I would make the same decisions again if I had the opportunity to do it all again.  This is hard to say.  On one hand, if I had the knowledge and experience I do now, after living with this incredible debt load for some time, that would definitely changes my mind about some of the less "vital" purchases.  On the other hand, I feel that by getting ourselves into our ultimate home, and by starting our family earlier, even before we could really afford to, we have had so many life-defining experiences that we would have been denied for quite a number of years.

From a purely logical point of view, debt is bad, and should be avoided at almost all costs.  But we do not live in a purely logical world: emotion is what defines our humanity, and drives our decisions.  Of course, emotion can drive us to extremes, where we end up going completely over the financial cliff, with devastating results.  You may think that I am teetering on the edge of that cliff right now, and you may be right.  But I prefer to see myself as standing firmly next to that cliff, standing strong and steady, and getting ready to start backing away from it.

I would never advise someone to get into extreme debt to finance their dreams, and then deal with the consequences.  That, however, is what I have done, and am doing.  Stopping myself from toppling over the edge has taken some significant changes in our lives, and even more changes will be needed to start us backing away.  Yes, with all the changes we have made, we are now no longer accumulating new debt, but we aren't able t pay much of it off, either.  But one step at a time: until you have a solid footing under you, it is impossible to start taking steps in the right direction.

A Lesson in Emergency Funds

One of the most common pieces of advice for those trying to get out of debt is to build an emergency fund.  This makes perfect sense: without an emergency fund, you will end up going further into debt to finance any unexpected, but necessary expenses.

Soon after I decided to put the breaks on the years and years of accumulating debt, I took this advice to heart and setup an ING Direct sub-account called "Emergency Fund".  I setup automatic transfers of $100 every two weeks, on payday, so that after a few months I would reach the $1,000 that the experts agree is the minimum size for an emergency fund.

It felt very strange to actually have a few dollars saved in the bank.  Whenever I had a few extra dollars in the past, from a bonus at work or even a birthday cheque, it went directly towards one of the many credit card balances I was carrying.  Unfortunately, because those balances were so high, nothing really made much of a dent in them, and within a few weeks I would spend enough to eliminate any gains.  But now, there were actually dollars building up that were not being spent soon after.  Fantastic!

A few weeks later, as I was pulling out of a parking lot onto a busy street, CRASH.  I collided with a car that was travelling down the centre lane, that I didn't see coming.  The damage?  About $3,000 between both our cars, and I was on the hook for all of it, lest she file an insurance claim and my rates go up even further.

Talk about a lesson in emergency funds!  If only I had been building my emergency fund months or years earlier, I would have simply withdrawn the $3,000 in cash, perhaps negotiating a discount for paying in cash, and moved on.  Unfortunately, at that point I had only saved about $400 in my fund.  Rats.

I decided to leave the $400 in the emergency fund, and as painful as it was, I put the repairs on a credit card.  After all I had learned and committed to do in terms of a debt reduction plan, this felt like going back to old habits.  But I tried to see it as a necessary evil, only necessary because I had not yet made enough progress to do things properly.  I vowed to continue to build my emergency fund, to avoid this type of situation in the future.

My emergency fund is now close to $1,000, and I plan to continue to build it at the same $100 every-other-week pace for quite some time.  Hopefully, but the time the next emergency hits, it will serve its purpose.

Babies and Houses and Debt, Oh My!

In the first two instalments of the introduction to our extreme debt story, you heard about where it all began, in the pre-debt era, and how we lay the foundation for extreme debt, in marriage and mortgage. In this third and final chapter to this introduction, we will see how we rapidly built on that debt foundation to get to the extreme situation we are in today.

As you may recall, we had a house, a couple of cars, and a total of $260,000 in debt, $60,000 of which was on two lines of credit, and $200,000 being a mortgage. Also, thanks to the newly opened second line of credit, we had plenty of room on our credit cards to continue to make more and more purchases.

But before we could get too far down that path, we took things to a whole new level. We decided to have children! Out came two astoundingly wonderful babies, about 18 months apart. (OK, I admit, it's easy for me to describe that in once sentence, while it was just a tad more involved for their mother.) While we have absolutely no regrets in the world about having kids, they certainly helped us to put that available credit on the credit cards to good use.

Once the second child arrived, we decided it was time to go house hunting again. While we thought our current house was OK, we thought that some extra space would be handy, and perhaps a nicer area for the kids to grow up in. After a few short weeks, we found exactly what we were looking for: 2,500 square feet on a quiet, family-oriented street. And the good news (good from my financially ignorant view at the time) was that the purchase price was exactly the maximum that we could spend.

Here's how the numbers worked out: The house cost $650,000 (such a big number that I didn't even have a frame of reference to understand its magnitude). We made a $150,000 profit from selling our old house, and the bank pre-authorized a maximum $500,000 mortgage. Perfect!

Well, almost perfect. One problem was that one of our two $30,000 lines of credit was a secured mortgage against our old house, so it needed to be paid off before we could do the deal. This resulted in a mad scramble of balance transfers and other credit card shenanigans to shift that $30,000 from the secured line of credit over to the cards. This process was completed just days before the sale went through. Talk about cutting it close!

The move itself resulted in a whole bunch of additional expenses, and we used the last bits of available credit to spruce up a few areas of the house, even though it was quite lovely already. The end result is our current situation: A $500,000 mortgage, $95,000 in credit card and line of credit debt, and $12,000 remaining on our car.

Grand total: $607,000.

When I think about that number, I try to visualize all of the things it bought us. Obviously, the largest chunk is the house, and despite its huge price tag, we could not be happier living where we are. It just feels right. Exactly the number and types of rooms we want, just the right amount of space, and a fantastic street with warm and friendly neighbours. Given all that, would I make the same decision to buy this house again, if I had another chance? Absolutely. While I am much more aware of the implications and risks of debt now than I was then, the daily fulfilment that living here provides seems to be worth the cost, and worth the risk.

What about everything else? Not quite the same feeling. There are many, many purchases that I would not make again, if I had another chance. Thankfully, about a month ago, some new synapse fired in my brain, and all of a sudden I starting thinking differently about debt. This didn't seem to be triggered by something specific: it just happened. I went from not really caring how much debt I was carrying, and merrily paying the minimums each month, to wanting desperately to eliminate every last cent of that I owed.

With this new mindset has come a lot of research, and based on that a lot of changes. We have yet to really see the positive impact of those changes, but hopefully that will start to happen. But the question is, with the mammoth size of what we owe, will we be able/willing to make enough changes to even start to pay this off, let alone eliminate it?

Only time will tell, and it will be a pleasure to have you along for the ride. Now that you know how we got to where we are today, new posts will focus on specific personal finance topics, techniques and discussions, including what we've tried, how it's turned out, and where we go from here.

Remember, this extreme debt story does not yet have an ending. If your debt situation is also open ended, then I hope that the insights I share here will be of value to you, as you figure out where your own story will take you.

Marriage and Mortgage

After several years of dating, I finally proposed. And she said yes! We both have big families, so the wedding was, well, big. Thankfully, our parents covered a good part of the cost, so wedding expenses are not a big part of this debt story.

Our guests were very generous with their monetary gifts, which totalled over $30,000. Jackpot!

Well, except that by that point, our debt had piled up to... wait for it... $30,000.

Oh, happy day! Paying off each credit card and the line of credit felt fantastic. You would think that this would have caused some sort of epiphany, where we would no longer spend more than we made, to take full advantage of this free pass. After all, how many people have the chance to completely wipe out their debt in one night?

Well, that's not exactly what happened. Instead, we went house hunting! After a few exciting weeks of looking at houses, we settled on a nice three-bedroom bungalow just outside of downtown. We put in an offer of $300,000, and it was accepted. In order to avoid a high-ratio mortgage, we decided to put 25% down.

Quick, time to come up with $75,000!

I cashed out my retirement savings under a plan that allows you to do this tax-free for first-time home buyers, which left us about $30,000 short. Good thing that line of credit is paid off, I thought to myself, and promptly withdrew the rest of the down payment from it.

And just like that, we went from being $30,000 in consumer debt, to being completely out of debt, to being back in $30,000 of consumer debt, plus a $225,000 mortgage. And of course, we had depleted all of our retirement savings as well.

What fuelled these decisions? Two things: emotion and lack of financial awareness. The whirlwind of getting married followed by talk of buying a house stirs up a great deal of emotion, which generates seemingly unstoppable momentum. The thought of not buying a house right away, and instead saving up for it down the road, didn't even cross our minds. And our lack of financial awareness, in terms of the impact of taking on this type of debt, meant no red flags were raised.

All of that said, we were tremendously happy to move into the house a few months later, and other than the debt (which rarely crossed our minds anyways), that house was a positive experience from start to finish. A classic case of ignorance being bliss.

Because of that bliss, we also continued to make many more purchases, take vacations, and just generally throw the plastic around without a care. Within a couple years, we had repeated our previous accomplishment, accumulating a new $30,000 of credit card debt. Seeing the credit cards near their limits, I took out a secured line of credit against the house (also known as a second mortgage), and transferred all the card balances to it.

Yes, that's right--we now had two lines of credit, with a total of $60,000 of debt on them, plus about $200,000 remaining on our mortgage.

What continues to amaze me now is how little that situation concerned me at the time. Somehow, I felt that as long as I could keep making the minimum payments, and had enough credit available for day-to-day expenses, all was well. I can't explain it in any other way other than complete and total ignorance about the potential risks of this type of situation.

We weren't done yet. In the next, and final instalment of the background story of how we got here, we hit and exceed the half-million-dollar mark. Stay tuned.

In the Beginning: The Pre-Debt Era

In the beginning, we had no debt. But you have to look pretty far back for this--in fact, before there was even a "we"--it was just me.

I moved out from my parents house, where I grew up, when I was about 20-years-old, and rented a reasonable sized apartment for about $1,000 per month. I was still going to college at the time, and was working at a part-time job, which paid enough to cover the rent and basic living expenses.

At that point, I had absolutely no financial worries, and the thought of accumulating some debt seemed perfectly fine. After all, my income would keep going up, and there would be plenty of time to pay things off. So, I started to make purchases without a second thought. Small, medium, large and really large.

I regularly ate out for lunch and dinner, either fast food or restaurants, most days. I bought plenty of computer and technology gear. I subscribed to the premium TV package, including an excessive amount of sports channels, for well over $100 per month. I leased a brand new sporty car for almost $500 per month. I went on several vacations, staying in nice hotels, and eating in nice restaurants. Basically, if something came to mind that I liked, I bought it on the spot.

Over the months, the balances on my credit cards began to rise, to the point where there was something like $20,000 in debt on them. I easily made the minimum payments, and didn't give a second thought to the interest I was paying, which was about 20% per year. I realized I was paying it, but oddly, was completely fine with this expense.

When I look back on this time of my life, the time when I first ventured out on my own, it is painfully obviously how easy it would have been for me to never have accumulated any debt at all. As many personal finance experts point out, not accumulating debt is all about spending less than you make (duh), and delaying purchases long enough that you always obey this rule. Oh, to have the benefit of hindsight when you first arrive in the world of financial responsibility!

But alas, lamenting the past will certainly not improve the future. And as silly as the above behaviour may seem, it pales in comparison to what comes next. More on that next time.

Prologue

We are a family of four--a husband (thats me), a wife and two young children. We live in a nice, 2,500-square-foot house, drive a late model car, and have all of the niceties you might expect of an upper middle class family.

The problem is that we don't fully own any of it. We have over half a million dollars in debt--about $610,000 to be more precise. This is a combination of a large mortgage (about $500,000) and unsecured lines of credit and credit cards (about $110,000).

Woah. Yup. That's a lot.

How did this happen? What are we doing about it? That's a long story, and one that I will tell you over the coming weeks and months. I will start at the beginning, and won't leave anything out. I'll give you the blow-by-blow of what decisions (or lack thereof) created this situation. Why? So that others can hopefully avoid many of the pitfalls we have fallen in to.

This is not a blog about how to recover from extreme debt. At least, not yet. It would not be truthful to write about how to recover from this kind of extreme debt, because we have not done it yet. We are certainly trying, and I will write about what approaches we are taking, and how things are turning out.

I read many personal finance blogs, and have read many related books. Many have great advice, and I do not intend to restate it. Instead, I will tell you exactly how that advice works in an extreme situation such as ours, and the behind-the-eyeballs consideration that takes place before making drastic changes in your life, as much of this advice suggests.

Ultimately, I hope that by telling this story, both the parts that have already happened, as well as the parts that are yet to come, I will give comfort to those of you out there who are in similar situations. Perhaps not as extreme, or perhaps worse (although I have come across few in that category). I hope I will also give you some ideas about how to tackle your financial situation, and how you might think and feel differently about the bind that you're in.

Welcome--it is a great pleasure to have you here.