(this is part 2, see part 1 here)
I’ve had several friends ask me “Why are you guys so focused on paying your debts off? What’s the big deal? Isn’t debt just part of life?” I’ve had others question my sanity when we’ve bought cars that were several years old. “Aren’t you just going to pay more in repairs? Don’t you want something reliable?” (really? that last question is necessary?!)
Disclaimer time: I AM NOT JUDGING YOU. Repeat after me “Jim is not judging me. He’s just writing about his own family’s crazy convictions. He’s actually a nice guy, once you get to know him…” Of course, if what I write causes you to think about your own situation, great! Believe me, I’ve logged many sleepless nights pondering this stuff. I also do not think all kinds of debt are bad. A mortgage, while it can involve serious risk, is often a great investment, given a steady and advantageous rise in property value as it’s paid down. In addition, business-related debt has a whole host of implications and dynamics attached to it – and is often the right move in those situations. But I’m not talking about those kinds of debts – I’m going to pick on consumer credit debt for this post.
Enough Disclaimers – Example Time
Let’s look at a simple example. Clever marketing has, for years, presented consumer credit debt as just another line of income. It’s subtle, but it’s there. And when the curtain is pulled back to reveal that you are, in fact, borrowing, with high interest, against your own future, we’re told to “Make other people’s money work for you”. Okay, then. Let’s look at how other people’s money works for us.
Meet Joe. He wants an iPad. I mean, there are ALL kinds of ways it would boost his productivity, and lift his mood. (Hey – not making fun, I *am* a developer. I LOVE tech toys, and I really want an iPad.) So Joe buys a 64 Gig iPad, and got talked into a really sweet Mac Book Air as well. After his trip to the genius bar, and some mall shopping, Joe now has a balance of $5k on his credit card. Don’t worry, that’s less than 1/3 the average credit balance per household that has credit debt. Joe’s credit card has an average rate of 13%, but he only pays the minimum each month. I mean, why waste that cash flow?
So, let’s take the iPad specifically. It cost him $699. If he can only pay the minimum payment, his iPad will actually cost him around $978 by the time it’s paid off. Not *awful*, but that amount could have scored him an iPhone as well – too bad for Joe. However, the real kicker is how that adds up over all the things Joe’s charged on his card. His balance of $5k, paying only the minimum, won’t be paid off for *over 21 years* and he will have paid an additional $4900+ in interest. Ouch.
Joe’s really mad about this, so he puts an extra $50 per month towards this credit card. That helps. Now he’ll have the $5k balance paid off in just under 3.5 years, and only pay $1100+ in interest. But man, that $1100 could’ve paid for the weekend at the cabin with his wife. Or it could have been a down payment on the new car he bought recently. But that money isn’t available yet – he has to earn it, and then spend it to pay the interest and principal on something he already consumed. Future income…present debt.
Multiple sources indicate that the average credit card debt being carried per consumer/household is around $15k. At the roughly-average rate of 13%, only paying the minimum payment, it will take almost 31 years to pay the balance off, and you will have paid roughly $15.7k in interest. “Jim, really? Who only pays the minimum payment?” Well, if Joe is 29, then there’s a chance he falls in the 41% that only pays the minimum for his age range. A third of Americans at any age have only paid the minimum for the last year. The upside is that 54% say that they *have* paid the balance in full in the last 12 months. But I digress. The point is that Joe is making other people’s money work so hard for him, that if he only pays the minimum, he’ll pay them double by the time all is said and done. Joe’s not making other people’s money work for him – he’s spending his future income before he’s earned it.
I work for a software consulting company. As developers, we *love* traveling to tech conferences and speaking. However, we have to be careful about the impact of the travel. You see, it’s not just the cost of the trip that the company covers. It’s the fact that I won’t be billing while I travel and speak. That’s called opportunity cost: “The loss of potential gain from other alternatives when one alternative is chosen.”
Now we get to one of my main concerns with consumer debt. If Joe’s iPad really costs him almost $1k, and not $700, he’s not only paying $300 more, he’s unable to use that $300 for anything else that could potentially gain value. At the very least, the $300 could be available for essentials, or even another “want” – even better if it’s earning him money through savings or investment. But not so, if it’s just paying the creditor.
So – let’s take that car question up again. I opted to pay $5k cash for a 2004 model car in 2009. What I *really* wanted was something new that cost in the range of $20k. Let’s assume I financed that new car at 5% interest, no money down, for 4 years (in TN…yay for sales tax): I’ll have $500 per month tied up in the payment, and by the end of the 4 years, I will have paid (just under) $24k for the car. The interest alone almost pays for the car I actually bought. Had I bought the new car, $24k of my money would be tied up over 4 years that couldn’t be used to gain value – either through earning interest or paying down debt. Yes, buying a used car has a risk. It requires a lot of research, and patience in selecting a vehicle. It means you need to be prepared for what repairs are normal for the age of the vehicle, etc. However, given my situation, I could pay the value of the car 3 more times in repairs (which I’d never do) before I’d ever come close to if we’d bought something more like what I want. I’m not knocking the peace of mind that can come with the new car smell – the “I don’t have to worry about the transmission dying on the way home” feeling – at least, you hope. But it comes at a cost – nothing is free.
If just the interest alone (from above) was placed in a certified deposit for the 4 years it would have otherwise been tied up, it would earn $163 in interest at 1%. If I’d had $24k on hand, and still chose to pay the $5k for the car, and placed the other $19k in the same cd, it would earn $774 in interest over the 4 years. Yes, I know that’s not much to write home about, but consider this: shy of interest bearing savings accounts, cds are one of the most conservative ways to grow money. I could also be investing in my retirement with that money (or some other investment). I could be paying ahead on my mortgage – the debt for the one asset that tends to appreciate in value (barring epic housing crashes, etc.).
The point? Getting into debt is easy, but the opportunity cost is HUGE. Our money is not only tied up paying a balance, but the finance charges are keeping us locked in for the duration unless we can climb above minimum payments and attack them aggressively. Debt compounds. The same is possible if we have our cash freed up to invest in things that earn value, or at least pay for essentials without incurring debt.
No, not really. But this is typically where people think I’m getting judgmental. The irony is, if I’m judging anyone, it’s myself. Does living like this mean I have to say no to things I want? Yes, not going to lie. Being responsible typically does mean you weigh choices and try to aim for the wise one. I wrestle – *a lot* – with what the implications are that our culture feels – that *I* feel - so entitled, and have so little grasp on delayed gratification, that we’d continue to rack up debt at such a concerning rate in spite of all the warnings signs around us. I have a problem with stating that I’m for a balanced Federal budget, while being unwilling to balance my own. To what moral high ground do I have a right, if I rail against selfishness, poverty, our national debt and unfunded liabilities, and more – only to neglect preparing for my kids’ educations, my own retirement and everything in between and after? In other words – I have no business demanding responsibility from those in power when I’m unwilling to live it myself. And on top of that, Proverbs 22:7 is spot on: “…and the borrower becomes the lender’s slave”. Why do I want to pay my debts off, and stay out of debt?
I want to be free.