The Importance of Understanding Your Debt

There’s a crisis that hits millions of Americans every single year.

And it’s one that with the right information and the right tools can be avoided.

I’m talking about debt. Crippling debt.

If you’re like most, you might feel like you’re drowning in debt, whether that be from student loans, credit cards, medical bills – you name it.

The good news is that having debt does not stop you from setting out on your wealth building journey.

In fact, understanding debt is one of the most important aspects of wealth building. In fact, there are many people who don’t understand their debts, and when this happens, it can leave them feeling like they’re, suffocating, or drowning in their debt.

Take this real-life experience from the 2008-2010 real estate meltdown…

Folks signed up for loans they didn’t fully understand.

One of them was Richard Varno. He sold his house after he lost his job. In turn, he thought this would get rid of his mortgage debt.

But then he got a phone call.

It was the second lien holder… asking for its $25,000. He didn’t understand what was happening.

(A lien holder is a lender that has legal interest in the property you own until you pay the debt for that property in full.)

“I told them, ‘Hey, you guys released the title,’” he said. “As far as I know, I’m off the hook.” Well, he was on the hook. Part of his mortgage included a “promise to pay” in the promissory note, or a written promise to pay a certain amount of money. That includes when the collateral is gone as well.

Then there was Vanessa Corey, who didn’t understand her debt, either. After a divorce and slowing economy, she couldn’t afford to keep her home. In 2010 she thought she could get out from under her mortgage debt by doing a short sale.

Looking at these stories, the truth becomes clear: People don’t understand the crippling debt they are signing up for.

Talking to CNN Money about the balance of her mortgage after the short sale, she said, “My understanding was that the deficiency [the difference between her mortgage and the sale price] was negotiated away.” It wasn’t. She didn’t fully understand the terms of her mortgage agreement. And she ended up having to declare bankruptcy.

Stories like these are all too common. But mortgage debt isn’t the only type of debt that’s misunderstood. Student loan debt is, as well.

In 2022, according to the most recent data, student loan now stands at over $1.75 trillion. And many former students don’t understand the debt they signed for. 

Understanding Debt

According to a study conducted by the National Association of Realtors and Morning Consultants, only 23% of student debt holders understood the cost of going to college before they took out loans, leaving the remaining 77% who didn’t understand the cost later drowning in debt after graduation.

At some rudimentary level, we all understand that spending money we don’t have makes us poorer. But in our daily lives, many of us go into debt with little thinking. We view it as a necessity. We buy homes with it. And cars. And boats. And toys. Vacations. Even that daily latte.

As I write this, the average American has at $90,460 in consumer debt, according to debt.org. Average credit card debt stands at $5,668 per person (according to moneygeek.com).

What’s scary is not the principal amount due on these (crippling) debts—but the unseen total cost (including interest) that must be paid back. It’s much more than most people realize.

Let me give you two examples.

Let’s say that, like most Americans, you are in the habit of buying things with credit cards. After a while, you notice that you have accumulated $20,000 in total debt. You decide to cut up your cards and repay your debt. You can devote $480 per month to paying it back. How long will it take and how much will it cost you?

It will take you nearly 5 years to pay off the credit card debt at 14.99% interest. And your total payments will be $28,419. Of that, $8,419 will have been in interest payments. That’s almost 50% more than what you originally “spent.”

Or let’s take a $250,000 home on which you take a $220,000 loan with a 5% interest rate over 30 years. The mortgage payments are $1,181 per month (not including property taxes and insurance).

But how much will that house really cost you, including interest payments? You will end up paying $425,166 for that house. Over half of that—$204,166—will have been to interest payments alone.

That’s a big, wealth-draining cost.

Drowning in Debt: Why the Problem Won’t Go Away

The question that comes to mind is: If it’s so important, why don’t people get better at understanding their debt?

The answer is simple:the commercial community (bankers and manufacturers) don’t want you to understand debt. And neither does the government. These institutions want you to like debt. They want you to use it. They want you to go into debt because it is good for them.

When you take out a mortgage to buy a home, or sign a lease on a car, or use credit cards to pay for expenses, the commercial community profits. The manufacturers make money on products you may or may not need. And the banks make money on your debt.

Since no one is on your side to help you when it comes to understanding your debt, what can you really do?

Take Control: Understand Your Debt 

Ask yourself two questions before you buy anything or take on debt:

• “How much does it cost?”

Right now, I want you to go get a copy of all of your debt statements. Grab a copy of your mortgage, auto loans, credit card statements and agreements, and any statements dealing with personal loans, business loans, or student loans.

Now, look over those statements and identify the terms of your loans. How much are your payments? Over how many months? What interest rate are you paying?

Next, I want you to learn how much interest you will pay over the life of each loan. Plug your loan information into a mortgage or loan calculator. You will understand the true cost of your debts when you do this.

If you are having trouble understanding anything in the documents, review them with a friend, family member, CPA, or attorney who does. It’s important that you know what you have signed for.

• “Can I afford it?”

This question is a bit harder to answer. How much you can afford depends on several factors.

If you are troubled by a large amount of debt you don’t understand, know this: You can learn. Decide to banish your ignorance regarding debt.

With an understanding of your debt, you can then begin the hard work of digging yourself out so that you don’t have crippling debt. But only after you do the work necessary to understand what your debt is costing you. If you don’t understand your debt, you’ll be forever stuck in a hole you can’t climb out of. Don’t let that be you.

Do the action steps outlined above right now. You’ll finally understand the costs of your debt. And then, once you have an understanding of your debt, you’ll be ready to take decisive action to get out of it.