When you borrow, you’ll pulling spending forward, that is, you’re spending tomorrow’s income today. Sometimes that’s smart; sometimes it isn’t. In fact, debt can be a killer.
It can kill your retirement. Your security and well-being. Your marriage. Your job. Your dreams. Even your life (suicide rates rise during recessions and periods of high unemployment).
Yet America is in love with debt. But perhaps it’s a toxic love affair. Perhaps, Vera, you’d do well not to fall in love with debt as so many of your fellow Americans have done.
Not all debt is bad though. Income-generating debt often isn’t. But debt to fuel consumption usually is. And excessive debt always is.
You live in a country that has dug a huge debt hole for itself. Debt as a percentage of GDP is higher today than it was just prior to the 2008-09 financial crisis. Many people’s homes are still underwater (that is, they owe more on their mortgages than the houses are worth). Student-loan debt is approaching a staggering $1.4 trillion, and default rates are high. Junk auto loans (loans to borrowers with poor credit ratings) have ballooned in recent years. Corporate America has borrowed huge amounts to fund stock buybacks, acquisitions and dubious investments (witness the oil and gas industry), eroding their balance sheets and propelling some into bankruptcy (with more to follow). Many pension funds are in extreme deficit positions, which is effectively debt. Some have already defaulted and more will default in the months and years ahead, leaving retirees, future retirees and taxpayers holding the bag (to add to all the bad student-loan debt taxpayers are absorbing).
Vera, like many people, I’ve borrowed, in earlier times, when I shouldn’t have. I’ve borrowed for consumption when I shouldn’t have. I’ve borrowed for new cars when I shouldn’t have. And I spent when I should have saved. Fortunately, debt never got me into trouble, but perhaps that was attributable more to luck than wisdom.
If I had a chance to live life over again, I’d like to think I’d approach debt differently. Perhaps you can benefit from what I’ve learned about debt over the years, both in my personal life and in my clients’ lives as well (both individuals and companies).
Here are some guidelines for your consideration:
- Don’t borrow for consumption.
Don’t borrow to buy clothes, electronic devices, jewelry, furniture, toys (including the adult ones), recreational items, Christmas gifts, groceries, new cars, booze, illicit drugs or weed (not that I’ve done all of this!), or to eat out, take vacations or attend sporting events or concerts. I’m sure I’m missing something, so the better guideline is not to borrow to fund current consumption or to buy things you don’t need.
- Borrow only for income-producing assets and a reasonable amount for a house.
Business. Borrowing to finance a sound business makes sense (although be careful about borrowing for a lame or reckless business idea, which I’ve seen happen quite often, and be careful about borrowing more than your cash flow can service comfortably, factoring in a margin of safety to cover the inevitable recessions and other downturns).
Education. Borrowing to finance certain education can make sense, too, provided it’s related to the income-producing potential of the degree or other credential. But be careful about borrowing too much for an undergraduate degree. Certain graduate or professional degrees are far more valuable than most bachelor’s degrees. In general, today’s bachelor’s is yesterday’s high school diploma (with certain STEM exceptions). Keep your borrowing powder dry for graduate or professional school as much as possible. Those are the degrees that have the most income-generating potential.
Cars. Borrowing to buy a used auto (or new one if you can’t find a reliable used one at a good price) can make sense, too, although often it doesn’t. If you need transportation to work (an income-producing endeavor), then an auto might be necessary and, therefore, can be considered an income-producing asset (although walking, cycling, Uber or public transportation may be preferable where feasible). If, early in your career, you must borrow for an auto, then keep the amount as low as practicable. Don’t spend on luxury. Don’t spend for more than you actually need. In general, a quality, reliable used car is always the better value. And make sure you get good gas mileage. Gas won’t be $2 per gallon forever. (Also remember that an auto lease is debt, often more expensive than debt to purchase.)
Houses. From a strictly financial standpoint, it’s often better to rent than to buy a house, but I realize there are other factors. Most of us want our own nest, even if it will cost us more in the long run. That’s fine. As for home mortgages, the chief mistake I see people make is they buy more house than they need and end up borrowing too much. And spending too much on taxes, utilities and furnishings. It’s tempting to want to keep up with the Joneses. And who doesn’t want to have a nice home, with ample room and a modern, spacious kitchen and baths? But all of that comes at a cost, and it’s not limited to the mortgage payments. The greater cost, in my opinion, is the denial (or significant deferral) of financial independence.
- Never carry a balance on a credit card.
Debt on credit cards incurs an exorbitantly high interest charge. It just doesn’t make sense to pay such high interest. If you can’t pay off the balance in full each month, or if you lack the discipline to pay it off, then cut up the credit cards.
- Ensure a proper balance between student debt and the value of the degree.
Many young people (and even older college students) are going deeply into debt. This debt anchors them. If excessive, it inhibits their ability to land certain jobs (employers run credit checks), rent an apartment, buy a house, save for retirement or achieve financial independence. Among American households, student-loan debt is exceeded only by mortgage debt.
The mistakes I see students make are twofold: 1) they fail to judge what an experience and degree are worth and 2) they fail to minimize their expenses.
Degrees vary greatly in value. A degree from MIT (or your parents’ alma mater, Rose-Hulman) is very valuable and would justify a relatively large loan if that’s what it took to obtain it. But a social work or religion degree, or many degrees from unranked colleges, aren’t valuable (financially) and would not warrant the incurrence of high debt (or, in many cases, any debt at all).
While the major is the factor that most determines earning potential, the prestige of the college has a bearing on it, too. I’m always surprised by the number of students who are willing to borrow a lot to attend a lowly regarded college.
That’s not to say you should choose your area of study solely or even principally on the basis of its earning potential. It is to say, however, that earning potential should be a major factor in your decision whether to go into debt to secure the degree and, if so, by how much.
I also see quite a few students recklessly manage their expenses. I see students attend private colleges when a lower-cost public college or university would have been just fine (or even better from an educational standpoint). I see students borrow considerable sums to attend a public flagship university when they could have saved a lot by attending a community college the first two years and then transferring to the flagship university or highly regarded private college for the last two. I see students take five or six years to complete their degrees when they could have graduated in four years or less.
All of these are choices students and their parents are free to make, of course. But they have consequences. And being saddled with debt may be one such consequence. Never forget that debt carries a price. It’s better to learn this lesson the easy way and not the hard way.
Debt serfs abound in many societies, including our own. You’d do well to avoid becoming one, Vera. You’d do well to appreciate the insidious nature of debt.
It’s hard to be happy and secure when you’re over-extended financially. It’s liberating to be free of debt. It’s even more liberating to be financially independent.
To be debt-free and financially independent, you need:
- to be disciplined (live within your means and save);
- to be able to contribute something to society that others value (hence, are willing to pay for, because no one owes you anything); and
- to want it (it’s a choice, not a mandate — do what’s best for you).
It’s not complicated. But it’s harder than it looks.
Many people, companies and colleges will tempt you. They will make it incredibly easy for you to borrow. They don’t care if you live beyond your means. That’s your problem, not theirs.
They don’t care if you’re ever financially independent either. In fact, they might prefer you weren’t. That way, you’ll have to work. And the cost of labor to businesses will be suppressed, to the benefit of companies and their investors (many of whom are financially independent).
But it’s your life, not theirs. Don’t cede decision-making power to anyone else. Make your own decisions. Decide what’s important to you, and what isn’t. Decide how much you value freedom. Decide what the true cost of debt is for you.
Each time you borrow, you forfeit some of your freedom. Some reasonable amount of debt may make sense. But unnecessary and excessive debt may merely enslave.