How to Get Out of Debt

In Generation Debt, Carmen Wong Ulrich explains how college graduates laden with debt can take back control over their finances. While she advocates budgeting and cutting back on unnecessary purchases, she also acknowledges the need for some indulgences. And she makes the case that despite the hefty debt loads carried by young adults, financial success is possible with a bit of extra work. U.S. News spoke with Ulrich about how to get there. Excerpts:

Who is “Generation Debt”?
I wrote the book with a certain group in mind—younger Americans from ages 18 to 35—but it embraces anybody in a substantial amount of debt and looking to do things like buy their first home…. This generation has certain financial concerns that are very different from previous generations’. Starting entry-level incomes haven’t really budged since the 1970s, but in the 1970s, Pell grants paid for over 80 percent of college tuition, so you could graduate without huge debt levels. Now, the norm is graduating with five figures of debt, and a college education is more important than ever. You’re starting up behind, so you have to be really careful in the beginning to set certain routines and mind-sets.

As you say, debt is almost unmanageable for many graduates. Is there really a way to get control of it?
Absolutely. The biggest way to get control is to have the attitude to get control of it. That is the biggest hump that most people in debt have to get over. It’s a real combination of attitude and behavior. It’s getting a better picture of what you want.

When you have barely any income, the mind-set has to first be to take control. You have to make the decision to do it, and you have to have a reason why. Not just, “I want to get out of debt,” but is it causing a lot of anguish? Is it because you want to own your own home? Having these concrete goals in mind helps you follow up with the actions you need. It’s like a switch in your brain. Once you flip the switch, you are much more likely to succeed. It’s kind of like stopping smoking. Something just needs to click in your head that says, “This is detrimental to me.”

As a young college graduate with a lot of debt, do you basically have to resign yourself to living a spartan lifestyle?
Spartan in the sense that you won’t have as much as the buddy whose parents could give him a free ride but not spartan in the sense that you just completed one of the best investments in your adult life. If you think in the next couple years, “I can’t have that, I can’t go there, but in a couple years, I’m going to be out of debt and I will have a home and have a car and won’t be in debt,” then maybe it’s spartan now, but you are maximizing the investment you just made, and you’re doing it all for a reason. And there are ways you can still have some luxuries.

What are some of those ways?
The best thing is, once you really know how much money you have coming in and how much you owe and how much it costs to have the things you want, then it really helps you get an idea. Do I need to get a second job? Find a higher-paying job? It gives you a realistic picture of what you can afford to do. You do need little luxuries, and you can fit them in no matter how small [your income] is, but you can’t have them all the time.

So it’s OK to have some indulgences.
Absolutely. It’s the whole dieting thing. If you go from five cookies after dinner to having one cookie, you’ll probably stick to the diet a little longer. If you’re going to have no luxuries, you’ll feel like crap. Then you’ll do stupid things like use your credit card because it all builds up inside you. You’ve got to let yourself have those little things, especially when you’re living a spartan life.

Boomers sometimes say, “Stop buying bottled water, stop buying lattes,” and I’m like, you can’t realistically ask this generation to do that. It’s part of being a social human being in your 20s and 30s.

What are your indulgences?
Music on iTunes. I take cabs once in a while. That, to me, is an indulgence. I’m always cognizant of how often I do it. And pedicures. If I can fit that in, I’m thrilled.

You make the point that you shouldn’t necessarily upgrade your lifestyle when you get a raise or a new job—do people tend to jump the gun on that?
It’s easy to think, “I’m getting a raise,” but the truth of the matter is, after taxes, especially since entry-level income levels are so low to begin with, even if you are getting a raise and especially if you are in debt, you can’t necessarily afford to make a lifestyle jump. Go get yourself a celebratory drink, but the first thing you should do is put another percentage point towards your 401(k). That’s like giving yourself another little raise. And if you are in debt, any raise you get doesn’t actually exist. Say you have $10,000 in credit card debt and $10,000 in the bank. You have no money. So you have to think about a raise that way. Until that debt is gone, you can’t really enjoy that raise.

How would you define financial management success—does it mean having no debts?
You are financially successful just if you have a handle on your finances. I don’t care if you have $20,000 in debt. If you made the commitment—got your bills automated online, are building up an emergency bundle, are funding your 401(k)—if you’re on top of these things, it doesn’t matter how much money you have, because if you are trying to get out of a situation you’re not happy with, you’re going to get there, because you put the system in place.

So you don’t have to be making $80,000 a year to get there.
No. You should feel fantastic about yourself if you’re making $35,000 and have the same amount in student loan debt, if you’re paying it on time, know how much you owe, and have some other financial goals. If you continue that way, it doesn’t matter how much money you make. So many people make six figures, and they are so poor. They are overextended. They’re not living any better than someone living on $40,000. They can’t afford to go out even once a week, and a person making $40,000 can go out a couple times a week. It’s all about how you manage what you’ve got.

Five-Star Ratings for Credit Cards?

Sen. Ron Wyden, along with cosponsor Barack Obama, wants to create an easy way for consumers to understand credit card policies by rating them according to a five-star system. The concept is similar to the five-star crash test rating system used for cars, with more stars given for more consumer-friendly policies and the Federal Reserve serving as referee. The proposal has come under fire from the credit card industry on the grounds that consumers are a diverse group and one person’s five-star card might be a one-star to someone else. U.S. News spoke with Wyden, an Oregon Democrat, about why he believes credit card reform is needed. Excerpts:

Why do we need a five-star credit card rating system?
I think a lot of these credit card agreements are almost incomprehensible. They’re written in so much legalese that anybody who doesn’t spend their day reading the Uniform Commercial Code pretty much can’t understand them. So what I want to do is make sure, as it relates to safety and debt and fairness, that the consumer gets a better shake. This is a third-path kind of approach in between what the credit card companies want to do, which is pretty much nothing, and what some say ought to be done in terms of regulating everything under the sun.

Why do we need a five-star credit card rating system?
I think a lot of these credit card agreements are almost incomprehensible. They’re written in so much legalese that anybody who doesn’t spend their day reading the Uniform Commercial Code pretty much can’t understand them. So what I want to do is make sure, as it relates to safety and debt and fairness, that the consumer gets a better shake. This is a third-path kind of approach in between what the credit card companies want to do, which is pretty much nothing, and what some say ought to be done in terms of regulating everything under the sun.

What criteria would you like to see used in judging safety?
Today, there’s a lot of advertising around some of the big issues—interest rates, annual fees, rewards, and things like that, which are areas that really are for the markets. Those are where people make their own judgments about what it is they really care the most about.

But what I want [is for] people to see an objective evaluation of whether this is a card that treats the consumer fairly and adheres to the sensible safety principles. And that involves not the question of comparing fees and interest rates and rewards, but on things like, do they hide all of the material terms in a bunch of legal jibber-jabber? Do they give people adequate notice if they make changes? Issues that go to safety and fairness, and not picking winners and losers. And I hope that we can bring that distinction out between the two, because I think if we do, we’re going to have a very powerful coalition for the legislation.

It seems that you’re saying people don’t have the information they need to make decisions.
By and large, a lot of these companies have gone to great lengths to hide a lot of what is in their agreements. And that isn’t fair. I don’t think it’s safe, given the amount of credit card debt individuals in our country have racked up.

The credit card industry has argued that even some of the criteria you mention, such as universal default, affect only a portion of consumers, so it would be impossible to develop a rating system that applies to everyone.
You’re going to have to have a debate about what the practices are that go to basic fairness and basic safety. The Congress will do that, and, if the legislation passes, the Federal Reserve really has the job, as professionals in the field, of making sure that that’s done. I happen to think universal default goes to a fundamental safety sort of question. Other people may see it differently. That’s the point of the debate.

Why do you think universal default (where credit card companies raise interest rates on cards after consumers default on other loans) is unfair?
I think to stick it to a consumer for something that’s unrelated to your relationship with [the] company isn’t in line with sort of basic commercial principles…. I think it speaks to an arbitrariness and also raises in my mind, well, where do you stop? If you’re going to now say, our agreement really doesn’t matter, we’re going to penalize you for something else, why don’t they just penalize you for all kinds of other things? I think it really violates a basic sense of fairness which is built around the idea you and I have a relationship, and we’ve got to adhere to it.

The industry just says it’s simply pricing based on risk levels. If a consumer defaults on his auto loan, then he has a better chance of defaulting on his credit loan, and the card provider needs to be paid for that risk.

My obligation is to the company I’ve signed an agreement with, and the question is: Do I meet my obligations to the person I entered into an agreement with?

Do you think it’s fundamentally fair to charge more to people who exhibit riskier behavior?
I think by and large, pricing debt is built around the proposition that you’re going to disclose all of the terms and do it in an understandable way, which isn’t what goes on today. The Government Accountability Office says [on average] credit card agreements are written at a reading level that 50 percent of Americans don’t understand. So to me, if you’re communicating what your terms are and your terms will factor in risk and the like, it is appropriate, but you’ve got to be straight with people and transparent, and that’s not being done today.

But you don’t support interest rate caps?
I’ve always felt that caps and price controls and the like end up usually harming the consumer, because there are all kinds of ways that powerful businesses and business lobbies can get around them, but the consumer gets caught. Obviously, there are some things that are so egregious and so offensive that I would vote to restrict, but I’m not a big caps fan.

Have you ever have had credit card debt?
I haven’t had any serious kinds of issues. I think once or twice as an adult, I had to pay a little back but nothing serious, certainly nothing in the last decade.

Making the Buy-or-Lease Car Decision

The decision to buy or lease a car goes well beyond a simple monthly budget calculation. While lease deals are often cheaper, they also leave consumers with no equity in their vehicles at the end of the contract. Having trouble deciding which option is best for you? Here are the key factors to consider.

The cost. Manufacturers and dealers often offer subsidies on leases to encourage consumers to drive off in one of their cars. The best deals are usually on slower-selling models. To evaluate whether or not you’re getting a good deal, focus on the four factors that determine how much money you will end up spending, says Philip Reed, senior consumer advice editor for Edmunds.com. Those factors are the monthly payments, the length of the lease, the down payment, and the mileage restrictions on the lease contract. Exceeding the mileage restrictions often leads to hefty fines, and keeping a lease for longer than three years usually forces the driver to pay for new tires and other maintenance costs.

Your budget. While leases usually offer the cheapest short-term deals because they often come with no down payment and low monthly costs, they are almost always more expensive than buying a similar car and keeping it for a decade. Of course, continuously leasing new cars, while more expensive, means always having a relatively new car. Drivers who prefer to replace their cars every few years with a new one save money by leasing instead of buying.

Life plans. Think you may move across country in three years? Or go from being a single professional to the parent of three? For consumers anticipating major life changes, leasing can provide much-needed flexibility. Selling a compact car after three years and replacing it with a minivan, for example, would be more expensive than leasing the first car and then simply returning it.

Driving habits. Leases often charge consumers for any damage to the car, in addition to exceeding mileage restrictions. That’s why Art Spinella, president of CNW Research, warns people who drive a lot, or are hard on their cars, such as Rottweiler owners, against leasing. “Excess wear and tear can cost you a lot,” he says.

More numbers. Edmunds.com offers a buy-versus-lease decision calculator, which considers taxes, financing terms, and other factors to help consumers make their decision.

Gay Couples Face Extra Financial Challenges

It may pay to get married, but not everyone has that option. The Human Rights Campaign, a civil rights organization for people who are gay, lesbian, bisexual, and transgendered, launched a campaign this week to bring attention to the financial challenges that same-sex couples are forced to deal with. The group points out that gay and lesbian couples lack the protection and benefits conferred by over 1,000 different federal provisions.

Among the disadvantages that gay couples face compared with legally married ones:

• Unmarried couples often cannot include each other on employer-based health plans without paying tax penalties.
• They often lack job protection when taking time off to care for their partner.
• They can not give Social Security survivor benefits to their partner.

The campaign offers more information and tips for dealing with such challenges.