A lot of people think that a debt crisis can be solved by simply increasing their income. While a higher income level can really help you pay off your debts, it is not right to assume immediately that it can avert a financial problem.
According to an article published on CNN.com, the income divide is increasing between the top 5% of Americans and the bottom 95%. But while the income difference is getting bigger, so is the debt. As the rich gets richer, the 95% have to make do with the wealth that is left behind. As they divide it amongst themselves, they find that it is not enough to keep up with the lifestyle that they are used to. That means they have to take in more debt. In 1983 they owed 62 cents for $1 earned. In 2007, they borrowed $1.48 for every dollar that they take home. This deficit is what puts them further in debt – which becomes a vicious cycle that leads to a financial crisis.
The article stated that the rich, having more extra money, puts it to where the 95% can borrow it. That is how they get even more rich and the rest are buried deeper in debt.
While all of these are true, does that mean the rich are not in debt because they have a higher income level than the rest? Well here is where we will try to make things clearer. A higher income does not necessarily mean you will be spared from a debt crisis. In fact, the article from the CNN website mentioned that Americans “used debt to climb up the societal ladder.” Their intention to keep up with the lifestyle they got used to is the reason why they take on more debt – even if they clearly cannot afford it.
2 realities about debt and your income level
There seems to be a lot of confusion about the relationship of debt with one’s income level. If you think about it, it does seem logical that increasing your income will lead to less debt. But that is not the sole factor that you have to consider here.
To illustrate further, let us discuss two realities about the relationship between debt and your income level.
Reality 1: Earning more does not guarantee you will be debt free.
Here’s the truth, earning more, while it will help avoid a debt crisis, does not guarantee that you will be spared from it. There are people earning a six figure income but are under so much debt. In the same way, there are those earning the minimum wage but are not burdened by debt.
It is not about how much money you are earning. It is how you choose to spend that money that will really guarantee that you will not be put in a financial crisis. If you earn $100,000 a year and you spend on a lifestyle that costs $110,000, that will put you in debt. But if you earn $40,000 a year and you spend $35,000, that will give you enough savings for the rainy day.
There are many rules when you get an increase in income and one of them is to keep yourself from updating your lifestyle immediately. At least, do not be too quick to upgrade your life without looking at more important expenses like saving up for retirement or your kid’s tuition. You may have debts to pay off or an emergency fund to build. These are more important places to put your income increase rather than that vacation home that you do not really need.
Reality 2: Being debt free does not guarantee you will gain financial wealth.
Another truth that you need to learn about is that being debt free also does not guarantee that you can build up your financial wealth to its full potential. It can help because you are not wasting your money on interest. But that does not mean you will be growing your money at a rate that it should. In some cases, debt is needed to help you push your wealth to its full earning potential.
Here’s an example. Let us say you have saved $50,000. You look for a home worth $250,000 and used your savings as down payment. You then applied for a 30 year mortgage loan for the $200,000. Once the home is yours, you rented it out for $1,500. If you subtract the monthly amortization for the loan (which will fall at $1,073 a month assuming a 5% APR), you will still earn more than $400 a month.
Imagine if you just let that money stay in your account and you saved up for the home because you did not want to end up in debt. It will take you years before you can buy that home investment. In the meantime, your money will only take in so much interest in the bank.
If you really want to grow your money, there are instances when you have to put yourself in debt. You just have to make sure that you will practice the right payment behavior to ensure that your debt will not get ahead of you.
In the end, what we learn from these two realities is that there are certain financial concepts that makes more sense than simply earning more. You can go beyond your preconceived notions about debt. it can help you grow your wealth. You just have to learn how to be wise when it comes to financial management. That is how you avoid a debt crisis.
6 characteristics that will keep you from a financial crisis
As you can see, it is not really about earning more that will help you become a financial success. Sometimes, what you really need is to change your attitude about your finances. You need to find out your priorities – especially when it comes to your debt level.
While debt can help you grow your money, you have to understand that it only applies to certain type of debts. There are still debts that can destroy you and lead to a debt crisis when it gets out of hand. An example of this is credit card debt.
A study done by Bankrate.com revealed that 28% of Americans have more credit card debt than their savings. Definitely, you want to have more savings than debt so you should revise your personal financial habits to turn things around. We have a lot to learn about our finances and it pays to begin by learning the habits that will help us become better managers of our money.
In a previous article, we discussed the characteristics of a modest millionaire. Now, let us discuss the 6 traits that will help you avoid the compulsion to take on unnecessary debt.
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Practicality. Being practical will help you make better choices when it comes to your spending. The spending rule you will live by is this: if you do not need it, you will not buy it.
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Self confidence. This simply means you feel good about yourself no matter how many possessions you own.
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Patience. Credit card teaches us to be impatient because it allows us to purchase things on credit. That means we borrow money to pay for something that we cannot afford to pay in cash. You need to learn the opposite. You have to be patient so you can wait until you have saved the money before buying something.
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Organized. You also want to be organized so you can manage your finances well. You want everything to be in order so you can identify the key points in your finances that will help you make a smart decision about it.
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Self reliance. You also want to be self reliant. That simply means you do not want to rely on other people’s money to help get what you need.
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Sense of responsibility. Lastly, you want to possess a sense of responsibility. You know that you are responsible with your actions and that should help make you more conscious about your decisions.
Keep all of these traits in mind and start developing them if you really want to avoid a debt crisis.