Ever wonder what factors lead some people to go into debt, which can negatively impact your credit score? We interviewed Catherine P. Montalto, Ph.D., associate professor in the College of Education and Human Ecology at The Ohio State University, about spending behavior and how people can motivate to become better money managers.
Q. Being a poor money manager is more about behavior than about money. Are there any common personality traits among debtors (besides that they're all in debt)?
A. People who are financially healthy share two common personality characteristics: they pay themselves first, and they have a spending plan.
Paying yourself first means that as soon as you receive your paycheck, you put a predetermined portion of that pay into a savings account. A general rule of thumb is to save 10 percent -- but the more you are able to save, the better! Money in savings grows because of interest compounding. Saving just $15 a week (equal to the cost of one pizza) at 5 percent compounded interest would grow to nearly $3,500 in four years and over $10,000 in 10 years. Money set aside in savings not only provides resources for unexpected emergencies (for example, an unexpected medical or automobile expense) but also allows you to build up savings that can be used for future purchases.
Having a spending plan means that you think purposefully about what you want to buy and how much it will cost. Additionally, you compare what you want to spend against the money you have available for spending, and adjust accordingly. With a spending plan you are able to track where your money goes, and make sure that money is available to purchase the things you need or plan to buy.
People who carry credit card debt pay large amounts of interest on their debt, and take an unplanned approach to spending.
Credit card debt is expensive. Interest rates applied to the unpaid balance on a credit card can range from 11 percent to 25 percent. If only minimum payments are made on a credit card balance of $500, at an interest rate of 15 percent, it would take two years and seven months to pay off the credit card debt, and the total interest paid would be over $103. Basically, you are paying back $603 to cover $500 worth of spending on credit! Good money management involves paying down credit card debt -- the more you are able to pay off each month, the sooner the debt will be paid off, and the lower the total amount of interest paid.
When spending is unplanned, it is easy to lose track of money and to come up short when it is time to buy needed items.
Q. What is the best way to motivate someone to become a better money manager?
A. Personal goals provide important motivation for managing money well. Goals need to be SMART -- specific, measureable, attainable, relevant, and timely. The goal to get out of debt is very broad. A more specific goal would be to pay off the credit card balance of $500 within one year. This specific, measureable goal can be reached with planned payments of $48 per month. As a result, in 12 months the credit card would be paid off, with total interest paid of only $39. Once the credit card debt is paid off, the specific, measureable goal could be to continue to save $48 each month. And this saving represents "paying yourself first."
Catherine P. Montalto, Ph.D., is an associate professor in the College of Education and Human Ecology, Department of Human Sciences at The Ohio State University.