Several columns ago I posed the question: what if you had no debt payments? For many Americans, this is a life-changing idea, something they may not have considered before, because the idea you must carry debt to live the life you want (or to be like your friends) is so pervasive in our culture today. We’ve been conditioned to the idea that debt is the only way to afford an education, or a car that runs well, or buy the stuff, or do the things “everyone else” does.
That idea is false. You don’t have to rely on debt to fund your lifestyle, no matter your income. Some short-term sacrifice will likely be required to create long-term stability, but I speak from experience – it can be done, and it is worth it.
The best way to grow your net worth is by investing in assets that go up in value (such as retirement or taxable investments, a house, etc.) rather than borrowing money to finance assets that mostly go down in value over time (such as TVs, vehicles, and other material things). The best way to do that is with your income, and if your income is tied up in debt payments each month, gaining traction to become financially secure will be slow and difficult.
I would not necessarily argue, from a moral perspective, that it is wrong to be in debt. However, debt puts you at a distinct financial disadvantage compared to those who move at the speed of cash, and it’s not too difficult to see why: if your income mostly goes toward payments, not only are you paying hard-earned money for the privilege of borrowing money, you are losing valuable time that your income could have been being invested and compounding. You are also losing out on other opportunities, such as taking a vacation with cash instead of putting it on the credit card, or other things you would truly enjoy if you had the cash resources to fund them.
Have you ever wondered why even people with six-figure incomes live paycheck-to-paycheck or can’t afford even a small, unexpected emergency expense? Much of the time, debt is the problem. Their income funds debt payments, such as car payments, car leases, student loans, credit cards, personal loans, home equity loans, and all the other loans. The rest goes toward monthly essentials, like bills or food, leaving little left. They have no margin, or extra, in their monthly budgets. The lesson here is “it’s not what you earn, it’s what you keep”, and what you keep can be used for paying off debt, saving up cash for specific purposes, or investing. Having margin is a good thing.
On a related note, being generous toward those in need requires having the capital to do so in the first place. This is another good reason why having a budget plan, living on less than you make, and staying out of debt are great goals to pursue, because they allow you to make a difference in the lives of others while still putting food on the table and investing in the future of yourself and your family. If we are constantly broke, how can we provide meaningful help to others?
Now, concerning mortgage debt: Dave Ramsey and the Financial Peace school of thinking would say buying a home is the one kind of debt that isn’t to be shunned, and I would agree. Though paying cash is the obvious best choice when buying a home, housing costs vary widely depending on where you live in this country, and there is a distinct difference between saving up to pay cash for a $6,000 car versus a $300,000 house.
If you do need to take out a home loan, the preferred method would be a 15-year fixed-rate mortgage with a payment not to exceed 25 percent of your take-home pay each month. This allows you to pay off your house faster than a 30-year mortgage, saving you staggering amounts of interest. The folks at Ramsey Solutions crunched some numbers: for a $200,000 house (conditions: 20 percent down payment, 5 percent interest and 4.5 percent interest respectively), a 30-year mortgage would cost $386,000 in total, and a 15-year mortgage would cost $275,000 in total. So, in summary, the privilege of financing your house payments over 30 years instead of 15 years will cost you $111,000 in extra interest costs!
Of course, you should still avoid purchasing more house than you can actually afford, tempting as the idea may be. This behavior was a primary cause of the Great Recession in 2008. Lenders have since tightened standards for borrowers, and according to Rocket Mortgage, lenders generally like to see a debt-to-income ratio (your debt divided by your income) of 50 percent or less. Trying to purchase a home while debt payments and bills consume half your income every month is a very shaky place to be, and when you factor in other costs such as maintenance, repairs, and the unexpected, owning a home under these conditions would be stressful indeed.
Many of us don’t want to admit the difference between “wants” and “needs.” We want it all, and we want it now: a house, a “safer” and bigger new car for the kids or grandkids, an expensive apartment without roommates, the vacation to Europe with our friends (pre-COVID, anyway), a new mattress, the iPhone 12. It’s possible to cash-flow things like these, but it’s faster to use debt to obtain them, and instant gratification entices many people.
None of the above are things you truly “need”, though there’s nothing inherently wrong with them. In fact, when you put yourself into debt, you’re taking away income to pay for actual needs, which can take away the opportunity to obtain those “wants” in the future. Early in our marriage, my wife and I decided we wanted to own what we had, and we weren’t going to finance our lifestyles with payments – not even iPhone payments on the cell phone plan. We would own everything outright, or we wouldn’t buy it at all.
Actions you can take today, right now: if you have debt, devise a plan (such as Dave Ramsey’s Seven Baby Steps) by yourself or with the help of a financial coach to use the margin in your budget to pay it off as quickly as possible. This will likely mean delaying some gratification temporarily. Be careful about investing in things that go down in value, even with cash, but particularly through debt. Leveraging oneself leads to trouble. Instead, invest mainly in assets, or things that have value or go up in value, rather than going into debt or investing in things that go down in value.
In Robert Kiyosaki’s book, “Rich Dad, Poor Dad”, he asks: is your house your biggest asset, or your biggest liability? For my wife and I, it’s our biggest liability, and we are aiming to pay it off early to be completely debt-free, at which time it will be our biggest asset. This philosophy has changed the way we live and operate. When you don’t have payments, you have tremendous flexibility and freedom. You can write that down and underline it!
Luke Miller is passionate about helping others succeed in their finances, careers, and lives. A fourth-generation aviator, he is a pilot for a Seattle-based major airline. Luke and his wife live locally in Enumclaw. This article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice.
