I’ve had an on again, off again relationship with debt my whole life. It created a way for me to have some independence as a teenager with a truck loan, but that same “opportunity” debt provided me led to some significant stress.
I always fundamentally knew I had to pay back everything I borrowed. However, I didn’t understand the true cost of financing something or how much I could really “afford” to take on. However, there’s one fact that cannot be denied: debt is definite.
Debt is Definite
I know this may sound silly to say, but debt is definite. What I mean is this: you are contractually obligated to pay back what you owe to a lender. Even if there was no written agreement, good people pay back their debts.
Sure, there’s the possibility of filing for bankruptcy or hoping for something like national student loan forgiveness. However, bankruptcy isn’t exactly a walk in the park and the government and politicians don’t always deliver what they promised. I’m not a big believer in counting on hopes and prayers to take care of me (I still pray for guidance and wisdom to help me through things).
Regardless, what I’m talking about here is debt you take on with the assumption you’re an honest person who plans to pay the debt off. We’ll say this is from a financial institution like a bank which charges interest. From here forward, this is what I’m talking about.
My First Loan, and Another, and Another…
I remember my first ever loan quite clearly. I had just turned 16 and 10 days later I totaled my dad’s truck on a snowy gravel road. He promptly let me know I was on my own to figure out getting me a vehicle.
I did what I thought was “normal” and went to the bank to see about getting a loan. This was a small-town bank and everyone knew me and my family well. I was approved for a loan.
I found a 1991 Ford Ranger (gray, extended cab, 2wd, 5-speed for those who like vehicle details). I wrote a check for $3,500 and drove it home. I can’t remember for sure, but I believe the interest rate was right around 8%.
Borrowing Became Normal
I took out several more loans for vehicles after this. Ironically, a truck loan was what got us on a path to becoming debt free. It never occurred to me to just save up cash and buy a vehicle outright (which is what we do now).
I also never understood the true cost of borrowing. I didn’t even bother paying one loan off before buying another vehicle and rolled negative equity into the next loan. I never took the time to step back and really see how I was giving money to the bank.
My Introduction to Credit Cards
I actually don’t remember my first credit card, but I got plenty of them right away. If I remember correctly, I had six by the time I was 19 – and I maxed them all out. Once again, I’m not an idiot (but I was young), and I knew I had to pay the money back. I just didn’t ever pay attention to what the true costs were.
Honestly, I just always “needed” something, and the quickest, most immediate solution was to get a credit card and “figure it out” later. Kind of like when I “needed” a laptop.
The Best Buy Credit Card
A perfect example of my borrowing habits is when I needed a laptop to take with me on deployment. A new credit card was the answer. My wife and I went to Best Buy knowing we didn’t have the cash to buy a laptop. We both filled out the credit card application and I was approved for $800.
Sure enough, I found a laptop for about $800. Applied. Approved. Maxed. All in one day.
I did end up getting a lot of use out of that laptop, but did I need it? Nope. And I’m pretty sure that card had a 27% interest rate (can’t remember for sure). I did pay it off within a year, but I certainly overpaid. And this was only one of six cards I had – not even the smallest.
A quick calculation shows I probably paid $121 in interest over a year. That’s 15% more than what it should have cost me. Essentially, by using the credit card, I turned an $800 laptop into a $900+ laptop. If you were looking at two identical computers (or anything else) side by side, would you pick the one which costs $121 more and does the exact same thing? I’m guessing no.
Totally Maxed
Before my first deployment, to Iraq, in 2006, I had all the debt I could get my hands on. We had six credit cards maxed, a Jeep loan, a financed wedding ring set (which turned into a wonderful marriage of 17 years and counting), and I can’t honestly remember what else. All I know is I couldn’t even get another credit card if I wanted to.
We had just gotten married and I was totally maxed out. I knew I was deploying soon, so it was kind of a weird “YOLO” type of mentality toward spending for a while. I had no idea exactly how much money I was going to make on deployment (or the deployment would get extended to 15 months), but I knew I’d be making more tax-free money.
Is Debt Good or Bad?
I want to pause for a moment to give you my current thoughts on debt. I don’t think debt is 100% bad. However, now I avoid it as much as possible. Most of my loans and other debts like credit cards just took advantage of my immaturity and gullibility.
We do use credit cards again after a break for several years. However, we never carry a balance. We pay the card off as soon as we can – we don’t even wait until the billing cycle. I pay that sucker off immediately. Actually, you can pay your credit card off several times in t a month if you want.
Debt is Just a Tool
At the end of the day, debt just allows you to use future earnings now – for a fee. You’re literally taking money from your future self and paying the lender a fee for the ability to do so. Imagine getting a pizza with 8 big slices for free and then getting the next 10 pizzas you ordered with one missing piece. That’s kind of what you’re doing when you borrow money.
On the flip side, the lender gives you the initial loan and gets regular payments on top of getting their money back. It’s as if they gave you a pizza to start (8 slices), and then once a week you buy them 2 slices of pizza for 5 weeks (10 pieces total).
You actually have the ability to flip this equation by investing. However, you need the money to invest first. You can get started pretty easily. I literally turned $50 a month into over $30,000.
The “Opportunity Cost” of Paying Off Debt
I often hear the argument that if you can earn a higher return than the interest rate on the loan then it’s okay, or even good, to carry debt. I can understand where this might make mathematical sense in a vacuum, on paper.
The argument typically goes, if I can borrow money at __% and the stock market or [insert other investing hotness here] is returning double or __% more “cash on cash,” I’m better off keeping the debt and investing the money. I can see how this makes logical sense, but this is only if all variables are otherwise equal.
Often that’s not the case. You won’t likely find a guaranteed rate of return higher than your loan interest rate. Also, people tend to compare rates and not the total dollar amounts, or interest paid versus interest earned. People also forget about a little thing called amortization (you pay more interest at the beginning of the loan).
Unless all holding periods, interest rates, dollar amounts, and risk profiles are the same, it’s not a fair or equal comparison. Also, your gains in the stock market or elsewhere are not amortized (you don’t get paid more returns up front) in the same way.
You’re Adding Risk by Using Loans to Create Leverage
Essentially what you’re doing by taking on more debt, or keeping debt versus paying it off, is adding risk to your life. The whole idea of investing is you’re putting money at risk (you might not get it back) for the reward of earning more money. The higher the potential returns, the higher the risk involved.
If you take out a loan on a piece of property like a car, truck, or house, those are at risk of being taken if you don’t pay the loan. If you own it outright, you can’t have them taken away (unless you don’t pay your property taxes). They are at risk because of the loan.
The same principle applies if you keep a loan and instead invest the money you would have used to pay off the loan. It’s the same as if you’d had a paid off car, taken a loan against it as collateral and then invested it somewhere. In both scenarios, you’re actually using borrowed money to invest and therefore raising your overall risk in the investment.
Gains Aren’t Guaranteed
The biggest thing I want to shout at the top of my lungs is, “Debt is Definite! Gains Aren’t Guaranteed!” There’s a reason why financial advisors, investment companies, and broker dealers are legally required to say things like, “Past performance doesn’t guarantee future results.” or some other variation. It’s true. They can’t guarantee anything (other than their fees).
Most investments cannot and will not guarantee results. Other than CDs (certificate of deposit) and U.S. Treasury securities, few things carry any kind of guaranteed rate – and they’re low when they do offer a guarantee.
On the flip side, your bank has a legally binding contract you signed stating how much you’re required to pay them, at what rate, and when it’s due (as well as all kinds of other things you didn’t read). There’s no ambiguity on their part. You will pay the money back or else get a ding on your credit, have things repossessed, or be taken to court. Plus, if you’re in the military, they’ll contact your command and then you’ll have the threat of UCMJ added as well. You’re committed to making your payments.
I just want you to understand and really think about what you can actually guarantee. Assuming you might get a higher return, or you’ll get to deduct from your taxes your mortgage interest paid (if you even itemize), doesn’t carry the same weight as you will pay this loan back.
And this all comes from someone who truly believes in the power of investing. I believe investing in the stock market, yourself, entrepreneurial ventures, and many other things have their place. I just avoid doing it with borrowed money. I don’t put money I don’t have at risk.
How You Feel Matters
Having an unhealthy amount of debt is a surefire way to feel stressed and cause issues in your life. Debt doesn’t feel good.
Ignorance of Debt Isn’t Bliss
They say ignorance is bliss, but they weren’t talking about debt. Debt will catch up to you. I was blissfully ignorant (willingly so) until things got messy.
Debt led us to a place where we had no extra money. Actually, we were going into the hole every month for a while. I remember what it feels like to put rent on a credit card (I’m getting the same pit in my stomach now just thinking about it).
You know what feels a whole lot better? Not owing anyone a damn thing.