You May Be Broke and Not Know It(bloomberg.com)
bloomberg.com
You May Be Broke and Not Know It
http://www.bloomberg.com/news/articles/2016-08-10/you-may-be-broke-and-not-know-it
13 comments
"It doesn’t feel good when your net worth is a negative number. But many of these debtors aren’t necessarily doing something wrong. It can make sense to borrow when you’re young—to get an education, buy a home, or even sometimes to meet emergency expenses—as long as you’re pretty sure you can pay it off later when you’re earning more money."
(Regardless, the article is quite shallow and it seems to come from the Department of the Bleeding Obvious).
(Regardless, the article is quite shallow and it seems to come from the Department of the Bleeding Obvious).
To properly balance the equation, the skills and future time a person has would need to be valued at something greater than zero.
If you view education as an asset then borrowing to fund it is a normal value proposition.
If you view education as an asset then borrowing to fund it is a normal value proposition.
This.
Also, "reducing" your net worth may be a great decision. Talking about your example, if I had $100k in a bank, it would make perfect financial sense to borrow $100k and get that degree, while getting in the red.
People already understand this when they talk about business — and a lot of companies routinely have a lot of debt without any problem, because they make this money work. Why not apply the same logic to people?
Also, "reducing" your net worth may be a great decision. Talking about your example, if I had $100k in a bank, it would make perfect financial sense to borrow $100k and get that degree, while getting in the red.
People already understand this when they talk about business — and a lot of companies routinely have a lot of debt without any problem, because they make this money work. Why not apply the same logic to people?
It's probably different in USA, but in lots of countries there is no such thing as a personal bankruptcy. So, that (once not so large) personal debt can just keep to weigh you down for the rest of your life, if not even worse.
FWIW, you can't escape student loan debt in the USA -- even in bankruptcy. It is not "wiped away" and you will owe it (until it is paid, with heavy interest) forever.
Re B and your med school scenario:
If you're living paycheck to paycheck, or just barely above, then yes, you'd be broke. In particular, a lot of people in this situation find themselves treading water, financially. Their income may grow, but so does their debt (accruing interest and more debt due to lack of cash). They're not insolvent, until they lose their job. But they're also not able to (reasonably, many still do) spend money on much beyond necessities.
If you're living paycheck to paycheck, or just barely above, then yes, you'd be broke. In particular, a lot of people in this situation find themselves treading water, financially. Their income may grow, but so does their debt (accruing interest and more debt due to lack of cash). They're not insolvent, until they lose their job. But they're also not able to (reasonably, many still do) spend money on much beyond necessities.
But this scenario doesn't apply to the vast, vast majority of folks in the med school situation. These newly minted doctors will make low wages in residency, but they are still great credit risks because they can be expected to make much higher salary in the future withOUT the need to acquire additional debt.
The problem with these "insolvency" calculations is that by going into debt for education you are trading cash for future earning potential. If you valued that future earning potential like an annuity, it many cases it would be worth millions of dollars, but straight net worth calculations value it at 0.
Of course, the problem with student debt is that a lot of folks are making really bad investments on that "annuity" - trading large sums of cash for a minimal if any increase in future earning potential. Despite all the upheaval in medicine, however, almost all doctors can expect to make much, much more income after they finish residency.
The problem with these "insolvency" calculations is that by going into debt for education you are trading cash for future earning potential. If you valued that future earning potential like an annuity, it many cases it would be worth millions of dollars, but straight net worth calculations value it at 0.
Of course, the problem with student debt is that a lot of folks are making really bad investments on that "annuity" - trading large sums of cash for a minimal if any increase in future earning potential. Despite all the upheaval in medicine, however, almost all doctors can expect to make much, much more income after they finish residency.
Not to mention that, by Bloomberg's standards, most companies are "broke".
Debt isn't intrinsically good or bad, it can be very good in the right situation. I, as OP, recently left grad school with over $100k in debt, which will be paid easily in less than 5 years.
Debt allows you to leverage your future earnings to do something now. I wouldn't be able to pay for grad school without debt, and would be in a worse situation without it.
Debt isn't intrinsically good or bad, it can be very good in the right situation. I, as OP, recently left grad school with over $100k in debt, which will be paid easily in less than 5 years.
Debt allows you to leverage your future earnings to do something now. I wouldn't be able to pay for grad school without debt, and would be in a worse situation without it.
As long as you graduate - but if you drop out of med school then what?
There's a third way to be poor: cash poor. Technically positive net worth, but the assets aren't liquid or accessible.
For instance, retirement savings may be accessed early with penalties (IRA) or early as a loan (401(k)) that you have to payback before leaving your current job. Or stocks and other investments which you don't want to sell because their value and earnings are greater than your CC or other debt interest (a good problem to have, but still a problem). Or you may have paid off that home or car, removing debt, but at the cost of losing your liquid cash. Selling the home or car are not options because you don't have a backup and require (at least the vehicle) for earning your income. The home is sellable, but not promptly, could be rented but that also introduces liabilities and other risks.
EDIT: I imagine for many of you in SV, this is things like stock options as well. You can't sell it for several years, and there's no guarantee of its value at that point anyways. You may leverage it for obtaining debt (still staying networth positive, on paper), for things like home purchases, but ultimately you still lack liquid assets.
For instance, retirement savings may be accessed early with penalties (IRA) or early as a loan (401(k)) that you have to payback before leaving your current job. Or stocks and other investments which you don't want to sell because their value and earnings are greater than your CC or other debt interest (a good problem to have, but still a problem). Or you may have paid off that home or car, removing debt, but at the cost of losing your liquid cash. Selling the home or car are not options because you don't have a backup and require (at least the vehicle) for earning your income. The home is sellable, but not promptly, could be rented but that also introduces liabilities and other risks.
EDIT: I imagine for many of you in SV, this is things like stock options as well. You can't sell it for several years, and there's no guarantee of its value at that point anyways. You may leverage it for obtaining debt (still staying networth positive, on paper), for things like home purchases, but ultimately you still lack liquid assets.
In banking they talk about "liquidity" and "solvency" being two primary axes of financial difficulty. It's the common wisdom in some places to say that solvency is over-emphasized in lay discussions -- that an insolvent bank can shuffle on for a long time, "dead man walking," so long as it can get its hands on cash for today and tomorrow by borrowing somewhere. On the other hand, a solvent bank with liquidity problems can die very quickly. Bank runs are an obvious example here.
(In a sense you might say that all terminal solvency problems eventually manifest as liquidity problems. I guess you could argue that the reverse is true too, though.)
The solution to the "solvent but illiquid" problem tends to usually be "loans from someone who is liquid." A bank may lend you money against your house or your shares, central banks loan money to deposit-keeping banks against the banks' assets (mortgages, bonds, whatever banks tend to have these days...)
(In a sense you might say that all terminal solvency problems eventually manifest as liquidity problems. I guess you could argue that the reverse is true too, though.)
The solution to the "solvent but illiquid" problem tends to usually be "loans from someone who is liquid." A bank may lend you money against your house or your shares, central banks loan money to deposit-keeping banks against the banks' assets (mortgages, bonds, whatever banks tend to have these days...)
"Even people with good jobs can owe so much on credit cards, student loans, or mortgages that, on paper, they’re worth less than zero."
So, by that rationale, almost everyone with a mortgage is "broke"? Because, generally (except in recent times where money is cheap to borrow), you get a mortgage when you don't have the cash to buy a house outright (and probably won't for decades).
So, by that rationale, almost everyone with a mortgage is "broke"? Because, generally (except in recent times where money is cheap to borrow), you get a mortgage when you don't have the cash to buy a house outright (and probably won't for decades).
By "broke" they mean liabilities are more than assets. So if someone uses credit cards to pay for a $3,000 vacation, they have $3,000 in debt and no measurable asset. If someone takes a $300,000 mortgage to buy a $300,000 house, the asset equals the liability. (Minus transaction costs and all that good stuff) If the house increases in value to $500,000, they are $200,000 in net assets minus whatever they've paid down. If the house value drops $100,000 below the mortgage, then they're still negative. (In much of the US, houses are still worth less than what people paid for them 10 years ago)
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No, it's relatively easy to estimate the "net value" of a mortgaged house, which should (except in a housing market crash) be positive, otherwise the bank wouldn't lend you the money in the first place.
On the other hand, it's very very hard to calculate e.g. net "student loan value" (i.e. future earnings - future loan payments) - in fact, many people took out huge student loans but found themselves making way less income than they expected (hoped for)! Unfortunately, lenders don't care about that, becaue the government guarantees the loan...
On the other hand, it's very very hard to calculate e.g. net "student loan value" (i.e. future earnings - future loan payments) - in fact, many people took out huge student loans but found themselves making way less income than they expected (hoped for)! Unfortunately, lenders don't care about that, becaue the government guarantees the loan...
It doesn't work that way for secured loans. So you can take out a $250K loan on a $300K house, and it results in +$50K in net worth. For credit card loans, there is no underlying collateral. For student loans it's the same.
No that isn't a negative becuase you can sell the house and pay back the mortgage, as long as it's value hasn't nosedived.
I agree that it's not a very useful definition of "Broke", but you can sell the house, pay off the mortgage and (probably) have money left. With student loan debt etc. there is nothing on the other side of the balance sheet (except from hopefully higher earning potential over the long term).
From the article: "It turns out credit cards and student loan debt are the main reasons Americans are ending up with a negative net worth. Mortgages are a minor factor, the New York Fed found. Only 19 percent of people with negative net worth are homeowners"
The recent housing finance crisis converted a lot of negative net worth homeowners to not-homeowners (whether of negative net worth or otherwise) -- by both procedurally streamlining and reducing social stigma attached to various methods of getting out from under mortgage debt.
(Of course, it did so only after first producing a lot of negative net worth homeowners out of people who were positive net worth homeowners, so its not clear where the net effect is.)
(Of course, it did so only after first producing a lot of negative net worth homeowners out of people who were positive net worth homeowners, so its not clear where the net effect is.)
This article is talking about negative wealth, not just people in debt. Meaning that the small number of homeowners who have negative wealth have debt (primarily student loans) larger than their home equity and other investment.
And what about the early years of a mortgage, where your home equity is very low?
"It doesn’t feel good when your net worth is a negative number. But many of these debtors aren’t necessarily doing something wrong. It can make sense to borrow when you’re young—to get an education, buy a home, or even sometimes to meet emergency expenses—as long as you’re pretty sure you can pay it off later when you’re earning more money."
Net worth = assets - liabilities
An asset is a house, a liability is a morgage. Taking out a morgage doesn't effect your net worth because while you add a liability you also add an asset that counteracts that liability.
An asset is a house, a liability is a morgage. Taking out a morgage doesn't effect your net worth because while you add a liability you also add an asset that counteracts that liability.
Yeah, I mean, it's tough to evaluate this with that thrown in, because it's technically a debt, but you have an incredibly long time to pay it off. If you're managing your money well, it is not a huge risk. I could not pay off my mortgage now outright, but I could make payments on it for YEARS even if I lost my job. So I don't consider myself "broke", even though this definition would suggest that I am.
Your first goal to financial security, if not a positive net worth, should be ensuring you have enough padding in your savings to handle unpredictable events like loss of job.
Your first goal to financial security, if not a positive net worth, should be ensuring you have enough padding in your savings to handle unpredictable events like loss of job.
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Hmmm.... not sure I agree with the definition "broke". Let's take this scenario (which isn't that uncommon):
You're a student who just graduated college and you have $40K in student loans, but a bright career ahead of you (STEM degree or similar). Overall you're net worth is minus $40,000, but you're first job is paying your $75K and it's likely to only go up from there.
I wouldn't call such a person broke.
You're a student who just graduated college and you have $40K in student loans, but a bright career ahead of you (STEM degree or similar). Overall you're net worth is minus $40,000, but you're first job is paying your $75K and it's likely to only go up from there.
I wouldn't call such a person broke.
I'd call that a broke person with potential, but that person is still currently broke. I would hope that person looks in the mirror and also agrees they are broke, and will make financial decisions with that in mind.
In many ways, this is how so many folks end up drowning in debt. They "bet on the come" by assuming they are investing in the right education, will be successful in their field, etc.
They delude themselves into thinking that just because they make $75k/yr that they aren't broke.
In many ways, this is how so many folks end up drowning in debt. They "bet on the come" by assuming they are investing in the right education, will be successful in their field, etc.
They delude themselves into thinking that just because they make $75k/yr that they aren't broke.
Yeah, I wouldn't call this broke. You owe more money than you have, but you don't need to hand it all over right now. Broke is you need a hundred more dollars to pay rent, and even if you have a million in an account somewhere, you have no way to get that hundred before the date rent is due.
You wouldn't say the United States is the poorest country in the world, even though it's in the most debt.
You wouldn't say the United States is the poorest country in the world, even though it's in the most debt.
Literally me right now. Of course, as someone who lives in Australia, where our government-run student loan scheme is both income-contingent and deducted straight from payroll as part of income taxation, the only time I notice how much I owe in student debt is once a year when I'm doing my tax return... other than that, I don't worry about my student debt at all, knowing that even if I lose my job it's not going to drive me broke.
Yes, they take two terms with precise meanings (insolvent and negative equity) and muddle them up with being "broke". They also struggle with the unmeasurable. It's hard to measure the value of an education, or good health, so they don't.
Stupid question: if your estate can't satisfy your debt obligations, do your descendants inherit the debt or do the creditors just forgive the debt? (US, but I'm curious if it's different elsewhere). I would think that it must be the former otherwise there'd be a legitimate reason to discriminate against extending credit to old people, right?
I've not heard of a modern country where debt is inherited by the children.
However, you said, 'estate', which can be sent into receivership due to defaulting on loans. So your assets may be seized before they are transferred to the next generation.
But the debt itself is certainly not transferable, unless your descendants have co-signed on a loan.
However, you said, 'estate', which can be sent into receivership due to defaulting on loans. So your assets may be seized before they are transferred to the next generation.
But the debt itself is certainly not transferable, unless your descendants have co-signed on a loan.
> I've not heard of a modern country where debt is inherited by the children.
In Austria, you can opt-out and have 2 more choices: inherit "unconditionally", which means you inherit before even knowing the net worth / debt status (creditors may surprise you with bills afterwards - it happened to me personally, an uncle demanded €25k for nursing my mother after she had died), as well as "conditionally", which means creditors get a time frame for disclosing their demands (demands made later are void) and at the end you know exactly what the net worth/debt is and you can choose not to inherit it (this takes longer and is more expensive).
In Austria, you can opt-out and have 2 more choices: inherit "unconditionally", which means you inherit before even knowing the net worth / debt status (creditors may surprise you with bills afterwards - it happened to me personally, an uncle demanded €25k for nursing my mother after she had died), as well as "conditionally", which means creditors get a time frame for disclosing their demands (demands made later are void) and at the end you know exactly what the net worth/debt is and you can choose not to inherit it (this takes longer and is more expensive).
So the girl I dated awhile back who said she had $90k in debt because she inherited it from her mother when she died, that wasn't legit? She mentioned something about signing something and not realizing it at the time, though. This is in the U.S.
It wouldn't surprise me too much if it wasn't true, as there were other things she said and did that didn't seem completely honest and straightforward, but I didn't see any reason for her to lie about that.
It wouldn't surprise me too much if it wasn't true, as there were other things she said and did that didn't seem completely honest and straightforward, but I didn't see any reason for her to lie about that.
As I understand it, shady creditors and debt collectors will sometimes contact the deceased's family. They claim you have inherited the debt, or have some moral obligation to make good on their relative's debts, then pressure you to sign paperwork acknowledging that fact. Then they try to collect the money from you instead saying it's your debt, using that same logic and now that paperwork you signed.
It's a deceptive and despicable scam, but I'm not a lawyer and I don't know the legalities of it. I suspect, in most jurisdictions anyway, it's not legally enforceable and she could probably have refused to pay anything and the creditor wouldn't have a leg to stand on.
It's a deceptive and despicable scam, but I'm not a lawyer and I don't know the legalities of it. I suspect, in most jurisdictions anyway, it's not legally enforceable and she could probably have refused to pay anything and the creditor wouldn't have a leg to stand on.
She mentioned something about signing something and not realizing it at the time, though.
That will do it. That "something" was probably an agreement to co-sign the loan, and thus making it her sole responsibility if the other party fails to pay.
That will do it. That "something" was probably an agreement to co-sign the loan, and thus making it her sole responsibility if the other party fails to pay.
Can that be done posthumously? Because if I remember correctly she said it was after her mother died, like there was something in the will, asset-wise (or supposed to be) that she signed for, and it turned out she ended up with the debt. I don't quite remember her wording, this was several years ago.
Sounds like she may have cosigned on the debt.
The reason lenders ask for cosigners is because the would-be debtor is a poor credit risk. They want someone to go after in the likely event that the person stops servicing the debt.
Never, never cosign someone else’s debt. Yes, here come a million and one what-ifs for this and that goofy situation. Don’t do it.
The reason lenders ask for cosigners is because the would-be debtor is a poor credit risk. They want someone to go after in the likely event that the person stops servicing the debt.
Never, never cosign someone else’s debt. Yes, here come a million and one what-ifs for this and that goofy situation. Don’t do it.
Some creditor took advantage of her naivete and tricked her into taking on her late mother's debt. Probably illegally.
Either that or she was a cosigner and her mom probably was not straightforward with her about what she was getting into when she cosigned. Shitty parents do that sometimes.
Either that or she was a cosigner and her mom probably was not straightforward with her about what she was getting into when she cosigned. Shitty parents do that sometimes.
She probably co-signed on a loan.
in the US: Not usually. Its fairly complex, but so long as you did not co-sign on any loans with your parents, or put forth any personal guarantee's on their debts - you're not responsible for them if they pass away. The "estate" is responsible, so they would liquidate any assets they had to cover the debts.
Here in Czechia, you as a descendant can opt out and decide not to inherit anything. In that case, you will not inherit the debt, but you'll also lose the right to any other inheritance you might otherwise get.
In the US they are forgiven. Family is not responsible for paying this. If you wanted to keep a house or something you could choose to have that debt transferred to you but if not it's the bank's problem.
No. Except in the case of jointly-held debt (e.g. spouses, someone who co-signed on a loan).
In the Netherlands, you're advised not to accept the inheritance before having investigated the legator's credit situation. If you do accept the inheritance, you WILL be hold accountable for all debts.
In the USA, should your descendants decide that they want to keep something where money is still owed, they may opt to take on the debt.
In Japan during the heyday, you could take out multi-generational mortgages.
In Japan during the heyday, you could take out multi-generational mortgages.
That's secured debt, which is different from unsecured. Basically everything settles against the estate, and then you inherit if there is any left.
> about 14 percent of U.S. households have a credit card balance of more than $10,000
That's amazing, but not surprising. I used to have some neighbors who started shopping for a house. Everything was going well - they had found a home they liked and had gone to apply for a mortgage. Which is when it was revealed that one of them had a couple of credit cards the other didn't know about - with a $14k balance on them.
People debate over the best method to pay them off and get out of credit card debt, and it just doesn't matter as long as you get started. Once you get into the habit of watching the balances decline, then you can optimize by doing things like paying the higher-rate ones first, or paying off the smallest balance one first, whichever works for you.
That's amazing, but not surprising. I used to have some neighbors who started shopping for a house. Everything was going well - they had found a home they liked and had gone to apply for a mortgage. Which is when it was revealed that one of them had a couple of credit cards the other didn't know about - with a $14k balance on them.
People debate over the best method to pay them off and get out of credit card debt, and it just doesn't matter as long as you get started. Once you get into the habit of watching the balances decline, then you can optimize by doing things like paying the higher-rate ones first, or paying off the smallest balance one first, whichever works for you.
They didn't explain the "not knowing it" part. Who doesn't know they are broke and why?
It's because they're twisting the normal use of the word "broke" in an attempt to make a catchy headline. What they're really saying is that there's another way to be considered "broke" and that many people won't realize they fit that definition. Mainly because it's non-standard and basically never used.
It's just a trick for clicks.
It's just a trick for clicks.
That's how governments around the world tried to conceal the deceleration of economy, encouraging people to get into debt. Was funny to see the Brazilian government commit the same error in late 2000s.
The dose makes the poison.
In Brazil, people started getting their _first_ mortgages. In the US, people had 5 or more at the height of the subprime boom.
Only recently has credit for second mortgages been available in Brazil.
In Brazil, people started getting their _first_ mortgages. In the US, people had 5 or more at the height of the subprime boom.
Only recently has credit for second mortgages been available in Brazil.
In Brazil the best mortgages available have about 13% interest. It's basically impossible to reach the same debit level of the US, but consequences are much more severe.
"And not know it"
If you don't have some idea of your net worth, you probably deserve it...
Deserve what?
What's with the "and not know it" part of the headline? Is that just clickbait, or do people really not know that they are broke?
How does a mortgage drive your net worth down? Sure you owe a lot of money to the bank for a while, but you have the value of the property to cover for it. Or is it only for cases where the property value dives just after one bought it with a new - now over-estimated - mortgage? Usually banks perform their own evaluation of properties before issuing the mortgage.
I am very much aware of my student loan debt, thanks Bloomberg. Quite aware.
Oh trust me, I know I'm broke.
(A) Insolvent: Unable to pay for necessary outgoings (rent, food, loan payments) as they become due.
(B) Negative equity: The value of total liabilities (e.g. loan principal) exceeds the value of total assets (e.g. cash, bank balances, stocks, and real estate).
The word 'broke' is usually used to indicate (A), but Bloomberg is redefining it to mean (B).
Imagine I've just graduated from medical school, top of my class, and have debts of $200k that I incurred during my studies. I have $10,000 in my bank account. I have a job lined up that will pay me enough to live on, but I expect rapid rises over the next few years.
Would you consider me 'broke'?
Bloomberg would, because they'd calculate my net worth at negative $190k.