Monday, August 31, 2009 | In this tough economy, we all know friends and colleagues facing financial problems. Some are making tough decisions and plotting a course for recovery. Others are making only cosmetic changes — living in ignorance or outright denial of their mounting liabilities.
Suppose a friend, Louise, is facing severe financial problems and asks for advice on handling her household budget. She lays out a list of her liabilities — from mortgage payments to multiple credit card balances.
Louise goes on to provide her forecasted monthly payments for each of these liabilities — $25 per month for Credit Card A, $50 per month for Credit Card B, $2,500 per month for a mortgage payment, and so on.
While Louise should be credited with outlining a spending plan, her approach is ultimately inadequate. Her forecast lacks any indication of whether her monthly payments will result in eliminating or even reducing the sizeable debt she faces.
A closer look at Louise’s financial condition over a five-year span from a liability standpoint reveals her dire predicament. Her mortgage is an interest-only loan, and her payment is expected to double in the coming years. Worse, she is planning to only make minimum payments on each credit card — meaning she will end the five year period in deeper credit card debt than when she started.
After constructing a true financial forecast showing all of Louise’s liabilities and incorporating her intended efforts to pay them off, a clear conclusion emerges. Louise has to find a way to cut expenses and renegotiate her liabilities. Anything short of such decisive action will perpetuate, or even make worse, Louise’s financial quandary.